Financial cardinals needed

Of the many financial measures available, only three qualify as financial cardinals – the ones whose alarm bells must ring to prompt action in good time

They are total revenue, total cost and profitability

They’re ‘catch-all’ measures covering all outputs, outcomes and inputs:

  • Total revenue covers net outputs sold and outcomes the customers took into account before making their purchases
  • Total cost covers the mix of costly input resources used
  • Profitability covers how well those input resources were used – a ‘total productivity’ measure in effect

 

Trends in each one need to be regularly monitored

In the private sector, the three must be monitored together – otherwise managers might be tempted to make themselves look good by boosting one at the expense of another

For instance, senior managers have been known to buy other companies to boost their revenue and profits growth record – however, their capital employed will also have increased so profitability, not profits, may well have fallen

In the public sector, there’s only one financial cardinal – total cost

Overall, if something goes wrong, it may not show up in the financial cardinals – minor failures can be cancelled out by minor successes when results are aggregated

But, if something goes badly wrong ‘below decks’, it should be noticed not only by the manager responsible but also his peers – transparency and honesty between them all are key

And once understood, quick action will be vital – hence, financial cardinals must always be presented in good time, not months later as many are

To quote Dr Devi Shetty, chairman of the Narayana Cardiac Hospital in India: “If you get the profit and loss at the end of the month, it’s a post mortem, the patient is dead – if you get the profit and loss daily, it’s a diagnosis and you can treat”

Financial metrics are not enough

  • How do you know if an organisation has performed well?

 

  • If it’s a private company, financial results will reflect customers’ valuations of what they were offered and translate them into revenue and profits

 

  • If it’s a public sector unit, the tax-paying public will judge quality and service levels received – actual costs are not their concern unless their taxes become unacceptably high – until then, they leave it to service unit managers and government ministers to manage resources needed and so costs

 

  • Currently, there’s a glut of financial measures available and, confusingly, more than one definition for some of them – they include:
    • Free Cash Flow – FCF
    • Net Assets – NA
    • Capital employed – CE
    • Return on Sales – RoS
    • Return on capital employed – RoCE
    • Asset turn
    • Added value – AV
    • Economic value added – EVA
    • Gearing
    • Working capital
    • Liquidity

 

  • The problem, as Peter Drucker once pointed out, is: “Financial accounting is an X-ray of an enterprise’s skeleton but most of the diseases we commonly die from such as heart attacks, cancer or Parkinson’s disease do not show up in a skeletal X-ray – a loss of market standing or failure to innovate does not show up in an accountant’s figures unless the damage has gone beyond repair”

 

  • Hence, financial measures have their limitations

 

  • And they don’t drive results – they’re the results of actions already taken – they show where an organisation has been, rather than where it’s going

 

  • Warren Buffett famously described them as ‘rear mirror, not windscreen’ measures

 

  • Using them alone would be like steering a boat by watching its wake and hoping there are no dangers ahead

 

  • That said, there are some financial measures which are vitally important – the financial cardinals, detailed later

Most plans go unseen or unused

The following is an extract from ‘Productivity Knowhow’

  • A good corporate plan is a punchy summary of where an organisation aims to be in five years’ time and, broadly, how it is to get there

 

  • Essentially, the plan should define the organisation’s ‘business model’ – how it will be better than its rivals and harder to copy – how it will make money

 

  • Glen Moreno, Chairman of Pearson and a director of Man Group and Fidelity, said: “A corporate plan is the reallocation of scarce capital resources towards the best opportunities for growth in earnings and returns”

 

  • Author, Stephen Covey, said: “Plans are the knowledge about what to do and why – others then have to provide the how to do and employee motivation for want to do

 

  • According to Peter Drucker, the corporate plan should provide answers to: “If we were not in this business, would we be going into it now?”

 

  • Jack Welch, when CEO of GE, said an organisation’s strategy should define the ultimate aim of: “How it intends to win in business:
    • It’s actually very straightforward
    • It’s an approximate course of action that you frequently revisit and redefine according to shifting market conditions
    • It’s about funding the big ‘aha’, setting a broad direction, putting the right people behind it and then executing with an unyielding emphasis on continual improvement
    • It’s resource allocation, given you cannot be everything to everybody, whatever your size”

 

  • Good plans are thus not long-winded glossies but short statements of broad aims and how they are to be achieved – not prescriptive in every detail – and they deliberately leave tactics to others

 

  • They’re the written equivalent of the inspirational briefings that General George Patton or Vice Admiral Horatio Nelson gave to their commanders before battle – their commanders didn’t need, or want, any more

 

  • However, many managers think their corporate plans are a waste of time and effort – an annual ritual conducted by a few senior managers whilst those who have to implement them never know much about them – and, once written, even their authors tend to ignore them

 

  • The current situation was best summarised when Roger Smith, Chairman of General Motors, said: “We got these great plans together – then we put them on the shelf and marched off to do what we would be doing anyway – it took us a little while to realise that wasn’t getting us anywhere”

The evolution and future of productivity

The Universe is some 15 billion years old, apparently – ‘Big Bang’ followed, some 10 billion years later, spawning Planet Earth – then, over the last 4.5 billion years, life appeared on Earth and a wide variety of species, both flora and fauna, eventually emerged

At first, resources needed for their survival – food or sunlight, say – were plentiful – hence numbers of species grew

But those same resources were limited so, as demand for them grew, competitive battles began

Eventual winners proved to be ones which:

  • Either had an edge over others for the resources available at the time – fauna had to be bigger, stronger, have sharper teeth/ beaks/ claws or be faster – flora had to grow taller, quicker or need less water
  • Or, lacking such an edge – extra speed or stamina for catching prey, say – had the wit to organise themselves into over-powering teams e.g. lions, wolves or hyenas hunting in packs 

The result was the strong became stronger, and more fecund, whilst the weak became weaker, with many species dying out

Eventually, a ‘balance of nature’ would be reached when the great majority of winner species had ‘enough‘ to survive – they didn’t need or want more – they preferred to spend their spare time either asleep or watching others

And this happy state would only be interrupted by the occasional asteroid hitting the planet or Krakatoa-like volcanoes erupting, either one sending so much dust into the atmosphere that it blotted out sunlight on which most of life depended

Evolutionary battles would then start up again

And so it was until ‘homo sapiens’ appeared only some 200,000 years ago – a mere blink in the annals of total Earth time (< 0.01%):

  • It took ‘man’ most of those 200,000 years to invent stone tools and the use of fire to feed, warm and protect himself better
  • Then, in only the last 10,000 years, his brainier colleagues invented farm tools, gunpowder, the abacus and paper for books to make his life easier – they also enabled him to win all his battles with other species and become ‘king of the planet’
  • From then on, he could and would take whatever resources he needed, and more, leaving all the other species to fight for what was left – his only serious battles ever since have been with his own species
  • Tribes formed villages, then towns, then cities – groups of them became nations – some nations went further and built empires
  • Battles between tribes for resources became wars between nations for power and glory as well – the result was, over just the last 2,000 years, man has slaughtered hundreds of millions of his fellow-men
  • However, over the same period, man’s inventiveness has also enabled his total population to grow exponentially and far exceed this slaughter rate
  • But this net expansion of numbers did not improve the standard of living for most – life for all but a very select few was a constant struggle – most people were serfs, poor and miserable – their average lifespan was short, health poor and creature comforts rare compared to today
  • Rumblings for big changes thus started to be heard

Then, only some 300 years ago, the productivity revolution started in the UK – followed by Belgium and Germany:

  • Newcomen and Watt’s steam engines pumped water out of coal mines to increase supply
  • The steam engine then powered Hargreaves, Arkwright and Cartwright’s  spinning jennies, frames and looms for the northern cotton and wool mills
  • Using local coal and iron ore, Bessemer’s furnaces also started the UK’s iron and steel industry which enabled ship and bridge building
  • Stephenson’s ‘rocket’ locomotives and Brunel’s railways and tunnels soon followed

And, ever since, man has continued to find ways to invent more and better stuff to make his life longer and healthier, easier and more enjoyable

The result is the human population on Earth has now grown to some seven billion souls – some experts say it will soon reach 10 million and keep on rising – others claim vital physical resources are at their limit so, if the population does keep on rising, our future will comprise nothing but wars for them or starvation from being without

Such gloomy forecasts are not new, however

Back in the 18th century, Thomas Malthus, an English cleric, announced that growth of human food production (at the time) was linear whereas population growth had become exponential so, if nothing changed, mass starvation was inevitable – in the 1970’s the learned ‘Club of Rome‘ reached much the same conclusion

Happily, Malthus had not allowed for the capacity of man to improve productivity – to get more and better out of existing, albeit limited, resources

Indeed, over the last 300 years:

  • Man has contrived to produce more and more food from existing finite land – and whilst needing less and less human effort to do so
  • He was also able to produce more and more volume of stuff to meet his basic personal needs, the first rungs on Maslow’s hierarchical ladder – many things which once were considered a luxury for a few became an affordable necessity for the many e.g. motor cars, colour TVs
  • And, with his basic needs sated, more stuff came to be offered at affordable prices which made human lives not only easier but also more enjoyable e.g. dishwashers, package holidays 
  • Now, under pressure from customers and competition, suppliers not only offer more volume of affordable stuff but better quality stuff too – e.g. cars and TV programmes  

Thus, in a mere 300 years, most human lives, at least in so-called developed nations, have been transformed from what they were over man’s first 199,700 years – it’s been truly astonishing progress

But can it continue?

Modern-day pessimists, the equivalent of Malthus, say ‘no’

The most famous of them is the respected Professor Robert Gordon of North Western University, USA – he claims that invention of GPTs (General Purpose Technologies like the steam engine, electricity or computers) has been exhausted and there will be no more

But maybe this is is a selfish and blinkered view:

  • Selfish because it ignores the plight of most of the current human population on Earth who have yet to enjoy most of the benefits of the productivity revolution
  • Blinkered because it ignores the many unknowns we have yet to know about, not to mention all the unknown unknowns

And maybe a global paradigm shift is also in the offing – one where we humans now find ourselves at a watershed, moving:

  • From an ‘old world’ focussed on producing more and better tangible stuff from limited physical resources at lower unit costs – one which seeks to improve our SoL (Standard of Living)
  • To a ‘new world’ focussed on developing more and better intangible stuff from unlimited knowledge resources, much of it offered for free – one which seeks to improve our QoL (Quality of Living)

At this juncture, productivity improvement efforts become even more important to both our SoL and QoL:

  • SoL because some five billion of the seven billion people on Earth still live relatively wretched lives and need help to catch up with the rest of us – and we better-off two billion will not be content to just stand and wait for them, forever wanting to improve our SoL further
  • QoL because the ‘new world‘ opening up before us requires a radical review of what our likely needs will be in future

So what might life be like some 20 years from now when the ‘new world’ could well have taken over?

A. SoL factors?

  • Wages will be unnecessary – a UBI (Universal Basic Income) experiment will be short-lived and found pointless:
    • All private sector goods and services will be produced by AI (Artificial Intelligence) and robots, and be free – cash will not be needed to buy or exchange them – everyone will have what they want – expensive luxuries to reward success will be passé – IP (Intellectual Property) protection and patenting for commercial gain will no longer be needed as latest and best ideas will be immediately shared with all
    • Public services will also be free – taxation to fund them will be unnecessary
  • ‘Work’ will thus cease – we’ll all do only what we want to do, for fun, not what we had to do, for money
  • Wealth, and inequality, will no longer be measured by physical possessions but mental capacity beyond that available from AI
  • ‘Old world’ poverty will disappear as everyone will have all the physical stuff they need
  • ‘New world’ poverty will never arise as everyone will be able to learn basic skills instantly, for free e.g. downloads to their brain to play the piano or speak Swahili

B. QoL factors?

  • Every single person will consider themselves, and be considered by others, to be of equal importance – life will no longer be ‘unfair’ for most
  • Class systems, royalty, aristocracy and unmerited power will have disappeared
  • Status, fame and Olympic gold medals will be confined to those with exceptional minds, not those topping promotion ladders, looking good or winning track races 
  • We’ll all have the choice to live for as long as we like, disease free, either in our physical form thanks to major medical breakthroughs or via digitally uploading ourselves to ‘clouds of the day’ 
  • We’ll fill our time:
    • Either being proactive – learning new skills, socialising with others, being altruistic or helping push out boundaries in the arts and sciences
    • Or reactive – watching our favourite sports teams or being entertained by others 

In other words, life on Earth, and any other place we’ve populated, will probably be very different to now – one where the volume and quality of outputs needed most will be information on ideas, systems and controls

And the most important input resource will be knowledge – K – either held ‘in heads’ or ‘in files’ – for example, K stored in the form of data, flow charts, formulae, reports/ articles, customer details and contacts or experience gained from successes and failures etc.

However, there is one big difference between ‘old world’ physical inputs and ‘new world’ mental inputs:

  • Labour, materials and capital are all limited, often unrenewable and all costly
  • On the other hand, K is unlimited, can grow rapidly and is mostly free for, if you and I each have a £1 coin and exchange them, we each still have £1 but if you and I each have a good idea and exchange them, we each have two good ideas

Hence, unlike physical resources, mental K resources have enormous potential to improve the SoL and QoLof every man and woman on the planet

As ever, however, man already wastes most of this potential

Consider the following three performance measures usually applied to physical resources but now to the K available within your team, organisation or nation:

  • KA% = K Availability = Amount available in-house/ Total needed = 60%
    • The actual volume ‘in heads’ is usually more than adequate for any team to complete its work well
    • However, the volume ‘in files’ is usually poor – people are reluctant to record their experiences – systems are not in place for others to find it
    • And whilst the volume available from outside and in the public domain is vast, and said to be doubling every year, it’s currently biassed by search engine algorithms and optimisers which determine what one sees on first pages – hence much valuable information can be hidden on later pages, or completely ignored
  • KU% = K Utilisation = Amount used/ Amount available in-house = 30%
    • Only a small % of the K available in-house is made use of by others because:
      • They don’t know it exists, or how to find it
      • They find it difficult to access
      • It’s kept secret by owners because ‘knowledge is power’
      • It’s of poor quality and often out-of-date 
    • Hence many people in many organisations either keep re-inventing the wheel or make no advances
  • KE% = K Efficiency = Improvements made/ expected = 20%?
    • Key outputs sought from good use of K are more and better ways to do things which improve the quality of lives – also known as Kleverage, the ability to obtain significant benefits from the K available
    • KE% is a measure of the value of actual gains made versus those expected
    • The higher this %, the more it feels like having a Thomas Edison, Albert Einstein or Alexander Fleming on board – people who turn K into gold

Overall, the above product measures the efficiency of your team’s use of the knowledge available to it viz:

KAUE% = 60% x 30% x 20% = 3.6% = Very Poor

Clearly, ways to make big improvements to KA%, KU% and KE% are needed here – and given the above numbers are optimistic for the current position in most teams, the sooner the better

Fortunately, major advances are already under way, including:

  • Taxonomy and Knowledge Management, two disciplines still in their infancy, which seek to improve the availability and utilisation of K
  • Humans have limited capacity to absorb and analyse Big Data – masses of data and information – however, AI is able to dig far deeper, wider and quicker into all K that exists, seeking patterns, correlations and solutions, many beyond human comprehension – AI already offers the potential to discover whole new and better ways of doing things, from winning games like chess and ‘Go’ through to curing health problems, creating music or saving the planet 
  • Apps, expert systems and computer models have already mushroomed on a wide spectrum of fronts, many offering better, even optimum, solutions for specific personal or business problems faced 

So, whilst we humans might well be approaching peak performance levels in our physical ‘old world’, there’s a long and steep climb ahead as a mental ‘new world’ opens up before us

At present, man is still in the foothills of the K mountain, taking his first tentative steps, yet K productivity has already become the biggest issue he faces

Unlike the ‘old world’ however, if we ever near the top of this mountain, we must expect another higher mountain to appear soon after – K2?

Our future is thus mental, infinite and very exciting

 

 

 

 

Excess regulations and legacy systems solve productivity puzzle?

Brian Caplen, editor of The Banker, says the challenges banks face with regulation and legacy IT systems hold lessons for the wider economy

He points out that ‘great minds have been pondering the productivity puzzle – so why, in a time of rapid technological change, is productivity stagnant in many advanced economies?’

The UK has particular problems related in part to the tendency of firms to hire cheaply from an EU migrant pool (one which may disappear post-Brexit) rather than invest in new equipment.

But there are two other reasons — less often cited and especially pertinent to banks — which might explain this so-called mystery.

  1. The first is regulation and compliance:
    • Banks can be forgiven for thinking that theirs is the only industry suffering from regulation overload given the slew of regulation since the financial crisis
    • But all industries are engaged in a massive regulatory push across areas ranging from data protection to employment law to health and safety
    • These require not only additional resources to implement but also take out management and employee time filling in spreadsheets in order to comply
    • Many of these new regulations have noble objectives but are a direct hit to productivity
  2. Then there are control systems run on legacy IT that also eat into productivity:
    • These typically involve purchasing and invoice systems that require numerous steps to complete and ask for multiple lines of information
    • All very nice for the data collectors but they use up lots of staff time
    • Banks again are in the frontline as they are often running these off legacy and cumbersome IT systems

 

The US administration is currently under fire for revisiting regulation and loosening it where appropriate.

In fact, a thorough cost-benefit analysis of regulation and compliance across sectors could produce better outcomes, consume fewer resources and help solve the productivity puzzle.