“understanding the numbers has to come from understanding the business. People go badly wrong when they try to do it the other way round”
I'm a working commercial real estate appraiser. The above sentences nicely summarize the difference between intelligent commercial real estate appraisers who are good at the job, and intelligent commercial real estate appraisers who are bad at the job. (Dumb appraisers are a dime a dozen and they understand neither the business nor the numbers.) There are some smart appraisers out there who have mastered all the mathematical tricks to generate opinions of value ... but sometimes following the numbers leads you to very strange places, and if you don't know the business, you won't know you went astray. Sometimes the smart appraisers trust the math so foolishly that they mess up worse than any dumb appraiser ever could!
First, financial accounting is designed for lenders dealing with the short and medium term. It is reasonably fit for purpose. It is of only limited use for equity investors, and of no use for managers. But top management these days seems more concerned with managing investors than their business. There is a reason the CFO is the #2 glamour job in a big corporation. It is not a good reason.
Second, the Ricardian fallacy is a form of physics envy, not shared so much by physicists. Eugene Wigner once wrote an article: "The Unreasonable Effectiveness of Mathematics in the Natural Sciences". Or there is the line attributed to Ludwig Boltzmann: "Elegance is for shoemakers and tailors."
I'd definitely agree with the first there - financial reporting is only one kind of accounting, and not the relevant kind for most people, but it's the kind of accounting that you *have* to produce for legal reasons and so, since accounting is expensive, the temptation to use it for things it wasn't meant for is powerful
I have been CFO'ing or investing in high capex, complex solution companies for all of my career.
It took me about 20 years to provide a solution which meant that I never again heard the line from an account holder (person responsible for a significant piece of spend) "I don't recognise those numbers, they came from finance."
The downside is that when you sit with hedge fund analysts post-results it's very difficult to reconcile P&L's to real world activities.
FWIW the solution was a "controlled" Excel environment with templates co-designed by the account owner. It also reduced monthly/quarterly budget meetings to - "let's focus on that number - everything else seems in line" and even my children began to recognise me.
I am randomly in an old post but my personal response to this comes from a bunch of time making video games: people generally really *like* simplified models that make clear what you should do next. Game players often claim they prefer more opacity in the name of “realism” - but titles that try to provide such are generally punished in the market.
The idea that “if you clear away a knowable number of weeds and grow a knowable number of turnips, Mineral Town will definitely be revitalized” seems to be a very appealing fantasy for a lot of people not involved in accounting at all.
I have never heard of the Ricardian fallacy before and it definitely resonates--it is also the curse of consultants. (I've created those toy models before that didn't really capture a business but captured what was easy to measure.) And I didn't know about your Brompton book--the transition from piece work to line work is painful.
“understanding the numbers has to come from understanding the business. People go badly wrong when they try to do it the other way round”
I'm a working commercial real estate appraiser. The above sentences nicely summarize the difference between intelligent commercial real estate appraisers who are good at the job, and intelligent commercial real estate appraisers who are bad at the job. (Dumb appraisers are a dime a dozen and they understand neither the business nor the numbers.) There are some smart appraisers out there who have mastered all the mathematical tricks to generate opinions of value ... but sometimes following the numbers leads you to very strange places, and if you don't know the business, you won't know you went astray. Sometimes the smart appraisers trust the math so foolishly that they mess up worse than any dumb appraiser ever could!
Always a good idea to pay attention to the flow of causation when choosing a variable to control. You should do a post on perceptual control theory.
I like this idea but it would require more bluffing than (even) I am comfortable with! why don't you do the post and I'll link to it ;-)
Touché
I have two points to make.
First, financial accounting is designed for lenders dealing with the short and medium term. It is reasonably fit for purpose. It is of only limited use for equity investors, and of no use for managers. But top management these days seems more concerned with managing investors than their business. There is a reason the CFO is the #2 glamour job in a big corporation. It is not a good reason.
Second, the Ricardian fallacy is a form of physics envy, not shared so much by physicists. Eugene Wigner once wrote an article: "The Unreasonable Effectiveness of Mathematics in the Natural Sciences". Or there is the line attributed to Ludwig Boltzmann: "Elegance is for shoemakers and tailors."
I'd definitely agree with the first there - financial reporting is only one kind of accounting, and not the relevant kind for most people, but it's the kind of accounting that you *have* to produce for legal reasons and so, since accounting is expensive, the temptation to use it for things it wasn't meant for is powerful
I have been CFO'ing or investing in high capex, complex solution companies for all of my career.
It took me about 20 years to provide a solution which meant that I never again heard the line from an account holder (person responsible for a significant piece of spend) "I don't recognise those numbers, they came from finance."
The downside is that when you sit with hedge fund analysts post-results it's very difficult to reconcile P&L's to real world activities.
FWIW the solution was a "controlled" Excel environment with templates co-designed by the account owner. It also reduced monthly/quarterly budget meetings to - "let's focus on that number - everything else seems in line" and even my children began to recognise me.
super interesting - that sounds like exactly the solution everyone needs, but I guess most firms aren't prepared to make the investment
I am randomly in an old post but my personal response to this comes from a bunch of time making video games: people generally really *like* simplified models that make clear what you should do next. Game players often claim they prefer more opacity in the name of “realism” - but titles that try to provide such are generally punished in the market.
The idea that “if you clear away a knowable number of weeds and grow a knowable number of turnips, Mineral Town will definitely be revitalized” seems to be a very appealing fantasy for a lot of people not involved in accounting at all.
I have never heard of the Ricardian fallacy before and it definitely resonates--it is also the curse of consultants. (I've created those toy models before that didn't really capture a business but captured what was easy to measure.) And I didn't know about your Brompton book--the transition from piece work to line work is painful.
Is this an example of Donald MacKenzie's models are engines not cameras idea? (or maybe he is referencing someone else's idea...)