Righttrack Whispers: Developing Financial Skills

by Derek West

As a financial trainer, I consider it my mission to de-mystify what for many people is a mysterious and scary area, and yes, even to show that finance can be fun!

All of the financial wisdom in the world is contained in the famous lines of Mr. Micawber in Charles Dickens’ David Copperfield: "Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery"

The subject of money (whether translated as economics, finance, accountancy, or whatever) is thus a simple one; but as there are careers to be built, and fortunes to be made, in making it appear as complex as possible, a huge industry has grown up to provide ‘financial services’. As a result, most of us prefer to leave it to ‘the experts’. At work, this means we take the view that ‘finance can deal with it’, or more often ‘it’s all finance’s fault’.

At home it means that, before we even see our hard-earned wages, they go to the government, the pension fund, the insurance company, the building society, the bank – and until recently we have had the touching faith that each of these institutions has the expertise to look after our money, and our best interests at heart. Since this has been shown to be patently untrue, perhaps it’s time to take back a little bit of control. But if we are to exercise that power, a little knowledge is needed, so let’s start with some basic principles.

There are only four things you can do with money:
You can earn it – ‘income’
You can spend it – ‘expenditure’
You can own things that you have bought with it – ‘assets’
You can owe it – ‘liabilities’

These four aspects of money lay at the heart of all accounting and bookkeeping systems.

The key distinction here is between money that flows out as expenditure, i.e. when it’s gone it’s gone; and money that is invested in assets which we can continue to enjoy, usually known as a ‘capital’ investment.

There are only four ways to improve your finances:
Increase your income, i.e. sell more, or sell the same amount at a higher price
Reduce your expenditure
Sell your assets and use the money raised for something else
Reduce your ‘working capital’, i.e. the amount you have tied up in inventory, or debtors, or cash
that is not earning interest

Of these four options, we can say:

Selling your assets or reducing your working capital rely on the good fortune of having assets in the first place; and remember, you can only sell an asset once (unless you are Enron, but that’s another story!) – so the benefit is limited.

The best way to improve your finances is to increase your revenue – but it is also the hardest, as it requires inventiveness, imagination and the ability to anticipate and fulfil customer needs. So most organisations in hard times go straight for the cost-cutting option because it is relatively easy, the effects can be seen quickly, and it produces a nice virtuous feeling of sacrifice and pain. Perhaps this is why, at the recent conferences of the three main political parties, 1,703 references were made to potential cost-cutting measures to ease the national debt – and how many specific proposals were made for ways to increase national wealth? Precisely none.

Your organisation survives and thrives by providing customers with things they want. Consequently, your financial systems should be judged by their ability to answer two simple questions:
Can I tell how much money we make from any given customer or group of customers?
Can I tell how much money we make from each of the specific goods or services we supply?

The answers to these questions need to take into account not just the income received from each customer and/or product, but also the precise costs of serving each customer or supplying each product.

For most organisations, knowing the answers to these questions will provide the following insights (or something very similar):

About 80% of our profits come from 20% of our customers (and a similar proportion if we are
taking a product / service perspective)
We are actually losing money by continuing to supply about 10% of our customers
The 20% of our customers who provide the lion’s share of our profits are precisely the ones we are
most at risk of losing to our competitors.

Of course the percentages will vary from organisation to organisation, and industry to industry, but the principles will be the same.

So let’s conclude with some recommendations:

Regain Control: don’t keep leaving it to Finance. Apply these principles in your job, and in your daily
life. If the Finance Department (or the bank, or the pension fund…) can’t explain why the numbers
are as they are, keep asking (politely of course!) until they do
Think about customer and product profitability: again, your Finance Department should be able to
break down your bottom-line profits from a customer and a product / service perspective in a way
that allows you to make meaningful management decisions. If they can’t, ask why not, and what
prevents them from doing so. If they can, think about what those numbers mean – how can we
make sure that we keep and develop our most profitable customers, and how can we best deal
with the unprofitable ‘tail’?
Remember - the Finance Department are your friends! And they are just waiting for your call…