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Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean
Companies expect managers to use financial data to allocate resources and run their departments. But many managers can't read a balance sheet, wouldn't recognize a liquidity ratio, and don't know how to calculate return on investment. Worse, they don't have any idea where the numbers come from or how reliable they really are. In Financial Intelligence, Karen Berman and Joe Knight teach the basics of finance--but with a twist. Financial reporting, they argue, is as much art as science. Because nobody can quantify everything, accountants always rely on estimates, assumptions, and judgment calls. Savvy managers need to know how those sources of possible bias can affect the financials and that sometimes the numbers can be challenged. While providing the foundation for a deep understanding of the financial side of business, the book also arms managers with practical strategies for improving their companies' performance--strategies, such as "managing the balance sheet," that are well understood by financial professionals but rarely shared with their nonfinancial colleagues. Accessible, jargon-free, and filled with entertaining stories of real companies, Financial Intelligence gives nonfinancial managers the financial knowledge and confidence for their everyday work. Karen Berman and Joe Knight are the owners of the Los Angeles-based Business Literacy Institute and have trained tens of thousands of managers at many leading organizations. Co-author John Case has written several popular books on management.
272 pages, Hardcover
First published January 12, 2006
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April 16, 2018
A very accessible material for non-professionals and professionals alike. If you want to get an understanding of how the finance would have sounded like had it had a human face, read this.
Q:
If you read the news regularly, you have learned a good deal in recent years about all the wonderful ways people find to cook their companies’ books. They record phantom sales. They hide expenses. They sequester some of their properties and debts in a mysterious place known as off balance sheet.
Some of the techniques are pleasantly simple, like the software company a few years back that boosted revenues by shipping its customers empty cartons just before the end of a quarter. (The customers sent the cartons back, of course—but not until the following quarter.) Other techniques are complex to the point of near-incomprehensibility. (Remember Enron? It took years for accountants and prosecutors to sort out all of that ill-fated company’s spurious transactions.) As long as there are liars and thieves on this earth, some of them will no doubt find ways to commit fraud and embezzlement. (c)
Q:
If you read the news regularly, you have learned a good deal in recent years about all the wonderful ways people find to cook their companies’ books. They record phantom sales. They hide expenses. They sequester some of their properties and debts in a mysterious place known as off balance sheet.
Some of the techniques are pleasantly simple, like the software company a few years back that boosted revenues by shipping its customers empty cartons just before the end of a quarter. (The customers sent the cartons back, of course—but not until the following quarter.) Other techniques are complex to the point of near-incomprehensibility. (Remember Enron? It took years for accountants and prosecutors to sort out all of that ill-fated company’s spurious transactions.) As long as there are liars and thieves on this earth, some of them will no doubt find ways to commit fraud and embezzlement. (c)
July 20, 2017
Cuốn sách cô đọng và thú vị nhất về tài chính của mình cho tới thời điểm này. Ngay trước khi được tặng cho cuốn này mình vẫn luôn là đứa có ác cảm hay nói đúng hơn là dân dummy đối với tài chính. Có 2 lý do mình cho cuốn sách này 5 sao:
(1) Nó không dạy cách định khoản, hạch toán, cách trở thành một kế toán viên mà đưa ra những dẫn dắt cho bất cứ ai trong một tổ chức hiểu các vấn đề tài chính của công ty, cách đọc các báo cáo tài chính, hiểu lý do tại sao chính sách trả lương, hoa hồng, KPI thay đổi, etc.,
(2) Nó đề xuất một tầm nhìn, một kỳ vọng minh bạch tài chính trong mỗi tổ chức. Khi từng thành viên của tổ chức hiểu rõ hơn tình trạng hiện tại của cty, nỗ lực và cam kết để cùng nhau vượt qua khó khăn sẽ lớn hơn vì mỗi người là một mắt xích làm thay đổi kết quả kinh doanh. Đó là chính sách phát triển bền vững và lành mạnh nhất mà một tổ chức nên hướng tới.
(1) Nó không dạy cách định khoản, hạch toán, cách trở thành một kế toán viên mà đưa ra những dẫn dắt cho bất cứ ai trong một tổ chức hiểu các vấn đề tài chính của công ty, cách đọc các báo cáo tài chính, hiểu lý do tại sao chính sách trả lương, hoa hồng, KPI thay đổi, etc.,
(2) Nó đề xuất một tầm nhìn, một kỳ vọng minh bạch tài chính trong mỗi tổ chức. Khi từng thành viên của tổ chức hiểu rõ hơn tình trạng hiện tại của cty, nỗ lực và cam kết để cùng nhau vượt qua khó khăn sẽ lớn hơn vì mỗi người là một mắt xích làm thay đổi kết quả kinh doanh. Đó là chính sách phát triển bền vững và lành mạnh nhất mà một tổ chức nên hướng tới.
January 3, 2021
It was actually really good. I am not a finance person and it broke down the financials for me. Still not a fan of balance sheets and cashflow statements, but I kinda get it now!
Highly recommend.
Highly recommend.
December 9, 2015
Useful! Geared a bit more towards larger organisations than mine, but I still learned a lot. I can finally read my balance sheet, yay.
January 9, 2015
Back when I was in college I learned about the beauty of finance and accounting. It was a very interesting subject that I almost decided to switch course and be an accountant. Nevertheless, up to this day, I still find accounting not just exciting but very useful.
This book by Karen Berman and Joe Knight is an excellent primer for any non-accountant managers who want to understand what the numbers really mean. It is very easy to understand and full of insightful stories (and sometimes jokes) that will make the reading experience worthwhile.
I have to confess that I tried to read this book several months before but stop myself because I thought this will demand that I bring out my calculator. Well I was wrong. The book has full of easy to understand examples and computations that will make us learn how a business works from financial standpoint.
I urge everyone who is running a business to read this. The insights here are very useful so one would understand why a business is taking a particular course of action (especially those that seemed ridiculous and shaded with office politics). This book will not make you an accountant. This book is carefully written with the non-financial person in mind. Whether you are an manager, a front-line employee, or just someone who wants to learn about business, you will surely get something that you can use right away from this book.
This book by Karen Berman and Joe Knight is an excellent primer for any non-accountant managers who want to understand what the numbers really mean. It is very easy to understand and full of insightful stories (and sometimes jokes) that will make the reading experience worthwhile.
I have to confess that I tried to read this book several months before but stop myself because I thought this will demand that I bring out my calculator. Well I was wrong. The book has full of easy to understand examples and computations that will make us learn how a business works from financial standpoint.
I urge everyone who is running a business to read this. The insights here are very useful so one would understand why a business is taking a particular course of action (especially those that seemed ridiculous and shaded with office politics). This book will not make you an accountant. This book is carefully written with the non-financial person in mind. Whether you are an manager, a front-line employee, or just someone who wants to learn about business, you will surely get something that you can use right away from this book.
December 30, 2008
This book is probably the best overall reading material in understanding Managerial Accounting and to be able to understand what people in your finance departments at work, be it your CFO or co-workers to even better understanding your CPA at tax time.
I am somewhat biased to most books from Harvard Business Publishing (due in part to a contributing author/member of the Harvard Business Review advisory council) mainly because their material is very in depth and not always that easy to jump into. This book is the exception to being able to jump in and understand quickly where Ms. Berman is going with her descriptions and definitions.
I am somewhat biased to most books from Harvard Business Publishing (due in part to a contributing author/member of the Harvard Business Review advisory council) mainly because their material is very in depth and not always that easy to jump into. This book is the exception to being able to jump in and understand quickly where Ms. Berman is going with her descriptions and definitions.
February 28, 2018
Absolutely amazing! This book really makes finance interesting.
Will read again soon. Sumary:
There is 3 statements that are basic and helpful when it comes to analyzing any business: income statement, balance sheet and cash flow statement.
I. Income statement: reports business financial state after a period (a month, a quarter, a year) 3 things => revenue, expense and profit. Some notes:
- Revenue is the the value(cost) of the product/service that sells to customers. It should be noted whenever a customer makes a purchase. For retail, usually the customer pays immediately when a purchase happens, but when it comes to a big sale or some kind of special custom made product, it takes much more time to get the money from the customer (like 30 -60 days).
- COGS (cost of good sold) or COS (cost of service) is the expense that get directly involved in the process of making the product/service. It 's also called variable expense (the more products are made, the bigger the cost is).
=> Gross profit = Revenue - COGS. It tells how good the business is in making money from selling the product/service.
- Capital expenditure: (initial investment when start up business) not listed in this statement, usually used for PPE, intellectual properties (IP), ... and shows up as Depreciation/Amortization.
- Operating expense: (also called fixed expense, mostly unchanged in a period of time)
1. The indirect expense that keeps your business smoothly operate everyday: electric bills, water bills, cable bills, internet bills, phone bills, rental cost, employee wages...
2. Depreciation/Amortization: value deduction periodically from fixed asset (long-term asset).
Depreciation is for tangible assets PPE: (Property, Plants & Equipments), transportation, ...
Amortization is for intangible assets: patents, intellectual properties, technologies, ...
=> Question is how long should the depreciation/amortization last?
- Other expenses: SG&A expenses (Sale, General and Admin).
=> Operating profit = Gross profit - Operating expense. It tells how good the management and administration is in operating the business.
=> Also called EBIT (Earnings before interest(for debt)/loss and tax)
- Interest/Loss is deductible from tax. It 's used as a financial leverage as a tax shield.
- Net profit = EBIT - interest - tax. The final figure, what remains!!
=> Matching principle: expense and revenue should match together in a same period.
II. Balance sheet: shows everything that the business owns! at one point (often after a fiscal year)
=> Balance equation: (Total) Asset = Liability(Debt) + Equity(Capital)
- Current assets (short-term assets): assets that can be converted in cash within a year like cash and equivalence, A/R (account receivables: money that customers still owe) and inventory(may include raw material, work-in-process product, finished product).
- Fixed assets (long-term assets): like PPE (tangible), goodwill, IP (intangible)
- Other assets: prepaid asset.
- Current liability: short-term debt (debt needs to pay back within a year), A/P (account payables: money that business owes to providers) .
- Long-term liability (debt): why long-term? => boost up a business that may be often unable to bring any profit in the first year.
=> Working capital = Current assets - Current liability. It shows how much cash/idle money that the business has in short-term.
=> If this figure is low, maybe the business will have trouble paying for their expenses, or even can't pay debt.
III. Cash flow statement:
- For investment activities: research, business expanding, buying properties, ...
=> Will the business be scaled up? Market expanding? New products?
- For business activities: money from customers, expenses, ...
=> Is the business thriving?
- For financial activities: borrowing and paying back money, capital funding, paying dividends, ...
=> How dependent the business is on outside resources?
=> Cash is not Profit!!
=> Cash shows business health in a vivid picture!!
IV. How can these statement be assessed, are they good or bad?
=> Use some important ratios:
1. Gross profit / Revenue ratio
2. Operating profit/ Revenue ratio
3. Net profit/ Revenue ratio
=> the bigger the better
4. Return on Asset: ROA = Net profit / Total asset. For example, ROA = 5% means for every 100 USD invested in business, it returns 5 USD as profit. (The conversion ratio from asset to profit).
=> the bigger the better.
5. Return on Equity: ROE = Net profit / Equity => the bigger the better.
=> Debt-2-Equity = Debt / Equity. Usually noticed by the banks, to see if a business has too much debt or not and whether it should get a loan. => the smaller the better.
6. Interest coverage ratio = EBIT / annual interest. Usually noticed by the banks, to see the capability of paying debt of a business. => the bigger the better.
7. Current ratio = current asset / short term liability. It has similar meaning as working capital.
Also quick ratio = (current asset - inventory) / short term liability. It tells how quick a business can pay their debt without even selling the inventory. => the bigger the better
8. Days in inventory (DII) = average inventory / COGS (per day). It tells averagely, how long a product stays in inventory => the smaller the better.
Also Inventory turn = 360 (days) / DII => same meaning => the bigger the better.
9. Days sale oustanding: DSO = A/R (at the end of period) / COGS (per day). It tells how quick a business can collect its money from customers. => the smaller the better.
Similarly, Days payable oustanding (DPO). => how quick a business pay back money to providers.
V. Now what?
- We invest!!! When starting a business or to invest in a new project, should consider some factors:
1. Cost of capital = cost of debt + cost of equity: (weighted) average profit ratio
For example, we start a business, we need capital => borrow from banks 25USD with 4% interest, and we get invested 75 USD from investors with the hope of getting 16% profit.
So, CoC = 25%x4% + 75%16% = 13% => the maximum profit we will get.
=> Question is, what ratio is acceptable? how we can manage that?
2. Return on Investment: ROI, several ways to calculate this.
=> It tells how long a business will eventually return the investment money.
=> Question is, how long is acceptable and worths investing? Google Net Present Value (NPV)!
3. Always consider all opportunity costs and the time value aspect of money: present value, future value.
- Apply those understandings/analysis to make the business better
Will read again soon. Sumary:
There is 3 statements that are basic and helpful when it comes to analyzing any business: income statement, balance sheet and cash flow statement.
I. Income statement: reports business financial state after a period (a month, a quarter, a year) 3 things => revenue, expense and profit. Some notes:
- Revenue is the the value(cost) of the product/service that sells to customers. It should be noted whenever a customer makes a purchase. For retail, usually the customer pays immediately when a purchase happens, but when it comes to a big sale or some kind of special custom made product, it takes much more time to get the money from the customer (like 30 -60 days).
- COGS (cost of good sold) or COS (cost of service) is the expense that get directly involved in the process of making the product/service. It 's also called variable expense (the more products are made, the bigger the cost is).
=> Gross profit = Revenue - COGS. It tells how good the business is in making money from selling the product/service.
- Capital expenditure: (initial investment when start up business) not listed in this statement, usually used for PPE, intellectual properties (IP), ... and shows up as Depreciation/Amortization.
- Operating expense: (also called fixed expense, mostly unchanged in a period of time)
1. The indirect expense that keeps your business smoothly operate everyday: electric bills, water bills, cable bills, internet bills, phone bills, rental cost, employee wages...
2. Depreciation/Amortization: value deduction periodically from fixed asset (long-term asset).
Depreciation is for tangible assets PPE: (Property, Plants & Equipments), transportation, ...
Amortization is for intangible assets: patents, intellectual properties, technologies, ...
=> Question is how long should the depreciation/amortization last?
- Other expenses: SG&A expenses (Sale, General and Admin).
=> Operating profit = Gross profit - Operating expense. It tells how good the management and administration is in operating the business.
=> Also called EBIT (Earnings before interest(for debt)/loss and tax)
- Interest/Loss is deductible from tax. It 's used as a financial leverage as a tax shield.
- Net profit = EBIT - interest - tax. The final figure, what remains!!
=> Matching principle: expense and revenue should match together in a same period.
II. Balance sheet: shows everything that the business owns! at one point (often after a fiscal year)
=> Balance equation: (Total) Asset = Liability(Debt) + Equity(Capital)
- Current assets (short-term assets): assets that can be converted in cash within a year like cash and equivalence, A/R (account receivables: money that customers still owe) and inventory(may include raw material, work-in-process product, finished product).
- Fixed assets (long-term assets): like PPE (tangible), goodwill, IP (intangible)
- Other assets: prepaid asset.
- Current liability: short-term debt (debt needs to pay back within a year), A/P (account payables: money that business owes to providers) .
- Long-term liability (debt): why long-term? => boost up a business that may be often unable to bring any profit in the first year.
=> Working capital = Current assets - Current liability. It shows how much cash/idle money that the business has in short-term.
=> If this figure is low, maybe the business will have trouble paying for their expenses, or even can't pay debt.
III. Cash flow statement:
- For investment activities: research, business expanding, buying properties, ...
=> Will the business be scaled up? Market expanding? New products?
- For business activities: money from customers, expenses, ...
=> Is the business thriving?
- For financial activities: borrowing and paying back money, capital funding, paying dividends, ...
=> How dependent the business is on outside resources?
=> Cash is not Profit!!
=> Cash shows business health in a vivid picture!!
IV. How can these statement be assessed, are they good or bad?
=> Use some important ratios:
1. Gross profit / Revenue ratio
2. Operating profit/ Revenue ratio
3. Net profit/ Revenue ratio
=> the bigger the better
4. Return on Asset: ROA = Net profit / Total asset. For example, ROA = 5% means for every 100 USD invested in business, it returns 5 USD as profit. (The conversion ratio from asset to profit).
=> the bigger the better.
5. Return on Equity: ROE = Net profit / Equity => the bigger the better.
=> Debt-2-Equity = Debt / Equity. Usually noticed by the banks, to see if a business has too much debt or not and whether it should get a loan. => the smaller the better.
6. Interest coverage ratio = EBIT / annual interest. Usually noticed by the banks, to see the capability of paying debt of a business. => the bigger the better.
7. Current ratio = current asset / short term liability. It has similar meaning as working capital.
Also quick ratio = (current asset - inventory) / short term liability. It tells how quick a business can pay their debt without even selling the inventory. => the bigger the better
8. Days in inventory (DII) = average inventory / COGS (per day). It tells averagely, how long a product stays in inventory => the smaller the better.
Also Inventory turn = 360 (days) / DII => same meaning => the bigger the better.
9. Days sale oustanding: DSO = A/R (at the end of period) / COGS (per day). It tells how quick a business can collect its money from customers. => the smaller the better.
Similarly, Days payable oustanding (DPO). => how quick a business pay back money to providers.
V. Now what?
- We invest!!! When starting a business or to invest in a new project, should consider some factors:
1. Cost of capital = cost of debt + cost of equity: (weighted) average profit ratio
For example, we start a business, we need capital => borrow from banks 25USD with 4% interest, and we get invested 75 USD from investors with the hope of getting 16% profit.
So, CoC = 25%x4% + 75%16% = 13% => the maximum profit we will get.
=> Question is, what ratio is acceptable? how we can manage that?
2. Return on Investment: ROI, several ways to calculate this.
=> It tells how long a business will eventually return the investment money.
=> Question is, how long is acceptable and worths investing? Google Net Present Value (NPV)!
3. Always consider all opportunity costs and the time value aspect of money: present value, future value.
- Apply those understandings/analysis to make the business better
August 27, 2022
3.5*
This book was pretty good. It opened up some doors in my mind, but I think I need a reread to grasp some of the concepts better.
The book talks about the importance of finance, and how financial elements impact each other and the business performance in various ways. The central thesis is that understanding finance makes you a better employee, since it allows you to align your job with the business' financial performance.
This book was pretty good. It opened up some doors in my mind, but I think I need a reread to grasp some of the concepts better.
The book talks about the importance of finance, and how financial elements impact each other and the business performance in various ways. The central thesis is that understanding finance makes you a better employee, since it allows you to align your job with the business' financial performance.
January 12, 2019
At our Thanksgiving gettogether, I was attempting to explain my job duties to my Uncle and found myself struggling to find the right words. I work as an account manager at a corporate training and SaaS company with a respectable market cap--simple enough, right? But beyond that, I could not explain the purpose behind my job's day to day activities. Revenue and its implications govern my work, yet before reading this book I didn't fully understand how my actions affected the company's financial health, nor even the rules that I follow every day.
The authors took a topic most avoid--corporate finance--and made it easy to understand. They avoided jargon, provided real-world examples, and kept the numbers, decimals, and complicated ratios to a minimum. For me, this led to many 'a-ha!' moments in which the book demystified the seemingly arcane procedures of our CFO and his gang of eggheads. At our next financial review, I look forward to actively listening instead of checking twitter and hoping for a swift conclusion.
But let's be real this shit is mad boring. You gotta really WANT it, like I did, to get through this one. Moreover, if you're like me, you'll come away disgusted with how unregulated corporate accounting is. Of course the market crashes every 15 years, the enforceable standards are hieroglyphics! Companies can make their numbers say just about anything using shady accounting practices that in many cases are perfectly legal and barely frowned upon.
Anyway, this book fit a particular need for me and I'm glad to have read it.
4/5, borrow from your MBA dropout friend.
The authors took a topic most avoid--corporate finance--and made it easy to understand. They avoided jargon, provided real-world examples, and kept the numbers, decimals, and complicated ratios to a minimum. For me, this led to many 'a-ha!' moments in which the book demystified the seemingly arcane procedures of our CFO and his gang of eggheads. At our next financial review, I look forward to actively listening instead of checking twitter and hoping for a swift conclusion.
But let's be real this shit is mad boring. You gotta really WANT it, like I did, to get through this one. Moreover, if you're like me, you'll come away disgusted with how unregulated corporate accounting is. Of course the market crashes every 15 years, the enforceable standards are hieroglyphics! Companies can make their numbers say just about anything using shady accounting practices that in many cases are perfectly legal and barely frowned upon.
Anyway, this book fit a particular need for me and I'm glad to have read it.
4/5, borrow from your MBA dropout friend.
June 15, 2016
WOW! That sums it up.
20 years ago I started my Undergrad degree in Finance...I quickly learned I hated debits and credits and swiched to Operations. Since then I have worked my way up in Corporate America. I am constantly bombarded by various financial jargon. Some of which I have picked up, but much of it still could be as foreign as learning Latin.
Financial Intelligence cuts through the jargon to provide you a clear definitition of what the various statements, reports and ratios mean and more importantly...how can you impact them to better yourself and your organization.
I listened to this via audiobook and found it very easy to follow. However I do plan on purchasing a hardcopy for future reference. The toolboxes the author's discuss should be handy for immediate reference.
20 years ago I started my Undergrad degree in Finance...I quickly learned I hated debits and credits and swiched to Operations. Since then I have worked my way up in Corporate America. I am constantly bombarded by various financial jargon. Some of which I have picked up, but much of it still could be as foreign as learning Latin.
Financial Intelligence cuts through the jargon to provide you a clear definitition of what the various statements, reports and ratios mean and more importantly...how can you impact them to better yourself and your organization.
I listened to this via audiobook and found it very easy to follow. However I do plan on purchasing a hardcopy for future reference. The toolboxes the author's discuss should be handy for immediate reference.
July 2, 2020
Just what I needed - this book is great read for those interested in how business is viewed through the financial perspective and a must read for someone like me, i.e. who didn't have any business financial intelligence. If I had to give it another title, it would be CFO for dummies.
August 23, 2018
I'm slowly getting myself into studying again --where did summer break go?!
The professor at school recommends this for students with no or little experience in Finance --the way the authors intended it to be.
The book explains that most corporates are measured by numbers (well duh) and that is why managers who are working their way up need to understand how their decisions affect these numbers. The authors are trainers themselves and I find their explanations comprehensible eg. how delaying buying inventory can benefit cash flow, why an upgrade in system can be irrelevant, how net profit is not equivalent to cash, and so on.
It also provides interesting examples of companies most readers are familiar with such as Apple, Boeing, Hewlett-Packard although when explaining some technicalities, the authors use simple business model eg. cupcake store with equity of $25. I find this especially useful (and probably some finance folks will, too when explaining these terms/concepts to non-finance colleagues/friends).
"With all these terms for the same thing, one might get the idea that our friends in finance and accounting don't want us to know what is going on. Or maybe they just take it for granted that everybody knows that all the different terms mean the same thing."
Perhaps because I am an accountant myself that I do apply this knowledge in my personal life as well. I am rather conservative in managing my financial (budgeting, re-forecasting, reconciling, etc) and clearly not the #yolo kind. (I think this is obvious haha). And since the end of last year, I have received many questions from friends/acquaintances who are quite eager in joining the hype of cryptocurrency. And from now on, I will ask them to follow this investment strategy from Warren Buffet that I found in the book. It is quite simple but says a lot:
"First, he evaluates a business on its long-term rather than its short-term prospects. Second, he always looks for businesses he understands. (This led him to avoid many Internet-related investments.) And third, when he examines financial statements, he places the greatest emphasis on a measure of cash flow that he calls owner earnings.”
And lastly, if you are hesitant to learn about finance because you think it requires sophisticated math, worry not:
“It might surprise you to know that, for the most part, finance involves addition and subtraction. When finance people get really fancy, they multiply and divide. We never have to take the second derivative of a function or determine the area under a curve (sorry, engineers). So have no fear: the math is easy. And calculators are cheap.”
The professor at school recommends this for students with no or little experience in Finance --the way the authors intended it to be.
The book explains that most corporates are measured by numbers (well duh) and that is why managers who are working their way up need to understand how their decisions affect these numbers. The authors are trainers themselves and I find their explanations comprehensible eg. how delaying buying inventory can benefit cash flow, why an upgrade in system can be irrelevant, how net profit is not equivalent to cash, and so on.
It also provides interesting examples of companies most readers are familiar with such as Apple, Boeing, Hewlett-Packard although when explaining some technicalities, the authors use simple business model eg. cupcake store with equity of $25. I find this especially useful (and probably some finance folks will, too when explaining these terms/concepts to non-finance colleagues/friends).
"With all these terms for the same thing, one might get the idea that our friends in finance and accounting don't want us to know what is going on. Or maybe they just take it for granted that everybody knows that all the different terms mean the same thing."
Perhaps because I am an accountant myself that I do apply this knowledge in my personal life as well. I am rather conservative in managing my financial (budgeting, re-forecasting, reconciling, etc) and clearly not the #yolo kind. (I think this is obvious haha). And since the end of last year, I have received many questions from friends/acquaintances who are quite eager in joining the hype of cryptocurrency. And from now on, I will ask them to follow this investment strategy from Warren Buffet that I found in the book. It is quite simple but says a lot:
"First, he evaluates a business on its long-term rather than its short-term prospects. Second, he always looks for businesses he understands. (This led him to avoid many Internet-related investments.) And third, when he examines financial statements, he places the greatest emphasis on a measure of cash flow that he calls owner earnings.”
And lastly, if you are hesitant to learn about finance because you think it requires sophisticated math, worry not:
“It might surprise you to know that, for the most part, finance involves addition and subtraction. When finance people get really fancy, they multiply and divide. We never have to take the second derivative of a function or determine the area under a curve (sorry, engineers). So have no fear: the math is easy. And calculators are cheap.”
January 3, 2022
Easily earned 5 stars from me. I never, ever, thought I would find a book about finance that explained all the why’s, what’s and how’s in such a simple and easy way. Additionally to that, the book is engaging. An engaging finance book?!
If you want to learn how to read income statements, balance sheets, cashflow statements, understand what each piece mean and especially why they exist or used the way they’re used, and especially, clarify the infinite and confusing finance vocabulary, this is it.
This book beats any course I’ve ever taken. You can also come not knowing anything as it never assumes you “should” know something.
I’ll recommend this book to death.
If you want to learn how to read income statements, balance sheets, cashflow statements, understand what each piece mean and especially why they exist or used the way they’re used, and especially, clarify the infinite and confusing finance vocabulary, this is it.
This book beats any course I’ve ever taken. You can also come not knowing anything as it never assumes you “should” know something.
I’ll recommend this book to death.
July 2, 2018
Đối với một người làm product như mình thì đây quả là một quyển sách:
1. Hơi phức tạp, phức tạp không phải vì khó hiểu, phức tạp vì quá nhiều thuật ngữ
2. Wow, phải nói là cực kỳ hữu ích, một trong những công cụ hỗ trợ bật lại CEO, CFO, COO:
+ Doanh thu khi nào mới được gọi là doanh thu?
+ Báo cáo kết quả kinh doanh là gì?
+ Bảng cân đối kế toán là gì?
+ Báo cáo lưu chuyển tiền tệ là gì?
=> Một mớ thuật ngữ, phân tích và số liệu trên đưa ra một cái nhìn chung về sức khỏe tài chính của công ty, họ đang làm gì, đầu tư như thế nào, tỷ lệ hoàn vốn ra sao....
1. Hơi phức tạp, phức tạp không phải vì khó hiểu, phức tạp vì quá nhiều thuật ngữ
2. Wow, phải nói là cực kỳ hữu ích, một trong những công cụ hỗ trợ bật lại CEO, CFO, COO:
+ Doanh thu khi nào mới được gọi là doanh thu?
+ Báo cáo kết quả kinh doanh là gì?
+ Bảng cân đối kế toán là gì?
+ Báo cáo lưu chuyển tiền tệ là gì?
=> Một mớ thuật ngữ, phân tích và số liệu trên đưa ra một cái nhìn chung về sức khỏe tài chính của công ty, họ đang làm gì, đầu tư như thế nào, tỷ lệ hoàn vốn ra sao....
January 17, 2022
در هر موقعیتِ استفاده از صورتهای مالی یک شرکت برای سرمایهگذاری، کنترل داخلی، حسابرسی و حسابداری باشید؛ نیاز دارید بدانید پشت عددهایی که در این صورتها نمایش داده میشوند، چه حدس و گمانهایی زده شده و چه فریبهایی احتمالا سعی شده به خورد خوانندهی صورت مالی بدهند.
تا حدی پیشنیاز خواندن کتاب حسابداری است، یعنی اگر حسابداری بلد باشید اذیت نمیشوید و اگر بلد نباشید باید زمان بیشتری وقت بگذارید تا مفاهیم را متوجه شوید.
از شاهکارهای حوزهی مفاهیم مالی، میتوانم به این کتاب اشاره کنم. حسابداری زبانِ کسب و کار است و این زبان در بسیاری از مواقع، چند پهلوست! این کتاب به شما یاد میدهد زبان حسابداری را دقیق و بدون کنایه بفهمید.
تا حدی پیشنیاز خواندن کتاب حسابداری است، یعنی اگر حسابداری بلد باشید اذیت نمیشوید و اگر بلد نباشید باید زمان بیشتری وقت بگذارید تا مفاهیم را متوجه شوید.
از شاهکارهای حوزهی مفاهیم مالی، میتوانم به این کتاب اشاره کنم. حسابداری زبانِ کسب و کار است و این زبان در بسیاری از مواقع، چند پهلوست! این کتاب به شما یاد میدهد زبان حسابداری را دقیق و بدون کنایه بفهمید.
August 11, 2018
An Excellent introduction to the Art of Finance. I especially enjoyed examples of companies. I would recommend this to everyone.
Deus Vult
--Gottfried
Deus Vult
--Gottfried
February 23, 2021
Cannot recommend this enough. Esp recommended if you own a small biz, want to start a small biz, or if you work for start-up.
December 17, 2021
Great business book for non-finance people!
- Whether you’re running your own business or working for an organization, it’s important to have financial intelligence.
- Finance and Accounting is more art than science. An accountant must make lots of judgments and decisions such as when to recognize a revenue, and how to categorize an expense, and so on. Sometimes companies group lots of losses on one quarter to make the next quarters look better. Sometimes companies recognize revenue that shouldn’t be recognized yet. At the end, they can’t put something that is not there, but they can skew the numbers and their categorization to make the company look better than it actually is. This is done sometimes to avoid share price from dropping, but not for long.
- A revenue should be recognized at the time of delivering the product/service not at time of signing the contract and not at time of receiving the payment from the customer. If the service is spread over time (for example support service for 12 months), then the revenue should also be spread on these months.
- The Income Statement shows revenue, expenses, and profit for a period of time. It’s also called a profit and loss statement (P&L). The bottom line of income statement is net profit, also known as net income.
- Operating Expenses are the costs required to keep the business going from day to day. They include salaries, benefits, and insurance costs, among a host of other items. Operating expenses are listed on the income statement and are subtracted from revenue to determine profit.
- Capital Expenditures (CAPEX, الإنفاق الرأسمالي) is the purchase of an item that’s considered a long term investment, such as computer systems and equipment and machines and buildings. Operating expenses show up on the income statement, and thus reduce profit. However, capital expenditure show up on the balance sheet; only the depreciation of a piece of capital equipment appears on the income statement.
- An accrual is the portion of a revenue or expense item that is recorded in a particular time span. Product development costs, for instant, are likely to be spread over several accounting periods, and so a portion of the total cost will be accrued each month. The purpose of accruals is to match costs to revenues in a given time period as accurately as possible.
- Allocations are apportionment of costs to different departments or activities within a company. For instant, overhead costs such as the CEO’s salary and HR department and Finance department are often allocated to the company’s operating unit.
- Let’s say that you have worked on developing a product on June and it was launched in July. The accountant needs to decide how to accrue your salary and where to allocate it. He needs to make an assumption regarding if you have helped with producing the first batch of products. If much of your salary was put under development cost and not under product cost, it would reflect to the CEO concerns on the risks related to developing a new product and also it will reflect product costs cheaper than the actual cost which could lead to the product being priced less than the cost. And vice versa. Indeed, accountants must make artful assumptions and decisions.
- If product costs go up, gross profit goes down. Gross profit is a is a key measure for assessing product profitability. Development costs, however, go into R&D, which is included in the operating expense section of the income statement and doesn’t affect gross profit at all.
- Depreciation is the method accountants use to allocate the cost if equipment and other assets to the total cost of products and services as shown on the income statement. It is based on the same idea as accruals: we want to match as closely as possible the costs of our products and services with what was sold. Most capital investments other than land are depreciated. Accountants attempt to spread the cost if the expenditure over the useful life of the item.
- 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 $1 million and the acquirer pays $3 million, then goodwill of $2 million goes onto the acquirer’s balance sheet. That $2 million reflects all the value that is not reflected in the acquiree’s tangible assets. For example, its name, reputation, and so on.
- The balance sheet reflects the assets, liabilities, and owners’ equity at a point in time. In other words, it shows, on a specific day, what the company owned, what it owed, and how much it was worth. The balance sheet is called such because it balances. Assets always must equal liabilities plus owners’ equity. A financially savvy manager knows that all the income statements ultimately flow to the balance sheet.
- Profit is based on revenue, and revenue is recognized when a product or service is delivered, not when the bill is paid. So the profit is often no more than a promise. Customers have not paid yet, so the revenue number does not reflect real money. 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. Sometimes a highly profitable company can be tight on cash and can’t expand on expenses.
- The income statement measures the sales and expenses, it doesn’t reflect the cash flow. The income statement is an estimate and it’s not 100% accurate.
- If an ink-and-toner supplier buys a truckload of cartridges in June to resell to customers over the next several months, it does not record the cost of all those cartridges in June. Rather, it records the cost of each cartridges when the cartridge is sold. The reason is the matching principle which is a fundamental accounting rule for preparing an income statement. It simply states: “Match the cost with its associated revenue to determine profits in a given period of time”. In other words, one of the accountants’ primary jobs is to figure out and properly record all the costs incurred in generating sales.
- The income statement tries to measure whether the products and services that a company provides are profitable when everything is added up. It’s the accountants’ best effort to show the sales the company generated during a given time period, the costs incurred in making those sales (including the costs of operating the business for that span of time), and the profit, if any, that is left over. A sales manager needs to know what kinds of profits he and his team are generating so that he can make decisions about discounts, terms, which customers to pursue, and so on. A marketing manager needs to know which products are most profitable so that those can be emphasized in any marketing campaigns.
- Over time, the income statement and the cash flow statement in a well-run company will track one another. Profit will be turned into cash. However, just because a company is making a profit in any given time period doesn’t mean it will have the cash to pay its bills. Profit is always and estimate. And you can’t spend estimates.
- It happened many times before that a company ships products to their partners at the end of the quarter just to mark these shipments as sales. This is known as “channel stuffing”. What happens is that the partners send back the shipments that they didn’t even ask for.
- Gross profit is revenue minus cost of goods and services, it reflects the profitability of your products. Operating profit is gross profit minus the operating cost, it reflects the profitability of the operation of your business over all. Net profit is operating profit minus taxes and interests. Net profit is what is left over after everything is subtracted.
- Contribution margin is sales minus variable costs. It tells you how profitable a product is and it tells you how much of your product you need to sell in order to cover the fixed cost. It also helps with the pricing of the product. This area is also related to Product Management.
- No matter what’s your company style of recording revenue and costs, what matters is the consistency from year to year.
- The above has focused on the income statement. As for the balance sheet, it is a statement of what a business owns and what it owes at a particular point in time. The difference between what a company owns and what it owes represents equity.
- Equity is the shareholders’ “stake” in the company as measured by accounting rules. It’s also called the company’s book value. In accounting terms, equity is always assets minus liabilities; it is also the sum of all capital pain in my shareholders plus any profits earned by the company since its inception minus dividends paid out to the shareholders.
- Over time, the equity section of the balance sheet shows the accumulation of profits or losses left in the business.
- The rule of the balance sheet goes as follows: assets = liabilities + owners’ equity
- Assets consist of cash and stocks (liquid assets) and equipments and lands and goodwill. A lot of art goes into estimating the current value of non-liquid assets.
- Accounts Receivable is the amount customers owe the company. Revenue is a promise to pay, so accounts receivable includes all the promises that haven’t yet been collected. Why is this an asset? Because all or most of these commitments will convert to cash and soon will belong to the company. It’s like a loan from the company to its customers.
- Sometimes a balance sheet includes an item labeled “allowance for bad debt” that is subtracted from accounts receivable. This is the accountants’ estimate -usually based on past experience- of the dollars owed by customers who didn’t pay their bills. In many companies, subtracting a bad-debt allowance provides a more accurate reflection of the value of those accounts receivable.
- Land doesn’t wear out, so accountants don’t record any depreciation each year. But buildings and equipment do. The point of accounting deprecation, however, isn’t to estimate what the buildings and equipment are worth right now; the point is to allocate the investment in the asset over the time it is used to generate revenue and profit (the matching principle). The depreciation charge is a way of ensuring that the income statement accurately reflects the true cost of producing goods or delivering services.
- If a company buys another company for $5 million. If you pay cash, the asset called cash in your balance sheet will decrease by $5 million. That means other assets have to rise by $5 million. If the bought company physical assets are worth $2 million, that doesn’t mean that you made a bad deal. A brand name like Coke Cola is worth much more that its physical assets. The difference of $3 million is to be marked as goodwill.
- If you paid for rent of $60,000 for 12 months in advance and recording it as $5,000 each month as per the matching principle, where did the other $55,000 cash go in the balance sheet? It gets marked as prepaid asset (you own the place for the upcoming 11 months) and decreases each month by $5,000 and gets reflected in the income statement as $5000 cost of operational cost.
- Should you mark a marketing campaign cost of $1 million as one time cost or do you divide it into the upcoming 24 months claiming that the impact of the campaign would extend over that period? It’s an art more than a science.
- Deferred revenue gets marked as part of liability. It represents money received for products or services that have not yet been delivered. Once the product or service has been delivered, the corresponding revenue will be included in the income statement and it will come off the balance sheet. Industries where you might see deferred revenue on the balance sheet includes airlines (you pay before you fly) and project- based businesses.
- Retained earnings are the profits that have been reinvested in the business instead of being paid out in dividends. Investors don’t like it when a company retain earnings as cash that is not being invested anywhere and they pressure the company to at least make it into dividends.
- What the balance sheet is balancing? On one side are the assets, which is what the company owns. On the other side are the liabilities and equity, which show how the company obtained what it owns. You can also look at it this way: the assets consist of two parts, one which needs to be used to pay for the liabilities and one is capital and profits for the owners. The balance sheet lists nicely all the company assets in one side, and in the other side it lists the owners of these assets.
- If you open a company and put $50,000 in cash. Then in assets side there will be $50,000 as cash, and in owners’ equity side there will also be amount of $50,000. Let’s say you took a loan of $10,000, now the assets side includes $60,000, so from where this came from? We simply add $10,000 in liabilities side. Remember, transactions affect both sides of the balance sheet.
- Profits in the income statement gets reflected in the balance sheet as equity. On the assets side, it gets reflected as either cash or accounts receivable.
- When a company buys a piece of capital equipment, the cost doesn’t show up on the income statement; rather, the new asset appears on the balance sheet, and only the depreciation appears on the income statement as a charge against profit.
- Many profitable companies close down in their first year. The reason is that they would run out of cash. The more sales you’re generating the more expenses you’re paying for the materials, all while not yet turning the accounts receivable into cash.
- If a company is profitable but short on cash, then it needs financial expertise, someone capable of lining up additional financing. If a company has cash but is unprofitable, it needs operational expertise, meaning someone capable of bringing down costs or generating additional revenue without adding costs.
- There is much less room for manipulation of the numbers on the cash flow statement than on income statement and balance sheet. Less room doesn’t mean “no room”. For example, if a company is trying to show good cash flow in a particular quarter, it may delay paying vendors or employee bonuses until the next quarter. Unless a company delays payments over and over -eventually vendors who don’t get paid will stop providing goods and services- the effects are significant only in the short term.
- You can calculate a cash flow statement just by looking at the income statement and two balance sheets.
- Reconciliation, in a financial context, means getting the cash line on a company’s balance sheet to match the actual cash the company has in the bank.
- Operating lease is widely used in the airline industry and others. Rather than buying equipment such as an airplane outright, a company lease it from an investor. The lease payments count as an expense on the income statement, but there is no asset and no debt related to that asset on a company’s books. Some companies that are already over-leveraged are willing to pay a premium to lease equipment just to keep the ratios of interest coverage (operating profit / annual interest charges) and debt-to-equity ratio (total liabilities / shareholders’ equity) in the area that bankers and investors like to see.
- To know how good your company is at collecting their money, divide average account receivable by the revenue then divide by 365 (the number of days in a year).
- To know how tight your company is with using inventory (the tighter the better), divide average inventory by COGS per day. Walmart’s ratio is 47. This means that inventory gets sold on average after a month and a half. That’s a good average in super market industry. For Target, it is 74 meaning that it takes two months and a half for them to sell an item as soon as it gets into the inventory.
- Numbers that are important to investors:
- 1. Revenue growth from one year to another
- 2. Earnings per share (EPS)
- 3. Earning before interest, taxes, depreciation, and amortization (EBITDA) - a strong healthy company should experience growth un EBITDA over time. Also it is often used in valuing businesses. Many companies are bought and sold at a price that us an agreed-upon multiple of EBITDA.
- 4. Free cash flow - divide cash flow by EBITDA, if the ratio is low it may indicate that the company is trying to make its EBITDA stronger than it is.
- 5. Return on total capital, or return on equity
- 6. Market cap (the number of shares multiplied by the share value)
- 7. Share price to earning - usually it’s between 16 and 18. Companies with higher ratios are considered to have high growth potential.
- Companies with high market cap and high share price to earnings are healthy and their jobs are more secure, and there is more opportunity to grow in the company. And the company is more likely to get loans when needed and is more likely to survive tough economies.
- These above two numbers depend on market perceptions, which in turn are driven by: the company’s current financial performance + the company’s prospects for growth in the future + the company’s anticipated cash flows in the future + the predictability of its performance, that is, the degree of risk involved + investors’ assessments of the expertise of a company’s management and the skills of its employees
- Also there are other factors, such as the overall state if the economy, the condition of the stock market in general, the level of speculative fervor, etc.
- At any given point in time, investors will disagree about a company’s “true” value, which is why some are willing to buy shares at a particular price and some are willing to sell them.
- Investors understand that investment is a game of psychology as well as of economics. As the economist John Maynard Keynes once pointed out, buying stocks is like trying to anticipate who will win a beauty contest. You want to choose not the person who you think is the most beautiful but the person you think everyone else will see as most beautiful. [note: this is the opposite of what Warren Buffett is suggesting which is to invest in companies that are underrated and that you wouldn’t mind investing in them for very long time]
- Astute management of the balance sheet is like financial magic. It allows a company to improve its financial performance even without boosting sales or lowering costs. Better balance sheet management makes a business more efficient at converting inputs to outputs and ultimately to cash. Companies that can generate more cash in less time have greater freedom of action; they aren’t so dependent on outside investors or lenders.
- Working Capital is the money a company needs to finance its daily operations. Accountants usually measure it by adding up a company’s cash, inventory, and accounts receivable, and then subtracting short-term debts. The longer a company’s DSO (days outstanding receivables), the more working capital is required to run the business. If your daily sales are $1 million, then you’ll get additional $1 million in cash for each day you cut from the DSO.
- Companies who pay their vendors as early as possible get greater support from these vendors. Vendors are usually small scale and they need the cash flow to function comfortably. Be their champion, and they will work hard for you.
- Educating the staff on finance and accounting, increasing their financial intelligence, is important. It always increases staff dedication and efficiency. When they understand the “why” behind management decisions, they will commit to it, instead of seeing management like bunch of guys who don’t know what they’re doing. Educate with the real numbers. Even private companies can do that by scaling down the numbers but keeping the patterns.
- Whether you’re running your own business or working for an organization, it’s important to have financial intelligence.
- Finance and Accounting is more art than science. An accountant must make lots of judgments and decisions such as when to recognize a revenue, and how to categorize an expense, and so on. Sometimes companies group lots of losses on one quarter to make the next quarters look better. Sometimes companies recognize revenue that shouldn’t be recognized yet. At the end, they can’t put something that is not there, but they can skew the numbers and their categorization to make the company look better than it actually is. This is done sometimes to avoid share price from dropping, but not for long.
- A revenue should be recognized at the time of delivering the product/service not at time of signing the contract and not at time of receiving the payment from the customer. If the service is spread over time (for example support service for 12 months), then the revenue should also be spread on these months.
- The Income Statement shows revenue, expenses, and profit for a period of time. It’s also called a profit and loss statement (P&L). The bottom line of income statement is net profit, also known as net income.
- Operating Expenses are the costs required to keep the business going from day to day. They include salaries, benefits, and insurance costs, among a host of other items. Operating expenses are listed on the income statement and are subtracted from revenue to determine profit.
- Capital Expenditures (CAPEX, الإنفاق الرأسمالي) is the purchase of an item that’s considered a long term investment, such as computer systems and equipment and machines and buildings. Operating expenses show up on the income statement, and thus reduce profit. However, capital expenditure show up on the balance sheet; only the depreciation of a piece of capital equipment appears on the income statement.
- An accrual is the portion of a revenue or expense item that is recorded in a particular time span. Product development costs, for instant, are likely to be spread over several accounting periods, and so a portion of the total cost will be accrued each month. The purpose of accruals is to match costs to revenues in a given time period as accurately as possible.
- Allocations are apportionment of costs to different departments or activities within a company. For instant, overhead costs such as the CEO’s salary and HR department and Finance department are often allocated to the company’s operating unit.
- Let’s say that you have worked on developing a product on June and it was launched in July. The accountant needs to decide how to accrue your salary and where to allocate it. He needs to make an assumption regarding if you have helped with producing the first batch of products. If much of your salary was put under development cost and not under product cost, it would reflect to the CEO concerns on the risks related to developing a new product and also it will reflect product costs cheaper than the actual cost which could lead to the product being priced less than the cost. And vice versa. Indeed, accountants must make artful assumptions and decisions.
- If product costs go up, gross profit goes down. Gross profit is a is a key measure for assessing product profitability. Development costs, however, go into R&D, which is included in the operating expense section of the income statement and doesn’t affect gross profit at all.
- Depreciation is the method accountants use to allocate the cost if equipment and other assets to the total cost of products and services as shown on the income statement. It is based on the same idea as accruals: we want to match as closely as possible the costs of our products and services with what was sold. Most capital investments other than land are depreciated. Accountants attempt to spread the cost if the expenditure over the useful life of the item.
- 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 $1 million and the acquirer pays $3 million, then goodwill of $2 million goes onto the acquirer’s balance sheet. That $2 million reflects all the value that is not reflected in the acquiree’s tangible assets. For example, its name, reputation, and so on.
- The balance sheet reflects the assets, liabilities, and owners’ equity at a point in time. In other words, it shows, on a specific day, what the company owned, what it owed, and how much it was worth. The balance sheet is called such because it balances. Assets always must equal liabilities plus owners’ equity. A financially savvy manager knows that all the income statements ultimately flow to the balance sheet.
- Profit is based on revenue, and revenue is recognized when a product or service is delivered, not when the bill is paid. So the profit is often no more than a promise. Customers have not paid yet, so the revenue number does not reflect real money. 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. Sometimes a highly profitable company can be tight on cash and can’t expand on expenses.
- The income statement measures the sales and expenses, it doesn’t reflect the cash flow. The income statement is an estimate and it’s not 100% accurate.
- If an ink-and-toner supplier buys a truckload of cartridges in June to resell to customers over the next several months, it does not record the cost of all those cartridges in June. Rather, it records the cost of each cartridges when the cartridge is sold. The reason is the matching principle which is a fundamental accounting rule for preparing an income statement. It simply states: “Match the cost with its associated revenue to determine profits in a given period of time”. In other words, one of the accountants’ primary jobs is to figure out and properly record all the costs incurred in generating sales.
- The income statement tries to measure whether the products and services that a company provides are profitable when everything is added up. It’s the accountants’ best effort to show the sales the company generated during a given time period, the costs incurred in making those sales (including the costs of operating the business for that span of time), and the profit, if any, that is left over. A sales manager needs to know what kinds of profits he and his team are generating so that he can make decisions about discounts, terms, which customers to pursue, and so on. A marketing manager needs to know which products are most profitable so that those can be emphasized in any marketing campaigns.
- Over time, the income statement and the cash flow statement in a well-run company will track one another. Profit will be turned into cash. However, just because a company is making a profit in any given time period doesn’t mean it will have the cash to pay its bills. Profit is always and estimate. And you can’t spend estimates.
- It happened many times before that a company ships products to their partners at the end of the quarter just to mark these shipments as sales. This is known as “channel stuffing”. What happens is that the partners send back the shipments that they didn’t even ask for.
- Gross profit is revenue minus cost of goods and services, it reflects the profitability of your products. Operating profit is gross profit minus the operating cost, it reflects the profitability of the operation of your business over all. Net profit is operating profit minus taxes and interests. Net profit is what is left over after everything is subtracted.
- Contribution margin is sales minus variable costs. It tells you how profitable a product is and it tells you how much of your product you need to sell in order to cover the fixed cost. It also helps with the pricing of the product. This area is also related to Product Management.
- No matter what’s your company style of recording revenue and costs, what matters is the consistency from year to year.
- The above has focused on the income statement. As for the balance sheet, it is a statement of what a business owns and what it owes at a particular point in time. The difference between what a company owns and what it owes represents equity.
- Equity is the shareholders’ “stake” in the company as measured by accounting rules. It’s also called the company’s book value. In accounting terms, equity is always assets minus liabilities; it is also the sum of all capital pain in my shareholders plus any profits earned by the company since its inception minus dividends paid out to the shareholders.
- Over time, the equity section of the balance sheet shows the accumulation of profits or losses left in the business.
- The rule of the balance sheet goes as follows: assets = liabilities + owners’ equity
- Assets consist of cash and stocks (liquid assets) and equipments and lands and goodwill. A lot of art goes into estimating the current value of non-liquid assets.
- Accounts Receivable is the amount customers owe the company. Revenue is a promise to pay, so accounts receivable includes all the promises that haven’t yet been collected. Why is this an asset? Because all or most of these commitments will convert to cash and soon will belong to the company. It’s like a loan from the company to its customers.
- Sometimes a balance sheet includes an item labeled “allowance for bad debt” that is subtracted from accounts receivable. This is the accountants’ estimate -usually based on past experience- of the dollars owed by customers who didn’t pay their bills. In many companies, subtracting a bad-debt allowance provides a more accurate reflection of the value of those accounts receivable.
- Land doesn’t wear out, so accountants don’t record any depreciation each year. But buildings and equipment do. The point of accounting deprecation, however, isn’t to estimate what the buildings and equipment are worth right now; the point is to allocate the investment in the asset over the time it is used to generate revenue and profit (the matching principle). The depreciation charge is a way of ensuring that the income statement accurately reflects the true cost of producing goods or delivering services.
- If a company buys another company for $5 million. If you pay cash, the asset called cash in your balance sheet will decrease by $5 million. That means other assets have to rise by $5 million. If the bought company physical assets are worth $2 million, that doesn’t mean that you made a bad deal. A brand name like Coke Cola is worth much more that its physical assets. The difference of $3 million is to be marked as goodwill.
- If you paid for rent of $60,000 for 12 months in advance and recording it as $5,000 each month as per the matching principle, where did the other $55,000 cash go in the balance sheet? It gets marked as prepaid asset (you own the place for the upcoming 11 months) and decreases each month by $5,000 and gets reflected in the income statement as $5000 cost of operational cost.
- Should you mark a marketing campaign cost of $1 million as one time cost or do you divide it into the upcoming 24 months claiming that the impact of the campaign would extend over that period? It’s an art more than a science.
- Deferred revenue gets marked as part of liability. It represents money received for products or services that have not yet been delivered. Once the product or service has been delivered, the corresponding revenue will be included in the income statement and it will come off the balance sheet. Industries where you might see deferred revenue on the balance sheet includes airlines (you pay before you fly) and project- based businesses.
- Retained earnings are the profits that have been reinvested in the business instead of being paid out in dividends. Investors don’t like it when a company retain earnings as cash that is not being invested anywhere and they pressure the company to at least make it into dividends.
- What the balance sheet is balancing? On one side are the assets, which is what the company owns. On the other side are the liabilities and equity, which show how the company obtained what it owns. You can also look at it this way: the assets consist of two parts, one which needs to be used to pay for the liabilities and one is capital and profits for the owners. The balance sheet lists nicely all the company assets in one side, and in the other side it lists the owners of these assets.
- If you open a company and put $50,000 in cash. Then in assets side there will be $50,000 as cash, and in owners’ equity side there will also be amount of $50,000. Let’s say you took a loan of $10,000, now the assets side includes $60,000, so from where this came from? We simply add $10,000 in liabilities side. Remember, transactions affect both sides of the balance sheet.
- Profits in the income statement gets reflected in the balance sheet as equity. On the assets side, it gets reflected as either cash or accounts receivable.
- When a company buys a piece of capital equipment, the cost doesn’t show up on the income statement; rather, the new asset appears on the balance sheet, and only the depreciation appears on the income statement as a charge against profit.
- Many profitable companies close down in their first year. The reason is that they would run out of cash. The more sales you’re generating the more expenses you’re paying for the materials, all while not yet turning the accounts receivable into cash.
- If a company is profitable but short on cash, then it needs financial expertise, someone capable of lining up additional financing. If a company has cash but is unprofitable, it needs operational expertise, meaning someone capable of bringing down costs or generating additional revenue without adding costs.
- There is much less room for manipulation of the numbers on the cash flow statement than on income statement and balance sheet. Less room doesn’t mean “no room”. For example, if a company is trying to show good cash flow in a particular quarter, it may delay paying vendors or employee bonuses until the next quarter. Unless a company delays payments over and over -eventually vendors who don’t get paid will stop providing goods and services- the effects are significant only in the short term.
- You can calculate a cash flow statement just by looking at the income statement and two balance sheets.
- Reconciliation, in a financial context, means getting the cash line on a company’s balance sheet to match the actual cash the company has in the bank.
- Operating lease is widely used in the airline industry and others. Rather than buying equipment such as an airplane outright, a company lease it from an investor. The lease payments count as an expense on the income statement, but there is no asset and no debt related to that asset on a company’s books. Some companies that are already over-leveraged are willing to pay a premium to lease equipment just to keep the ratios of interest coverage (operating profit / annual interest charges) and debt-to-equity ratio (total liabilities / shareholders’ equity) in the area that bankers and investors like to see.
- To know how good your company is at collecting their money, divide average account receivable by the revenue then divide by 365 (the number of days in a year).
- To know how tight your company is with using inventory (the tighter the better), divide average inventory by COGS per day. Walmart’s ratio is 47. This means that inventory gets sold on average after a month and a half. That’s a good average in super market industry. For Target, it is 74 meaning that it takes two months and a half for them to sell an item as soon as it gets into the inventory.
- Numbers that are important to investors:
- 1. Revenue growth from one year to another
- 2. Earnings per share (EPS)
- 3. Earning before interest, taxes, depreciation, and amortization (EBITDA) - a strong healthy company should experience growth un EBITDA over time. Also it is often used in valuing businesses. Many companies are bought and sold at a price that us an agreed-upon multiple of EBITDA.
- 4. Free cash flow - divide cash flow by EBITDA, if the ratio is low it may indicate that the company is trying to make its EBITDA stronger than it is.
- 5. Return on total capital, or return on equity
- 6. Market cap (the number of shares multiplied by the share value)
- 7. Share price to earning - usually it’s between 16 and 18. Companies with higher ratios are considered to have high growth potential.
- Companies with high market cap and high share price to earnings are healthy and their jobs are more secure, and there is more opportunity to grow in the company. And the company is more likely to get loans when needed and is more likely to survive tough economies.
- These above two numbers depend on market perceptions, which in turn are driven by: the company’s current financial performance + the company’s prospects for growth in the future + the company’s anticipated cash flows in the future + the predictability of its performance, that is, the degree of risk involved + investors’ assessments of the expertise of a company’s management and the skills of its employees
- Also there are other factors, such as the overall state if the economy, the condition of the stock market in general, the level of speculative fervor, etc.
- At any given point in time, investors will disagree about a company’s “true” value, which is why some are willing to buy shares at a particular price and some are willing to sell them.
- Investors understand that investment is a game of psychology as well as of economics. As the economist John Maynard Keynes once pointed out, buying stocks is like trying to anticipate who will win a beauty contest. You want to choose not the person who you think is the most beautiful but the person you think everyone else will see as most beautiful. [note: this is the opposite of what Warren Buffett is suggesting which is to invest in companies that are underrated and that you wouldn’t mind investing in them for very long time]
- Astute management of the balance sheet is like financial magic. It allows a company to improve its financial performance even without boosting sales or lowering costs. Better balance sheet management makes a business more efficient at converting inputs to outputs and ultimately to cash. Companies that can generate more cash in less time have greater freedom of action; they aren’t so dependent on outside investors or lenders.
- Working Capital is the money a company needs to finance its daily operations. Accountants usually measure it by adding up a company’s cash, inventory, and accounts receivable, and then subtracting short-term debts. The longer a company’s DSO (days outstanding receivables), the more working capital is required to run the business. If your daily sales are $1 million, then you’ll get additional $1 million in cash for each day you cut from the DSO.
- Companies who pay their vendors as early as possible get greater support from these vendors. Vendors are usually small scale and they need the cash flow to function comfortably. Be their champion, and they will work hard for you.
- Educating the staff on finance and accounting, increasing their financial intelligence, is important. It always increases staff dedication and efficiency. When they understand the “why” behind management decisions, they will commit to it, instead of seeing management like bunch of guys who don’t know what they’re doing. Educate with the real numbers. Even private companies can do that by scaling down the numbers but keeping the patterns.
January 29, 2022
Must read for non-MBA managers who wants to be able to discuss numbers and accounting of their company
October 22, 2018
Best explanation of "what the numbers really mean" that I've ever read. How finance is as much art as science and why the numbers aren't as set in stone as a non-finance people might think.
November 11, 2020
One of the best books I have ever read!! It is:
1. a splendid Refresher Course for any finance professional
2. an incisive handbook for any non-finance person who is interested to understand financial statements/ operations of a business from a financial perspective
Note - This book has been published before "Financial Intelligence for Entrepreneurs: What You Really Need to Know About the Numbers" which is by the same authors.
Hence, please do not read the latter since the content is virtually the same as this book .
Standout features:
1. Authors make the content interesting by highlighting many cases of financial shenanigans committed by various companies. By reading this, non-finance people will appreciate the machinations. And finance people will be able to relate to the rationale behind introducing various Accounting Standards on revenue recognition, leases etc.
2. Detailed breakdown of financial statements, ratios and operations.
Useful insights from the book:
1. Accounting and finance are not reality, they are a reflection of reality, and the accuracy of that reflection depends on the ability of accountants and finance professionals to make reasonable
assumptions and to calculate reasonable estimates.
2. Finance is an art as much as it is a science; the financial statements are prepared using assumptions, estimates and biases.
3. In a familiar phrase generally attributed to Peter Drucker, profit is the sovereign criterion of the
enterprise. The use of the word sovereign is right on the money.
4. Income statement - Creating income statements for smaller business units has provided
managers in large corporations with enormous insights into their financial performance.
General Motors had developed this divisional system. (this fact has been mentioned in the book Relevance Lost)
5. Accrual v/s Pro forma income statement - Pro forma is a projection whilst accrual is based on actual numbers
6. You can think of operating expenses as the cholesterol in a business. Good cholesterol makes you healthy, while bad cholesterol clogs your arteries. Good operating expenses make your business strong, and bad operating expenses drag down your bottom line and prevent you from taking advantage of business opportunities. (Another name for bad operating expenses is “unnecessary bureaucracy.”
7. Relationship between Balance Sheet and Income Statement:
What is this relationship? Consider an analogy. Profitability is sort of like the grade you receive for a course in college. You spend a semester writing papers and taking exams. At the end of the semester, the instructor tallies your performance and gives you an A- or a C+ or whatever. Equity is more like your overall grade point average (GPA). Your GPA always reflects your cumulative performance, but at only one point in time. Any one grade affects it, but doesn’t determine it. The income statement affects the balance sheet much the way an individual grade affects your GPA. Make a profit in any given period, and the equity on your balance sheet will show an increase. Lose
money, and it will show a decrease. Over time, the equity section of the balance sheet shows the accumulation of profits or losses left in the business; the line is called retained earnings (losses) or sometimes accumulated earnings (deficit).
8. Cash is not equal to profit. The ultimate lesson here is that companies need both profit and cash. They are different, and a healthy business requires both.
9. There are four categories of ratios that managers and other stakeholders in a business typically use to analyze the company’s performance: profitability, leverage, liquidity, and efficiency.
Each type of ratio provides a different view - like looking into a house through windows on all four sides.
10. There are many more golden nuggets!!
I do hope you find this review useful. Please let me know your reviews after reading the book. Thanks!
1. a splendid Refresher Course for any finance professional
2. an incisive handbook for any non-finance person who is interested to understand financial statements/ operations of a business from a financial perspective
Note - This book has been published before "Financial Intelligence for Entrepreneurs: What You Really Need to Know About the Numbers" which is by the same authors.
Hence, please do not read the latter since the content is virtually the same as this book .
Standout features:
1. Authors make the content interesting by highlighting many cases of financial shenanigans committed by various companies. By reading this, non-finance people will appreciate the machinations. And finance people will be able to relate to the rationale behind introducing various Accounting Standards on revenue recognition, leases etc.
2. Detailed breakdown of financial statements, ratios and operations.
Useful insights from the book:
1. Accounting and finance are not reality, they are a reflection of reality, and the accuracy of that reflection depends on the ability of accountants and finance professionals to make reasonable
assumptions and to calculate reasonable estimates.
2. Finance is an art as much as it is a science; the financial statements are prepared using assumptions, estimates and biases.
3. In a familiar phrase generally attributed to Peter Drucker, profit is the sovereign criterion of the
enterprise. The use of the word sovereign is right on the money.
4. Income statement - Creating income statements for smaller business units has provided
managers in large corporations with enormous insights into their financial performance.
General Motors had developed this divisional system. (this fact has been mentioned in the book Relevance Lost)
5. Accrual v/s Pro forma income statement - Pro forma is a projection whilst accrual is based on actual numbers
6. You can think of operating expenses as the cholesterol in a business. Good cholesterol makes you healthy, while bad cholesterol clogs your arteries. Good operating expenses make your business strong, and bad operating expenses drag down your bottom line and prevent you from taking advantage of business opportunities. (Another name for bad operating expenses is “unnecessary bureaucracy.”
7. Relationship between Balance Sheet and Income Statement:
What is this relationship? Consider an analogy. Profitability is sort of like the grade you receive for a course in college. You spend a semester writing papers and taking exams. At the end of the semester, the instructor tallies your performance and gives you an A- or a C+ or whatever. Equity is more like your overall grade point average (GPA). Your GPA always reflects your cumulative performance, but at only one point in time. Any one grade affects it, but doesn’t determine it. The income statement affects the balance sheet much the way an individual grade affects your GPA. Make a profit in any given period, and the equity on your balance sheet will show an increase. Lose
money, and it will show a decrease. Over time, the equity section of the balance sheet shows the accumulation of profits or losses left in the business; the line is called retained earnings (losses) or sometimes accumulated earnings (deficit).
8. Cash is not equal to profit. The ultimate lesson here is that companies need both profit and cash. They are different, and a healthy business requires both.
9. There are four categories of ratios that managers and other stakeholders in a business typically use to analyze the company’s performance: profitability, leverage, liquidity, and efficiency.
Each type of ratio provides a different view - like looking into a house through windows on all four sides.
10. There are many more golden nuggets!!
I do hope you find this review useful. Please let me know your reviews after reading the book. Thanks!
Read
March 13, 2021Read for an MBA Financial Management class.
MBA 6130
MBA 6130
November 19, 2018
If you look for a deep understanding of finance and accounting, this book is a must-read. Actually, I 've been looking for such a book for some time, but all I got was some full-of-number books. To be honest, although I am a big fan of finance, I never felt like a deep understanding!
Just to give you a hint about the value of the book, I remember from college days, that we were taught different methods of depreciation and renewing the book value of all PPEs at the end of each year. But I never understood the deep rationality behind it. I never understood why P&L statements don't account for capital expenditures. Aren't we supposed to subtract each period's expenses from its revenue to get the bottom line? well, it turned out I never comprehend what the Matching Principle is all about :)
If you are just familiar with the most basics of accounting, you could understand all of the concepts of this book. So, you don't need to be a savvy financial expert to be able to read this book.
Just to give you a hint about the value of the book, I remember from college days, that we were taught different methods of depreciation and renewing the book value of all PPEs at the end of each year. But I never understood the deep rationality behind it. I never understood why P&L statements don't account for capital expenditures. Aren't we supposed to subtract each period's expenses from its revenue to get the bottom line? well, it turned out I never comprehend what the Matching Principle is all about :)
If you are just familiar with the most basics of accounting, you could understand all of the concepts of this book. So, you don't need to be a savvy financial expert to be able to read this book.
April 22, 2020
This book provides fundamental knowledge about finances like a textbook but in the narrative style of a non-fictional book. It helps the reader catch the idea with down-to-earth explanations, however, it is quite hard to structure knowledge by constantly repeating the definition of the terms. You better jot down & shape it yourself.
The book goes through three key components of Financial statement are Income statement, Balance Sheet and Cash Flow statement at non-financial perspective. It did a great job by blowing my mind, finance & accounting are not just only about numbers and facts but it is an art contains rational assumptions & estimates.
"Art of 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"
The book goes through three key components of Financial statement are Income statement, Balance Sheet and Cash Flow statement at non-financial perspective. It did a great job by blowing my mind, finance & accounting are not just only about numbers and facts but it is an art contains rational assumptions & estimates.
"Art of 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"
January 10, 2012
I bought this back when I was in college, I think, and never got around to reading it. I had a free evening and decided to pull it off my shelf. Since I bought it, I have gotten a CPA and various broker-dealer certifications, so the book was essentially useless at this point > I skimmed it over the course of an evening. I think this would serve as a pretty good primer to financial management for someone who doesn't have any background in it.
July 15, 2018
Slow reading but thorough and to the point. I like the practical application of ratios and theories. I would wish for a more complete explanation of those theories, however, he goes straight to use and skips history and development.
March 16, 2014
Really illuminating. A must read for every board member.
March 19, 2017
One of the best book I've read. The author translates complex financial terms into day-to-day words, very easy to understand.
July 26, 2017
Great - jargon-free, which is refreshing, and a very relatable look at the numbers via case studies to freshen up the financial brain cells!
November 4, 2017
Fantastic book on financial intelligence for non-financial managers. Should be a must read for any manager or MBA student.
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