“I’ll leave all this financial mumbo-jumbo to the green eye shades guys. I am going to focus on selling good products. The financial results will follow!” Three months after these words were said, by the CEO, the company ran out of money and was out of business. As the airline pilot uses the gauges to understand how the plane is performing, an executive must use financial information to make sure the company is performing as expected. Anyone who leads a business or evaluates businesses should have a basic understanding of the financial information that reflects the performance of the business.
Business executives don’t have to become experts in financial accounting practices as a partner in an accounting firm does. But, executives should understand the basics of a financial model. The fundamental concepts that should be understood are:
- Departmental budgeting — reflecting all the costs and expenses that will be incurred by a functional department of a business, like development, marketing, sales, operations, manufacturing and administration. Each of the department budgets has unique expense items that have to be estimated.
- Cash and accrual accounting — determining the manner in which you are going to account for your actual revenue and expenses. You can choose to account for transactions on a cash basis; that is, when you actually get the money or pay the money. Or, you can account for transactions when they are incurred, accruing for the eventual receipt or payment of cash.
- Revenue planning — portraying the details of when and how a sale is accounted for as revenue, how and when it is collected, the implications of credit and the payment of sales taxes. The process of claiming revenue has to be clearly understood, and is quite complex especially in software businesses.
- Inventory management — to insure that your business is not spending cash unwisely by producing too many finished goods or stocking too may parts.
- Financial statements — these seemingly convoluted calculations show how the company is performing, like the dash board of your car shows how your car is running. There are three reports that an executive should intimately understand:
- Cash Flow — shows the usage of cash, and summarizes, month by month, how much cash there will be at the end of each month. For a start up company, this is the most important report of all. Without proper monitoring and management, a company can run out of money. It’s both rough and embarrassing to run out of money, and nobody sees it coming. Achieving and maintaining positive cash flow is the name of the game.
- Income and Expense — reflects all the income of the company, the costs of the products and services sold, the expenses incurred by all departments within the business, and summarizes both before and after tax profit.
- Balance sheet — summarizes, at specific points in time, the status of the assets, liabilities and stockholders equity of the company. The overall health of the company is shown in the balance sheet. An executive can see the nature of all the assets of the company, like cash, inventory, property and accounts receivable. This is weighed against all the company’s obligations, like accounts payable, debt and stockholder’s equity.
Learning about these basics is important. It can be easily achieved by reading a basic accounting primer, taking a business accounting course, and attending financial seminars. Take the time to it. If you are in the drivers seat of a business, you need your dash board of financial information to steer you company in the right direction. You most important task is to insure that the business has the financial resources to execute the business plan, and that all spending is kept within the bounds of the financial plan.
PART TWO, tomorrow: “Financial Models.”
Bill Warner is managing partner of Paladin and Associates. You can reach him via e-mail (email@example.com)