Good Critical Thinking Requires Knowing Why

One of the most needed skills in analyzing a credit request is good critical thinking.  This skill is hard to develop, and many analysts will often take the easy road in reporting what is obviously apparent in the numbers.  Stand-alone comments like “sales went up by 10%” or “net profits were down by 4%” is what we call elevator analysis.  The write up that is filled only with this offers no real value over just a mere presentation of the financials spread in multiple columns for the reader. 

One of the best ways lenders can show real value is not only to use good critical thinking tools in the analyzing of a credit, but to also share these questions with the client to help them to better understand and improve their business.  Often, the business owner gets stuck in all the day-to-day minutia of opening the doors, making sure the equipment is running, keeping adequate staff, or responding to emails.  Staying in this low road every day, prohibits the business owner from rising above to get a critical look at their company.  Even the best run companies often fail to rise above and study.

Steven Covey categorized time spent in good critical thinking as that in Quadrant II of a four-part time division.  Quadrant II represents things that are very important but are not often urgent.  We tend to spend more time on the urgent flashing light in front of us since that must be accomplished now.  At times, when the urgent has passed, we may gravitate to things which are not important and not urgent since completing those items give us a sense of accomplishment.  But those items do not move the needle of true value. 

Since most business owners or employees in a company have a hard time practicing good critical thinking on their own firm, the lender can add real value with sincere questions to help understand what is driving the business.  Now these questions should be tempered with an honest desire to lean about the business and its owners.  It is essential to understand both to have an accurate credit recommendation for approval or proper management strategy for an existing loan.

Whenever you are presented with a company’s financial status, you need to understand why things are the way they are.  Mike Figliuolo believes that the question “Why?” must be asked at least five times in order to gain true insight into the root cause of the problem and gain real insight.  Sometimes these questions may help the business owner know what items are needed to make good decisions to positively change the business direction.

One example I can cite is a horizontal contractor who experienced large losses in some subdivision work during the economic crash.  The request came in for an additional loan or some payment relief to help them through this problem.  But to grant that without fully understanding why would be of no service to the bank or the customer.  I armed myself with the initial financial spreads of the company as I sought to learn more.  Our conversation went something like this.

Customer: “We need payment relief since we took losses on these three subdivisions.’

Me: “Why did you take the losses?”

Customer: “Because we did not get paid fully for our work.”

Me: “If you have the ability to bill during the project, why weren’t you able to recoup more of your costs?”

Customer: “Because the job had such a low margin and we also had to make concessions on payment terms in order to get it.”  Here was insight number one, the company needed to change the way they progress billed for construction work.  I had this nugget after the second why!

Me: “Why did you take a job with such low margins?

Customer: “We need to discount to get the job.”

Me: “Why is it important to bid a job that is not profitable just to get it?”

Customer: “We need to continue to keep our employees busy or they will go to work for someone else.”

Me: “Why can your company be viable in the long term if you bid projects cheaply that will not cover costs if there is a payment hiccup?”

By this time, we uncovered the following:  1.  They needed to change how they billed for jobs and try to at least recapture their costs sooner in the job.  2.  They were chasing after low margin work, when they had higher margin corporate and government jobs waiting for them.  3.  Keeping a large staff busy may not be the best option to maintain the company into the future.  None of these insights would have been discovered if I stayed at the top request for payment relief or a new loan and did not do the deep dive into why.

The owner took these suggestions to heart.   They purchased new bidding software, set a minimum profit threshold and began to pass up jobs that were not up to their profit standards.  They changed their progress billing methods to recapture more of their costs earlier in the job.  Then they began to look at idle workers and shrunk their workforce because of less work they were doing, and they also sold a division of the company which diverted their time and attention from their core business.  Slowly, the business returned to sound financial footing.

Often, when you are first presented with a credit request or the need to understand a business financials you are seeing a symptom and not understanding the real cause.  Diving down into multiple layers of “Why?” will help you uncover the truth behind the initial statement.  Using this skill can also help you immensely in your own business and life.