The Algorithm Blog

Physics and Financial Reporting

One of my downtime activities is doing dot-to-dot puzzles.  Not the ones of puppies or sail boats from elementary school, but 1000 dot recreations of classic art masterpieces or landscapes.  I love connecting the dots and seeing a new picture emerge. 

I try to apply that mindset everywhere I go and in everything I do.  How about connecting some dots with me?

The 2nd Law of Thermodynamics and Financial Reporting? 

Heat_flow_hot_to_cold.pngYou probably just laughed at me.  That’s okay.  It’s not as big of a stretch as you might think.  Let’s get started.

I have always loved physics, I don’t understand a good deal of it, but I have learned that there are laws and theories in physics that you can apply to other areas of life and business.  One of these is the second law of thermodynamics. Here is a laymen definition from Kevin Wandrei on Seattlepi.com.

The second law of thermodynamics says isolated systems gravitate to a state of maximum disorder.

To better understand the second law, I want to make sure we define an "isolated system."  

An isolated system is one that does not exchange energy with its surroundings, either incoming or outgoing.   A simple way to think of this is the analogy of an overflow pond.  With no fresh water feeding it, eventually, it becomes stagnant, loses its ability to sustain any life, and eventually dries up.

Now that you have had your mini physics lesson, let’s connect the dots. 

Largely, financial statements are standard documents.  Balance sheets show a company’s financial position and income statements show the results of operations. 

There may be different presentation formats, but all in all, there is little variation.  Oftentimes, the management team will find a format that shows them what they want to see, possibly with some comparative columns, and that becomes their truth. However, businesses evolve, surroundings change, information needs change, and different perspectives are required to accommodate the change. 

When financial reporting remains unchanged for a long time, it becomes an isolated system—like the stagnant pond in our analogy above.  The financial information, and thus the decisions it supports, begins to be less effective.

Financial planning & analysis (FP&A) can take over where accounting leaves off. 

Accounting focuses on an accurate presentation of the results of operations and financial positions and without accounting, FP&A is of little use because the information available is suspect at best.  However, implementing FP&A in a business is no small undertaking and requires skilled personnel, solid systems, a strong technology platform, but most of all, a recognition that there is a need to explore change.

I look forward to starting a discussion on FP&A and helping you get the most from the great work your accounting department does.  Among other things, we will be discussing incremental changes, skill sets, what you can do to drive deeper analysis, and how to enable all of that with technology.

Stay tuned.

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