Harvard Business Review - Finance Basics

Finance Basics

Get up to speed fast on essential business skills. Whether youre looking for a crash course or a brief refresher, youll find just what you need in HBRs 20-Minute Manager seriesfoundational reading for ambitious professionals and aspiring executives. Each book is a concise, practical primer, so youll have time to brush up on a variety of key management topics.

Advice you can quickly read and apply, from the most trusted source in business.

Titles include:

Creating Business Plans

http://hbr.org/product/creating-business-plans-20-minute-manager-series/an/16998-PBK-ENG

Delegating Work

http://hbr.org/product/delegating-work-20-minute-manager-series/an/16999-PBK-ENG

Finance Basics

http://hbr.org/product/finance-basics-20-minute-manager-series/an/16864-PBK-ENG

Managing Projects

http://hbr.org/product/managing-projects-20-minute-manager-series/an/16862-PBK-ENG

Managing Time

http://hbr.org/product/managing-time-20-minute-manager-series/an/17001-PBK-ENG

Managing Up

http://hbr.org/product/managing-up-20-minute-manager-series/an/16863-PBK-ENG

Presentations

http://hbr.org/product/presentations-20-minute-manager-series/an/16865-PBK-ENG

Running Meetings

http://hbr.org/product/running-meetings-20-minute-manager-series/an/17003-PBK-ENG

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Library of Congress Cataloging-in-Publication Data

Finance basics.
pages cm (20-minute manager series)
ISBN 978-1-62527-085-6 (alk. paper)
1. CorporationsFinance. 2. Managerial accounting.
HG4026.F487 2014
658.15dc23

2013039035

ISBN: 978-1-62527-089-4 (ebook)

Preview

No matter where you work in your organization, youll do your job better if you understand basic financial concepts. Youll be a more effective contributor to your companys efforts to make money and grow.

This short book explains the basics of finance. Though reading it wont make you a finance expert, it will help you:

Make sense of the three key financial statements.

Gauge your companys financial health.

Weigh costs and benefits before committing resources.

Consider financial risks when making decisions.

Estimate future performance.

Track investments against what youve budgeted.

Contents

Finance Basics

Why Understand Finance?

Why Understand Finance?

Finance matters to all companies because they all have to bring in money and spend it in order to do business. On the bringing-in side, smart managers consider questions like these:

How much of our money comes from the owners? How much from sales? How much from borrowing?

Which of our product lines and regions earn the highest profits? Which ones fail to perform?

How long does it take to collect money that customers owe us?

On the spending side:

Are our costs what they should be? Are we spending the right amount on our people and on our physical assets, such as office space and computer equipment?

If we can invest in only one of several opportunities for growth, how do we determine which one would generate the most value?

If we increased our output by 20%, would we make 20% more money?

Your companys finance department (or bookkeeper, if its a very small company) produces financial statements, budgets, and forecasts. By understanding these documents, youll gain the information you need to ask essential questions and make smart decisions for your division, department, or team.

By the way, finance uses jargon that may be unfamiliar to you. Sometimes different terms mean exactly section at the end of this book.

Navigating the Three Major Financial Statements

Navigating the Three Major Financial Statements

The underlying purpose of every company is to make money. So if youre a manager, part of your job is to help your company earn a profitideally, a bigger one each year.

Of course, you may work in the nonprofit or government sector, where making money isnt the most important goal. But you will still have to monitor the money that comes in and goes out.

Wherever you work, you can improve the financial health of your organization by reducing costs, increasing revenue, or both. You can help the organization make good investments and use its resources wisely. The best managers dont just watch the budgetthey look for the right combination of controlling costs, improving sales, and utilizing assets more effectively. They understand where revenue comes from, how the money is spent, and how much profit the company is making. They know how good a job the company is doing at turning profit into cash. (No, those are not the same thing. Well discuss the difference later.)

To learn all this, managers rely primarily on three documents: the income statement, the balance sheet, and the cash flow statement. These are called financial statements, or just financials. Publicly traded companiesthose that sell stock to the public on an exchangemake summary financial statements available to everyone, usually on a quarterly basis. Privately held companiesowned by one person, a family, or a small group of investorsoften keep their financial statements private. But nearly every company produces detailed financials for internal use.

Accounting methods

You dont have to be an accountant to understand finance. But you do have to know just a couple of important things about accounting.

First, financial statements follow the same general format from one company to another. Individual line items may vary somewhat, depending on the nature of the business. But the statements are usually similar enough that you can easily compare performance. The reason for the similarity is that accountants all follow the same set of rules. In the United States, those rules are called generally accepted accounting principles, or GAAP (pronounced gap).

Second, GAAP allows two different methods of accounting. Cash-based accounting is typically used by very small companies. Its really simple. The company records a sale whenever it receives cash for a product or a service and records an expense whenever it issues a check.

The other method, accrual accounting, is a little more complicated and far more common. The company records a sale whenever it delivers a product or a service, not when cash changes hands. (That might be a month or two later, when the customer pays the bill.) It records an expense whenever it incurs one, not when it actually writes a check. The key to this method is what accountants call the matching principle: Match every cost to the revenue that is associated with it.

Lets look at an example. Amalgamated Hat Rack, an imaginary company that manufactures hat racks from imitation moose antlers, records revenue each time it ships racks to a customer. Because the customer hasnt paid yet, revenue always includes estimates of cash the company will receive in the future.