Managers must constantly evaluate their firms’ strategies to assess how their decisions have been performing, modify these strategies as conditions change, and devise new strategies to boost performance in the future. Which activities should we devote more resources to and which should we cut back on? Which resources are not being used effectively? Should we outsource an activity or continue to perform it ourselves? Business decisions like these need to be based on information, and financial statements are a major source of this information.
But many managers don’t have a background in accounting and finance, so they don’t have the tools they need to answer these questions. They don’t understand the reports they are given to help them make these decisions. They either ignore the information completely, they misinterpret what the numbers mean, or they aren’t even aware of what isn’t in the numbers at all. All of these behaviors are dangerous to your firm’s financial health. They are like trying to fly a plane with no instruments and with the windshield fogged up.
Does this mean managers should run out and memorize a bunch of rules and regulations or hone the art of compiling financials? No, leave that to the accounting and finance teams. What managers and business owners should be concerned with is how to use the financial statements that are provided to them to better assess company performance and pinpoint opportunities.
As a business decision-maker who wants to evaluate investment strategies and make better business decisions for long-term profit, the following areas of knowledge are critical. To get a better sense of your financial literacy, check off the items you know how to do:
- Read and interpret balance sheets, income statements, and cash flow statements.
- Dissect an income statement and balance sheet to understand the drivers of profitability.
- Understand financial reporting concepts, such as revenue recognition, inventory costing, depreciation, and taxes.
- Recognize how capital structure — the mix of debt and equity used to finance assets — influences profits and risk.
- Identify the relevant costs for decisions and calculate break-even points.
- Evaluate investment strategies and conduct discounted cash flow analysis.
- Put all of this together to develop a coherent business strategy.
If you have some open spots on the checklist, then there is still great untapped potential to put financial statements to work for you. Interpreting data and mastering financial statements can help you make better decisions and increase one’s value to a firm whether you are an experienced manager, executive, or leader at a large or small public or private company.
Another important reason for you to learn accounting and finance skills is to help you become a more valuable participant in discussions of corporate strategy and to be more effective in championing your ideas in the boardroom.
Gaining a better grasp of financials helps you know what questions to ask and what to focus on, determine what’s most important, and know what to avoid and to what to pay attention. It’s the synergies that arise from merging managerial experience with finance and accounting skills that can generate the most value to you and to your organization. Hence, boosting your financial knowledge makes good business sense.
© 2011 Richard A. Lambert, author of Wharton Executive Education Finance & Accounting Essentials,
Richard A. Lambert, author of Wharton Executive Education Finance & Accounting Essentials, is Miller-Sherrerd Professor of Accounting at the Wharton School of the University of Pennsylvania, where he teaches finance and accounting in the MBA and Executive Education programs, as well as seminars in the doctoral program. The recipient of several teaching awards, his articles have appeared in The Accounting Review, Journal of Accounting Research, Journal of Accounting and Economics, Rand Journal of Economics, and Strategic Management Journal.
For more information please visit Finance and Accounting Essentials at Wharton Digital Press.