Regardless of your technical background, the higher you move within an organization, the more you need to understand about the organization’s finances.
Accounting is often referred to as the language of business. And I believe it. Before I studied corporate finance and accounting, I often felt lost. I didn’t speak the language. I remember sitting in a board meeting where other managers and board members were reviewing the financials for the organization. And I simply didn’t understand what all the numbers meant. By the time I starting making some simple two connections, the meeting had moved onto the next topic.
Not understanding the terminology and concepts left me with no chance of understanding the financial performance and trends of the business.
As a young engineer, I remember coming up with (what I thought were) brilliant ideas. And I would convey these ideas for a new process or new piece of equipment to my manager. But so often, those ideas were placed on the back-burner for reasons not obvious to me at that time. It was frustrating.
What I didn’t realize until later in my career was that I wasn’t conveying my ideas in the terms that were aligned with my organization’s objectives. I just decided I had a great idea because it seemed great in my mind. But I wasn’t taking time, and didn’t have the expertise, to put those ideas into financial terms … in terms related to initial investment, return on investment, change in net working capital, and so on.
And in retrospect, my past managers were likely too busy to do that legwork themselves. So, my project ideas got side-lined.
Business finance is not only one of the most critical skills that you’ll need to become an effective manager, but it’s also one that you’re least likely to encounter naturally in your role as a maker since business finances are generally handled by the finance professionals.
So unless you’re studying finance and learning these topics, you’re not going to just pick these skills up on your own. And as a result, you’re going to get left out of those key business decision making processes.
Business finance also has a deceiving nature. Some very intelligent engineers and programmers believe they understand business finance because they borrowed money for a car, they’ve bought a house, they’ve invested in the stock market, etc. But realistically, those things have almost nothing to do with business finance. While related, these are issues of personal finance.
Non-financial managers need to understand three major areas of business finance in order to be successful: financial accounting, managerial accounting, and return on investment analysis.
Financial accounting is the branch of accounting that involves summarizing and reporting a company’s business transactions through four main financial statements: the balance sheet, the income statement, the cash flow statement, and the statement of owners’ equity.
These documents describe an organization’s financial structure and performance. And to an informed reader, they hint at strengths and weakness, opportunities and threats.
The second area is managerial accounting. These are the calculations, reports and metrics that focus on internal decision making. These are the items managers use to steer the company forward.
Managerial accounting encompasses many areas, but one of the main areas would be product and service costing. In order to decide how much to sell a product for, you have to understand how much it costs. Costs like direct and indirect labor, and fixed and variable overhead are components of a product’s cost. Understanding these terms and how they’re derived therefore is essential for accurately costing your products.
Knowing the components of product or service costs also helps you identify areas of improvement. If you’re not measuring indirect material for instance, it could drift out of control. They also allow managers to set budgets for future times periods, another key area of managerial accounting.
The third essential area of business finance or successful organizational management is return on investment analysis. This is the process of estimating the value of a major investment will return to an organization and its shareholders.
There are many “back of the napkin” return-on-investment (ROI) measures like payback period, the estimated time it would take an organization to recoup its initial investment, or break even point, the estimated number of units needed to sell to recoup the initial investment. And these methods are marvelous brainstorming tools to use prior to the planning phase of a project.
But to make actual business decisions that your employees, other managers, and your shareholders can rally behind, you’re going to need something more than an informal analysis method.
The gold standard for ROI models is called the net present value method (NPV). This method starts with estimates of all your costs and revenues across the life of the project, then provides a means of converting those estimates into a present-day value considering the time value of money.
Like all models of course, NPV is subjected to the “garbage in, garbage out” mantra. But without a robust analysis model, the quality of your data is meaningless as well.
Understanding the essentials of these three areas of business finance – financial accounting, managerial accounting, and return on investment analysis – will prepare you for the increasingly complex duties of a business leader. And like all skills, learning them is simply a matter of putting in the time and energy. YouTube, Udemy and used college textbooks can offer you all you need and more at little to no financial cost.
Ray Harkins is a manufacturing professional and online educator. He teaches a variety of low-cost, high-quality manufacturing and business-related courses at Udemy.com. Click on the course links below to get details and receive substantial discounts on these courses.
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