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What Do You Really Know About Business Finances?

Over my years running this company I have met many people who clearly don't understand the basics about business. I like to keep it pretty simple ... if I'm not making money then I'm not in business, and then I can't afford to employ people, give money to charities, pay taxes, give work to suppliers, provide a good service to my clients OR pay my mortgage!

I could at this point talk about Premier McGuinty's Ontario government, who either don't understand business or just don't care about the fact that companies need to make more money than they spend ... but I'll refrain (or at least not belabor the point) from picking on those guys (they have to live with themselves).

I could talk about companies who sign deals where the margins are so much lower than their operating costs that you know they are "hoping" (that's kind of like dreaming in technicolour) that volume will make up for it ... but it never does! There was a show in England called "Never Mind the Quality Feel the Width" ... and that saying always comes to mind when I see these deals happening.

I could talk about the procurement professionals who load discount upon discount into their models so that by the end of the day IF the supplier is making any money it's a miracle. But maybe they are related to Premier McGuinty and don't care! Oops I wasn't going to mention him again.

I could talk about the salespeople who come back with the "wacky deals" that their company MUST sign because we'll only be one of three suppliers ... that would be three "going out of business" suppliers.

Alas it appears I may have found the answer! Business Brief, an e-newsletter I receive quoted a Harvard Business Review survey of 300 managers. Here is what they found out ...

Asked to take a basic financial-literacy exam, a representative sample of 300 managers - from C-level executives to supervisors - scored an average of only 38%.

Get this: Over half didn't know the difference between "profit" and "cash." Many didn't know the difference between an income statement and a balance sheet. Nearly two-thirds thought that discounts offered by sales reps had no effect on gross margin.

Does it matter? When delivering the results of the test, Harvard presented scenarios in which that lack of knowledge could cripple a business. For instance, imagine an inventory manager who doesn't understand the relationship between inventory on hand and cash flow.

Here are three sample questions from the test (answers at the bottom):

1. You should be pleased about your company's financial results if --
a. There is a negative trend in operating margin.
b. There is an increasing trend in COGS.
c. Cash flow is coming from company investing.
d. Cash flow is coming from company operations.

2. A company has more cash today when --
a. All customers pay their bills sooner.
b. Accounts receivable increases.
c. Profit increases.
d. Retained earnings increases.

3. To investors and analysts, free cash flow is a key number because --
a. It reflects the cash that is "free" - that is, your company doesn't have to pay interest on it.
b. It is the cash that can be used to pay shareholders their dividends.
c. It reflects the operating cash that has flowed into the business that year.
d. It is the cash that investors put into the business.

1. d.
2. a.
3. b.

I guess if these high level managers can't understand this, then it explains why we encounter such strange business situations day in and day out!