This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
Chapter Summary
- Cash cycles are the tracking of cash into usable resources for the business and back into cash again (hopefully more cash). Many cash cycles occur at the same time, and it is the manager’s job to keep an eye on how well the process is flowing.
- Net cash flow and net profits are never the same. Managers should keep track of both.
- Fast growing companies need more cash than most, so it is the manager’s job to arrange multiple lines of credit, before they are needed.
- Investments into inventory and accounts receivable (giving customers credit), risk being lost before turning back into cash.
- Cash flows forecasted six to 12 months, allow a manager ample time to secure lines of credit for when they will be needed.
Cash Flow Cycle
A business starts with cash, has some setup costs, buys assets, obtains credit, produces something, sells it, collects the revenue and turns it back into cash.
Obtaining credit allows a business to leverage more money than it would otherwise have. Making $5,000 turn a margin of 10%, when the bank loan only cost you 4% is a wise investment.
More businesses fail because of cash flow issues, rather than not having enough profits.
Cash Basis vs. Accrual Basis
There are different ways to account for your revenues and expenses. One, is by keeping track of when money leaves the account and when money comes into the account. The other, more common method, is to record items when they happen, even if the actual exchange of cash is later.
Three reasons for a business to use accrual accounting are:
- concerns about gross margin
- needing to know when they’re making money, and when they’re not
- relationships with lenders, investors and the government require the accounts to be kept that way
Net Profits vs Net Cash Flow in Your Financial Reports
- increase profits w/o increase in cash (accts receivable)
- decrease in profits w/o decrease in cash (accts payable, net30)
- increase cash w/o change in profit (loans)
- decrease cash w/o change in proft (paying a loan back)
This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
Summary points for this chapter include:
- The same line-items on different companies’ income statements may be identified by different words, but look for the commonalities between the names.
- Sales should be recorded in the periods they were earned and closed, not just where they look the best.
- EBITDA : Earnings Before Interest Taxation Depreciation and Amoritization
- Comparing the income statement with a benchmark like a budget, or prior year, you can increase your understanding of a company’s well being.
Starting the chapter, we learn that the Income Statement can be known by a couple other different names; Profit and Loss (P&L), as well as Statement of Income and Expenses.
Some non-financial managers are surprised not to see specific individual transactions on an income statement that they thought should be there. There are two reasons why an income statement might not have recorded a transaction in the time period that a manager might think it should have shown up:
- time passage between the time when the invoice was sent to the supplier or customer, and the time when the invoice was actually paid.
- confusion over when a transaction should be recorded according to GAAP.
The second bullet may need some explaining. Transactions, according to GAAP, become irrevocable when the supplier has delivered something. Before a shipment is received, the purchased order, the invoice, all “agreements” are revocable, until something has actually been delivered. Therefore, when accounting for a purchase, the transaction is recorded when the goods are received.
Sales income is only recognized for those exchanges of products or services, regularly offered to the customer under normal business circumstances. When a business sells buildings or land (unless the business of the business is selling buildings and land), those sales are not recognized as sales. Money earned by sales of services might be called revenue, but the terms sales and revenue are interchangeable.
Cost of sales (cost of goods sold) are those expenses directly related to making the sale. Delivery, raw materials, even training, sometimes commission, all contribute to cost of sales.
Take away cost of sales, from the sales themselves, and you’re left with gross profit. Gross profit is an important number because the business will pay for operating expenses based on gross sales. Operating expenses are those expenses that are needed to keep the business running. R&D, administrative expenses and sales and marketing all are part of the operating expenses. There may be other expenses, and some companies might not list the categories above. Each business will record those expenses using categories that describe the biggest impacts to the business.
Research and development, engineering expenses, and product development are all terms used to define the processes that happen in order to create new sales. Because all of these activities happen before the sale is to be made, they are not a part of cost of sales, and therefore must be paid as part of operating expenses.
Sales and Marketing expenses, outside of those expenses directly related to the cost of sales (eg commissions), include brand development, market research and test marketing.
General and Administrative expense (G&A) is a catch all category for all those expenses that do not fit into the other categories listed in the Operating expenses category. Listed in the G&A are: executive salaries, human resources, employee benefits, and all costs associated with supporting the administration of a company.
EBITDA is mentioned passingly as a new trend, but whose merit has not been judged yet.
Other income and expenses is found next on the Income statement, and contains income/expenses that are not a part of normal day-to-day business, but could significantly impact net income. Some examples of the numbers that might make up other income are: interest income/interest expense, gain/loss on equipment sold, and gain/loss on investments that are non-essential to the business.
All of the incomes and expenses on the income statement up until the point just after Other income/expenses, sum to a number called Pretax Income. On the income statement, tax estimates are shown for income taxes that will be paid, and the company’s final bottom line, net income is shown right before dividends are taken out and distributed.
Earnings are distributed through shares of the company. Earnings per share (EPS) can tell outsiders about the profitability of the company, and also can hint at price increases for stock options (in a publicly traded company). EPS can be calculated a number of ways though, so there are two numbers that get shown on the income statement, EPS, and fully diluted EPS. Fully diluted EPS takes into account the shares that no one owns, that could be bought before dividends are distributed, and therefore could dilute each individuals’ earnings.
The final point the chapter makes is that the income statement gives much more insight when compared to a benchmark. Those benchmarks could be the income statement for the same time last year, a company’s balance sheet, or even another income statement from another company within the same market, for the same time period.
This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
As I start this second post (see first post) of a 2 post double team of one chapter, I skim the remaining pages of the chapter and find that the Liabilities portion consists of: CURRENT LIABILITIES, LONG-TERM LIABILITIES, and STOCKHOLDER’S EQUITY.
CURRENT LIABILITIES are like current assets in that they are expected to be paid back within the next 12 months. Current liabilities include:
- accounts payable
- accrued payroll
- other accrued liabilities
- notes payable and other bank debt
- current portion of long term debt
Accounts payable, the biggest portion of the liabilities, is made up of bills from service providers and suppliers. Accrued payroll is that portion of payroll that has been worked for, but not paid out yet. Other accrued liabilities, such as loan interest that does not get invoiced, or supplies that have been bought, but for which no invoice exists yet, are included under this sub heading. Actual loans (not the interest paid on the loan) is shown in the notes payable and other bank debt. As a side note, banks sometimes add what are called covenants to business loans. These are rules to either do (like send quraterly reports, keep insurance etc.) or not to do (be a part of a merger, or use business assets as collateral for another loan etc.) certain things. Current portion of long term debt is self-explanatory.
In the section on LONG-TERM LIABILITIES, the book states that many sub headings can be found under that term, but only describes those that are on the Wonder Widget’s balance sheet, those being: lease contracts, long-term debts, and loans to stockholders, with the balancing sub heading of less current portion of long term debt.
Lease contracts, if actual leases, may not show up on the assets and liabilities of a balance sheet, because at the end there is not a transfer of ownership (no asset) to be tracked (note to self: research leases, as I do not totally understand this statement). That being written, some leases are written as purchase agreement, and do show up on the balance sheet. More often seen on privately held companies’ balance sheets, loans from stockholders often refers to the money that business owners have leant the business in times of need. Also mentioned in this same section is a tidbit that states, “…these amounts can end up looking more like owner’s equity than loans to the company, often a frustrating reality for entreprenuers and small business owners, who had hoped to be repaid at some point.” [Siciliano, Gene. Finance for Non-Financial Managers. New York: McGraw-Hill, 2003.]
Finally the book talks about STOCKHOLDER’S EQUITY under the chapter sub heading of “Ownership Comes in Various Forms” with the sub-sub-headings of: capital stock and contributed capital, and retained earnings.
Stocks are sold at par-value and the purchasing of stock at par value is listed under capital stock. Because some par value on stock is listed as $0, money contributed to the company beyond the face value of the shares of stock is listed under contributed capital. RE, or retained earnings are those monies that the company either lost or gained (through profits) over the years. Only corporations may have retained earnings, as profits from other unincorporated business structures must flow their revenues through to the organization’s owners. Retained earnings are usually kept in order to some time in the future:
- Buy other companies
- Protect itself against a possible catastrophe
- Repurchase its own stock, when prices are low
- Ensure adequate working capital to run the business
(the above bulleted list was taken directly from [Siciliano, Gene. Finance for Non-Financial Managers. New York: McGraw-Hill, 2003.]).
This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
This chapter seems a bit longer than the previous two, and a quick skimming of the chapter subtitles reveals that it will be a step down into the Accounting technical weeds. Armed with this knowledge, I’m going to take another hint from How to Read a Book and start by reading the chapter summary, so I am aware of the chapter’s main points before I read them in the chapter itself.
5 Summary Points
- The balance sheet is a point-in-time report highlighting a company’s cash management, profitability, and adequacy of invested capital.
- current assets (+) and current liabilities (-) are related in that both have a shelf life of 12 months. Current assets are used to pay for current liabilities, and the difference between the two is called net working capital.
- Collectibility is the most important aspect of an accounts receivable; a customer-by-customer review is in order to understand its quality.
- Inventory can be a high risk for the business if management practices don’t guard against the inventories deterioration, obsolescence and breakage.
- Delaying payment of their accounts payable, cash strapped businesses can find a temporary way to make it through the day-to-day. Shhh!… don’t tell their creditors.
The 5 points above were summarized from Finance for Non-Financial Managers.
The Chapter starts by introducing you to the Wonder Widget Company and their balance sheet. Assets and liabilities/stock holder’s equity, the two sides of the balance sheet, balance. The chapter proceeds by going through the balance sheet line-by-line.
The first sub category on the assets side of the balace sheet is called the CURRENT ASSETS and has the following line items listed under it:
- cash and equivalents,
- accounts receivable,
- allowances for bad debt,
- inventory and
- prepaid expenses.
The sub heading of cash and equivalents holds the value of all assets that could be used to pay off debts in a short amount of time (usually within 1 year). Savings accounts, certificates, and money market accounts are all examples of the values that would be summed to give you a sub total under cash and equivalents. Accounts receivable displays money that is owed by customers that is expected to be paid back within the next 12 months. Other then customer accounts that will be received throughout the year, businesses may also be expecting to be repaid for loans made to their employee, or they may be expecting a tax refund. The sub heading “allowance for bad debts” refers to those debts that are outstanding, that the company is stating will not be paid back. These are not usually specific sales that the company does not think it will be paid back, rather the number usually reflects a percentage of sales that the company thinks is likely not to be paid back, generically speaking. The self-explanatory inventory sub heading is further broken down into raw materials, works in progress and finished goods. It is interesting to note that under finished goods, amounts for factory rent, and labor are represented within this line item. Prepaid expenses are unique in the Current Assets sheet in that they are the only items that will not be converted into cash within the next 12 months. The prepaid expenses item is there to record cash set aside for insurance payments, as well as tax liability payments.
FIXED ASSETS are different from current assets in that they were not purchased with the idea* of selling them in the future for a profit. Rather, fixed assets are bought and used, usually until their value becomes $0, and then they are replaced. Under the fixed assets sub-heading, the values of the fixed assets are subtotaled, and then the accumulated depreciation is subtracted.
The final category, OTHER ASSETS are for miscellaneous items that do not fit in neither the current assets nor the fixed assets. Examples of other assets might be deposits that are currently being held by others, as well as long-term investments made on behalf of the company.
Next the chapter discusses the Liabilities/Owner’s Equity side of the balance sheet.
* the phrase “with the idea” is inserted here, because although land is not bought as a part of a regular business with the intent to make a profit, land usually increases in value, and therefore can be sold for a profit.
This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
Chapter 2 starts off with an analogy between “taping” (I guess DVRs didn’t catch on until after the book was published) and reviewing a football game, and between the balance sheets and income statements of a business. Income statements are like watching Rashaan Salaam run for a touch down, or like watching John Elway throw an interception (you can tell how long it has been since I watched football, yes?) and the balance sheets are like pausing the VCR (pausing the game at a specific instance in time) to review the play, seeing if Salaam actually did step out of bounds on the 20. As a side note, one of the tips-of-the-trade in this chapter sums up why I have decided to read this book.
The more familiar you are with the concepts of accounting and finance, the more of the “hidden” information you’ll get from your company’s financial reports and the less time it will take you to get it, even though others may miss the point entirely. [Siciliano, Gene. Finance for Non-Financial Managers. New York: McGraw-Hill, 2003.]
After describing the ebb and flow of two particular financial statements, the chapter continues with a brief introduction to the Chart of Accounts. Take away: Buckets make the Accountants’ world go ’round. All transactions are organized into categories and sub categories, with the categories even having their own section headings: Assets, Liabilities, Owners’ Equity, Revenue and Expenses.
Reading the next section regarding the General Ledger brings back nightmares of my Accounting I class in college. In principle, I get that the “Ledger Always Balances”, but I think the nuances (like accounting for depreciation) are what get me flustered. I’ll have to take some extra time during the reading of Chapter 3 (The Balance Sheet) to make sure I have a clear understanding of “why” it makes sense that the Balance Sheet must always balance.
A couple of paragraphs are given to discuss Accrual Accounting. The “rule” of accrual accounting basically states that a transaction is recorded when the binding action occurs, not when payment is sent or received. You bought a new/used book on the 13th, even though you didn’t receive the book until the 15th (which is the quickest bestS3ller1981 could get it shipped to you). Since your agreement was made on the 13th, the 13th is the date the transaction should be accounted for, even though there was no exchange until a couple of days later.
The chapter winds up with a summary of each of: the balance sheet, the income statement, and the statement of cash flows.
To wind up this post, I’d like to point out another reason why I am continuing to read _this_ book in particular. During the football game analogy the author describes a scenario where the reader has just witnessed a ref who seemingly makes a horrible call. To describe the disgust of the reader for the ref’s judgment the author writes, “This time, you’re sure the ref is smoking something…” I enjoy the little infusions of humor into a topic that is not full of buckets of laughs.
This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.
This is the first post in a series regarding my experiences following the PMBA. The PMBA has a great reading list, and I chose to start out reading Finance for Non-Financial Managers.
The first chapter was a very easy read and I finished it in about 15 minutes (checkout a really good resource for learning how to read non-fictional material that I came across a reference to, from the PMBA website). The first chapter is a good primer for someone who has absolutely no idea what Finance and Accounting involves, and why it is useful. If you already have a good understanding regarding the difference between Finance and Accounting, you may be able to skip this chapter and be no worse for the wear.
I think my biggest take-away from this first chapter was that all levels of management are ultimately responsible for the finances of the company. “Managers need to understand the rules of accounting and the boundaries of proper finance well enough to avoid getting into trouble as they agressively try to achieve their goals.” [Siciliano, Gene. Finance for Non-Financial Managers. New York: McGraw-Hill, 2003.]