There is an astonishing phenomenon that occurs in business.
It happens when different departments get together to talk about finance. It is this:
People sometimes use different words to refer to the same thing…
Operating Income (or Operating Profit) is a line on the Income Statement (or P&L) that tells you the profit you have made after paying the Cost of Sales (or direct costs) and the operating expenses, but not finance charges or taxes.
It is commonly called EBIT (earnings before interest and tax in the US). It is a very important number, so much so that it is called the Primary Result in Denmark (or Result Number 3 in Germany).
Five labels for the same thing… and there are more.
Or they use the same words to refer to different things.
Ask the sales team how much profit they made this month–they might say $300 million.
But when you ask the finance team, they say the company lost $100 million. How in the world does that happen?
It’s because each team is using the word “profit” differently—the sales team is thinking of Gross Profit (Sales – Cost of Sales) and the finance team is thinking about Net Profit, or the bottom line–and that happens because they see different things as important.
It’s like the satellite that burned up in the Mars atmosphere in 1999: one software measured with pounds while the other used the metric system. It’s just people thinking about things in different ways. And without a common language, it’s hard to reach a goal.
In business, that common language is the language of ‘finance’. It’s a uniting concept that everyone in the company needs to understand for healthy business.
Basic financial understanding will allow you to ask the really important questions. Here are 3 of them.
1) Will this product be profitable?
Imagine a scientist who rises to the top of an R&D group and is now managing a multi-million dollar budget. But they don’t have the language or the concepts for handling it appropriately, so they may make some poor decisions.
The thinking might be: “We’re going to develop a drug; it’ll cost us $1 a pill to produce, we can sell it for $5, and easily sell 1 million pills per year, so the company will make $5 Million which is a decent profit.”
They are not considering that it could take 10 years to develop a drug, and the company will spend a lot of money in that time. And since not every drug is successful; they’ll discontinue several ineffective drugs after a few years.
The successful drug has to cover not just its direct costs and its 10-year development costs, but also all the costs of the unsuccessful drugs.
What looks like a decent profit is not always adequate.
“What does this drug cost?” will have completely different answers, depending on your perspective and your overall business understanding.
2) Are we being paid quickly enough to meet our needs?
Salespeople know they cannot go below the floor price. They assume someone else has done the math and believe anything below that price is not profitable. That’s Sales 101.
But they also need to understand Days Sales Outstanding, which is how long it takes your customers to actually pay you after you invoice them.
Salespeople need to understand what happens if the customers are slow to pay. It may not look like a big deal—they’re either going to pay this month or next.
But multiply that attitude across the entire company, and you will soon run low on cash which will then limit some present needs for the business.
Goals like expanding capacity are hard to reach without actually having cash in hand. It is helpful when the sales team understands that it’s better if the customers pay sooner. (It is even more helpful if the entire team understands that.)
3) What is the time value of our money?
Everyone in the company needs an understanding of the very basic concepts of finance; they have to understand profit and the importance of cash… and then there’s the impact of time.
When does money leave the business? When does it come back into the business? The planning cycle matters.
For example, a profitable company has adequate cash flow; but if you push back the average time it takes to receive money from customers on invoices–by only 15 days–that same company could suddenly have a negative checkbook balance. It is still just as profitable, but that one tweak in Days Sales Outstanding dramatically changes the cash flow standing of the company.
You can also look at the time value of money–money coming back into the company 10 years from now is not worth as much as it is today. i.e. $1 today is better than $1 in 10 years.
But what about $1 today or $5 in 5 years? Which is worth more?
Knowing the time value of money will help you decide where that line is.
What about a longer time frame–would you rather have $1 today or $5 in 10 years?
Income|Outcome teaches the language of finance in a way that’s sensitive to the business.
Power plants need to understand time value of money because of their long and expensive development time. Supermarkets don’t have the same need, because of their easy development and rapid cash turnover.
But both equally need a common understanding of finance to be at their best.
Different departments see their piece of the puzzle, but they don’t always have a holistic view of how the business is running and the impact of their decisions.
Similarly, some people understand their own industry very well, but they don’t always understand the business of other industries.
Both of these limitations can be overcome by developing a big-picture understanding of business. This big-picture understanding is universal: any company, in any industry, anywhere in the world, can be described and analyzed by an income statement and a balance sheet.
So there’s a career development aspect of business understanding which makes you more valuable and more mobile. As with any other language, “speaking” finance gives you a personal skill and a way to break down walls of confusion in your work environment.
You already live in the nation of Business: why not speak the language?
Interested in having your team speak the language of business? Contact us today to arrange for FSL (Finance as a Second Language) workshops.