Before we got into the financial discussion, I thought it was a good idea to address some of the concerns people have about Finance. Check it out!
“Why don’t people like finance?” I want to address this question before we get too far along in these videos because I think sometimes people can get a negative perception of finance and a lot of times this comes from their personal experiences. If you work in an office, this might be a situation you’ve encountered. Someone might come into your office one day and they’re wearing a suit and a tie and they’re introduced as the finance person. What typically happens is this person will sit in their office for about a month doing calculations on their computer. And then at the end of that time, there will be some change that happens. Some people might get laid off. There might be restructuring in the department. And then the finance person will move on to somebody else’s department. So this can lead to a negative perception, in addition to the negative stories we hear about problems on Wall Street or corporate fraud. People might be left asking, “why are we spending all this money on finance? Does it really lead to the best answers?” And there is even the idea that finance people are only about the numbers and are somehow missing the big picture.
So I want to address this because finance as an academic study is really neither good or bad. The intentions are pure. Finance is there to assist in decision-making. How it works is you look at a complex business decision that you are trying to solve and you attempt to model that using a financial model. You assess the situation and try to pull out what are the important factors involved. So you make a list of all your assumptions and you put these into your financial model. If you have good assumptions and have captured all the important factors, this will create some output that can then be used to guide decision making. This will lead to a decision or an outcome that is the most aligned with your organization’s goals and will create the most value for all your stakeholders. But if you use bad assumptions, or you leave out some important factor, then those bad assumptions are going to lead to a bad outcome from your model.
Let me talk about an example that will illustrate how this works. Let’s say you are considering a new job and you are looking at two different options. One of the options will give you a salary of a hundred thousand a year. It’s a pretty good opportunity, but you know that it is going to require you to work 65 hours a week. The other job opportunity is going to give you sixty thousand a year but you will only have to work 35 hours a week. So in evaluating these two options you have to make a decision. This shows the difficulty in these financial decisions. Because clearly a hundred thousand is more than sixty thousand, but we all know that in choosing a job, the salary alone is not the only factor. In this case, there is a significant difference in the amount of free time you will have outside of work, and for whatever reason, if this free time is important to you, if you can put a value on it, that will help aid in your decision making process. In this case, if that free time is worth more than forty thousand, then the sixty thousand opportunity is actually more valuable to you and that’s the job you should pick. However, if that free time is not worth that much, then you should choose the hundred thousand opportunity.
So let’s bring this back to some typical corporate finance examples. Some things you might be dealing with is capital expenditures. You might deal with strategic decision-making and you might be dealing with right-sizing a department. With capital expenditures, you are dealing with things like purchasing equipment or building a new building. You are making really large investments of capital based on what you think is going to happen in the future. It helps to have a financial model to help make these decisions. When you look at strategic decision making, you’re making changes to your organization, setting policies, and giving directions, based on what you think is going to happen in the future. Again, a financial model will be useful. And finally, determining whether you have the right staff size to deliver on the commitments you made to your customers, a financial model could be useful. So these are typical examples you would see in a corporate environment. And these are big decisions. We are dealing with large amounts of money, and they are very complex situations. It’s important to have good assumptions because good assumptions are going to lead you to making the best decision.
It’s important to realize that we are talking about the invisible hand of economics. So we are talking about things like change and impact on people’s lives and that can create some pain. Whenever we’re spending money somewhere, that means we’re not spending money somewhere else. Sometimes that causes pain because we don’t like it when we can’t get everything that we want. This is the essence of budgeting. You’ll have an organization with a bunch of different departments and you’ll have a manger for each of those departments. That manager gets to set a budget. They have a limited amount of money and based on what you think is going to happen for the future of this organization will impact your decision on how much money to give to each department. Some departments are going to get more money and some departments will get less. But this is all based on your understanding of what will have the biggest impact for the future and how you think it will make everyone as a whole better off. If you do have a negative perception of finance, I hope you can set that aside while you watch my videos, because there is a big opportunity here. The reason I do finance is because I see the positive impact it can have on an organization. If you use financial tools and processes, you’ll end up making better decisions and that makes everyone better off.
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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.