Let’s try to get rid of some common misconceptions regarding finance – many professionals think: a) it’s rocket science, b) it’s the most boring topic ever invented, and c) we don’t need to know or care about it because we’ve got a strong finance department and CFO.
Many think that finance is a hard and complicated topic – yet this is far from reality! Corporate finance is centered around a number of logical principles and building blocks, and the basics are rather straightforward to grasp. Initially, you might be overwhelmed by all the fancy terms finance people use, and you will be amazed by how many alternative wordings and abbreviations there are to refer to the same underlying concepts! For instance, the ‘profit and loss account’ (or P&L) is also called the ‘income statement’, and its top line is referred to as sales, revenue or turnover, with the bottom line called earnings, profits or income.
But once you know what is behind the terminology deployed in the language of finance, you will agree that it’s not rocket science at all – common sense will take you a very long way in this field.
BUSINESS AND FINANCE NEWS IS FASCINATING!
You will also be surprised by how broad the field is – it is for sure not a small isolated domain but one with many links to other management domains, such as strategy, supply chain and operations, marketing, and many more. Furthermore, you will be amazed by how fascinating it can be to keep abreast with the business and finance news once you can talk about recent events like major IPOs (Initial Public Offerings – companies being listed on the stock market, like Spotify in early 2018) and corporate mergers & acquisitions (M&A – like the recent deal between Disney & Fox) and you understand what is meant by terms like ‘market cap’ (in mid-2018, Apple reached $1 trillion), NPV (Net Present Value) and EBITDA. Yes, once you understand its relevance and appreciate the broad range of situations in which finance concepts and principles play a role, you will stop believing that finance is a boring and dull topic.
MODELLING THE FIRM’S FUTURE
An example of an important theme in finance is ‘budgeting and financial planning’ – in which one tries to model the firm’s future and forecast what future P&Ls, cash flows and balance sheets will look like. Of course, to do so, you should be quite familiar with financial terminology and knowledgeable about how financial statements interact. But that’s all rather straightforward. The most challenging (and of utmost importance) aspect is an in-depth understanding of the business and the environment in which it operates, including the competitive landscape and key trends. Financial planning will prove to be useful in assessing the need for raising funds, identifying the most suitable type of financing, building business cases for capital budgeting projects (including joint ventures or M&A), as well as for valuing companies and shares.
OPTIMISING CASH FLOWS
Another important topic involves ‘managing the cash conversion cycle’ – which is basically trying to optimize the cash in- and out-flows from operational activities. The ideas and concepts are pretty accessible − yet, just like financial planning, this aspect is often overlooked or ignored, especially by small firms, SMEs and start-ups, because they are simply not aware of why it matters. But even multinationals – or BUs within multinationals − can neglect this matter, because, although headquarters is probably aware of the importance, the employees may be driven by other KPIs and incentives. Also, be aware that often the hard part in finance is not entering everything into Excel and computing items like forecasted cash evolution, or KPIs like NPV, payback period or IRR … no, the tricky and most time consuming part is obtaining a realistic view on credible input assumptions.
We can spend a lot of time discussing what a company’s goals should be, but some minimum financial criteria should always be satisfied. For instance, firms should always have enough money to pay employees, suppliers and debtors (like banks) on time – severe liquidity or solvency issues will disrupt a firm’s operations and might lead to bankruptcy. If profitability is disappointing to shareholders, these financiers will push the company to take action and improve performance quickly, or they will take their funds and invest elsewhere… Every manager should thoroughly understand that a company’s ‘financials’ do not really depend on the finance department – they are simply the global reflection of the company’s overall performance, displaying how well (or poorly) a firm is doing in terms of business development, marketing, supply chain, sales, strategy execution, and so on. So, you/we are all driving the numbers and bear mutual responsibility.
And here are a number of additional triggers that may motivate you to understand the basics of finance. Every manager needs to attend meetings and presentations in which financial terminology − like ‘cash flow’ and ‘margins’ − is used. If you do not really understand these terms, you may feel quite uncomfortable; whereas, when you know what they mean and why they matter, you can raise your voice and have impact. Speaking the language of finance can also facilitate communication between you and your suppliers, customers, boss or MD, board members, and the finance department, and help you better grasp what you read in the business headlines. Plus: when you have a wonderful great idea, and you want to build a business case to pitch to senior management, your chances of success rise rapidly when you understand that decision-making is often driven by the financial outlook of what you are proposing.
SUPPORTING ALL KINDS OF BUSINESSES
Finance principles will help you recognize why, for instance, your company decided to change strategy, or divested a business unit (perhaps because of mature markets, declining margins and large upcoming capex requirements). Also, if you ever consider becoming an entrepreneur and starting your own business, some knowledge of finance is key. The same applies if you would like to become a board member someday − at Tesla, for example: if you can’t read a balance sheet or are unfamiliar with working capital issues and how to assess profitability, it will prove hard to be a board member that can engage management in critical discussion and add value to the firm.
But even if you have no ambitions to become an entrepreneur or board member, you will still see that climbing up the corporate hierarchy typically comes with roles that put more focus on finance, especially when the economic environment is challenging and in industries with strong competition. Finally, should you ever consider investing some of your savings in bonds or company shares, the ability to read financial statements will shed crucial light on the investment’s attractiveness and risk exposure.
As a final note − given your role, position and responsibilities − please reflect on how you can contribute to better company performance through the impact of your decisions. And please realize that finance people – although you may feel they challenge you continuously and always give you less budget than you’d like – are primarily there to support the business.