Finance & Measurements, as Taught by Eli Goldratt · Lesson 1 of 8
Finance, the score-keeper
Finance does two jobs: it monitors the money, and it provides the judgments that steer every big decision. Goldratt's question is whether the trouble lies in late, inaccurate data, or in the judgments themselves. A cautionary tale of a CEO rewarded for driving his company towards bankruptcy.
Brightline Components, a maker of industrial assemblies. The quarterly board meeting.
CEO: “Our numbers come too late and they’re never accurate. I can’t steer a company on last month’s guesses.”
Comptroller: “It takes weeks to collect and process the data. We need a new, robust computer system.”
Helen Park, the new CFO, writes the request down. Later that week she asks Ruth Adler, the TOC coach the operations team has been working with, whether a new system will fix it.
Ruth: “Before you buy anything, tell me: what does your department actually judge?”
The two jobs of Finance
Ask what Finance is responsible for, and most people list the first job:
- Monitoring the money: payroll, payables, receivables, the relationship with the bank.
The second job matters far more:
- Judging major decisions and actions. Finance is the organisation’s score-keeper. And judgments, especially numerical ones, dictate behaviour. In Goldratt’s phrase: tell me how you measure me, and I’ll tell you how I’ll behave. So the judgments Finance provides have a crucial impact on how the whole organisation performs.
The five judgments
| What Finance judges | How it is judged today |
|---|---|
| The performance of the company as a whole | The financial statements: balance sheet, profit and loss, cash |
| Investment in equipment | Return on investment, from the cost savings it brings |
| Make or buy | Comparing the purchase price with the internal cost |
| Subsystems | Declaring them profit centres, each with its own P&L |
| Product and service viability | Calculating a “product cost” for each one |
Is the problem the data, or the judgments?
The common complaint is that the information comes too late and isn’t accurate enough, and the common fix is a new computer system. Goldratt asked a sharper question: are the main problems the timeliness and accuracy of the judgments, or are the judgments based on wrong measurements, so that faster and more accurate data only produces wrong answers faster?
His answer was blunt. He called the current measurements enemy number one of productivity. And he set out to prove it.
A cautionary tale
In his broadcasts, Goldratt described the fate of a very large company. Here is the shape of the story. A CEO took over and set about improving profitability, guided by three conventional judgments:
- Make or buy. He compared the cost of each part the company made with the price of buying it outside. Where buying was cheaper, he outsourced it and trimmed the internal operation accordingly.
- Justifying investment. He examined the biggest investments and set out to exploit them as much as possible. Assembly plants were told to keep producing, even if it meant producing for stock.
- Judging the company as a whole. At year end, the financial statements showed the company had made more money. The CEO was rewarded for his initiatives.
Within a few months it became clear that the initiatives hadn’t improved the company at all. They had nearly driven it into bankruptcy.
Pause and think: each judgment the CEO used was conventional and carefully calculated. What does the outcome suggest?
- The data he used was out of date by the time each decision was made
- He made arithmetic mistakes
- Each of the three judgments contains a major distortion
- Outsourcing never works
Make-or-buy “savings” that didn’t materialise. Investments “exploited” into stockpiles. Financial statements that showed profit while the company was weakening. If every conventional judgment pointed the wrong way, the distortion is in the judgments themselves, not in the speed or accuracy of the data.
The rest of this course goes through the judgments one by one: what is wrong with each, why companies keep using them anyway, and what to use instead.
Check your understanding
Answer all five. Get four right to complete the lesson.
1. Finance’s most influential job is…
- Payroll
- Judging major decisions and actions
- Dealing with the bank and the shareholders
- Collecting receivables
Judgments steer the behaviour of the whole organisation.
2. Investment in equipment is judged today by…
- Added sales
- Its effect on the constraint’s capacity
- Market share
- Return on investment from cost savings
We’ll test that judgment in lesson 3.
3. Product viability is judged today by…
- Calculating a product cost
- Throughput per constraint unit
- Customer surveys
- Sales volume
Goldratt called it the most cherished sacred cow in industry.
4. Goldratt’s claim about the usual fix, a better computer system, was that…
- It solves the problem, since better data gives better decisions
- It is too expensive
- The real problem is wrong measurements, not late or inaccurate data
- Data doesn’t matter
Faster wrong answers are still wrong.
5. In the cautionary tale, the financial statements…
- Showed the decline early, but nobody acted on them
- Showed more profit while the company was being weakened
- Were falsified
- Were not used
The judgment of the company as a whole was distorted too.