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Finance 101 – what do the results really mean?

August 11th, 2008

I have written a number of posts regarding questions such as “Who really owns the Budget?”, as well as speaking about my belief in developing collaborative cross-functional relationships to enhance the budgeting and forecasting efforts. It’s so easy to assume that key managers and directors should be clear about balance sheets and cash flow statements since they are always covered in even the most basic business and accounting classes, at the both undergrad and graduate level. Naturally, everyone should know the interaction between these two….right?

While I have successfully created these cross-functional relationships and have been able to have these same managers & directors embrace their budgeting efforts, they are typically not clear about the relationships between the three main financial statements. For most, the absolute bottom line question is whether we are profitable as a company. No question that this is key, but profitability does not always ensure that the company has the resources it needs to support the growth it might be experiencing. For the most basic example, lets assume a $100 million revenue company is growing at a modest 15% and produces net income of 7% per year. This gives the company, without incurring any additional debt, $7 million additional current capital to support the 15% increase.

    But what are the additional investments that need to be made by the company?

-What additional inventory will need to be added to support new growth? New product line?
-Will the company need additional sales people to invest in future sales? New sales group?
-Are their system upgrades or implementations that need to be invested in to support growth?
-Is the company outgrowing it’s current facility and needs to consider expansion?
-What inflationary increases need to be accounted for in the Budget? Wages and insurances…?
-Is the company currently servicing an existing level of debt previously incurred?

Once we start getting into the issues of working capital management and the effects on the balance sheet and cash flow, it’s quite possible that the picture may not be as optimistic. After running through just the few questions listed above it’s easy to see how quickly your profit from the year has just been whittled down, or may not even cover the needs of additional growth. It’s when the management from all functional areas understand these relationships that it becomes much easier to rally their support and involvement in the forecasting process. While your colleagues don’t need to possess the skillset to build these financial statements, their understanding and support will go far when the business environment is challenging, as it is now.

Thanks for reading . . . .

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