Episode 17
Financial decision making – mistakes and fallacies
Category : Financial Decision Making
This episode of the Counterpoint Podcast focuses on the financial aspects of decision making. When it comes to anything financial, organisations typically depend on a department "specialising" in it - the finance department. Dr. Anil Lamba, a financial literacy activist, discusses with us how this fact is the very reason why companies, at times, take disastrous decisions. Listen to this episode to understand why financial know-how and know-why is critical for every manager and what happens when wrong decisions are taken.
Transcript
| Shubham Agarwal : | Hello, everyone, welcome to the Counterpoint podcast. I’m Shubham Agarwal. And we’re here in a very interesting episode today, we received many messages asking us to touch upon an extremely important domain, which is about financial decision making. Eli Goldratt way back in the 80s had made a very controversial statement that cost accounting is a public enemy number one for productivity. He was highlighting his frustration on how managers used to take wrong decision using cost accounting methods, which impacted the flow of goods in the shop floor. For example, managers increasing batch of production in a non-bottleneck machine to reduce unit costs, which then impact the delivery lead times or cases of managers optimizing on transportation costs, using bigger trucks, which in turn impact the delivery to warehouses. There are many such cases of local decisions which impact the company negatively on the overall level. So we thought we’ll go deep down into this topic and discuss upon it. We’re touching upon a topic of discussion making using finance and accounts the right as well as the wrongs, what is lacking in practice in the industry. And what is the way forward? We have with us Dr. Anil lamba, an expert in finance and accounting, who also holds a view that most managers have probably limited financial literacy. He’s on a mission to improve financial literacy amongst managers. He would have spent, I think, the last few decades with close to 10,000 hours of training, consulting and conducting workshops to help improve financial literacy of working managers and has written many books, which demystify the topic as well. We have Dr. Lamba today with us. So let us welcome him. Hello, Dr. Lamba. Welcome to the CounterPoint Podcast. |
| Dr. Anil Lamba : | Hey Shubham, thank you so much. Pleasure to be here with you. |
| Shubham Agarwal : | It’s it’s, it’s our pleasure to have you here on the podcast sir. Great. So, let us let us start our discussion for the day. I want to start by understanding some of your views, you know about the topic of decision making using finance and accounts, have you come across cases of erroneous decisions, what is in your view, you know, lacking in organizations. |
| Dr. Anil Lamba : | I come across such cases all the while Shubham. And I think it’s a universal phenomenon because first of all my opinion is every decision is a financial decision, because every decision of every individual within an organization has a financial implication attached to it. In fact, good finance management in my opinion is nothing but a collection of financially intelligent decisions taken by everybody within an organization. Unfortunately, many many decisions are not financially intelligent, and where they are, it is by default not by design. And therefore, financial literacy, which means, if somebody is armed with the ability to understand the financial implication of what you do, and basically the financial implication is of two things you got to understand the impact of your actions on the organization’s bottom line. And you should understand the impact of the actions on the cash flow. And when these two things are taken into account, then the decision is taken it becomes a financially intelligent decision. And financial literacy is lacking almost at every level within an organization up to the top most level, nobody’s fault, because the perception is finance management is the responsibility of the finance people. Whereas the actions of everybody has a financial implication. In fact, the least impact on the bottom line is of the actions of the so called finance people that those who understand the subject are not the ones who are taking financial decisions and those whose actions have a financial impact call themselves non finance so it’s not their fault. They never thought it was my responsibility. |
| Shubham Agarwal : | Yeah |
| Dr. Anil Lamba : | I mean you can you can learn that you think you need to learn but if you say mera kaam hi nahi hai I am a non finance look, what a ridiculous statement that is. So the moment you say you are non finance you’re absolving yourself of the responsibility of taking financially intelligent actions. |
| Shubham Agarwal : | This is a very strange paradox so to see if I can if I can say that but how did this happen? What what in your view |
| Dr. Anil Lamba : | I don’t know, I just discovered this by default. You know, I went when people like me who are, let’s say, who study the subject of Finance. I’m a chartered accountant. Yeah. So when you pass out and you come out into the big bad world, you think you are the Johnny come lately, the rest of the world knows you, I am the one who’s new. And then to discover how little people understand. And then you discover the void that exists. So we kind of switched to this long back trying to spread Financial Intelligence, which is the need of the hour everywhere. And I find this ignorance to be universal doesn’t matter which country you are doesn’t matter which industry you belong to. |
| Shubham Agarwal : | |
| Shubham Agarwal : | So I will say this Anil Sir, you know, we’ve seen how companies take care of their books every year, it takes a lot of time for companies to close their book of accounts, end of the quarter, end of the year, this implies that, you know, such companies don’t have an idea of the P&L or the balance sheet on a daily basis. Now, I’ve always wondered how these companies take decisions, which are holistic in nature on a daily basis, what what do you think about it? |
| Dr. Anil Lamba : | You know, I always felt these are two different subjects accounts and finance, you are correct, that, since it takes fairly long to close the accounts, and then eventually prepare the p&l and the balance sheet. And very often the top people top management within a company only knows where they stand after the statements are delivered to you. Which also, I think is ridiculous, because I’ve always maintained let the accounts guy do your own job. But you should, at every point, know where you stand. And therefore, the thing that we teach is we teach them techniques where if you just monitor your top line, by looking at the top line, you should have an idea of the bottom line. And when the accountants give you this information, it should only be meant to verify what you already knew. Since the techniques are kind of give you rounded of numbers, put a tolerance level of 5-10 percent for errors. But you should have a fair idea of where you stand if you thought my profit is supposed to be, let’s say, 100. If the accountants tell you it is 101, 101.5, 98.7 accept it. |
| Shubham Agarwal : | Which is okay |
| Dr. Anil Lamba : | But if they give you a drastically different figure, you should be able to as a so called non finance person, you should be able to tell that person I think you’ve made a mistake somewhere. But the scary part is I know business owners, I know managing directors, if the company has made a profit of 100. And the typist either puts an extra zero or a zero less and tells them its 1000 or it’s 10 he will accept that. I mean, that’s crazy. Are you so dependent that if an accountant or a typist puts an extra zero or a zero less, you will accept that as the gospel truth and based decision making on that? No way. No way. So you got to be independent of accounting. |
| Shubham Agarwal : | What one needs is a method of understanding the impact of local decisions on the bottom lines of the company, without depending on the accounts department |
| Dr. Anil Lamba : | Ofcourse ofcourse we teach that all the while. Oh, yes. You know, you see if everybody knew the impact of their actions on the bottom line, if every action was financially intelligent at the root level, then the accounting is a post mortem. Whereas you knew what you’ve done beforehand. |
| Shubham Agarwal : | Alright. |
| Shubham Agarwal : | Right, what are your views on activity based accounting or costing? You know, Ellie goldratt dismissed it as a waste of time for organizations and he was against the idea which was allocating? Yeah. |
| Dr. Anil Lamba : | Yeah, see each costing technique has its merits and demerits but I have unfortunately not read Mr. Goldratt but I find many places he is in my views match. I’ve also said all along, allocating fixed costs is a waste of time, what is important is the contribution. So suppose a company makes multiple products, each company tries to work out the profitability of each product, and I feel don’t work out profitability work out contribution of each product which Ellie calls as throughput which the accounting term for that is, contribution, work out contribution per product, add the contribution of all the products, arrive at the organization’s contribution and minus one fixed cost. All the products put together should first help you recover the fixed costs and the balances properly. But the moment you want product wise profitability, you are allocating fixed costs. First of all allocation itself is a hypothetical thing. There is no product wise fixed costs, so so I kind of I’m a bigger believer of the subject of marginal costing rather than ABC. |
| Shubham Agarwal : | Is marginal costing, also called throughput accounting, a better approach for decision making? |
| Dr. Anil Lamba : | I mean yeah in times of competition, it helps you you know, you can, you want to have competitive pricing. See, sometimes I find people refuse orders when they should be grabbing them. On the other hand, they out of desperation, they accept orders that they should not have touched. Whereas the concept of contribution tells you if need be, you might have to sell below your cost also, the cost which is arrived at including fixed costs. |
| Shubham Agarwal : | Correct. |
| Dr. Anil Lamba : | But never ever doesn’t matter how desperate the situation never ever accept an order, which is at a negative contribution. So, profit could be negative, contribution should not be negative. So, that gives you the range up to which you can negotiate your property. Right. |
| Shubham Agarwal : | Yes and if the constraint resources are identified, then one can understand how loaded orders will deliver total contribution which will account for the total operating expenses and the desired profits.Great could you tell us something about your latest book ‘eye on the bottom line’ |
| Dr. Anil Lamba : | Frankly, eye on the bottom line is actually a sequel to Romancing the Balance Sheet, you know, Romancing the Balance Sheet I’d written because I was grounded for 10 days, because of some, I was unwell. And then when I got Okay, and I kind of it became a book and it written enough for it to be justified as a book. But there were many topics which I didn’t cover in that. So later on, I decided to write kind of a sequel, even though we don’t call it a sequel. So all the topics that were not covered in Romancing the Balance Sheet, I included it in eye on the bottom line. So together, they make more sense, if somebody wants to know almost all the things that are essential for any business leader, any business manager, any business owner. To run the business from a financial standpoint, then these two books together, cover most of those topics, |
| Shubham Agarwal : | Lovely. Any parting thoughts from your side Dr. Lamba? |
| Dr. Anil Lamba : | No, my only mission in life seems to be how to spread literacy, financial literacy, I wish more and more people are financially literate. Because the price the world pays due to financial illiteracy is huge. It’s not not funny. Most business failures in the world, the businesses that fail, out of those businesses 90% or more fail due to financial mismanagement. And I feel it’s easy to say you know, business fail, but we don’t understand the price that it extracts. When a business fails. First of all, the person who invested in it has lost the money. But that is not the only person who has lost the money. The bankers who lent them lose the money. The employees suddenly come on the streets, they are jobless. The vendors lose money, the shareholder lose money. I mean, the impact is horrible. And only a person who’s sitting in that position knows what it means. And why did they shut down because of financial mismanagement. Why did it happen? Because the fellow didn’t realize it’s my responsibility. That means it was an avoidable reason. I mean, I can understand a business shutting down due to unavoidable causes. Your product itself was faulty and it shutdown, deserve to shut down, you know, something else happened, calamity happened, like pandemic happened. You couldn’t help it, but financial mismanagement reason you could have helped. And you just understood that I should have, you know, been financially literate. So So I think this is something which we can change. And all of us who understand the importance should get together to help the world change.Shubham |
| Shubham Agarwal : | Great. I think that that’s a very strong message that would go out to all the listeners and everyone who comes across this discussion because this is extremely important. And I also believe in it and I think vector as an organization also believes in it. And therefore the the focus on financial decisions as well. Great. Thanks a lot for the discussion Dr. Lamba. It was wonderful having you on the podcast. |
| Dr. Anil Lamba : | it was a pleasure Shubham as always talking with you, you yourself are doing a phenomenal job with communicating these messages continue doing what you’re doing. Godspeed. Best of luck. |
| Shubham Agarwal : | In the next episode on the this topic, we will discuss simple methods that can help managers take local decisions, by understanding their global impact on the organization as a whole. If you have any doubts or comments on this topic, please connect with us. You can also write to Dr Lamba. |
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Vector Management Consulting Pvt. Ltd.
10th floor, Thane One, DIL Complex,
Ghodbunder Road, Majiwada,
Thane (West), Maharashtra - 400610, India.