Is Finance Accountable for Some Major Business Failures?

Any business failure can be attributed to one obvious reason; bad decisions. Who is responsible for bad decisions? Of course, the management. Who else? Finance. But why? Because we proudly call ourselves strategic business partners helping our business partners to make good decisions. Agree? Let's take a deep dive.

Clayton Christensen, a highly respected Harvard Professor in his classic best-seller 'Innovator's Dilemma' identified three common approaches used by Finance for evaluating major investment decisions that may lead to disastrous consequences if not applied correctly.

1) Discounted cash flow and net present value, as commonly used, underestimate the real returns and benefits of proceeding with an investment. Most executives compare the cash flows from innovation against the default scenario of doing nothing, assuming—incorrectly—that the present health of the company will persist indefinitely if the investment is not made. In most situations, however, competitors’ sustaining and disruptive investments over time result in deterioration of financial performance.

The DCF Trap

Most executives compare the cash flows from innovation against the default scenario of doing nothing, assuming—incorrectly—that the present health of the company will persist indefinitely if the investment is not made. For a better assessment of the innovation’s value, the comparison should be between its projected discounted cash flow and the more likely scenario of a decline in performance in the absence of innovation investment.

2) Fixed- and sunk-cost conventional wisdom confers an unfair advantage on challengers and shackles incumbent firms that attempt to respond to an attack. Executives in established companies, bemoaning the expense of building new brands and developing new sales and distribution channels, seek instead to leverage their existing brands and structures. Entrants, in contrast, simply create new ones. The problem for the incumbent isn’t that the challenger can spend more; it’s that the challenger is spared the dilemma of having to choose between full-cost and marginal-cost options.

3) The emphasis on short-term earnings per share as the primary driver of share price, and hence shareholder value creation, acts to restrict investments in innovative long-term growth opportunities.

The list of these critical flaws hampering the quality of business decision-making does not stop here. Many assumptions used in such investment evaluations could be questionable but usually accepted as given.

The expected useful life, terminal values, discount rate used etc. provide a wide cushion to play with the numbers and distort the outcome in favor of certain stakeholders.

Besides, major considerations like short-term vs long-term profitability focus are largely dictated by shareholders' priorities, stock market reactions, and incentive plans for CEOs and other senior executives.

These are not bad tools and concepts, but the way they are used to evaluate investments creates a systematic bias against successful innovation.

A structural weakness in the decision-making process of today's businesses is the separation of Finance and Strategy functions. This alarming flaw is even not recognized by many finance professionals. They mistakenly believe they know enough about strategy even if they have not attended any formal strategy training. The reality is that they don't know what they don't know.

This problem, however, starts at the academic level where Finance and Strategy are considered separate subjects. There is some Strategy taught in Finance and some Finance taught in Strategy but there is not enough integration to produce finance professionals with deep strategic insight and high-quality strategic thinking.

Finance profession cannot survive fulfilling the regulatory requirements or taking care of the compliance and controls only. Our future lies in serving our business partners as their true strategic advisors. To achieve this critical goal, we need a new mindset, a new framework.

The Accounting curriculum we use today to develop finance professionals for the future is quite outdated. It is heavily concentrated on Accounting principles and frameworks that are fast becoming obsolete.

Feeding the young minds with heavy doses of principles like conservatism, historical cost, objectivity, and tangibility is doing more harm than any good. We are living today in a world characterized by uncertainty, subjectivity, intangibility and futurism. We need to be innovative enough to bring such realities into a practical framework to create value for the businesses we serve.

We need to fundamentally shift our focus from Accounting, controls and compliance to decision support and business partnering. Simply talking about supporting business and having the ambition to become strategic partner is not sufficient. We need to build a solid structure and framework around the profession level to develop the talent of future finance leaders.

With the complex global structure of the Accounting profession that includes standards-setting bodies, regulatory authorities and certification institutions, it is not easy to implement even a small-scale change.

But a thousand-mile journey starts with the first step. With the presence of brilliant minds and strategic thinkers within the profession, we can not only save our profession from becoming obsolete but take it to a level where we can proudly serve our business leaders as their true strategic partners.

I invite you to join me in my little efforts to bring the desired change in our profession. There are two initiatives that I have started:

1) MECA CFO Academy Since 2016, we have been teaching a 12-month Strategic CFO Program that is designed for senior finance professionals to help them reach the CFO level. This program is heavily concentrated on Strategy, Leadership and Digital. We do not teach any Accounting or Finance.

2) CFO Coaching Club (CCC): This is a private exclusive community of finance professionals who aspire to become CFOs. This is a group of volunteers who are dedicated to helping and supporting each other in their career development through networking, peer-to-peer coaching and mentoring. The criteria for admittance is to be a highly disciplined, career-focused professional. If you are interested, you can apply here.

ABOUT THE AUTHOR:

Saleem Sufi is a CFO Leadership Coach and Strategy Expert with more than 20 years CFO level experience working for top world class Fortune 500 and Private Equity owned companies in Asia Pacific, Middle East, Europe and United States. He is the Founder and President of MECA CFO Academy where he leads the Senior Finance Community with an entire focus on leadership development and career growth.   

The Strategic CFO Program introduced by MECA CFO Academy in 2016 has evolved into an advanced strategy program designed for CFOs and senior finance professionals. We are now starting with batch-17 on 6th July.