My book "CFO Techniques: A Hands-on Guide to Keeping Your Business Solvent and Successful" (Apress, December 2,2011) is now available for pre order at Amazon and Barnes & Noble:
- ISBN-10: 1430237562
- ISBN-13: 978-1430237563
Category: Books
The Weakest Link in a Corporate Finance and Accounting System
Let’s say, as a CFO or Controller you have all policies outlined and procedures carefully designed. Everything is properly documented and bound into books and manuals, which are readily available for orientation, training, and daily reference. Through intensive internal audit program all components have been examined; everything have been tested in practice. Whatever did not work well has been tweaked; cumbersome procedures were replaced with more straightforward ones; the inferior ones have been improved.
Finally it has been determined that the internal control system is both effective and efficient in accomplishing the company’s goals and the executive management’s objectives. Is it reasonable at this point to expect that everything should be working like that expensive watch I keep mentioning as a model of a perfect mechanism? Unfortunately, not.
We don’t exist in the virtual world of The Matrix trilogy, where everyone is manipulated by the digital code. In real life it is the other way around: our well designed systems and structures depend on being properly handled by people. Their proficiency and diligence determine how well the policies and procedures are being performed. The truth is that every task performed by an employee is vulnerable to occasional unintentional errors, consistent sloppiness, and even deliberate mishandling.
Any designer of functional systems, with frameworks that include people as key elements, knows that humans are the weakest links in the chain of actions. Long time ago, when computers were so huge that a single unit occupied a hall the size of the New York Public Library’s Reading Room, all programs and data were coded on punch cards. A punched out spot was read by the computer’s card reader as a character or a digit. These cards were manually created by operators trained to use a keypunch machine. Guess what? Two separate people produced every card in duplicate. No exceptions. If the cards did not match, they have to be re-punched. Thus, the risk of human error was managed.
Such duplication of staff is unthinkable now. Today, we rely on computer systems to reduce at least the most common of the risks. The rest of flaws must be caught through vigorous and persistent scrutiny of performance quality. Monitoring is the cornerstone of internal control and one of the most important responsibilities of a supervisor. It brings the entire system together and assures that policies, procedures and people concur. A series of timely and thoughtful tests should become a part of your, or your internal auditors’, routine.
Remember: If not corrected, every mistake your employee makes will end up in financial data, documents and reports, for which you are ultimately responsible. One erroneous entry may affect your bank’s collateral statement or a presentation to the board of directors. Omissions will impair strategic decisions. Communication mishaps can impact commercial relationships. These flaws will most definitely be a poor reflection on your reputation as a financial leader. You have to create filters that will catch the debris before they pollute the results of your hard work.
You can read about various practical techniques of reducing accounting and finance systems' vulnerability to human factor in my upcoming book "CFO Techniques" (Apress, 12/02/2011), now available for pre-order at Amazon and Barnes & Noble.
New CFO’s Essential Knowledge Prerequisites
When you start as a CFO, the first thing to do is to get your bearings – to assess your position relative to your surroundings. As quickly as you can you must grasp general ideas about typical characteristics of your environment, your own role and purpose, expectations of others, as well as primary routes for channeling your talents and efforts. But as soon as you are done with that, comes the time to get down to the level of firsthand details and study the specific aspects of the business. You need to draw a detailed map that will help you on your journey as a financial leader.
This is a mandatory activity for a recently hired head of finance, new to the company. It is a good idea for someone who has been with the company for a while in a lower position and just been promoted – new vantage point may provide you with the better vision of your company. Even if you’ve held the top post for a few years, but never got around to do this and feel that incomplete picture prevents you from excelling, maybe now is a good time to go back to the drawing board.
This is your R&D stage, necessary for proper functional design. Your research will help you to improve future performance. Every CFO and controller must acquire an exhaustive understanding of his employer’s business. There is no doubt, that compilation of, what I call, the big picture is the key element in your strategic responsibilities. However, it is just as important for day-to-day hands-on management. In the absence of thorough knowledge of all operational and organizational features, it is impossible to construct budgets, define tasks, or determine reporting requirements.
At the very least, your information-gathering activities should be focused in the following four areas:
Study of Corporate Structure
Economic complexity pushes businesses into multiple levels of diversification – wider product ranges, additional services, new geographical and demographic markets, related industries, outsourcing, foreign productions, etc, etc. As companies pave new ways, their corporate structures adapt accordingly: branches are created, subsidiaries are formed, and satellite offices are opened. Today, a $10 million service company may turned out to be a surprisingly complicated organism. This affects nearly every accounting and financial function: local taxation, inter-company transactions, principles of consolidation, financial statements disclosures, banking facilities – just to name a few.
Study of Operational Flow and Value Chain
During your orientation stage this study has immediate practical applications. It is a prerequisite to identifying accounting cycles, classifying assets and liabilities, pinpointing cost centers, determining analytical and financing needs, etc., etc. There are transactions happening at every stage of the operational flow that give rise to accounting events. Without full comprehension of the value chain you run a danger of oversights and errors.
Study of Organizational Chart and Functional Distribution
If the previous section is about processes, in this one we survey people and their positions. I don’t have to convince anybody that it is important to figure out the chain of command and designation of responsibilities within your employer’s organization – you just need to know who’s who. It goes beyond just knowing your peers with whom you discuss company-wide issues and inter-departmental relationships. You have to know people along the value chain – those, who are in charge of cost and profit centers, have relationships with suppliers, vendors and customers, maintain your facilities and receive your mail.
Study of Existing Policies and Procedures
If you became a CFO or a controller in a company that already has policies in writing and documented procedures in place, even if they are deficient, consider yourself very lucky. You can study the existing papers, outline blind spots and pinpoint weak or erroneous steps. It is easier to enforce changes, if employees are already comfortable with an idea of adhering to a recorded set of rules.
On the other hand, you must be prepared to deal with a complete lack of anything in writing. Important thing to remember is that it does not mean policies and procedures don’t exist. They are there like an oral folklore of an ancient tribe, passed from generation to generation. It would be a big mistake just to ignore the traditions and try to impose a new order. You have to uncover and learn them first.
Excerpted from my forthcoming book "CFO Techniques: A Hands-on Guide to Keeping Your Business Solvent and Successful" (Apress, December 2011)
The Frustrated CFO Takes Lessons from Robert McKee
Human beings are like sponges – the second we are born we start acquiring general knowledge of things from everything around us. It is a natural process.
When it comes to intellectual knowledge, however, we tend to make our own choices. Some people read Pynchon, others prefer Sports Illustrated. Some go to see Black Swan, while others would never miss a new Transformers installment.
It gets even more selective for specialized knowledge - higher education, professional publications, technical books, etc. Even with the subjects of human psychology, relationships, our understanding of the world around us (all frequently featured in The Frustrated CFO's posts), people are more likely to go for books written by "specialists."
But the truth is that the nature of human interactions and the principles of emotional response to life do not change from industry to industry and from trade to trade. They are universal and I have learned long time ago that the knowledge of things pertaining to human experience can come to us from anywhere. There is a reason I frequently present my topics by referring to books, TV programs and movies – the best examples of these art forms pursue the truth of life; that is why we can relate.
Those who have seen Spike Jonze/Charlie Kaufman's "Adaptation" may remember the screenwriting guru character played by Brian Cox. Well, he is a real person – one of the best theoretician's of creative writing in the world Robert McKee. After several decades of writing for theater and television, Mr. McKee found his true calling in formulating a set of fundamental principles for compelling storytelling, which became the framework of his world-touring STORY seminar. He also compiled them into a bestselling book by the same name.
I happened to know a young screenwriter who attended McKee's seminar twice and described it as a life-changing experience – not just as a writer, but as a human being. You see, Robert McKee teaches how movies should be written so that they penetrate straight into the audience's soul. So, inevitably he touches on the subjects that reach far beyond cinematic matters. That, together with the fact that his films recommendation list pretty much matches my own roster of favorites, persuaded me to buy his STORY book.
What can I tell you? This is a very brilliant man. Anyone who loves movies should read this book… And everyone who considers himself a student of human nature should read this book. It is impossible to convey all the wisdom Robert McKee generously shares, but his study of "the principle of antagonism" is particularly invaluable.
He goes beyond the conventional knowledge that antagonistic conflicts are at the basis of existence (and a story, of course). He concludes that there are three primary antagonistic forces for any positive value, progressing from contrary to contradictory to "the Negation of the Negation," which, unlike in math where two negatives make a positive, is "a force of antagonism that's doubly negative."
He further constructs illustrative charts for such values as love, truth, consciousness, wealth, communication, success, bravery, loyalty, justice, wisdom, and freedom. I find the last three absolutely universal and applicable to many conflicts we encounter both in our professional and personal lives. They are reproduced below. It's mesmerizing: you look at them and it's like a reel of your life's events, fitting perfectly into these diagrams, unspools in front of your eyes.
The Frustrated CFO Attends a Panel on Risk, Probability, and Chance
Annual World Science Festival took place this week in New York City. It is a wonderful fair with over 40 events and I try to catch at least two or three. One of the discussions, I felt, was important for me to attend this time was The Illusion of Certainty: Risk, Probability, and Chance.
Not only that I find practical application of mathematical, statistical and cognitive theories to business risks, economic uncertainty and commercial intuition to be imperative for strategically inclined CFOs and Controllers, but also my upcoming book on functionality of hands-on financial executives will have a chapter on Risks. Besides, I've enjoyed books penned by two of the panelists – Leonard Mlodinow's The Drunkard's Walk: how randomness rules our lives and Gerd Gigerenzer's Gut Feelings: The Intelligence of the Unconscious (both are featured on by book list to the right). And even though the distinguished panel, which also included mathematician Amir Aczel and MIT's professor of Computational Cognitive Science Josh Tenenbaum, ran out of time before they got anywhere near concepts of risks, they have touched on quite a few other fascinating concepts that have direct application to our professional lives.
Here are few highlights.
I. Self-confidence vs. probability and empirical evidence. Our ambitions and drive to succeed mandates nurturing of confidence. Business schools and work experiences show us that only assertive people who stick to their positions, even if they are based on guesses, achieve their goals. Here comes, the Monty Hall Paradox – a logical statistical problem with an odd, but empirically demonstrable result.
It is a probability puzzle based on the TV program Let's Make a Deal originally hosted by Monty Hall. In the first round, the contestants on the show had to chose one out of three closed doors – two concealing goats and one hiding a car. Then, the host would open one of the remaining doors revealing goats. Now, that this door is eliminated, the following question is posted: do you want to switch or retain your original choice. The confident, "believe-in-yourself" people like us most likely will stick to their guns. Yet, years of replicating the experiment showed that changing your original choice doubles the probability of winning the car: from 1 in 3 to 2 in 3. This maybe a good indication that there is nothing wrong with rethinking your position – it may actually be beneficial.
II. Influence of visual presentation on interpretations of data. Throughout our careers we have been using graphs, charts, dashboards, etc. in presentations of performance results and other information, because experience shows that it impresses the data recipients better than numbers in tables or narratives. The reason it works so well is because our instinctive cognitive abilities are much better than conscious digestion of facts. We are capable of processing visual data flowing at us without even thinking about it.
Like in the chart below, which shows the relationship between marketing expenses (Y-axis, in thousands of dollars) and sales (volume represented by the bubbles, in millions of dollars). Just by glancing at the chart anyone can see that the larger bubbles (sales) correspond with higher marketing expenses. Biologically, it is not that much different from our ability to discern danger when we walk through the jungle. So, when we design our graphic presentations, we should keep that in mind and try to create images that don't just look pretty, but actually transmit the most valuable messages.
III. People's blind belief in numbers. This is something that all financial professionals constantly use while communicating with lenders, investors, bosses, commercial partners, etc., without even thinking twice about underlying scientific theories. Everybody knows, when you pitch a proposal, renew a credit line, or report on the business results, the more numbers you throw at "them," the better. Presence of the numbers in a message on its own creates the illusion of certainty, regardless of their substance.
Advertisers know that very well too. When we hear in a commercial that 9 out of 10 users of this new cosmetic product saw an improvement in their appearance (or whatever), we automatically accept this as a proof of great achievement. People forget that because these values are assigned by humans, they cannot be precise. First of all, what is the definition of "improvement?" And what if I tell you that the product was used on a group of 30 healthy, good-looking people, ages 20 to 25. Will you still think that it will work on you as well?
The Frustrated CFO 