There is an astonishing phenomenon that occurs in business. When departments discuss finance, people often use different terms to refer to the same thing.
For example, 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). This number is so important that it is called the primary result in Denmark.
People also 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 does that happen? Each department uses 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 (the bottom line).
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 allows different departments to communicate and collaborate with each other. It’s a uniting concept that everyone in the company needs to understand for a healthy business. The language of finance is based on fundamental concepts. Here are three overarching concepts to get you started.
1) Understanding Profit
Imagine a scientist who rises to the top of an R&D group, now managing a multi-million dollar budget. They don’t know the language of finance; they don’t understand basic financial concepts. They are ill-equipped to handle the situation or make financial decisions.
They might be thinking, “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 one million pills per year, so the company will make $5 million which is a decent profit.”
In this case, they are not considering that developing a drug could take ten years, and the company will spend a lot of money in that time. Since not every drug is successful, they’ll likely discontinue several ineffective drugs after a few years. The successful drug then has to cover the direct costs, the ten-year development costs, and the cost of the unsuccessful drugs. Once you incorporate these costs, the $5 million in profit is no longer accurate.
“What does this drug cost?” will have completely different answers, depending on your perspective and overall business understanding. Learning the language of finance is crucial to correcting these discrepancies.
2) Understanding the Importance of Cash
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 your customers take to pay you after you invoice them.
Salespeople need to understand what happens if customers are slow to pay. It may not seem like a big deal; they’re either going to pay this month or next. But if you apply that thinking across the entire company, you will soon run low on cash.
It is helpful when the sales team or, better yet, the entire team understands that it’s better if the customers pay sooner. Knowing the finance language and the difference between cash and profit is essential to ensure your business can continue operations while you wait for payment.
3) What Understanding the Time Value of Money
Everyone in the company needs an understanding of the basic concepts of finance; they have to understand profit, the importance of cash, and 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; if you push back the average time it takes to receive money from customers on invoices by only 15 days, that 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 company’s cash flow.
You can also look at the time value of money. Ten years from now, money coming back into the company 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? What about a longer time frame? Would you rather have $1 today or $5 in 10 years? Knowing the finance language and time value of money will help you identify where that line is.
Learning the Language of Business
Different departments understand their piece of the puzzle. But they don’t always see the bigger picture of how their decisions impact the business. Similarly, some people understand their industry very well but don’t always understand other industries’ business. 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 that makes you more valuable and mobile. As with any other language, “speaking” finance gives you a professional 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? We provide business simulation training that helps companies upskill their employees in the language of finance. Simulation participants will learn key competencies using critical financial planning and analysis tools in a fun and engaging environment. We offer our business simulations at five different levels, so every employee has the opportunity to learn the language of business. Contact us today if you’re interested in having your team speak the language of finance.