"You may be a great salesperson or an inspired engineer. You may be terrific with customers and employees. Your concept for a company is probably fantastic. But if you don’t know finance, you’re operating at a disadvantage in the world of business."
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Do you know what your burn rate is?
What about your cash conversion cycle?
Are you surprised that your company is running out of cash even though it’s profitable?
These questions, and more, are answered in Financial Intelligence for Entrepreneurs as Karen Berman and Joe Knight, founders of the Business Literacy Institute, break down what the numbers in your business really mean.
They walk through, step-by-step, how you can analyze your company’s Income Statement, Balance Sheet and Cash Flow Statement to really understand how your business is performing and how you can make more informed, and better, business decisions.
And no, you don’t need an MBA in Finance to understand all of it either.
But before you get caught up in calculating profit margins, return on assets, days sales outstanding and other critical ratios, it’s important to understand one fundamental principle: “finance is as much an art as it is a science.”
The Big Idea
Learn the Art of Finance
"The art of accounting and finance is the art of using limited data to come as close as possible to an accurate description of how well a company is performing."
I think we can all agree that 2 + 2 = 4.
But when it comes to the world of business finance, it’s not that clear cut.
“[bookkeepers and accountants] can’t know exactly what everyone in the company does every day, so they don’t know exactly how to allocate costs. They can’t know exactly how long a piece of equipment will last, so they don’t know how much of its original cost to record in any given year… Accounting and finance are not reality, they are a reflection of reality, and the accuracy of that reflection depends on the ability of bookkeepers, accountants, and finance professionals to make reasonable assumptions and to calculate reasonable estimates.”
Understand the Assumptions & Estimates
"If you aren’t aware of the assumptions and estimates that underline the numbers and how those assumptions and estimates affect the numbers in one direction or another, your decisions may be faulty."
Bookkeepers, accountants and other financial professionals in your organization make various assumptions and estimates when they prepare financial statements such as the Income Statement.
And it’s crucial to the success of your business that you understand what these assumptions and estimates are because these are the numbers you use to make daily decisions on the direction of your business.
Let’s look at an example that Karen and Joe share in the book:
“Imagine, for instance, that you run a business that resells specialized telephone equipment to local customers. Most of your customers buy the equipment with a maintenance contract, and the whole thing is wrapped up in one financial package. Now, suppose you deliver the equipment in October, but the maintenance contract is good for the following twelve months. How much of the initial purchase price should be recorded on the books for October? After all, you haven’t yet delivered all the services that you are responsible for during the year. Your accountant can estimate the value of those services, of course, and adjust revenue for October accordingly. But this requires a big judgment call.”
As you can see, even seemingly simple questions like “When is a sale a sale?” require some assumptions to be made. And if you take the example above one step further and realize that you most likely pay out sales commissions and bonuses according to how and when revenue is recognized, you begin to see that these assumptions have a significant impact on how you run your business.
So make sure you speak to your bookkeepers, accountants and other finance professionals to understand what the numbers in your financial statements really mean. Your business depends on it.
Follow the Open Book Management (OBM) Philosophy
"As everyone learns the numbers, people begin to take responsibility for making the numbers move in the right direction, in accordance with monthly or quarterly goals that they help set."
Once you understand the assumptions and estimates being made, you’ll get a better feel for the numbers and be able to make more informed decisions for your business.
But don’t stop there. Karen and Joe recommend that you not only share the financial information with your employees, but you also help them learn what the numbers really mean and how it affects their roles.
In fact, they recommend developing a strategy for developing a financially intelligent company from top to bottom. This strategy might include:
- Delivering three short training sessions (30 to 60 minutes long), where each session focuses on a single financial concept (i.e. one on income statement, one on cash flow and one on the balance sheet).These courses can be offered on a monthly basis and can be taught by you first.
- Have weekly numbers meetings where you share your organization’s key numbers with your employees.
- Use visual aids like scorecards and/or money maps to reinforce the key numbers to be aware of.
Now, I understand that there are different rules governing what financial information can be shared if you’re a public or private company, so keep those rules in mind.
The underlying philosophy here is that by being as transparent as possible with your numbers, your employees are not only more knowledgeable about the direction of the business, but they’re also able to make better and more effective decisions in their daily duties as a result (which is why you’ve hired them in the first place).
In fact, Joe followed this exact principle in his company Setpoint, and it helped him get through times of difficulty and crisis when his accountant thought they wouldn’t survive.
“You know, I think the reason why you get through these difficult times is because you train your employees and share the finances with them. When times are tough, the company rallies together and finds a way to fight through it.”
Understanding the numbers is critical to the success of any organization. Of course, with the limited time you already have as a busy entrepreneur, you may not have the time to get your MBA in Finance. Thankfully, Financial Intelligence for Entrepreneurs is there as your guide to the hidden language of Finance.
“Financial information is the nervous system of any business. It contains the data that shows how the business is faring – where its strengths are, where its weaknesses are, where its opportunities and threats are as well.”