Page 120 - (DK) The Business Book

118 INTRODUCTION

inance has always been finance, in other words, when business owners, particularly when
seen as having two distinct they do not report loss-making the failing institution has been a
F functions: recording investments on the company’s bank. Some financial commentators
what has happened (financial balance sheet, thereby appearing wonder whether the balance has
accounting) and helping businesses to boost profits. This leads to an swung too far away from tradition.
to make decisions about the future important question in relation to
(management accounting). Today, modern business: who bears the Director involvement
it has a third function: financial risk? Traditionally it was assumed When times are tough, directors
strategy. This incorporates that the risk taker was the have to make difficult decisions
judgments about risk, which some shareholder, because it is the about investment and dividends.
companies (especially banks) shareholders who collectively own Usually the directors will have an
have realized must play a larger the business. However, in Europe agreed policy in place—perhaps
part in financial decision-making. and the US especially, the desire that half the after-tax profit will be
to encourage entrepreneurship has paid as dividends to shareholders,
Understanding risk led to generous rules that reduce the while the other half will be retained
Fundamental to an understanding extent to which losses are borne by to invest in future growth. But
of financial strategy are the business owners. Since 2008, many during recessions it is wise to keep
concepts of leverage and excess business collapses have proved more cash within the business, so
risk. “Leverage” is a measurement expensive for customers, staff, directors may decide that dividends
of the extent to which a business and suppliers, but less so for the should be cut. If the business also
is dependent upon borrowings. cuts its investment plans, it can
The higher the leverage, the greater keep more cash in its current
the level of risk. In good times, account, providing the liquidity to
directors come under pressure to survive difficult trading conditions.
produce impressive profit growth, So who is responsible when
and one easy way to achieve it The bonus mania which things go wrong? This depends on
is to borrow money and invest caused the recession could the systems of accountability and
in the most profitable parts of the never have happened without governance within each company.
business. However, if the economy corrupted accounting rules. Ideally, the directors of the business
turns downward, toward recession, Nicholas Jones should be sufficiently involved to
heavy borrowings turn into know when things start to go wrong,
UK film maker, ex-accountant
an overwhelming burden. and call for discussion of a change
Leverage becomes toxic. in strategy. If the directors are too
The risk level generated hands-off, they may feel unable
by leverage is worsened when to hold the CEO fully accountable
businesses use off-balance-sheet when things do go wrong. Alert,