Six Levels of Financial Knowledge: Here's a Framework That Management Accountants Can Use to Help Their Organizations Reach New Heights of Financial Understanding and Become More Profitable

Article excerpt

In the October 2003 issue of Strategic Finance, Paul Sharman made the case for management accounting. This topic couldn't have been more timely then, and it's even more critical now. To the extent that the financial community can engage both itself and line management in a soul-searching look at what they really know about their businesses, the case for management accounting can be made emphatically. With the appropriate framework to shape financial knowledge, the management accounting function should become an organization's principal decision-support platform.

Few line managers or financial executives are satisfied with the current state of decision support because it's too heavily driven by the financial accounting template and cost systems motivated by overhead allocation. But dissatisfaction usually leads businesses to take a hard look at themselves and set some tough goals relative to acquiring more profound knowledge. What this engagement process requires is a solid but easily communicated framework for self-evaluation and planning, which I'll propose. With this self-evaluation vehicle, any company can face brutal reality and begin the journey toward reaching new levels of financial understanding.

The framework recognizes that we're on a cusp of decades of development coming together in cost measurement and estimation, data management, business process modeling, enterprise resource modeling and planning, mathematical optimization, raw computing power, electronic visualization, application software development, and more. As they said on The Six Million Dollar Man, "We can rebuild him. We have the technology."

I term my proposed framework "the levels of financial knowledge." As you read the description of each level, I expect you to ask, "Where is my business?" Any reasonably sized business may find itself with elements of more than one level operating simultaneously--depending on the function, location, or business unit. Nevertheless, the framework should be quite prescriptive for evaluation and planning.

LEVELS OF FINANCIAL KNOWLEDGE

The framework consists of six levels of financial knowledge, and the word "financial" is most operative here. I mean dollars and sense; this is much more than data and information-I'm talking about knowledge. First let's take a look at a synopsis of each level (see Figure 1), and then I'll go into more detail about each one.

Figure 1: Levels of Financial Knowledge

6. OPTIMIZATION ACROSS TIME

5. ENTERPRISE OPTIMIZATION

4. THROUGHPUT-BASED UNDERSTANDING

3. SUBSTANTIVE CVP

2. BASIC COST/VOLUME/PROFIT (CVP)

1. FINANCIAL STATEMENTS

Level 1: The business can count and keep score in the aggregate sense (business unit/corporate) by tracking cash, accounts receivables, payables, etc., and it can generate periodic financial statements.

Level 2: The business has a traceable measure of output volume and readily identifies fixed and variable costs. It has internalized the basic vocabulary of cost/volume/ profit (CVP).

Level 3: The business has a well-defined breakdown of CVP elements and understands how these more detailed elements relate to working capital behavior as well as to both Level 1 and Level 2 templates. It can fundamentally assess the business profitability drivers and can generate appropriate policy statements relative to spending money to make money.

Level 4: Throughput, as opposed to output, has become the focus of operational and financial knowledge. The fundamental engineering/economic recipes of input/throughput/output (ITO) are known. The primary transformation constraints are known, and this knowledge is a principal factor in planning and resource allocation.

Level 5: At least in a planning sense, but, more importantly, operationally, the business can optimize simultaneously across multiple inputs/costs/recipes/constraints/ outputs. Fed by the decision-support system, the methodology of marginal economics has moved from the theoretical to the practical. …