David Allen CBE, CIMA’s 1983-1984 president, continues his series exploring the advantages of strategic financial management. We noted at the end of last month’s article that the accounting model is unsuited for use at the strategic level of management. We should remember that accounting is not the only task which falls within the responsibility of a finance function. There is also financial management, and we confuse the two at our peril. The origins of accounting are found in stewardship reporting: explaining to investors what has been done with their money. Such reports need to be prepared, or at least endorsed, by passive and therefore impartial observers: words like regular, comparable and standardised come to mind. A moment’s thought is enough to realise that we do not control things by reporting on them after they have happened. Control calls for proactive involvement in the teams which make and monitor the decisions about what to do with the money currently entrusted to the company. The information needed by such teams varies from one enterprise to another, and is customised to the decisions being taken. Backwards and forwards Accounting is backward looking. If figures are to be verified by an outsider (the auditor) the focus must be on things that have already happened – on profits that have been realised in the form of tangible assets. It makes no claim to quantify the value of a business at a point in time. Financial management, on the other hand, is forward looking – comfortable with judgements about an uncertain future. Here the focus is on wealth creation and value, implying the potential to realise it at a future date. Until this time it is intangible. Accounting too is inward looking – designed by and for the outsider looking in. In order to be objective, however, the concentration is on costs, and the concept of ‘capital maintenance’. Here profit is defined as what you could afford to distribute and remain as well off as you were. By contrast, financial management needs to be outward looking, concentrating on the perceived value of outcomes. Bear in mind that value is subjective – like beauty, it is in the eye of the beholder. The process is not concerned with whether or not capital is being maintained, but whether enough wealth is being created, relative to the capital employed. In practice, this means seeking a return in excess of the cost of capital. Accounting is static – designed to allocate costs and revenues between discrete, relatively short, time frames. This is performed by way of concepts such as classifying outlays as revenue (to be charged against current revenue) or capital (to be carried forward). This contrasts starkly with financial management’s focus on the dynamics of a business over a longer term. It has no need for accounting concepts as it is rooted in cash flow. Different skills The skills required for the two tasks are very different. Accountants who have spent all their working lives seeking the precision of objectively verifiable truth about a certain past are unlikely to be comfortable with toleranced forecasts reflecting subjective judgments about an uncertain future. None of the above is to belittle the accounting model. It has an important part to play in corporate governance, the protection of creditors, the computation of tax liabilities, etc. Nor do I support the various attempts that have been made to modify the model in some way (by valuing intangibles or adopting current costs) since that would destroy the objective verifiability that has underpinned it for over 500 years. We must recognise the need for an additional model, designed to meet the needs of those making and monitoring strategic decisions, which shape the future of the enterprise. Strategic financial management is such a model. Next month I will explore the two aspects (external and internal) of financial management. This should clarify the financial objective of an enterprise, and the criteria for making and monitoring strategic

  David Allen CBE, CIMA’s 1983-1984 president, continues his series
exploring the advantages of strategic financial management.

We noted at the end of last month’s article that the accounting model
is unsuited for use at the strategic level of management. We should
remember that accounting is not the only task which falls within the
responsibility of a finance function. There is also financial
management, and we confuse the two at our peril.

The origins of accounting are found in stewardship reporting:
explaining to investors what has been done with their money. Such
reports need to be prepared, or at least endorsed, by passive and
therefore impartial observers: words like regular, comparable and
standardised come to mind.

A moment’s thought is enough to realise that we do not control things
by reporting on them after they have happened. Control calls for
proactive involvement in the teams which make and monitor the
decisions about what to do with the money currently entrusted to the
company. The information needed by such teams varies from one
enterprise to another, and is customised to the decisions being taken.

Backwards and forwards
Accounting is backward looking. If figures are to be verified by an
outsider (the auditor) the focus must be on things that have already
happened – on profits that have been realised in the form of tangible
assets. It makes no claim to quantify the value of a business at a
point in time.

Financial management, on the other hand, is forward looking –
comfortable with judgements about an uncertain future. Here the focus
is on wealth creation and value, implying the potential to realise it
at a future date. Until this time it is intangible.

Accounting too is inward looking – designed by and for the outsider
looking in. In order to be objective, however, the concentration is on
costs, and the concept of ‘capital maintenance’. Here profit is
defined as what you could afford to distribute and remain as well off
as you were.

By contrast, financial management needs to be outward looking,
concentrating on the perceived value of outcomes. Bear in mind that
value is subjective – like beauty, it is in the eye of the beholder.

The process is not concerned with whether or not capital is being
maintained, but whether enough wealth is being created, relative to
the capital employed. In practice, this means seeking a return in
excess of the cost of capital.

Accounting is static – designed to allocate costs and revenues between
discrete, relatively short, time frames. This is performed by way of
concepts such as classifying outlays as revenue (to be charged against
current revenue) or capital (to be carried forward).

This contrasts starkly with financial management’s focus on the
dynamics of a business over a longer term. It has no need for
accounting concepts as it is rooted in cash flow.

Different skills
The skills required for the two tasks are very different. Accountants
who have spent all their working lives seeking the precision of
objectively verifiable truth about a certain past are unlikely to be
comfortable with toleranced forecasts reflecting subjective judgments
about an uncertain future.

None of the above is to belittle the accounting model. It has an
important part to play in corporate governance, the protection of
creditors, the computation of tax liabilities, etc. Nor do I support
the various attempts that have been made to modify the model in some
way (by valuing intangibles or adopting current costs) since that
would destroy the objective verifiability that has underpinned it for
over 500 years.

We must recognise the need for an additional model, designed to meet
the needs of those making and monitoring strategic decisions, which
shape the future of the enterprise. Strategic financial management is
such a model.

Next month I will explore the two aspects (external and internal) of
financial management. This should clarify the financial objective of
an enterprise, and the criteria for making and monitoring strategic