Every day, managers make decisions that affect their company’s financial performance, whether it is scheduling operations, hiring and firing personnel, preparing a budget, approving a capital investment, or sending an invoice for payment. Often these managers lack the basic financial skills to allow them to understand the financial implications of their decisions. As a result, resources are wasted, poor decisions get made, and the financial performance of the organization suffers. Based on my experience working with nonfinancial managers over the years, I have identified five basic financial skills that anyone with management and supervisory responsibilities should have.
1. Cash Versus Accrual Accounting
There are two methods of accounting used to record business transactions: cash and accrual basis accounting. Most medium-sized and large corporations use accrual accounting, so it is important to understand what this means for you as a manager. When does an expense get charged against your budget? When do you receive credit for a sale? Does a purchase order generate an accounting transaction?
Understanding the difference between these two methods of accounting is important to manage your cash flow, spending levels, the obligations to your vendors, and the receivables due from your clients.
2. The Basic Financial Statements
Managers should be familiar with the basic financial statements prepared for external users and what information is presented in each statement. An understanding of the financial statements will provide you with the basic terminology needed to communicate with your accounting and finance personnel. In particular:
- What information is presented in the financial statements?
- How are my actions reflected in these statements and what line items do I affect?
- Does my company use a different format for internal financial reporting?
- Do I understand how to use these statements to improve the financial and operational performance for my areas of responsibility?
3. Budget Preparation
Managers should know how to prepare a departmental budget, a quantification of the resources you require to achieve the objectives and actions plans for the next fiscal year. It is not a formality to satisfy the demands of top management, lenders, or investors.
The budget preparation process is a time to question how resources are being used and if they could be used more effectively or efficiently. Departmental spending should be directly tied to the objectives, strategies, and action plans for the budget year and aligned with company’s strategic plan.
Managers should identify and document the operating assumptions that drive their spending levels. Each line item should have a reasonable basis of estimation, such as sales or production volumes, number of employees, percentage of salaries, and cost per employee, among others.
4. Variance Analysis
Managers need to analyze the variances against the budget or forecast. All significant variances, favorable or unfavorable, should be examined.
Managers should be able to relate the variances to what happened in their department or work area for the accounting period. Is this a one-time variance or will it be recurring for the remainder of the year? Do you need to include this variance, favorable or unfavorable, in the financial forecast for the quarter or the fiscal year? If you cannot explain the budget variances based on your knowledge of the operations, you should contact the finance department immediately.
5. Financial Analysis of Capital Investments and Strategic Initiatives
Managers often present and defend capital investments and strategic initiatives designed to improve operational and financial performance. The financial evaluation of these projects is key element of the approval process.
Managers should know the assumptions that underlie the financial analysis of any project championed under their leadership and ask the hard questions. I have seen companies waste millions of dollars in projects and initiatives based on a faulty financial analysis.
Managers should also understand the concept of return on investment (ROI) and how to interpret the results of the common financial techniques used to measure ROI: payback, net present value (NPV), and internal rate of return (IRR). They should identify how a project will affect particular line items on the balance sheet and the income statement and the impact on the financial performance of the site or the company if the financial objectives of the project are not met.
Financial skills are an integral part of the basic toolkit that any manager should have. Managers should understand the financial implications of their decisions and how to use financial information to improve their company’s performance. Training and development organizations should ensure that their leadership development programs provide the basic financial skills that their leaders need to manage the business more effectively.