Finance / Cash Flow
Finance for Non-Financial Managers
Some of us have no difficulties picking up a set of accounts and understanding them relatively easily. But the majority of managers (and especially those with little or no direct financial or accounting training) see columns of numbers set in accounts and find that we have a reaction similar to one or more of these: our mind stalls; or our eyes glaze over; or the numbers swim before our eyes; or words mean nothing to us; or we are confused by either the numbers or the jargon; or we cannot see relationships between the numbers; or we have a sense of panic; or we have feelings of financial/numeric inadequacy. What every manager needs to know is that these reactions are perfectly normal. This article attempts to explain why and how to overcome the barriers that can prevent us being financially literate in a world where this is becoming increasingly important.
Increasing Financial Literacy or understanding finance for non-financial managers involves the following key steps:
- Appreciate that most people struggle with Math.
- Note that you will only need Primary School Math to read accounts.
- Be prepared to draw graphs or to get your spreadsheet to do it for you.
- Understand that you will only need to use very basic and simple accounting.
- Be prepared to learn some basic jargon
- See accounting as an art form.
- Realize that Financial Literacy is as easy as A, B, C.
Let’s look at each of these in a little more detail.
Key 1: Overcoming the Anti-Math Syndrome
It has been estimated that 70% of children leave school with such a bad feeling about Math that they are put off the subject for life. The biggest single barrier to financial literacy are the consequences of this phenomena: Fear of numbers and beliefs such as “I am no good at Math” etc. We therefore need to appreciate that it is likely to have been the way in which many of us were historically taught Math that was the key problem, and not a deficiency in our intellect. In other words, if you found Math hard, boring or abstract, you are in the majority!
As individuals, we all have different behavioral, information processing and learning style preferences and traditional Math tuition appeals to only a very small grouping of these. If we operate using a different grouping of preferences we may well have found Math hard. The good news is that Accounting and Finance, at the level at which most of us need to understand them, use very simple and basic Math.
Key 2: The Misconception of Math in Accounting
Most of us believe that Accountants are some kind of advanced mathematicians. They are not. In fact almost all Accounting uses nothing more difficult than add, subtract, multiply, divide – and all of these are only primary school Math. The most difficult mathematics involved for most of us becoming financially literate is working out percentages, which is just being able to multiply by one number and divide by another.
Key 3: Financial Literacy is not Accounting
Financial literacy is being able to read and understand what is written in the accounts not to assemble the data or to present it in a formal accounting way. Financial literacy is as different from being an Accountant as the casual book reader is from being a novelist. The Accountant has to keep records, run systems, interpret and apply standards, balance ledgers and prepare the final accounts. The financially astute reader has a very different role – that of forming their own conclusions from what has been written in the accounts.
Key 4: Understand the 80:20 Rule
The Accounting knowledge needed to be financially literate is both basic and very easy. In fact 80% of all Accounting is easy … and we do not need to know the difficult 20% to read accounts. In other words, the vast majority of managers can get most of what they want to understand the numbers and make good decisions with a very small amount of effort.
Key 5: Learning the Jargon
Most professions use jargon as a shorthand way of communicating and to label critical things in a very explicit way. Accounting is no different and the jargon is a real barrier to Financial Literacy. Accountants use many terms that mean much the same thing. It’s a bit like snow to Eskimos – Eskimos have over 20 words for snow because it is of critical importance to their survival to know the difference between types of snow. Most of us just need the one word – snow. The accounting jargon we need to understand accounts is very limited and is mostly covered by the small glossary included at the end of this article.
Key 6: Reading Columns of Numbers
We all use three key ways of processing information: we see it (maps, diagrams, graphs), experience it (feel, touch, experiment) or we hear/read it (saying the words to ourselves or just handle it as facts or figures). We all have preferences for which modality to use and when information is presented in that mode we process it more easily than if it is not.
On average 45% of people prefer to see things, 40% experience things and only 15% hear things. Half of this last group process data best as facts and figures. This is the mode in which accounts have been written for centuries – as columns of numbers. If this is a difficult style for you, then you are in the vast majority. About 90% of people can understand graphs more easily than a column of numbers. If you are one of these, simply graph the data in the column and watch it spring to life.
Key 7: Understand that Accounting is More of an Art Form Than a Science
Accountants are paid to paint pictures with numbers. Like an artist painting a landscape, what they paint will be a reflection of reality as they see it. The artist uses palettes, oil paints and brushes to create on canvas their desired impression of the landscape. The Accountant uses numbers, accounting conventions and standards to paint the picture of the accounts they would like you to see. These will reflect reality but they will be biased towards either a conservative view or an optimistic view depending on the corporate culture of the reporting organization. Accounting standards allow plenty of room for interpretation.
If finance and accounting numbers are still a bit of a mystery, follow this check list:
- Carefully consider why you want or need to become more financially literate. Are the reasons strong enough to learn the simple basics of what, to most of us, is like a foreign language.
- Check your feelings when faced with accounts and identify the appropriate barrier that is creating these feelings.
- Be really clear that the problem is not you but it may be some of the things you used to believe about yourself. Most of our historic beliefs that were barriers to learning to be financially aware were really the inflexibility of our past teachers and role models.
- Some of the keys in this tool may seem a little difficult or awkward to accept at first. Be prepared to sit with them for a while.
- Practice transforming figures into graphs.
- Ask questions and ask for simple answers. Most Accountants are only too happy to help. Find one that can talk your language and understand that it is a skill of the very best professionals to be able to put things in simple lay terms.
- Make sure you ask for clarification on things you do not yet understand.
- Read the simple case study on the next page-it may well help overcome some big mental blocks!
A Real Life Example: The Not-For-Profit Director:
Wayne was a parent who became heavily involved in fund raising at his child’s independent private school. He had no business experience but was full of enthusiasm for the school values, goals and sense of belonging and wanted to do something to help foster this method of education for the benefit of the wider community. After a while, he was approached to become a director of the not-for-profit company that ran the school. Wayne readily accepted.
At his first Annual General Meeting, Wayne was asked to sign the audited school accounts for the previous year. He looked at the papers he was given and had no idea what he was being asked to sign, as he had never seen a set of financial accounts before.
A sense of panic set in as the numbers appeared to swim before Wayne’s eyes and no matter which way he read the words, they didn’t make much sense to him. Some were words he did not know, others were in an unfamiliar context and others were terms he had just heard in passing … and it all looked quite “official”. For a moment Wayne felt as if he were stupid.
Fortunately, Wayne had a secret weapon. His partner, Jo, was an Accountant and he could ask her to show him how to decipher the accounts. However, the first attempt at discussing the accounts was a disaster. Jo seemed to be speaking an alien language as she tried to explain.
Next time, Jo adopted a different approach and started from a layman’s point of view. She had prepared graphs to illustrate where the money came from and was spent in the accounts. She compared one year to another in the same graphical way. She explained that accounting was basically very simple – really about being able to add up and subtract, with some multiplication and division thrown in. Jo put all of the accounting jargon into simple everyday terms, describing assets as something the school owned and liabilities what they owed to others. She even pointed out how and where the accounts had been conservatively prepared.
Jo then asked Wayne questions about the market value of the school’s land and buildings and together they compared these to the original cost as it appeared in the accounts. Wayne could now clearly see that this cost was far lower than the current value … just like Wayne’s own home.
They did the same thing with “Debtors”, which Jo explained as the school fees that were owing by other parents. She pointed out the “Bad Debt Provision” and explained that this was a kind of reserve in case some parents did not pay. Wayne had seen the list of amounts due and realized that it was very unlikely that this reserve would ever be needed. Jo helped him see how the school Accountant had painted a very conservative picture. Wayne was relieved.
Wayne soon realized, as Jo showed him what things meant, that the accounts were not difficult to read, they were just different. As he learned the simple lay terms for the jargon, saw that he could make sense out of the numbers far more easily in graph form and began to see the relationship between the items in the accounts and everyday reality, so his confidence grew. He even sat down with the school Accountant and discussed the benefits and drawbacks of the accounting treatment used. The Accountant was delighted to answer his questions. Wayne found that achieving financial literacy was much easier than expected.
Financial Reporting Glossary – a Layman’s Guide
|Accounting||Includes bookkeeping, reporting, analysis and planning|
|Bookkeeping||Recording payments, receipts, inventory and receivables etc.|
|Profit & Loss Account||Tells us what we are earning (Statement of Financial Performance)|
|Balance Sheet||Tells us what we are worth (Statement of Financial Position)|
|Statement of Cash Flow||Tells us where the money is|
|Budget (Forecast)||Tells us how much money has been allocated or where we have potential to go financially|
|Cash payments||Money going out|
|Cash receipts||Money coming in|
|Inventory (Stock)||Items purchased for resale|
|Receivables (Debtors)||Money owed to us|
|Liabilities (Creditors)||Amounts which we owe to others|
|Capital (Equity)||Owners stake in the Business|
|Asset||Something that we own (tangible like a piece of equipment or an office, factory) or intangible (like a brand)|
|Current||Something that will probably turn into cash in less than 1 year|
|Revenue||Income that has been earned|
|Expenses||Cost of doing business – expenses are manageable|
|Depreciation||The amount of an asset’s useful life that has been used up|
|Tax||Is only an expense of doing business – with planning, tax is manageable|
|Profit||What we are earning after all expenses – Profit has nothing to do with cash|