A Q&A with Wharton's John Percival on how corporate financial needs meet with security department goals.
How do you justify a budget request for purchasing new security equipment or hiring new staff? In some companies, security does not get the resources it deserves because executives are not skilled enough at making the financial and strategic case for their priorities. We spoke recently with Wharton Adjunct Professor John Percival, who teaches in the Wharton/ASIS Security Executive Program, about why security executives need financial knowledge and what they need to know.
Why is financial knowledge important to security executives?
These executives are running a service organization within a larger business. They have to compete with other divisions within the organization for resources. How can you show the resources would be best invested in your area? To make your case, you need to be able to speak the language of finance. You may have a good case, but it will not be heard unless you know how to communicate it properly.
How can an executive make a case more effectively for investments in security?
It is important to understand the overall financial objectives of the organization. The company may be seeking to earn a rate of return on total investment that is greater than 12 percent at the same time that it grows at 10 percent per year. It is important to understand that larger story and be able to articulate the role that security is going to play in achieving it.
Security investments are often seen as a necessary expense. How could you make the case that an investment in security could contribute to the company's overall rate of return?
It may not seem like security investments could explicitly earn a 12 percent rate of return, but implicitly they might. For example, these investments in security might make employees feel more secure. Insecure employees could have a higher rate of turnover, and this creates costs for hiring and training new employees. Thus a higher sense of security could reduce turnover, reducing costs, and contributing to returns. Or, if better security can reduce shrinkage in inventories, this can also reduce costs and increase rates of return. It is not always possible to make these arguments-but you should at least be able to think in this way.
What are some of the differences in how finance and accounting executives think about investments?
There are a number of differences. They make a sharp distinction, for example, between expenses that hit the current income statement in full and those that are capitalized over time. Expensing and capitalizing have a very different impact on the rate of return. Imagine you are investing in security technology that would mean you need fewer security personnel. The salaries for the personnel would hit in full for the current year while the equipment could be capitalized and written off over a period of time. You have to understand the scorekeeping and rationale of finance people. They do not always think about things the way other people do.
What are some other ways that finance people think differently about investments?
They make a distinction between profits and cash flow, and they think about both. They also look at the time value of money. We also have a wonderful tool called discounted cash flow. In making an economic rationale for investing, we need to look at the time involved to achieve returns. It is OK to say you have to wait for a return, but we have to ask how long the wait will be and what the return is. A dollar spent or received five years from now is not the same as a dollar today.
Some executives, particularly those who come from non-financial backgrounds, find finance complex and intimidating. Is it possible for anyone to learn this?
The analogy is like learning to play tennis or golf. You can gain a certain level of expertise quickly. If want to be really good at it, then it gets much harder. You put in a lot more time and effort for smaller gains. It can be very complex at some level, but it does not have to be that complex. The finance sessions during the Wharton/ASIS program are not designed to convert participants to finance experts but to get them fairly quickly to a level of competence so they have the confidence to interact with finance people. You understand what it is that you do know and what you don't know.
You talk about the intersection of strategy and finance in your program session. In many organizations, these are seen as separate worlds. How are finance and strategy related?
We look at the objectives of the organization and how we achieve those objectives. That is the link between finance and strategy. I tend to be more practical about strategy than strategy people are. For example, some people in strategy may say "strategy is a series of questions." You may start with a series of question, but I am concerned not only with the questions of strategy but also the answers we come up with. This is a more practical approach.
How do you explore financial issues during the Wharton/ASIS program?
There are two parts. We spend time reading financial statements and looking at discounted cash flow. This offers an applied look at how to read, interpret, and understand these statements. This helps make participants better at reading them, understanding the thought process and language of finance, and making their own financial arguments. We also look at case studies to show how these concepts play out in a broader strategic context. A lot of this comes down to using finance to make your arguments more effective.