System Definition for CFOs.
CFOs often grow up in public accounting and industry with narrow responsibilities, often focused on assurance and financial reporting.
As they progress they are exposed to more and more of the organization, until, as CFO, they are responsible for looking at the entire organization and how it performs both financially and non-financially.
As a follower of the Theory of Constraints, I always want to make sure we are trying to optimize the entire system and not just individual parts of the system. We are looking for global optimization. Local optimization is rarely the path to optimizing the entire system.
For financial accounting we are trained to think of "the entity" as the system, but we still tend to break the organization into business units and divisions and departments and then report on these subcomponents as if they were the whole business.
CFOs would do well to understand how to get the system definition at the right level.
Here are some stories to illustrate.
The World is Our Ledger
As a young CA articling student, I remember sitting in the back of a generally boring financial accounting class. The instructor was talking about cutoff of transactions at year end and that an organization might make accruals for things like for goods in transit. One of my classmates was having a hard time understanding how a customer could record a transaction that the supplier hadn't recorded in the same way. Being young, impatient and a little bit insensitive, I called out from the back, "You don't have to reconcile the world!" Most of the class thought that was hilarious. While I tend to think of systems at higher level than I used to, I still don't think we have to take on the world!
AMC Bucks
In my first few months as CFO of Micralyne, originally the Alberta Microelectronic Centre, I was surprised that cross-department charges were a big thing. Directors would advocate for spending on a particular tool or activity, but then want to charge the cost to another department. Managers were quick to charge time and expenses to other departments
I kept trying to explain that only revenue from outside the company created profit but it didn't seem to be getting through. I got so frustrated that one night I came up with a scheme!
I used actual paper and scissors (it was 1997!) to cut a photo of our CEO out of a copy of the annual report. Using scotch tape and crude graphics software I created a fake one thousand dollar bill, with the name of our company and the CEO picture standing in for the Bank of Canada and the Queen. I put four on a page and made a whole bunch of copies, then cut them up into individual bank notes. I called them AMC bucks, after our company's acronym.
The next day I went into a director's meeting, armed with my stash of "cash". Inevitably, a discussion came up about a good idea or a needed expenditure and somebody asked, "Who's going to pay for that?"
As usual, nobody wanted to take the budget hit. After a bit of silence, I jumped up. "I'll pay for it!" I exclaimed, and went over to the proponent and started counting out AMC bucks, by the thousand, on the table in front of him.
"I can make more if you want!" I declared and everybody quickly grasped the ridiculous nature of our conversation. "AMC Bucks" became part of the company vernacular. I still have a thousand AMC bucks somewhere in my memorabilia.
Skin in the game
These are the stories CFOs tell. As a company fiduciary, departmental success at the cost of other parts of the organization has no value. Worrying about multi-company cutoff reconciliations may take us nowhere. CFOs have to dance the fine line of optimizing complex supply chain networks with suppliers and customers, all while protecting the company for when the balance shifts and "skin in the game' means "run for cover".
This dynamic is why being a CFO is such a great job! It's also why it can be invaluable to have someone who understands your world to talk through abstract concepts like, "how do we define the system we are trying to optimize?"
Thanks for reading,
Derek
⌲ Check out:
Essential Dynamics Podcast Episode 24 - The System - Getting System Definition at the Right Level - Release date April 19, 2021
