The “Laws” that Support the Profitability Analytics Framework

The word “law” has two quite distinct meanings. It may describe arbitrary regulations made by human consent in particular circumstances for a particular purpose, and capable of being promulgated, enforced, suspended, altered, or rescinded without interference with the general scheme of the universe. On the other hand, the word “law” is also employed to designate a generalized statement of observable fact.

In the first sense we may talk of tax laws, generally accepted accounting principles, or the rules of baseball. Such laws frequently prescribe that certain events will follow upon certain others; but the second event is not a necessary consequence: the connection between the two is purely formal. For example, if a fielder catches a batted ball before it touches the ground, the batter is “out.” There is, however, no inevitable connection between the capture of an in-flight baseball by a leather glove and the return of a human body from a patch of freshly mown lawn to a hard wooden bench. The two events are readily separable in theory. Should the rule-making body of baseball chose to alter the law, no cataclysm of nature would be involved.

In the second sense, we talk about the laws of nature. Such laws cannot be promulgated, altered, suspended, or broken at will; they are not laws at all in the sense that the laws of baseball or tax laws are laws. They are statements of observable facts inherent in the nature of the universe. Anybody can enact that murder will not be punishable by death; nobody can enact that the swallowing of a glass full of pure hydrocyanic acid shall not be punishable by death. In the former case, the connection between the two events is legal – that is, arbitrary. In the latter case, it is a true causal connection. The second event is a necessary consequence of the first.

The Profitability Analytics Framework has been designed to aid decision makers in developing the kind of comprehensive and relevant decision support information they need to optimize their organizations’ financial performance. It not a “method” like ABC, TOC, Kaizen, or the Balanced Scorecard. Instead, it is a comprehensive strategic management framework that encompasses revenue, cost and investment management – all three factors that determine return on investment – and addresses management’s need to formulate, validate and execute the organization’s strategy. At its core are causality-based models that reflect the fundamental laws of nature that underlie the organization’s operation, not arbitrary regulations prescribed by rule-making bodies or general formulas developed by subject matter experts.

Those causality-based revenue, operating, and investment models must be populated with data that also reflects laws of nature, not laws of man. This is especially true for expense and cost data. Financial accounting’s definitions of investment and expense must be reconsidered and modified. Investments must include those made in both tangible and intangible resources. Financial accounting’s need to assign “sunk costs” to future financial periods eliminated. A forward-looking replacement for depreciation that effectively measures the funds that need to be accumulated to preserve the existing capital base must be developed. Cost of capital must be recognized as a true cost of business. In short, financial accounting conventions which reflect laws of man must be replaced with economic laws of nature.

“Methods” such as those mentioned earlier can be used to effectuate portions of the Profitability Analytics Framework, but they are no substitute of the comprehensive view of the organization’s operation provided by the Framework.