Critical Financial Issues

Critical Financial Issues
My new book in the FT Business Briefings series highlights the six critical financial indicators for controlling businesses;
  • Cashflow
  • Liquidity
  • Shareholder Value
  • Profit Improvement
  • Capital Allocation
  • Financial Risk
These factors cover the entire operation of a business and the two elements of its cashflow - its trading and capital/financing. Cash is, by far, the most important indicator of business success and health. Shareholder Value on its own is of little use if cashflow is inadequate and that value quickly drains from the business in a cash crisis. I like the quotation from Jack Welch, the iconic CEO of GE
"I was asked what I thought of shareholder value as a strategy. My response was that the question on its face was a dumb idea. Shareholder value is an outcome—not a strategy."
 You can argue that cashflow and liquidity are closely related but they are not the same thing. Liquidity expresses the ease with which a short-term cashflow problem can be dealt with - how quickly the assets of a business can be turned into cash.

Encompassing the five financial indicators in the list there is the overall concept of risk. Businesses are about taking risks but how many adequately evaluate their risks, plan for and mitigate what can go wrong? The credit crunch and global banking crisis has show quite clearly that risk management matters, from the small owner-managed enterprise to the massive international banking conglomerate. It is also clear how, despite having whole risk departments, blind faith and driving ambition at board level has over-ridden weak controls and brought down some of those massive businesses. I would advise anybody who is interested in business risk to read Nissim Taleb's book, "The Black Swan". He does not tell you what to do but he does bring the whole issue back to dealing with risk through contingency plans and argues convincingly against blind faith in statistical approaches. These are invariably based on critical assumptions that you promptly forget you have made...except that they are important and should not have been forgotten.

 I find the simple financial model of the corporation helpful. It divides activities and cashflows into the vertical 'trading' stream and the horizontal financing/investing stream. In this view employees and government are just classes of supplier who are paid for services. The box labelled 'the enterprise' is where the two streams mingle and convert - one to the other. This conversion 'role' is important if we think of the vertical stream as being the Profit & Loss Account because some of the horizontal investment stream is amortised or paid as interest and dividends, converting it to reduction of profit.