Financial Intelligence Book Summary

Financial Intelligence by Karen Berman and Joe Knight is a book about corporate financial literacy for those lacking a finance background. I recently made a transition out of engineering to Sales and Business Development. Upon joining, I quickly realized the skill sets required to be successful in Sales and Business are quite different from engineering. A solid understanding of key financial terminology, like net present value, gross margin, and deferred balance are needed. This book did a great job laying out the high-level concepts in an understandable way. Among many topics, it covers:

• Assets vs Liabilities
• How to read a balance sheet
• Accounts receivable vs accounts payable
• How to read cash flow statements
• How to read a company’s annual financial report
• GAAP vs Non-GAAP reporting in accounting
• Key ratios used to evaluate businesses

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Top 5 Takeaways

1. Corporate finance is more of an art than a science
2. GAAP vs Non-GAAP measures of accounting
3. Cash is king, it’s much harder to hide behind your cash position
4. Ratios are powerful in helping to evaluate the health and state of a business
5. Corporate financial literacy is important regardless of position/title in a company

The Main Points

1. Corporate finance is more of an art than a science

Prior to reading this book, I thought that finance was black and white. A company earned what it earned and spent what it spent. This is only partially true. In this book, I learned that accountants have flexibility when deciding:

• How/when revenue is recorded
• How/when assets are depreciated over time
• If something is considered an operating expense or investment
• How profit is estimated and reported

These decisions, amongst many others, have an incredible impact on the balance sheet and apparent health of the business. Essentially, a business can be made to seem much more profitable and healthy than it actually is. This is important because investors and shareholders make decisions on how they will invest (buy or sell more stock) based on a company’s financial reporting. More than a few companies have attempted to take advantage of the allowed flexibility in financial reporting. They attempted to deceive shareholders by massaging financial statements, using perfectly legal methods at the time, but later determined as fraud. Savvy investors learn to read between the estimates and datasheets to get a more accurate depiction of company health. One important tool being the Cash Flow Statement.

2. GAAP vs Non-GAAP measures of accounting

GAAP stands for Generally Accepted Accounting Principles . If you need some good bedtime reading, go download the full Code of Federal Regulations (CFR). My short summary, in a business’s financial reporting methods, a company should:

• Be consistent in how key figures are recorded
• Be conservative on estimates of sales and profit
• Provide full disclosure of accounting principles and if/when they change
• Material changes: something that would affect the judgment of an informed investor about the company’s financial situation (ex. Possible 100 million-dollar lawsuit incoming)

Essentially, GAAP reporting helps investors perform an apples to apples comparison of different companies when deciding how to invest. This works, as long as companies are ethical in their reporting practices.

Non-GAAP accounting gives companies a bit more flexibility on how they report financials. Many internal business operations do not benefit by following GAAP reporting. It is primarily a tool for investors. Non-GAAP reporting gives businesses the ability to report financials in a manner that is custom to their industry. Some of the underlying principles still apply, like consistency and full-disclosure. However, they are not held to the same standard/monitored as financials reported using GAAP.?

3. Cash is king. It is much harder to hide behind your cash flow statement.

Yes, cash is still king, even today with all the “free” credit. As previously mentioned, some companies and shrewd accountants use many perfectly legal tricks to make their company appear more financially stable than it is. After being hoodwinked a few times, smart investors caught on and began to use a different measure to get a more accurate depiction of health, the Cash-Flow statement.?

Revenue and profit are estimates based on soon to be executed accounts payable and accounts receivables. Cash, however, generally represents the literal money in the bank. There are still some accountant tricks here, but much fewer are available to hide actual performance. Because of this, investors place much emphasis on the cash flow statement. Particularly, free cash flow, which is simply operating cash flow minus net capital expenditures. This communicates the actual money a company has to invest in future growth and make other business decisions. A cash flowing business is better positioned to survive rough periods of the economy. A business with consistent negative cash flow will eventually not make payroll for its employees and is at increased risk for bankruptcy.

4. Ratios are powerful in helping to evaluate the health and state of a business

A ratio is a way to compare two or more quantities. Ratios in corporate finance give business leaders and investors the ability to quickly analyze the health of business.?

Some fundamental ratios:

• Gross Margin %: gross profit / revenue
• Operating Margin %: operating profit / revenue
• Net Margin %: net profit / revenue
• Return on Assets %: net profit / total assets
• Debt to equity ratio: total liabilities / shareholders equity?

These ratios also help project managers decide on the potential profitability of business deals. It all depends on the perspective in which you want to evaluate the business. If you manage inventory, you may pay close attention to “days in inventory”, which is your average inventory divided by cost of goods (COGS) per day. Investors like to see:

• Earnings per share
• Free cash flow?
• Return on total capital

5. Corporate financial literacy is important regardless of position/title in a company

The authors of Financial Intelligence submit, corporate financial literacy is not only for investors and business executives. Rather, companies benefit when all levels of employees have some fundamental knowledge of their company’s financial position. When employees at all levels look to determine how they might contribute to the success of key financial metrics like free cash flow, everyone wins. The Sarbanes-Oxley Act of 2002 increased the accountability of financial leaders on their reporting methods. Therefore, as employees progress up a company and take on larger scopes of financial responsibility, a strong understanding of the implications of good or bad financial reporting is paramount.?

Regardless of position, entry-level web developers to directors of construction firms, look into your company’s financial statement and work to understand how your contributions impact them.

That’s it folks! Thanks for reading the second edition of Waller’s Reading Room! I deeply appreciate all my readers and your feedback. Let me know what you think of this summary!

Buy Book: Financial Intelligence ?