For some of us, finance may be the scariest word in the world of business. From business schools to retirement planning, it is the one subject that is relegated to “experts”. While the sight of an excel spreadsheet can make us shudder, finance remains one of the fundamental pillars of a company. After all, without its finances, what would a company be?
This fear of finance is often due to a misunderstanding of what it truly is at its core: the primary function of a company. What does that mean ,you ask? Well, it’s simple: Companies are financial pumps. First, you raise money and assets. Second, you earn revenues or incur expenses. And finally, these elements are expressed in terms of cash flows. While a lack of financial training justifies limited financial knowledge, it doesn’t justify the fact that its necessity has been played down. So just how crucial is understanding the role of finance in your company?
“War is too important to be left to generals”
As said by a famous 20th century French Prime Minister Georges Clemenceau, battles are to be fought by all. If finance is at the heart of a company, it must be democratized for everyday use by your team members. There are two reasons for this: 1) understanding better how to make more strategic decisions and 2) bettering communication with the financial department.
There are several steps that will allow you to reach that goal. The first one is especially helpful for increasing managers’ understanding of finance. Of course, there is a reason why finance is reserved for experts. The idea is not to develop complicated formulas on long spreadsheets, but rather to do what a Harvard Professor, Marc Bertonèche, calls envelope calculations: simple, efficient and relevant operations that will help you understand the state of your company’s present, past or future in a matter of seconds. That’s easy enough to say, but you might ask how knowing about finance will help you in your job. Glad you asked! The following are but a few examples of how finance can help you:
- Creating value: The simplest of all concepts to understand is that of value creation. Why? Because it’s probably the only one that is being used by managers and, unfortunately, often incorrectly. Creating value, unlike what many think, is not transferring value that exists already somewhere else to another place. Acquisition or tax reductions are not value creations but value transfers. Value creation is a difficult, long-term process, which will have deep meaning for society as well as your company, because it will add new value through bargaining power, size, or even economies of scale.
- Value-based management:
Value-based management is the task of every manager: creating value, but this time, in the sense that it has to be generated by the money that is being used on a return which is higher than its original cost. Of course, management is already aware of this, however there are ways to make value-based management more efficient by understanding valuation and its basis in a company, relate it to all team members’ role and create incentives among them to work toward that goal.
- Understanding the cost of money for your business:
Did you know that money has a cost? After all, money is just another raw material that is, probably, the only one all industries have in common. The cost of money or capital is this: equity holders bring capital to a company, capital that will enable benefits and returns. This return is the cost of capital. The rule of business is to generate a return on capital which is higher than the cost of capital invested.
- Working capital:
Managers must often deal with directing business units. To do so, they have to make use of fixed assets and working capital. Working capital points to how much money you need to run your business on a daily basis. And that definition makes it an unbelievably valuable asset to the company, because it is at the crossroads of its various functions, such as finance and marketing, finance and production, finance and purchasing. Because of that, it needs to be well-managed by all departments in the company, not just finance.
- Getting the full financial picture of your business:
Of course, to end this list, we must mention the obvious: finance is key to understanding the full financial picture of your business and therefore making decisions that are strategic and not endangering its status in the market.
Finally, it’s only fair to restructure the finance department as well. Unlike their current position out of reach in an ivory tower, finance departments should go through a similar process as all other departments in the past 20 years: be more efficient, get rid of all non-added value activities, increase productivity and outsource non-main activities. These actions all work toward the same end goal: working closely with all other departments to form stronger, better communication and a more solid team.
The tip of the iceberg
There are many questions left unanswered that we don’t have the luxury of tackling in one article. What about debt? How much is good for you? And the value of earnings per share? Why are some companies, like American Apparel, dying? Are financial forecasts any good? And what about mergers and acquisitions? 75% of them fail – is there a way to do better by using financial skills?
The insecurity of today’s world means one thing: no matter what forecast you make , you will always be surprised by what you find. However, although that is true, there is no value in finding yourself face to face with a wall you built yourself by avoiding learning about this fundamental aspect of your company’s success.