HBR Guide to Finance Basics for Managers

• Every business runs on financial data. If you don't know the tools of finance, you can't put that information to work.
• The three main financial statements: the balance sheet, the income statement, and the cash flow statement. These are the essential documents of business.
• Companies prepare balance sheets to summarize their financial position at a given point in time, usually at the end of the month, the quarter, or the fiscal year. The balance sheet shows what the company owns (its assets), what it owes (its liabilities), and its book value, or net worth (also called owners' equity, or shareholder's equity).
• Assets comprise all the physical resources a company can put to work in the service of the business.
• Liabilities are debts to suppliers and other creditors.
• Owner's equity is what's left after you subtract total liabilities from total assets.
• Fundamental accounting equation:
• assets - liabilities = owner's equity
• assets = liabilities + owner's equity
• The balance sheet shows assets on one side of the ledger, liabilities and owners' equity on the other. It's called a balance sheet because the two sides must always balance.
• Analysis of the balance sheet can give you an idea of how efficiently a company is utilizing its assets and managing its liabilities.
• Balance sheet data are most helpful when compared with the same information from one or more previous years.
• Generally, current  assets can be converted into cash within one year.
• The biggest category of fixed assets is usually property, plant, and equipment; for some companies, it's the only category.
• If one company has purchased another for a price above fair market value of its assets, the difference is know as goodwill, and it must be recorded.
• The category current liabilities represents money owed to creditors and others that typically must be paid withing a year.
• Long-term liabilities are usually bonds and mortgages--debts that the company is contractually obliged to repay over a period of time longer than a year.
• The absence of intangibles from the balance sheet is particularly significant for knowledge intensive companies, whose skills, intellectual property, brand equity, and customer relationships may be their most productive assets.
• Subtracting current liabilities from current assets gives you the company's net working capital, or the amount of money ties up in current operations.
• Shape your operations to minimize inventories.
• The use of borrowed money to acquire an asset is called financial leverage.
• Financial leverage can increase returns on an investment, but it also increases risk.
• Unlike the balance sheet, which is a snapshot of a company's position at one time, the income statement shows cumulative business results within a defined time frame, such as a quarter or a year. It tells you whether the company is making a profit or a loss--that is, whether it has positive or negative net income (net earnings)--and how much.
• The cost of goods sold, or COGS, represents the direct costs of manufacturing hat racks. This figure covers raw materials, such as lumber, and everything needed to turn those materials into finished goods, such as labor.
• The next major category of cost is operating expenses, which include the salaries of administrative employees, office rents, sales and marketing costs, and other costs not directly related to making a product or delivering a service.
• Subtracting operating expenses and depreciation from gross profit gives you ao company's operating earnings, or operating profit. This is often called earnings before interest and taxes, or EBIT.
• As with the balance sheet, comparing income statements over a period of years reveals much more than examining a single income statement. You can spot trends, turn-arounds, and recurring problems.
• Operating activities, or operations, refers to cash generated by, and used in, a company's ordinary business operations.
• Investing activities covers cash spent on capital equipment and other investments (out-going), and cash realized from the sale of such investments (incoming). Financing activities refers to cash used to reduce debt, buy back stock, or pay dividends (outgoing), and cash from loans or from stock sales (incoming).
• A sale isn't really a sale until it is paid for--so watch your receivables.
• The balance sheet shows a company's financial position at a specific point in time.
• The income statement shows the bottom line.
• The cash flow statement tells where the company;s cash came from and where it went.
• An understanding of a few financial measures coupled with an enterprise-wide perspective, Charan maintains, can help you get a grip on any company, regardless of its size or location.
• There are universal laws of business that apply whether you sell fruit from a stand or are running a Fortune 500 company.
• Problems arise when managers don't have a precise understanding of what "making money" means. Three measures can give you a good picture of whether and how a company is making money: growth, cash generation, and return on assets.
• Growth in sales is usually--but not always--a positive sign.
• Growth for its own sake doesn't do any good. Growth has to be profitable and sustainable.
• Even if your company is growing its revenues profitably and getting a respectable return on its assets, a cash shortage--or a declining cash flow--spells trouble.
• Cash from operations depends largely on two factors: accounts receivable (money owed by customers) and accounts payable (money owed to suppliers).
• A company's return on assets is its net profit divided by the average  value of its assets during a given period of time. This measure, usually expressed as a percentage, show you how well your company is using its assets--including cash, receivables, inventory, buildings, vehicles, and machinery--to make money.
• The other measure that needs to be monitored simultaneously is velocity--how hast a particular asset moves "through a business to a customer".
• By understanding growth, cash generation, and return on assets, managers can counteract the common tendency to think and act within one's "silo" (department or unit).
• A big-picture understanding of basic financial measures has very practical benefits.
• Growth, cash generation, and return on assets--these concepts, along with a focus on customers, form the nucleolus from which everything else about a business emanates.
• Part of your job as a manager is to help your company reach its financial goals--in other words, to help move the key numbers in the right direction.
• The income statement shows revenue, the various costs and expenses, subtotals such as gross profit and operating profit, and of course the bottom line--net profit. The balance sheet shows assets and liabilities, including accounts receivable and accounts payable. The cash flow statement shows how well the company is turning its profits into cash and  what it's doing with that cash.
• Ratio analysis allows you to dig into the information contained in the three financial statements.
• Return on assets (ROA). ROA indicates how well a company is using its assets to generate profit. It's a good measure for comparing companies of different sizes. To calculate it, just divide net income by total assets.
• Return on equity (ROE). ROE shows profit as a percentage of shareholder's equity. In effect, it's the owners' return on their investment--and you can bet that shareholders will compare it to what they could earn with alternative investments. To calculate ROE, divide net income by owners' equity.
• Return on sales (ROS). Also known as net profit margin, ROS measures how well a company is controlling its costs and turning revenue into bottom-line profit. To calculate ROS, divide net income by revenue.
• Gross profit margin. Gross profit margin shows how efficiently a company produces its goods or delivers its services, taking only direct costs into account. To calculate gross profit margin, divide gross profit by revenue.
• Earnings before interest and taxes (EBIT) margin. Many analysts use this measure, also known as operating margin, to see how profitable a company's overall operations are, without regard to how they are financed or what taxes the company may be liable for. To calculate it, just divide EBIT by revenue.
• Operating rations help you asses a company's level of efficiency--in particular, how well it is putting its assets to work and managing its cash.
• Liquidity ratios tell you about a company's ability to meet short-term financial obligations such as debt payments, payroll, and accounts payable.
• Leverage ratios tell you to what extend a company is using debt to pay for its operations and how easily it can cover the costs of that debt.
• Comparing a company's ratios to those of competitors and to industry averages often reveals specific financial strengths and weaknesses.
• Most line managers are directly responsible for controlling costs in their areas.
• Valuation often refers to the process of determining the total value of a company for the purpose of selling it. This is an uncertain science.
• Earnings per share (EPS) equals net income divided by the number of shares outstanding. This is one of the most commonly watched financial indicators. If it fails, it will most likely take the stock's price down with it.
• Growth indicators are also important in Wall Street's valuations, because growth allows a company to provide increasing returns to its shareholders.
• As a business becomes more complex, it gets difficult to trace costs to their origins.
• Large, complex companies often lack consistent information systems across their many business and geographies.
• Most complex companies have many brands or SKUs that contribute little to the bottom line.
• If a company streamlines a sufficiently large number of accounts, it can consolidate facilities and close the highest-cost production lines or service centers.
• Supply chains can account for a staggering 80% of an organization's costs.
• A better understanding of what users want creates a better understanding of which products will satisfy them.
• Companies should assign star players--and give them the proper incentives--to tackle the supply chain challenge. They should reward these executives not just for having enough stock on hand but also for increasing asset turns, growth, and share price.
• Profit, shown on the income statement, is not the same as net cash, shown on the cash flow statement.
• A sale is recorded whenever a company delivers a product or service.
• Cash flow, by contrast, always reflects cash transactions.
• A capital expenditure doesn't appear on the income statement when it occurs; only the depreciation is charged against revenue.
• Every cash-based business, from tiny Main Street shops to giants such as Amazon.com and Dell, has the luxury of taking the customer's money before it must pay for its costs and expense. It enjoys the float--and if it is growing, that float will grow ever larger. But ultimately, the company must be profitable by the standard of the income statement; cash flow in the long run is no protection against unprofitability.
• Understanding the difference between profit and cash is the key to increasing your financial intelligence. It opens a whole new window of opportunity to make smart decisions.
• 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 by is unprofitable, it needs operational expertise, someone capable of bringing down costs or generating additional revenue without adding costs. So financial statements tell you not only what is going on in the company but also what kind of expertise you need to hire.
• Informed decisions on when to take an action can increase a company's effectiveness.
• The ultimate lesson here is that profit and cash are different--and a healthy business, both in its early years and as it matures, requires both.
• You need to know not just whether the overall cash position is healthy but specifically where the cash is coming from.
• Most managers focus on profit when they should be focusing on both profit and cash.
• Disgruntled customers are not known for prompt payments--they like to wait until any dispute is resolved.
• A manger who leads a company in converting to lean thereby frees up huge quantities of cash.
• Our general point here is that cash flow is a key indicator of a company's financial health, along with profitability and shareholder's equity.
• The longer a company's DSO, the more working capital is required to run the business.
• Reducing DSO even by one day can save a large company millions of dollars per day.
• Managing inventory efficiently reduces working capital requirements by freeing up large amounts of cash.
• The challenge is to reduce inventory to a minimum level while still ensuring that every raw material and every part will be available when needed and every product will be ready for sale when a customer wants it.
• Keeping unit cost down is simply a way of managing all the costs of production in an efficient manner.
• An ROI analysis enables you to compare the financial consequences of two (or more) business alternatives.
• The ROI analysis is cash-based, whereas a P&L uses standard accounting principles to spread out costs in a reasonable fashion.
• Often an important element of building a cash flow is translating "soft" benefits into hard numbers.
• Payback period. This is the point at which all the costs expended have been recovered.
• Breakeven point. This is the moment when costs are matched by increased revenue or cost savings for that period.
• Discounted cash flow (DCF). This is a summarized cash flow that accounts for the time value of money, which is an adjustment for the fact that $100 received today is worth more than $20 a year for the next five years.
• Cost/benefit analysis involves the following steps:
• Identify the costs associate with the new business opportunity.
• Identify the benefits of additional revenues the investment will bring.
• Identify the cost savings to be gained.
• Map out the timeline for expected costs and revenues.
• Evaluate the non-quantifiable benefits and costs.
• Return on investment (ROI)--or, to use the more technical term, accounting return on investment--is not always the best measure of an investment's success.
• Any rational investor would want the money sooner rather than later. Thus, true ROI calculations must always factor in the time value of money.
• Breakeven analysts tells you how much (or how much more) you need to sell in order to pay for the fixed investment--in other words, at what point you will break even on your cash flow.
• Breakeven analysis can also help you think through the impact of changing price and volume relationships.
• Fixed costs. These are costs that stay mostly the same, no matter how many units of a product or service are sold--costs such as insurance, management salaries, and rent or lease payments.
• Variable costs. Variable costs are those that change with the number of units produced and sold.
• Contribution margin. This is the amount of money that every sold unit contributes to paying for fixed costs.
• Once you've covered all your fixed costs with the contributions of many unit sales, every subsequent sale contributes directly to profits.
• The relationship between fixed and variable costs is often described in terms of operating leverage. Companies with high fixed costs and low variable costs have high operating leverage.
• Operating leverage is a great thing once a company passes its breakeven point, but it can cause substantial losses if breakeven is never achieved.
• Once you've decided to undertake an investment opportunity, you should monitor its progress. Track your projections against actual revenues and expenses.
• The income statement and balance sheet may seem precise, but they aren't. They reflect all sorts of assumptions, estimates, and procedural decisions, such as which depreciation method to use.
• The Five Traps of Performance Measurement:
• Measuring against yourself
• Looking backward
• Putting your faith in numbers
• Gaming your metrics
• Sticking to your numbers too long
•  It's true that finance is the language of business, and unless you can grasp it, you will be at a perpetual disadvantage in any kind of business career. But make no mistake: the financials describe only a fraction of a company's reality, and sometimes a misleading fraction at that.
• Wise managers always keep one eye on the financial reports, the ultimate gauge of their performance. But they keep an equally sharp eye on all the non-financial or external factors that show up late, murkily, or not at all in the financial data.
• One limitation of financial statements is that they can be manipulated. The usual goal, of course, is to make things look better than they really are.
• The line between fraud and a reasonable change in procedures isn't always clear.
• Probably the most important financial fact the three major statements don't tell you is what a company as a whole is worth.
• For publicly traded companies, the value of the entire enterprise is known as its market capitalization, or just market cap. This is the amount, in theory, that an investor would have to pay to buy all the shares of stock. to calculate market cap, you simply multiply the stock price by the total number of shares.
• Healthy organizations are also nimble: Their people can make and execute good decisions without undue time or trouble.
• Every business is vulnerable to competitors, so the more you know about your rivals, the better off you are.
• To measure how well you're doing, you need information about the benchmarks that matter most--the ones outside the organization.
• Look for measures that lead rather than lag the profits in your business.
• The quality of managerial decision making is another leading indicator of success.
• Good management is about making choices, so a decision not to do something should be analyzed as closely as a decision to do something.
• Good or bad, the metrics in your performance assessments package all comes as numbers. The problem is that numbers-driven managers often end up producing reams of low-quality data.
• You can't prevent people from gaming numbers, no matter how outstanding your organization. The moment you choose to manage bny metric, you invite your managers to manipulate it. Metrics are only proxies for performance.
• It helps to diversify your metrics, because it's a lot harder to game several of them at once.
• Another way of providing budget flexibility is to set ranges rather than specific numbers as targets.
• As the saying goes, you manage what you measure. Unfortunately, performance assessment systems seldom evolve as fast as business do.