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
