Number games (February 22, 2005)
Managing For Society column, The Manila Times
Business managers constantly face, use and report numbers. Market share is down 3%. Net profit is up 16%. Revenues slide down by 5%. Stock price is up 6%. And so on.
Such numbers are produced for legitimate reporting purposes. Regulators need them to check on legal compliance. Investors rely on them to check on their returns. The public uses them to understand the status of a business and its performance. Most importantly, they alert managers on how well they are doing their jobs.
Often, though, managers fall into the trap of losing sight of the original purpose for the numbers. When the purpose becomes the numbers themselves, managers begin to play number games. The Enron and WorldCom fiascos in the US are only among the most publicized examples of number games gone terribly wrong.
It would be a mistake to assume that such financial disasters cannot happen here. Anywhere, managers who overly focus on numbers can easily fall into playing number games in harmful ways. This is because accounting numbers are by nature open to manipulation – all within the rules. Managers are given wide choices in the assumptions they make and estimation methods they use to come up with financial numbers.
Some of the ways managers can massage the business numbers are well-known: overestimate revenues, under-predict costs such as bad debts, change inventory accounting procedures, and boost cash flow through unusual transactions. More creative techniques for misrepresenting the financial health of a firm are being invented all the time.
Traditionally, accountants and auditors have been the first line of defense against such number games. Greg Navarro, president of the Association of Certified Public Accountants in Public Practice (ACPAPP), is reportedly pushing for the training of CPAs on the newly adopted principles-based International Financial Reporting Standards (IFRS). I’m hoping that these efforts among local CPAs to police themselves will strengthen the credibility of the numbers produced by business.
Other than the tendency for unreliable and manipulated accounting figures, I have more basic worries about the excessive focus of managers on numbers. First, it diverts managers’ attention from the real work of management. Aiming for number targets becomes a major preoccupation instead of improving the capability of the business to deliver value for its stakeholders. For example, an obsession with a good bottom line can make managers ignore the morale of employees even if this will hurt their companies’ competitive advantage. Such managers are running vending machines for shareholders – not real businesses.
Second, it makes managers lose touch with the operational and market realities of the business. For example, too much reliance on computer-generated reports can leave little time for feeling the pulse of the business on a day-to-day basis. Sam Walton, founder of Wal-Mart, emphasized that, “A computer is not—and will never be—a substitute for getting out in your stores and learning what’s going on. [It] can tell you down to the dime what you’ve sold, but it can never tell you how much you could have sold.” With the ability of its managers to separate fact from fantasy, it’s not surprising that Wal-Mart is now the biggest retailer, in fact the biggest company, in the United States.
Third, management by numbers tends to focus on the short-term while destroying the ability of a business to learn and adapt for the long-term. The quarterly schedule for financial reporting is unfortunate. Sustainable business results cannot be produced within such a short period. The pressure to report good numbers so often makes managers defer needed expenditures and investments in human capital such as maintenance and training, respectively.
Fourth, a narrow focus on numbers makes managers lose their sense of judgment. There’s something about numbers that can be so persuasive as to suspend normal human faculty. Many still believe that “numbers don’t lie” or that a number must be a “fact”. Nothing could be farther from the truth. Darrell Huff, author of the 1954 classic “How to lie with statistics” pointed out that "despite its mathematical base, statistics is as much an art as it is a science." In short, numbers do not excuse management from exercising judgment. The exercise of judgment can be a burdensome chore, unfortunately. So those who lack or doubt their judgment are tempted to rely on numbers as a substitute.
But despite all its limitations, I know that numbers are here to stay. They satisfy managers’ and the public’s need for speed, simplicity and clarity. So, let me suggest some numbers I’d like to see reported in business headlines and in annual reports: Employee morale at company Y improves by 15%! Independent survey says 90% of customers consider company X trustworthy. Stress-related problems drop 20% in Company Z as net profit rises by 15%. Smoke emissions at Company W falls by half.
Maybe I’m dreaming since, right now, business numbers are often used for looking good. But it’s definitely time to use them for sound management.