Beyond The Numbers
When Strategy Overcomes Theory
When I studied Economics in college, there was one phrase that really troubled me. I spent hours and hours reading and practicing an econometric model that was supposed to simulate what happens in real life. But when I got to the end of the chapter or essay, there was a section titled “Empirical Evidence” and it read “The empirical evidence suggests that this does not happen the way the Economic Model predicts in its entirety”. The first thing that popped into my mind was why did I even bother learning this model? What I didn’t know at the time was that in business, there are many other real life factors that are not covered in the theory and this is when a strategic mind comes in handy. I’ll give you two quick examples.
Investment Examples
During a Project Financial Evaluation class in my MBA, the teacher had us calculate the IRR (Internal Rate of Revenue) and the NPV (Net Present Value) for an investment a company wanted to make. After calculating these numbers, we would discuss whether or not to make the investment or not. Since the NPV was negative, meaning that the project did not create enough value to compensate for its investments, it seemed like a no brainer. Me, and most of my classmates, said no.
At the end the teacher showed us that the company went ahead with the investment. I was baffled. Why did they do such a thing that was clearly not profitable? The teacher explained that: “If they hadn’t made that investment, they wouldn’t have landed a strategic partner in that country and wouldn’t have been able to expand throughout the rest of the region”. This was college all over again, but it made sense. Sometimes you have to go beyond the numbers to make business decisions, which I think is one of the hardest things to do as a business owner/manager.
Debt & Interest Examples
The other example has to do with debt and interest. A client of mine asked for my opinion on which loan to take from the bank. Both had the same interest rate and loan amount, except that one lasted for three years and the other lasted for six years. In theory, you want to take the cheapest loan possible (including all other charges and fees) and the one that imposes the less fiscal effects on your company.
I had a bit more experience around this time, so I asked to look at his financial statements before giving my answer, specifically the Cash Flow Statement. After analyzing this, I suggested they take the 6 year period loan, even though they paid more interest on it and find out if they can cancel the loan before it is due without significant fees. The reasoning behind my logic was simple. After analyzing their cash flow statement, they simply could not afford the monthly installments on the 3 year period loan. They would have been well beyond their payment capacity. This shows you that having up to date financial information about your company helps you narrow down on decisions that, on the surface, seem to be logical.
How Can You Apply This To Your Business?
Theory is not always practiced in a straightforward way in businesses. It all depends on your current strategy and your current capacity (i.e. debt, cash, etc.). But you can’t just wing it. The only way you can give a certain degree of confidence to your decision is by analyzing accurate financial & commercial data on time. Being information a decaying asset, the sooner you have it about your company, the better decisions you can take (hopefully). Otherwise, you end up loosing a strategic partner or taking the “cheaper” loan without being able to pay the monthly installments.
How about you? Have you ever had to choose strategy over theory in your business? Tell me about your experience in the comments below or write me an email at info@thefinancecourse.com.
Giancarlo Jiménez, founder of The Finance Course, is a Finance Professional with more than 11 years of experience in the field of Finance and more than 4 years of experience teaching about Corporate Finance in a Business School. Want to learn how to interpret Financial Statements & Ratios to make decisions at your small business? You can Sign Up To The Free Course by visiting this page.
