Why financial literacy is essential for all decision-makers
Apart from strong strategic and leadership skills, those who want to make it to the top of the career ladder will, above all else, need one thing: a comprehensive understanding of finance. Executive search experts all agree on that. Yet, financial literacy is essential not only for CEOs and CFOs but also for COOs, Heads of HR and Directors of Marketing & Sales, as Prof. Jakob Müllner, Academic Director of the Professional MBA Finance, explains in this article.
Money makes the world go round - and it keeps the economy going. Financial aspects come into play in all matters relating to business decisions and their short-term as well as their long-term effects on performance. The same holds true in the context of exercising budgetary responsibility, and with regard to market entries and exits, innovation-related investments and risks, project costs and profit margins, share-price plunges and damage control.
But where there is finance, there needs to be financial knowledge - and that knowledge is more complex than ever. “The factors time and risk are at the center of finance,” says Prof. Jakob Müllner, Academic Director of the WU Executive Academy's Professional MBA Finance. Long gone are the days when program participants used to work primarily in banking. Today, the MBA attracts students from virtually the entire spectrum of industries and functions.
Prof. Jakob Müllner
How much risk should businesses take when it comes to investing in markets and innovations? How much profit can they expect to make in what contexts in fiercely competitive markets? Why are financial decisions influenced by big data? Knowing all this requires a thorough understanding of financial mechanisms - especially against the backdrop of a business world that is getting more and more complex as a result of globalization and digitization.
That's not the only reason, though, that finance is becoming increasingly attractive: “After the financial crisis, this fundamental area is on the upswing again - partly because of the rise of the fintech industry,” says Jakob Müllner. The growing popularity of finance is also illustrated by “Tomorrow’s MBA”, a recent survey carried out by CarringtonCrisp, a consultancy: Apart from IT, finance is the topic that prospective MBA students are the most interested in. And there is a revival of interest in corporate finance. 632 respondents from 56 countries were interviewed. To put it in a nutshell, all executives and decision-makers in a company - and especially all members of the C-suite - must have a thorough understanding of finance. What exactly this implies and what they need to focus on in particular, depends on their respective positions.
CEOs need to bring many skills to the job: They have to keep their finger on the pulse of the market and its future development, are required to steer the strategic orientation of the company and must think entrepreneurially. According to an analysis by Heidrick & Struggles, as many as one Fortune 500 CEO in three originally pursued a career in finance, but only 5% of the CEOs were CFOs directly before taking the helm of the company. 20% of them have a background in marketing and sales, and more than half worked in an operational role, such as COO or President, immediately prior to becoming CEO. This goes to show that making things happen at the operational level, thinking strategically and having an extensive knowledge of finance are key factors when it comes to achieving success as a CEO. A good CEO's skills must also include a comprehensive understanding of the mechanisms of the company's capital structures, of financing and of cost and risk factors. “Financial decisions have a direct and massive impact on how a company is doing,” says Jakob Müllner. The fact that a clear corporate-sustainable-responsibility strategy demonstrably makes companies act in less risky a manner should also set CEOs thinking.
Particularly widespread in the U.S., the central function of chief operating officer is becoming more and more common in Europe as well. The COO is literally the CEO's right hand. He or she executes the corporate strategy and manages day-to-day business operations. The COO is also responsible for translating strategic decisions into reality, for negotiating with stakeholders and for ensuring that the company grows in a financially profitable and effective manner. As COOs are involved in the daily business, they see the direct side effects and unfavorable consequences of strategies and can take action to remedy them. Because the COO works very closely with the CEO, it is necessary for him or her to understand, and put into the right context, the financial implications and possible risks of entrepreneurial decisions. “Therefore, COOs need a good grounding in corporate governance and thus in stock corporation law and market capital law. Frequently, the COO supports the CEO in raising venture capital, which is why he or she should know how to evaluate investment decisions. A thorough understanding of corporate finance is a tremendous asset in this context,” explains Prof. Müllner.
Initially, one might think that it is not essential for him or her to be financially literate. However, that's not true because it is in marketing and sales in particular that many classic mistakes are made if people lack financial know-how: “When it comes to exporting to countries with high-interest currencies, many M & S executives make the mistake of using current exchange rates as a basis for calculations,” explains Prof. Müllner, adding that often it is several months before payment is due. Forward contracts are a way of hedging against exchange-rate fluctuations, but it is important to know what foreign-currency risks one can take, for: “The longer the delivery time and the period allowed for payment, the bigger the difference between forward rates and the current exchange rate.”
In HR departments, there is a lot of talk about incentivizing people by means of compensation models and bonus systems. “HR directors should know what financial contracts can have what effects,” says Jakob Müllner. The financial crisis made it clear that linear bonus systems for managers in the banking sector had an undesirable side effect: The prospect of getting a bonus made them significantly more risk-loving than was good for many organizations. Compensation models have a direct influence on people's motivation and how they work with one another. Instead of using linear bonus systems, it may be better to incentivize people by means of non-linear systems, such as variable compensation in the form of securities or stock options. “In the course of the MBA Finance, we discuss, among other things, option pricing methods, making it possible for our students to deepen their understanding of how to design these financial contracts in such a way that they are particularly valuable,” says Jakob Müllner.
As a rule, (future) chief financial officers have a proven track record in finance. Hence, one might assume that it makes no sense for them to enroll in an MBA in finance. That said, they have to tackle increasingly complex challenges: The pressure in terms of costs and efficiency is mounting, and it is becoming harder and harder to stay on top of the market and the, at times, disruptive competition. According to a recent survey by PwC, a management consultancy, 86% of German CFOs reckon that, using data-based strategic consulting, they will, by 2025, add significant value to the management of organizations - in other words, they see themselves as even more of a strategic partner of CEOs than they currently are. Against this backdrop, an MBA in finance is a better investment than ever for CFOs: It allows them to develop their understanding of entrepreneurial as well as strategic aspects and provides them with an opportunity to put their financial know-how into a broader management context. “During the ‘Computational Finance’ module, for instance, our students acquire technical skills as well as a practical understanding of handling big data and of data analytics - that is to say of things such as calculations and estimates done in the context of company valuations or takeovers and mergers,” explains Jakob Müllner.
For more information about the Professional MBA Finance, please click here.