How Open Should You Be About Your Firm's Finances?

We live in different times. Just twenty years ago it wasn't uncommon for the team to have no idea what the hourly rate was, they weren't allowed to see proposals, and they certainly had no idea how a firm was performing financially. It was a minority of firms that operated that way, but it illustrates how radically things have changed.

Now you'll find a fair percentage of firms who share the books openly and salary levels are shared internally.

Is this good for us as principals? How open should you be? What else do you need to do if you're going to be "open book" about your firm's performance? This is a long article, so just set it aside and come back to it if it doesn't interest you at the moment, but I do think that there's a lot of nuance that we need to consider. So grab some coffee—this is going to take awhile. And if you prefer listening to a podcast on the topic, instead, Blair and I did an episode four years ago that sort of skimmed the surface.

The concepts behind open book management (OBM) have been around for quite some time, but as an identified management discipline it’s only been with us for a few decades. Most firms still have "closed" books except for mainly top line revenue; others like the idea but aren't sure if they want to open that can of worms; and few are doing it really intentionally. My goal is to help you think through it, and then help you do it well. I think you should probably be more open about how your business is doing.

What is OBM

OBM is not just opening your financial statements, though that misconception would be common. It’s about much more than that, which is partly what makes this topic so appealing.

Financial Information

First, it covers sharing financial information, obviously. Most of this information is on financial statements, but much of it is not. For example, you might talk about utilization, the cost of mistakes, or the profitability of certain client segments. This ancillary data is based on financial statements, but OBM goes further than the statements themselves by explaining what the data means and how individual activity affects it.

Decision Making

OBM also involves giving some decision making authority to those whose performance drives the numbers. In other words, OBM is not just “opening the financial books” but “managing openly” so that it’s less of a top-to-bottom arrangement.

Rewards

OBM also involves some degree of tying rewards to company, group, and individual performance. This makes more sense in an OBM environment because people understand where the company is and how their individual actions affect that position. You can see this in a crude way: if a sales person is compensated on new business, they want to see an accounting of all the new business they have brought in, and they want to have some input in the marketing plan.

Understanding

We shouldn’t use information to intimidate, control, or manipulate people, though unfortunately this happens quite frequently. We should instead teach them how to work together to achieve common goals and thereby gain control over their lives. At least to whatever extent that is possible. They might do everything perfectly and still get laid off, but at least it won’t come as a surprise if they are operating within an OBM environment!

Nevertheless OBM is largely financial. There’s no way around this, either. Whether you are comfortable with it or not, numbers are still the language of business and the currency of success. If you make lots of money, you won’t necessarily be happy. Good business people don’t just make money—they make money without giving up happiness.

Frankly, I would welcome a return to more emphasis on numbers in our management practices. With a few exceptions, there is too much “rah rah” and too little emphasis on numbers. Too many hollow cries of culture and not enough about running a stable business. It’s okay to do white water rafting for a weekend, climb simulated mountains on a local wall, bring a yoga instructor into your office, or sponsor Friday afternoon beer parties, but you can’t forget one thing. You can’t forget to make money to stay in business. Emotions have a legitimate role, but not at the expense of numbers, which are less likely to lie to you.

To OBM or Not

It was hard to know whether or not OBM was a fad, but now there is no question that it's here to stay. This is a genie you can't put back in the bottle, and employees bring these practices with them from job to job, raising the median. They are also the next generation founding firms like yours, and there's much less mystery around money.

It’s not about whether you use OBM or not, either, but rather to what degree you use it. We are all on a continuum. At one end we might only disclose that we are “having a good (or bad) month.” Further along we might talk about specific sales numbers. At the end of the spectrum everyone will see the financials and be privy to compensation arrangements.

If you implement OBM, you should do so because you think it fits your style, not because you think it will bring better results. And just to save you the trouble of looking it up, you’ll be hard pressed to find published data that shows significant improvement in profitability within OBM environments. That shouldn't be the reason.

To dig a little deeper on that point, even one of the largest proponents of OBM (the National Center for Employee Ownership) is forced to admit that they only see a 1-2% increase in sales (over the experience of non-OBM companies) . They have more data than any other organization, and their perspective is promotional, so there you have it.

Think about the examples of large flops that were employee owned and used OBM as a management tool (two things frequently found together): United Airlines, Hertz, etc. These are not stellar examples for us to emulate.

Another reason principals wrongly flirt with OBM is this notion that employees will now have the information (and incentives) to manage themselves. That's not happening, either.

Even proponents of full OBM really don’t practice it fully, though they will be loathe to admit this. One noted expert on OBM says that compensation levels should be kept confidential. He cites pay scales that are a jumble of seniority, skills, special deals, historical accidents, favoritism, and bureaucracy. But isn’t that the point? That men and women in the aisles will see this stuff and help root it out? After all, compensation is typically at least 45% of your expenses, and any serious attempt at controlling expenses must look at this area.

This just demonstrates that we all draw the line in different places. Personally I cannot recommend that you publish compensation data. When employees know what others make (except for direct managers), it usually means that we have a bad morale problem that has led to this comparison. It also means that nothing good can come of it, if only because we cannot easily separate assigning work value and personal value.

Stepping back and looking at the landscape, it’s clear that companies are doing better. They are providing better quality and better service, all within better cost structures. Competition and technology are powerful shaping forces.

But people aren’t doing as well. They are sometimes anxious and frustrated. They are viewing employers with increasing mistrust and misgiving. They are cynical, and their icon is Dilbert. Something must be wrong, so let’s move to the theory behind OBM and see if you buy it.

Theory Behind OBM

Access to information is control. Control allows change. Change allows happiness, only because we all want impact.

As you may have found, corporate reorganizations or deep work with a management consultant are self-limiting because they do not take place from the bottom up. Management consultants work from outside, and reorganizations take place from above.

You (as in “you” the manager) can only accomplish so much because there is only so much you can control. Ultimately, I suppose you could fire everybody, but there is a certain diminishing payout with that approach. Once you’ve got your systems humming again, your mistakes low, and your quality high, there’s just not much left to fix in a lasting way. And of course your better competitors have already done pretty much the same things that you have, to a greater or lesser degree.

Your performance may be as good as theirs, but it’s not likely to be measurably better. From this point forward there are only a few things left to boost performance over the long term, and one of those things is to have employees work enthusiastically and effectively and to take responsibility for their own work. Good procedures are indispensable. But what makes the difference in the end is whether the employees doing the job think about doing it just a little better and even care whether they do or don’t do it better.

Having said this, somebody still needs to lead, and your employees are probably not entrepreneurial leaders or they wouldn’t be working for you. So let’s not fool ourselves and go too far. “Animal Farm” doesn’t even work in a book, even though Andy Law tried it with a real firm in London.

But if you do want that edge, it just might be openness in your management environment. You have muttered this, right? “I just wish they would think like owners.”

Openness really is ownership because we are talking about ownership of information, ownership of responsibility, and ownership of results. An open environment provides all participants with an understanding of the intent of their organization. And it also provides them with the capacity to comply with that intent, if they wish, and then be accountable.

After all, when you understand, agree with, and have the capacity to comply, it’s pretty hard to hang around and not embrace the organization’s intent. That's what the Blessing + White people meant when they coined the phrase "quit and stay".

Advantages

There are many advantages to a more open approach to management. The specific ones will vary based on your circumstances, but these three will probably be universal.

Less Taking for Granted

Most people don’t understand that 45% (or more) of gross profit goes to salaries and that up to 40% of net goes to taxes (depending on your structure and compensation methods). Until they learn otherwise, they might very well assume you are making lots more money than you really are.

They also don’t know things like what retained earnings are or how a company might be making money but still be cash poor temporarily. They don’t necessarily appreciate how a mistake comes straight out of profit and how thin margins really are. Did you understand that stuff before you owned your own company? Did you ever complain about things, “unhindered by data”?

Fewer Rumors

In the absence of real facts, people tend to fill the void with rumors about all kinds of things. You can set the record straight easily and let employees concentrate on other things, like not filling out their timesheets.

Bigger Perspective

As you talk through the numbers and your plans to deal with them, people will begin to see the connection between their activities and the bottom line. You will also give them a sense of ownership because they understand and have impact.

All this teaches them that to be a viable company we need profit. Our survival and comfort depend on it. Sure, people are frequently told what to do in an eight hour day, but they aren’t shown how that activity fits into the bigger picture. For example, what does the team know about your client mix strategy? How you think about when to hire instead of using that contractor?

Disadvantages

On the other hand, there are three very significant fears that keep most owners from employing a more open system. My guess is that you’ve already thought of each of these already. But let me lay them out and then provide a bit of perspective on them. Here we are talking specifically about the financial component of OBM, though obviously there are other parts to a new, “open management” style.

Competitors Will Take Advantage

Once you print something out and give it to an employee, there is a legitimate fear that a competitor will get it (often when the employee becomes disgruntled or is talking with a friend who works with your competitor). But what really happens when a competitor gets your numbers? If they aren’t great, they’ll dismiss you. If they are great, they’ll have the results, not the methods. And if they don’t adopt your methods, it won’t matter. Our segment in the world of service industries is uniquely insular. We should get over this.

Employees Will Start Their Own Company

Some owners are most afraid of their most competent employees, certain they have taken the job only to leave and begin their own company with the new found knowledge you have provided. For one thing, you can’t really prevent this. And a “close to the vest” style will likely hasten their departure. For another, sharing honestly what it takes to run the company might dissuade them from starting their own! It’s a fact that many young entrepreneurs underestimate the capital, energy, and wisdom required to turn opportunity into money. Give me the choice between a stale company with employees who hang around forever and a dynamic place where team members cycle in and out rapidly, and I'll take the latter any day of the week. Let it happen. Be a place where you mentor entrepreneurs and share with them generously.

Employees Will Apply Undue Pressure

As Jack Stack, the founder of OBM, points out, a lot of companies hide their financials not because they’re afraid of their competitors, but because they’re afraid of their employees. They don’t think people will understand the numbers, and there’s some truth to that. If you don’t show employees how to use financial information as a tool to help the company, they might well use it as a weapon against the company. But you might be better off in the long run being open with some financial information. When the numbers are hidden, people make assumptions, and they’re often crazy ones. Nine times out of ten, people think a company has a lot more money to spend on wages and salaries than it does.

Even with good education, some employees might pressure you to spend money differently, like less money given to you and more to them. But explain that money comes from work, ownership, and risk. All three of those apply to you, and only one to them (work). Besides, in most non-OBM companies, they still want more money, right? In other words, everybody wants more money, but in a more open system you’ll have an answer more likely to quell their restless hearts.

You can see that on their own these are not good reasons to dismiss a more open environment out of hand.

Why OBM Is Hard To Do

With these obvious advantages, and having answered at least part of the objections, why is implementing OBM so difficult to do? I’ve noted three reasons in working with various entrepreneurs. These are in addition to the disadvantages noted above.

First, entrepreneurs don’t let go. They are control freaks, and as long as they control information they can control the decisions.

Second, entrepreneurs crave independence. They don’t want to “build consensus” and stop for obstacles. It’s easier to filter the data and ask people to take statements at face value rather than pause to give people a chance to digest and then approve. And what if they don’t approve? Entrepreneurs would rather ask forgiveness than permission.

Third, it only looks more difficult in a small company. Nearly all the big companies that disclose financials are the publicly held ones, and that only because they are required to do so by the SEC. Of course they are generally run by non-entrepreneurs, which makes it even easier to comply.

Small Company Issues

Speaking of implementation issues unique to small companies, here are three important guidelines.

Top Down

You must be excited about this. If another party, whether a group of managers or a group of employees, is pushing you toward this, it will fail. You can still be skeptical but you have to believe it’s the right thing to do. If there are others with you in the management group, there should be a clear consensus to do it.

Whole Company

You can’t do this just by department—it must be for the whole company. One of the most frequent disputes is over how to allocate overhead expenses, and there will be too many disagreements about who should be charged with the conference room, the copy machine, and the new server. Any open book system smaller than an entire company will only work in very large companies with very clear divisions.

Maturity First

You need to make sure that your company is ready for the increased scrutiny and that there is as little room as possible for confusion. To do this, make sure you are receiving regular, accurate financials. Those financials should reflect only company transactions, too. In other words, don’t intertwine your personal life. Get those personal cars and loans and expenses off the corporate books. The six minutes you discussed the marketing plan with a drink in your hand on the beach of Cancun was not a business meeting.

You’ll also want to spend some extra time making sure your managers understand the new data at least as well (and hopefully better) than the employees will.

And finally, make sure that the financial data you will be talking through is forward looking. In other words, include not just historical data, but also budgets, cashflow projections, and something about your planning process.

Your Motivations for Implementing OBM

All this to say that you should think carefully about why you are doing it. List the reasons for yourself, then ask yourself which ones are part of a larger philosophical picture versus a more momentary need.

In other words, this is much easier to do when things are bad and you need everybody’s help. But how will you feel when things are good and the disparity between your compensation and theirs has widened again?

So you now have an inkling of whether you want to do this, but you still need to make absolutely sure you're doing it for the right reasons.

Specific Reasons to Do It

There are typically four things that motivate such implementation. After boiling down all the philosophy, the bottom line looks like this. One of the reasons is bad—really bad—and the other three are good.

The first good reason to implement OBM is to clarify goals and align interests. In other words, you are telling employees what you expect, how to measure it, and what results will be achieved if these goals are met.

The second good reason to implement OBM is to improve the bottom line. After all, the primary form of measurement is financial, and so the results should be obvious. And the new results should benefit both management and employees.

The third good reason to implement OBM is to turn people loose and let them flourish because they will see the results of their actions, which is a basic human need. Economists call it "agency".

A Specific Reason Not To

But there is one very dangerous reason to implement OBM, and it is based on the belief that more information will create a “self-managed environment.” This is precisely where OBM fails because it expects results from a management system that can only issue from managers (vs. systems). In other words, OBM is a system which helps managers do a better job, not a system which lessens the need for management.

Management is more about making distinguishing decisions in an environment not conducive to it than it is putting systems in place that effectively “self-manage” people. If self-management were effective, every one of you would have such a system in place. Unless we recognize our tendency to insulate ourselves from the down and dirty side of management, we will waste precious effort on systems that are doomed to fail from the start.

Many of our management practices—including OBM to one degree or another—are meant to insulate us from the need to manage. They are disguised as “good management” when in fact they are not. For example, we create over-complicated employee manuals so that we can point to a page when any question surfaces. Or we install a simple formula for bonuses and invoke it once a year just before Christmas.

We don’t dare think of this as a great way to motivate people. Good management should strive to create equal opportunities without setting everyone on an equal plain.

“Distinguishing decisions” are the choices you make about how well people are living up to their potential, and OBM will not relieve you from the duty to keep making these decisions. If you are typical, you have strong feelings about the extent to which this is true for each employee under your care. But you are not trusting your instincts, leading to inaction. Being fair and being even are different things. Make distinguishing decisions and you’ll be as close as you should be to the practice of management. On the other hand, without frequent use of this management muscle, it will grow limp and increasingly ineffective.

So let’s agree that we aren’t trying to turn our people into rats who will run the maze with a smile on their faces. Nor are we trying to avoid the inevitable grayness otherwise called management. Instead, we are trying to do the right thing, looking for ways to clarify our expectations of people and to say thank you when they meet them. We are also trying to give them the tools to take more personal control of their environment. But OBM will not necessarily remove some of the need to manage people.

An Effective Environment

Now to the implementation of an OBM system. The place to start is with an environment that complements the system instead of nullifying any benefits it might bring.

This is important because unless there is a good environment employees won’t believe the numbers, and unless they believe the numbers this won’t work. There is no amount of disclosure that will reassure a skeptical employee if only because all of them are self-generated.

This skepticism is not unfounded in companies with difficult management environments. For too long numbers have been used to punish, supervise, intimidate, and control. In this case, though, we are talking about education. To be more specific about what it means to create an effective environment, here are some specific suggestions.

Assess your company. Look it over from top to bottom, assessing how effectively your company is poised to embark on some change. Do this yourself or hire an outsider to take a look.

How’s the morale? What would you change about your company? What would employees change? If you have to guess at their answer to this last question, why is it that employees fear being forthright with you? If I want to quickly assess the morale in a company, I typically just ask about it in a confidential employee survey, and usually employees are honest about it. But the best way to get at that information through the back door is to ask how conflicts are handled. Poorly managed environments sweep conflicts under the rug, or they are handled in a manner that is not appropriate (too publicly, through the wrong medium, etc.).

How’s the infrastructure? Do people know who their single supervisor is? Is that supervisor really managing people, or just providing technical advice on how to do things? Do you see accurate, timely numbers? Do you understand them and believe them yourself?

Have you gone through some big changes recently? These might include the loss of a key employee under less than stellar circumstances. Or a move into new facilities that required far longer than you would have liked. Or very poor results that fall far outside the norm. Or a divisive employee retreat. Or a controversial new personnel policy. How good a job has your company done in the past at adapting to change? Sure, OBM requires more change on your part than on theirs, but there is some adapting that needs to come from all quarters. I would draw your attention to one very significant point: by definition an entrepreneur’s tolerance for change is far greater than the tolerance of an average employee.

Working through these questions will help you predict the success of a more open environment. Where is your company right now? What major events have you faced recently? How well do your employees adapt to change? The main point is that you must be willing to address the larger context in order to give OBM a fighting chance to succeed.

From a helicopter view, employees need recognition, security, opportunity, money, time, and flexibility from you, and the most successful movements toward OBM are built on an otherwise stable environment.

Degrees of OBM

It may hearten you to know that OBM doesn’t mean going from your current closed system to sharing everything! There are many degrees of OBM, and there is no necessary correlation between “more open” and “better environment.” There are two things to consider in this regard.

First, decide who will be involved. The choices are obvious: owners, the accounting department, key managers, and then pretty much everyone else on the team. You could also throw in clients and competitors if you want to be comprehensive while you're at it.

Second, decide what information you will divulge. While you could obviously divulge all of it, few firms do. Instead, they pick and choose elements that are appropriate for their situation. This list is organized from “less risky” to “more risky” as generally perceived by principals.

Hourly rate

This is first because it’s the first baby step on the continuum of having a more open environment. Unbelievably, about 5% of firms attempt to hide their hourly rate structure from employees. Not only is this futile (how silly is it to keep something you reveal regularly to prospects from the people you work with?), it is counterproductive. The message it screams is paranoia. It also says “you aren’t smart enough to know that an hourly rate assumes a certain amount of overhead and corporate profit.” (Besides, the more successful your firm, the less your hourly rate matters anyway because that's not how you price things.)

Proposals

In the same vein, about 10% of firms don’t want employees to see proposals, thinking they’ll be inspired to go out on their own and “capture all that money.” They also fear that employees who could otherwise get things done quickly, will “use up all the time if they knew how much I allowed.” I would guess that employees are more sophisticated than that.

AGI

This is an abbreviation for “agency gross income,” composed of your fees and markup profit. It is also known as revenue, gross margin, or gross profit. It is taken from your income statement, and is generally a pretty “safe” number to reveal because in doing so you are not required to reflect any compensation related data or net profit. (Note that total revenue is not on this list. It’s a meaningless number since it might include large amounts of pass through income that distorts the picture.)

Income Statement

Your income statement shows all revenue, less all expenses, yielding net profit, for a given period of time. Because it reveals compensation levels—even if only in a large lump sum—and net profit, even principals who conduct a more open environment draw the line here. In other words, they reveal their hourly rate, proposals, and AGI levels, but not their income statement data.

Balance Sheet

Your balance sheet describes what you own, what you owe, and the difference between them (your equity). Many principles resist showing this because they are afraid it will make them look “rich” and because balance sheets are not easily understood by folks who haven’t been around financial statements. Terms like “retained earnings” or "paid in capital" are inscrutable to the average employee.

Compensation

Sharing this information would typically mark the most aggressive point on the continuum, and less than 1% of firms do it. No matter what we want in people, they still tend to impute value based on compensation values.In general I do not think it's helpful or healthy, though I'm in favor of publishing salary ranges for specific roles.

If all this seems overwhelming, here’s a simple suggestion. At a minimum, share your hourly rate, proposals, and AGI with all employees. Share your income statement and balance sheet with key, trusted managers. Obviously they will also know compensation of their direct reports, which might be as far as you want to go in sharing that data.

Assembling Your Own System

We have just looked at the typical financial data that is shared. It’s a place to start, but most people don’t understand financial data, and they certainly don’t understand what it means and how their actions impact it. For these reasons I would suggest that you develop your very own dashboard.

The dashboard in your car is not designed for you specifically. If it were, the gauges that mean the most to you would be positioned front and center, and their relative size would complement their relative importance. In much the same way, consider designing your own financial dashboard. The key is to choose meaningful metrics and then explain them carefully to employees.

What are these critical numbers? The answer depends on where you are and what you are struggling with (which suggests that they will change over time). These are the movements in your firm that are preventing you from being successful or helping you keep the success that you enjoy. And they can almost always be measured in financial terms.

But of course these should be part of a larger plan so that you don’t fixate on them. And what is that plan, by the way? What you want to watch has everything to do with where you want to go. If you are not interested in getting bigger, don’t talk all the time about gross revenue; instead, concentrate on net profit.

Not only should you be strategic in setting your measurements (concentrating on what you want to see change over time), but you should also be dynamic (watch it regularly) and holistic (what other plans will we need because of these efforts?).

After you’ve decided what to measure, set a benchmark or a goal for each number. You might even want to establish a time frame within which you’d like to meet the goal.

Next, identify the operations that affect this measurement. These are performance drivers. To illustrate, if we want a higher net profit, we’ll need a combination of these things: higher estimates, fewer expenses, fewer mistakes, less wasted time, etc. To achieve a greater cash cushion, we’ll need to take more cash in than we expend without incurring long term obligations. That means greater profitability and harder work or much smarter pricing.

Then after listing all the possible factors that might affect the outcome you desire, identify the best current opportunities and weaknesses that could be exploited. These will be the first places to concentrate as you chase the goal.

Next, track these metrics regularly. Report to the interested parties with a simple cover summary, backed up by lots of detail for those who are interested. Educate in the reporting, because financials will not be useful unless they are understandable, timely, unbundled (by department, if that applies to your situation), and with an element of forward looking.

Meetings are generally the best places to disseminate this information because they allow you to capture reactions and answer questions in real time. But also use bulletin boards, big charts that make a single point, intranets, handouts, newsletters, and emails. You are always anticipating questions. What does this mean? How will my actions affect the bottom line?

As you open the books, so to speak, tell them the stories behind the numbers. Let the data serve as a discussion point about what you really want to talk about.

Finally, after things have settled down and people begin to learn this new language of open book management, consider tying some compensation to financial metrics.

Starts at Hiring

Whatever the extent to which you implement OBM, make sure you begin the orientation to that system at the hiring stage. In other words, tell people that “we do this here,” showing them what types of information they’ll be privy to and how it might be interpreted.

If they are hired, provide extensive training during the orientation process. Of course include a statement about non-disclosure in your employee agreements.

Transitioning to a Greater Degree of OBM

As illustrated above, OBM does not necessarily mean that you’ll open your books to all employees. It’s more about a style of management that is more inclusive and participatory.

If you aren’t interested in taking any big risks, get your feet wet by first talking about the cost of health benefits. See how employees react to the disclosure short-term, and then gauge if it affects their behavior long-term.

If you want to take it a step further, you’ll find that OBM works best if these things are true at your firm.

• First, everyone should understand what the company must do to be successful.
• Second, make sure everyone is involved in the goal setting process. This will help with the next point.
• Third, everyone should understand their individual role in achieving the goals that define “success.”
• Fourth, problem solving and decision making should be done at a level closest to the issues to be solved. This assumes, of course, that the employees have the bigger picture.

The point is that OBM is not an “on” or “off” proposition. It’s just a greater degree of openness.

Fallacies

There are several things you’ll want to keep in mind, particularly if you think OBM will solve everything. There are three things I’d urge you not to assume.

• First, don’t assume that people will act smarter with information. Even trade groups (like the National Center for Employee Ownership) can’t show more than a few percentage point gain in profitability when employees know the numbers.
• Second, don’t assume that every employee will be fair. Some people will misuse the information and you must be prepared for that and stick to your plan regardless.
• Third, don’t assume that people will not measure each other’s value with financial criteria, whether that’s compensation data (which you shouldn’t divulge) or sales or client conversion or whatever else can be expressed in numbers.

What would I do in your shoes? I would have completely open books to the entire team, rolling up compensation data into one big number.

Best wishes on your critical quest for a more satisfying management experience, for you and others.