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department contributes

This is a book for businesspeople. All decisions in a business organization are made in accordance with how they will affect the organizations financial performance and future financial health. Whether your background is marketing, manufacturing, distribution, research and development, or the current technologies, you need financial knowledge and skills if you are to really understand your companys decision-making, financial, and overall management processes. The budget is essentially a financial process of prioritizing the benefits resulting from business opportunities and the investments required to implement those opportunities. An improved knowledge of these financial processes and the financial executives who are responsible for them will improve your ability to be an intelligent and effective participant. This book is special for a number of reasons:

1. It teaches what accountants do; it does not teach how to do accounting. Businesspeople do not need to learn, nor are they interested in learning, how to do debits and credits. They do need to understand what accountants do and why, so that they can intelligently use the resulting information-the financial statements.

2. It is written by a businessperson for other businesspeo-ple. Throughout a lifetime of business, consulting, and training experience, I have provided my audiences with

down-to-earth, practical, useful information. I am not an accountant, but I do have the knowledge of an intelligent user of financial statements. I understand your problems, and I seek to share my knowledge with you.

3. It emphasizes the business issues. Many financial books focus on the mathematics. This book employs mathematical information only when it is needed for the business decision-making process.

4. It includes a chapter on how to read an annual report that helps you use the information that is available there to better understand your own company. This chapter also identifies a number of other sources of information in the public domain about your competition that may be very strategically valuable.

5. It includes information on how the finance department contributes to the profitability and performance of the company. The financial staff should be part of the business profitability team. This book describes what you should expect from them.

6. It contains many practical examples of how the information can be used, based upon extensive, practical experience. It also provides several exercises, including a practice case study, as appendices.

The book is in four parts:

Part 1, Understanding Financial Information, Chapters 1 through 5. In Part 1, the reader is given both an overview and detailed information about each of the financial statements and its components. A complete understanding of this information and how it is developed is essential for intelligent use of the financial statements.

Part 2, Analysis of Financial Statements, Chapters 6 through 8. Part 2 describes the many valuable analyses that can be performed, using the information that was learned in Part 1. Business management activities can essentially be divided into two basic categories:

Measuring performance

Making decisions

Part 2 describes how to measure and evaluate the performance of the company, its strategic business units, and even its individual products.

Part 3, Decision Making for Improved Profitability, Chapters 9 and 10. This part describes the key financial analysis techniques that managers can use to make decisions about every aspect of their business. Financial analysis provides valuable tools for decision making. However, managers must still make the decisions.

Part 4, Additional Financial Information, Chapters 11 through 13 and appendices. Part 4 provides further information about elements of the financial process that can serve as tools for the business manager. These include the budget and methods of obtaining the financing to support the business. Part 4 also includes a glossary and quite a few practice exercises.

Part 1, Understanding Financial Information

Part 1 discusses the financial reports that the company produces. These include:

The balance sheet

The income statement

The statement of cash flows

Each statement is described, item by item. The discussion explains where the numbers belong and what they mean. The entire structure of each financial statement is described, so that you will be able to understand how the financial statements interrelate and what information they convey.

Part 1 also explains how to read and understand an annual report. The benefits of doing so are numerous. They include:

Understanding the reporting responsibilities of a public company

Further understanding the accounting process

Identifying and using information about your competitors that is in the public domain

Part 2, Analysis of Financial Statements

Now that we have learned how to read the financial statements, we can understand how they are prepared and what they mean. Part 2 describes management tools that help us to use the information in the financial statements to analyze the companys performance. The ratios that will be covered describe the companys:


Working capital management

Financial leverage (debt)

Profitability and performance

Part 3, Decision Making for Improved Profitability

Part 3 describes a number of tools that can help managers with decision making. It introduces breakeven analysis, which can be used to evaluate individual products and the product mix.

It also explores fixed cost versus variable cost issues within the strategic planning context, such as:

Supply chain management

New product strategy

Marketing strategy

Part 3 also covers return on investment analysis for investment decision making. It explains the principle of discounted cash flow and several methods of analysis that employ it:

Internal rate of return

Net present value

Profitability index

It also discusses ways of integrating profitability requirements with company performance targets and methods of planning and evaluating investments, such as:

Capital expenditure decisions

R&D analysis and justification

Acquiring other companies

Marketing programs

Strategic alliances

Part 4, Additional Financial Information

Part 4 describes in considerable detail some additional financial information that will benefit the businessperson. It includes discussions of the planning process and the budget, and why they are so important. It also covers ways of financing the corporation. While this is not a direct responsibility of most members of the management team, knowledge of debt and equity markets and sources of corporate financing is very beneficial.

There are also a number of practice exercises that will reinforce the knowledge gained from the book.

Additional Background

We study financial management because doing so helps us to manage our business more intelligently.

As mentioned earlier, business management activities may be divided into two major categories:

Measuring performance Making decisions

We measure the performance of products and markets in order to understand the profitability of the business. Knowledge of our companys products, markets, and customers enables us to make decisions that will improve this profitability.

The income statement measures the performance of the business for a period of time, usually a year, a quarter, or a month. It enables us to determine trends and identify strengths and weaknesses in the companys performance.

The balance sheet measures the financial health of the busi-

ness at a point in time, usually at the end of a month, quarter, or year. Are we able to finance future growth? Can the company afford to pay off its debt?

Breakeven analysis helps us to understand the profitability of individual products. We can use it to evaluate pricing strategies and costs. The company uses the results of this analysis in decisions concerning outsourcing options, vertical integration, and strategic alliances.

This book surveys these financial tools. We will provide descriptions and definitions of their components and gain an understanding of how they can help us and why we should understand them.

Accounting Defined

Accounting is the process of recording past business transactions in dollars. Training to become a certified public accountant (CPA) involves learning the rules and regulations of the following organizations:

The Securities and Exchange Commission. This is an agency of the federal government that, among other things, prescribes the methodology for reporting accounting results for companies whose stock is publicly traded. Most private companies adhere to most of these rules except for the requirement that they publish the information.

The Internal Revenue Service. This agency oversees the filing of all corporate tax reports consistent with the tax legislation passed by the U.S. Congress.

The Board of Governors of the Federal Reserve System. This executive branch federal agency prescribes the reporting and accounting systems used by commercial banks.

Two private accounting organizations are integral to the accounting profession:

The Financial Accounting Standards Board (FASB). This is a research organization that evaluates, develops, and rec-

ommends the rules that accountants should follow when they audit a companys books and report the results to shareholders. The products of the FASBs efforts are reports known as FASB Bulletins. The American Institute of Certified Public Accountants. This is the accountants professional organization (trade association). It is an active participant in the accounting dialogue.

The work of all these organizations and the dialogue among them, along with the work of the tax-writing committees of the U.S. Congress, result in what are known as generally accepted accounting principles.

Generally Accepted Accounting Principles

The concept of generally accepted accounting principles (GAAP) makes an invaluable contribution to the way in which business is conducted. When a CPA firm certifies a companys financial statements, it is assuring the users of those statements that the company adhered to these principles and prepared its financial statements accordingly.

Why Is This Important?

The use of GAAP provides comfort and credibility. The reader of the reported financial statements is typically not familiar with the inner workings of the company. GAAP gives a companys bankers, regulators, potential business partners, customers, and vendors some assurance that the information provided in the companys financial statements is accurate and reliable. It facilitates almost all business dealings.

Why Is This an Issue for the Business Manager?

While accounting principles and practices are critical for the presentation of past history, their mechanics, requirements, and philosophies are not necessarily appropriate when the business

manager seeks to analyze the business going forward. To understand this issue, we need to define financial analysis.

Financial Analysis

Financial analysis is an analytical process. It is an effort to examine past events and to understand the business circumstances, both internal and external, that caused those events to occur. Knowing and understanding the accounting information is certainly a critical part of this process. But to fully understand the companys past performance, it is important to also have information concerning units sold, market share, orders on the books, utilization of productive capacity, the efficiency of the supply chain, and much more. Every month, we compare actual performance with the budget. This is not an accounting process, it is an analytical process that uses accounting information. Accounting is the reporting of the past. The budget reflects managements expectations for future events and offers a standard of performance for revenues, expenses, and profits.

Financial analysis as a high-priority management process also requires forecasting. A forecast is an educated perception of how a decision being contemplated will affect the future of the business. It requires a financial forecast-a financial quantification of the anticipated effect of the decision on marketing and operational events, and therefore on cash flow.

Accounting/Forecasting/Budget Perspective

The end result of all the planning efforts in which a company engages, including forecasting, must be the making of decisions. These many decisions about spending allocations, products, and markets are reflected in a voluminous report called a budget. Therefore, the budget is really a documentation of all the decisions that management has already made.

The Issues

There are frequently cultural clashes between the accounting department and the rest of the company. This results from the false

assumption that the philosophies and attitudes that are required for accounting are also appropriate in business analysis and decision making. The budget is not an accounting effort. It is a management process that may be coordinated by people with accounting backgrounds. A forecast need not adhere to accounting rules. There is nothing in accounting training that teaches accountants to deal with marketing and operational forecasting and decision-making issues. In addition, to the extent that the future may not be an extension of the past, it is conceivable that past (accounting) events may not be very relevant.

Accounting is somewhat precise. Forecasting, by its very nature, is very imprecise. When the preparation of the budget becomes accounting-driven, those preparing it focus on nonexistent precision and lose sight of the real benefits of the budget and its impact on the bigger picture.

Accounting is conservative. It requires that the least favorable interpretation of events be presented. Business forecasting needs to be somewhat optimistic. Using a conservative sales forecast usually means that the budget will be finalized at the lower end of expectations. If the forecast is actually exceeded, as it is likely to be, the company will not be totally prepared to produce the product or deliver the services. In short, conservatism in accounting is required. Conservatism in business decision making can be very damaging.

Business is risky and filled with uncertainty. Accounting is risk-averse.


To eliminate these cultural clashes, accountants need to learn more about the business-its markets, customers, competitive pressures, and operational issues-and all other business managers need to learn more about the financial aspects of business. This includes the language of accounting and finance, the financial pressures with which the company must deal, and the financial strategies that may improve the companys competitive position, operational effectiveness, and ultimate profitability.

Some Additional Perspectives on the Planning Process

The planning process is a comprehensive management effort that attempts to ensure that the company has considered all of the issues and challenges facing it. The management team will focus on the companys strengths and weaknesses as well as on the resources necessary to properly grow the business compared with the resources available.

The financial team is a critical contributor to this process. The following are some of the issues that require management focus.

The Customers

Why do our customers buy our products and services? Why do we deserve their money? These are critical questions that must be answered if we are to focus our energies and resources on those efforts that will sustain growth. We need to expand our definition ofthe highest quality and devote corporate cash and people to distinguishing our company from and staying ahead of the competition.

Do we really know our customers needs, present and future? Are we prepared to support them in their goal of succeeding in their marketplace? Do they view us as a key strategic partner? After all, we are in business to help our customers make money. If we define our companys strategic mission accordingly, our customers success will be ours. What we do is only a means to that end.

The Markets

Products and services are provided in numerous markets. These may be defined by:


Product application

Quality and perception of quality

Means of distribution

Selling channel (direct versus distributor)

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