But it isn’t just a matter of scoring well on a test; financial literacy brings with it a host of benefits. Here’s a short list of the advantages you’ll gain.
Increased Ability to Intelligently Evaluate Your Organisation
Do you really know if your organisation has enough cash to make salary and wage payments? Do you know how profitable the products or services you work on really are? When it comes to capital expenditure proposals, is the return on investment analysis based on solid data? And is it even the right measure to base your decision on? And, by the way, how is it even calculated? Boost your financial intelligence, and you’ll gain more insight into questions like these. Or maybe you’ve had nightmares in which you worked or were on the board of Enron, or South African Airways, or maybe Steinhoff. Many of the people there, including board members, had no idea of their companies’ precarious situations.
Suppose, for instance, you worked at the big telecoms company WorldCom (later known as MCI) during the late 1990’s. WorldCom’s strategy was to grow through acquisition (that is, buying other companies). Trouble was, the company wasn’t generating enough cash for the acquisitions it wanted to make. So, it used shares as its currency, and paid for the companies it bought partly with WorldCom shares. That meant it had to keep its share price high; otherwise, the acquisitions would be too expensive. It also meant keeping profits high, so that Wall Street (the main financial district in the US) would give it a high valuation. WorldCom paid for the acquisitions through borrowing. A company doing a lot of borrowing has to keep its profits up; otherwise, the banks will stop lending it money. So, on two fronts WorldCom was under severe pressure to report high profits. Add to that the fact that top management are rewarded mainly for delivering on the corporate strategy.
That, of course, was the source of the fraud that was ultimately uncovered. The company artificially boosted profits “with a variety of accounting tricks, including understating expenses and treating operating costs as capital expenditures”, as BusinessWeek summarised the US Justice Department’s indictment. When everyone learned that WorldCom wasn’t as profitable as it had claimed, the house of cards came tumbling down. But even if there hadn’t been fraud, WorldCom’s ability to generate cash was out of step with its growth-by-acquisitions strategy. It could live on borrowing and stock for a while, but not forever.
Or look at Tyco International. For all the news stories about Dennis Kozlowski’s (former CEO of Tyco, who was later convicted in 2005 of crimes related to his receipt of $81 million in unauthorised payments, and so on) elaborate birthday party and zillion-dollar umbrella stand, there is another story that wasn’t widely reported. During the 1990’s, Tyco also was a big buyer of companies. In fact, it acquired some six hundred companies in just two years, or more than one every working day. With all those acquisitions, the goodwill[1] number on Tyco’s balance sheet[2] grew to the point where bankers began to get nervous. Bankers and investors don’t like to see too much goodwill on a balance sheet; they prefer assets that you can touch (and in a pinch, sell off). So, when word spread that there might be some accounting irregularities at Tyco, they effectively shut off Tyco off from further acquisitions.
Now, I’m not arguing that every financially intelligent manager would have been able to spot WorldCom’s or Tyco’s or Steinhoff’s precarious situations. Plenty of seemingly savvy Wall Street or JSE types were fooled by the three companies. Still, a little more knowledge will give you the tools to watch trends at your organisation and understand more of the stories behind the numbers. While you might not have all of the answers, you should know what questions to ask when you don’t. It’s always worth your while to assess your company’s performance and prospects. You’ll learn to gauge how it’s doing and to figure out how you can best support those goals and be successful yourself.
Better Understanding of the Bias in the Numbers
What will understanding the bias do for you? One very big thing: it will give you the knowledge and the confidence – the financial intelligence – to challenge the data provided by your finance and accounting department. You will be able to identify the hard data, the assumptions, and the estimates. You will know when your decisions and actions are based on solid ground.
Let’s say you work in operations, and you are proposing the purchase of some new equipment. Your boss says he’ll listen, but he wants you to justify the purchase. That means digging up data from finance, including cash flow analysis for the machine, working capital requirements, and depreciation schedules. All these numbers – surprise! – are based on assumptions and estimates. If you know what they are, you can examine them to see if they make sense. If they don’t, you can change the assumptions, modify the estimates, and put together an analysis that is more realistic and that (hopefully) supports your proposal. Sibongile, for example, likes to say that she’s a veteran finance professional and could easily come up with an analysis showing how her company should buy her a R30,000 computer. She would assume that she could save an hour a day because of the computer’s features and processing speed; she would calculate the value of an hour per day of her time over a year; and presto, she would show that buying the computer is a no-brainer. A financially intelligent boss, however, would take a look at those assumptions and propose some alternatives, such as that Sibongile might actually lose an hour of work a day because it was now so easy for her to surf the net and be on social media.
It’s amazing, in fact, how easily a financially knowledgeable manager can change the terms of discussion, so that better decisions get made. When he worked for Ford, Khaya had an experience that underlined just that lesson. He and several other finance people were presenting financial results to a senior marketing executive. After they sat down, she looked straight at them and said, “Before I open these finance reports, I need to know… for how long and at what temperature?” Khaya and the others had no idea what she was talking about. Then the light went on and Khaya replied, “Yes, Ma’am, they were in for two hours at 400 degrees”. She said, “Ok, now that I know how long you cooked them, let’s begin”. She was telling the finance people that she knew there were assumptions and estimates in the numbers and that she was going to ask questions. When she asked in the meeting how solid a given number was, the finance people were comfortable explaining where the number came from and the assumptions, if any, they had had to make. The executive could then take the numbers and use them to make decisions she felt comfortable with.
Absent such knowledge, what happens? Simple: the people from accounting and finance control the decisions. I use the word control because when decisions are made based on numbers, and when the numbers are based on accountants’ assumptions and estimates, then the accountants and finance people have effective control (even if they aren’t trying to control anything). That’s why you need to know what questions to ask.
The Ability to Use Numbers and Financial Tools to Make and Analyse Decisions
What is the ROI of that project? Why can’t we spend money when our company is profitable? Why do I have to focus on accounts receivable when I am not in the accounting department? You ask yourself these and other questions every day (or someone else asks them – and assumes you know the answers!) You are expected to use financial knowledge to make decisions, to direct your subordinates, and to plan the future of your department. I will show you how to do this, give you useful examples, and discuss what to do with the results. In the process I will try to use as little financial jargon as possible.
For example, let’s look at why the finance department might tell you not to spend any money, even though the company is profitable. I’ll start with the basic fact that cash and profit are different. I’ll explain later why, but right now let’s just focus on the basics. Profit is based on revenue. Revenue, remember, is recognised when a product or service is delivered, not when the bill is paid. So, the top line of the income statement, the line from which you subtract expenses to determine profit, is often no more than a promise. Customers have not paid yet, so the revenue number does not reflect real money and neither does the profit line at the bottom. If everything goes well, the company will eventually collect its receivables and will have cash corresponding to that profit. In the meantime, it doesn’t.
Now, suppose you’re working for a fast-growing business-services company. The company is selling a lot of services at a good price, so its revenues and profits are high. It is hiring people as fast as it can, and of course it has to pay them as soon as they come on board. But all the profit that these people are earning won’t turn into cash until thirty days or maybe sixty days after it is billed out! That’s one reason why even the CFO of a highly profitable company may sometimes say, don’t spend any money right now because cash is tight.
Although this course focuses on increasing your financial intelligence in business or in a not-for-profit, you can also apply what you’ll learn in your personal life. Consider your decisions to purchase a house, a car, or a boat. The knowledge you’ll gain can apply to those decisions as well. Or consider how you plan for the future and decide how to invest. This course if not about investing, but it is about understanding company financials, which will help you analyse possible investment opportunities.
Better Career Prospects
A demonstrably better understanding of the numbers can’t hurt your career prospects. Imagine the shock on your boss’s face if you made a case for a raise – and part of your case included a detailed analysis of the company’s financial picture, showing exactly how your unit has contributed. Far-fetched? Not really. The same goes for when you apply for that next job. Hiring experts always job seekers to ask questions of the interviewer – and if you ask financial questions, you’ll show that you understand the financial side of the business. You might also save yourself some pain by analysing the financial position of your next employer, and perhaps finding out that its not such an attractive prospect after all.
[1] Goodwill comes into play when one company acquires another company. It is the difference between the net assets acquired (that is, the fair market value of the assets less the assumed liabilities) and the amount of money the acquiring company pays for them. For example, if a company’s net assets are valued at R1 million and the acquirer pays R3 million, then goodwill of R2 million goes onto the acquirer’s balance sheet. That R2 million reflects all the value that is not reflected in the bought company’s tangible assets – for example, its name, reputation, customer lists, and so on.
[2] You’ll learn about a balance sheet later, but it is part of the financial statements of a company and reflects the assets, liabilities and owner’s equity at a point in time. The balance sheet is called such because it balances – assets always must equal liabilities plus owner’s equity.
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