How ChE Prepared Me for Business (and How It Didn’t): Finance

Most engineers I knew in my MBA program went into finance. It's not too surprising: you need to be analytical and highly skilled in Excel. Our academic cousins in physics were applying differential equations at Long Term Capital Management (the case study for "math gone wrong"), and prior to the housing crisis Wall Street was even hiring engineers without their MBAs (article). But there is a difference between finance for the Street and the finance used to drive operations. We'll focus on the latter and how it ties into our fundamental building block for ChE: The Material & Energy Balance.

The first concept we learn in ChE

Having spent time in my professional career in sales, marketing, and business development, I know that any audience can be lost in 30 seconds if you don't resonate with them immediately and succinctly. The first thing we learn in ChE: "You don't get something for nothing."

Officially the material and energy balance states that:

Massin - Massout = MassAccumulated

Energyin - Enegryout = MassAccumulated

The material and energy (M&E) balance really teaches us that nothing is for free:

  • You want to leave your TV on: your power company will burn gas to generate electricity and produce CO2.
  • You want to make biodiesel from corn: you will be spending resources to make the corn and even more to refine it.
  • You want to use nuclear energy to make electricity versus coal: you'll be trading off a decreased CO2 footprint with the cost of nuclear waste treatment.
  • You want to acquire a company: you'll need to incur debt, dip into reserves, or cut operations to break even.

How the M&E Balance applies to companies

Companies and non-profits (including governments when they aren't printing money) also follow a financial balance:

$in - $out = $Accumulated

The M&E Balance is so core to the ChE training that it's become a second nature template I use when analyzing any business organization's strategy. Understanding the financial balance leads to the fundamental questions being asked: How do you bring money in? What are your costs? How much are you making?

Most financial models used to justify business plans, or solicit funding, incorporate the time value of money = money is more valuable now than later. Ultimately you are trying to optimize the financial balance, whether it's for earnings now, or future earnings based on your current actions:

?$in - ?$out = ?$Accumulated

The art of finance is in the present and future valuation of an activity or event when there may not be a natural price tag. The amount of liberty with assumptions made in corporate finance would make any engineer initially squeamish, but the financial balance is a great place to start.

This formulation is basic, and obviously common sense, but you would be surprised with how effective a lens it is in tackling business strategy and operations. The financial balance lets you focus on the fundamentals of the business and prevents you from getting lost in the weeds: "How do you make your money, and what does it take to do so?"

Advanced M&E: Application to an industry

When you feel comfortable with the financial balance, pair it with stakeholder motivation analysis and you can understand most business' behaviors and strategies. Let's take a look at the primary financial drivers in the insurance industry using the financial balance:

$in - $out = $Accumulated

$in = Premiums, Investments

$out = Claim Payments, Fraud, General Operations

For publicly traded insurers, Wall Street is expecting $Accumulated to increase every year. So they need to increase $in (charge more for policies), or decrease $out (pay fewer claims). Given the fundamental financial drivers in health insurance, and the need to make a profit to satisfy shareholders, it's no surprise that health insurance costs to consumers (primarily premiums) have consistently outstripped inflation (article).

We could easily spend the next 12 posts on applying the financial balance to the banking system, or how to build an effective five-year business model, but we'll continue with a discussion of how the M&E balance relates to marketing. Marketing isn't just about advertising, it's about getting more customers and keeping the profitable ones. Another way for an insurance company to increase $in: get more customers, or change the current customer base (risky -> safer).

Using the financial balance, what are the key financial drivers of the industry you work in?

Photo: Robert J.Pennington,
(C)2011 Arkan Kayihan, used with permission