Finance leaders know that history is an imperfect guide.
When delivering executive education sessions to senior executives, I often start with a simple question. What is the difference between finance and accounting? I’ll get varied answers from different groups, but typical responses are as follows.
I’m often told that accounting is bean-counting. It deals with actual results. It is frequently described as ‘just bookkeeping’. Accounting deals with numbers rather than decisions. It is static not dynamic. When I probe further and ask for terms that come to mind, examples will include ‘tactical’, ‘GAAP’, ‘inventory’, ‘financial statements’, and ‘tracking cash’.
Finance, I’m often told, is about decision-making. Sure, it’s also about numbers. But it deals with risk and value-creation. Terms often associated with finance include ‘strategic’, ‘ROI’, ‘discount rates’, ‘PP&E’, and ‘investments’.
These analyses are too narrow. The truth is temporal: accounting is about the past; finance, the future. Accountants focus on what happened last month, last quarter, last year. It is scorekeeping. And we love to keep score and focus on results.
Finance considers what you are going to do next month, next quarter, next year.
Value says that a company is worth the sum of its future cash flows, not its historical cash flows. What you did last year is far less important than what you’re going to do next year.
We look at the past to give us an understanding of what could happen in the future. Yet the past rarely repeats itself exactly. Whatever comfort accounting records might give leaders, history is an imperfect guide. You cannot drive a car by looking through its rearview mirror.
Because accountants tend to look backwards, they trade on certainty. And because finance looks forward, it deals in uncertainty. In forecasting, we consider likely outcomes, probabilities of success, and possible scenarios. Thus, finance’s core currency is the calculation of risk.
In 2021, AbbVie had one of the bestselling drugs in the world. Its anti-inflammatory drug Humira had approximately $21.2 billion of sales. By 2026, Humira sales are expected to drop to approximately $5.6 billion annually: its patent will expire, allowing competitors into the market. Investors are thus reluctant to celebrate AbbVie’s success in 2021; they worry about how AbbVie is going to replace $15 billion of expected sales loss due to its expiring patent. Retrospective scorekeeping tells the wrong story about AbbVie’s prospective performance. It obscures the real financial challenges facing the company.
In contrast, chipmaker Nvidia reached a $1 trillion valuation in 2023. Looking at its 2022 results, you would struggle to grasp this valuation. In 2022, Nvidia reported revenue of approximately $26 billion and operating profit of approximately $9 billion. Impressive results – yet hardly worthy of a $1 trillion evaluation. Yet by 2027, Nvidia is expected to report $109 billion in revenue and $59 billion of operating profit. It is that staggering growth that is leading to its breathtaking valuation. Artificial intelligence is booming, and most AI is being processed in the cloud. Nvidia’s chips are well-suited to processing AI – data centers cannot get enough of them. Of course, no forecast is guaranteed, but the widespread expectation that Nvidia’s sales will grow exponentially has triggered huge financial success, leading to that $1 trillion evaluation.
The British novelist LP Hartley once noted that, “The past is a foreign country; they do things differently there.” He was right about that. History is known, but it is asymmetric to the present, and alien to the future.
As a leader, it is important that you keep a foot in both lands – the known past, and the unknown outlook. Businesses always keep score – that is why accounting is a very important discipline. Yet value comes not from what has been, but from what will be. The secret to financial leadership is to future-gaze – and be proved more right than you are wrong. You can never, though, be certain.
Professor Joe Perfetti is innovation fellow at Duke Corporate Education.