When I was a kid, my parents used to tell me to make sure I had “hard facts” at hand. What they meant was that if there was some question about something, you should have the answer ready.
It’s good advice, but it’s more complicated than they said. Suppose you’re worried about inflation. It seems obvious that it is bad for prices to go up, but the real issue is how fast it will happen. What if prices are going up very slowly? How do you know you are not being fooled by mere slow growth of prices into thinking that inflation is on the way?
The point is that you need the right kind of facts at hand. If prices are going up slowly with no sign of acceleration, you can’t be sure there isn’t an explanation other than inflation. But if prices are going up fast and accelerating, there is no doubt about what’s happening.
The whole point of financial reporting is to communicate information. The idea that good financial reporting must include numbers, even if they are ugly or impossible, is not obvious. But it is true. Financial numbers are one way to make information available.
The great advantage of numbers is that they are hard to fake. They don’t depend on your subjective impressions about a company’s prospects or its managers’ mental states.
Unfortunately, they also have a lot of disadvantages. Numbers have a tendency to grow bigger and bigger as you try to explain them. Keeping an eye on the right figures means you have to watch the whole business all the time, which requires a lot of staff and time and devotion.
That’s why most corporate financial reports try not to use numbers at all: instead they have lots of bright pictures illustrating what the company does, or diagrams showing how the company operates, or complicated tables showing what happens when one thing happens or another.
It is a common mistake to rely on the numbers in your spreadsheets instead of the numbers in your heads. In theory, your spreadsheets are supposed to be about building a picture of your financial situation. But the figures they contain are often of more use as input than as output.
Take balance sheets, for example. They are about making money; you want more assets than liabilities. But it seems more sensible to build a picture of how much you have of each kind of thing, not just of how much you have more or less of it than you had before.
So if you know that your bank balance is $100,000 and that your house is worth $200,000, it doesn’t make sense to say that the “net worth” of you is $100,000. It makes sense instead to say that the net worth is $200,000 + $100,000 = $300,000. That’s something you can look at and see; it tells you what assets you have and what liabilities you have; but remember that it is only part of the whole story.
In some circumstances, you can make a decision only with the help of numbers. In some circumstances, numbers are easy to work with. In other circumstances numbers are hard to work with. In those circumstances it helps to have the numbers organized in the right way.
There are three kinds of numbers.
- There are the numbers you measure directly.
- There are the numbers that describe the things you measure.
- There are the numbers that describe how to use the things you measure to make conclusions about other things.
The first kind is easy to understand, but it is often hard to get hold of correctly. The second kind is easy in principle but hard in practice, because it depends on how well your instruments and processes work in practice. And the third kind is hard in principle but easy in practice, because it depends on knowing how to use something else that can be measured — humans, say, or data or rules or whatever — in order for your measurements to have meaning.
Once you’ve made the decision to take the job, it’s crucial to keep faith with it. If you feel yourself drifting away, back up your decision by making a clear list of reasons for staying. And make sure you have solid reasons for not moving along at all.
The most important of these reasons may be something like “I’m scared. But if I go, I’ll never be able to go home.”
We think of financial accounting as a ritual, but if you’re going to make decisions about what to do with your money, you need to know the facts.
Many things can affect a company’s profits or loss: sales fluctuate, people get sick, a new product fails, a tariff is imposed. But these are not the things that affect long-term profitability. What affects it is cost structure and competitive position, and these things usually aren’t affected by short-term fluctuations.
You can’t just trust your intuition. The right question is not “What should I do?” but “How much damage will this do?”