Financial Statement Literacy for Directors and Executives

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For executives and directors who come from a finance or accounting background, the ability to read and review financial statements is second nature; these individuals have been inundated with so many financial reports that they can immediately identify problems or inconsistencies within these documents. This provides a substantial advantage as it relates to financial management because they are able to process information more quickly than those without this experience.

One of the key reasons for this ability to quickly process data is because executives with these types of backgrounds KNOW EXACTLY WHAT THEY ARE LOOKING FOR. This, in a nutshell, is the key to literacy as it relates to financial statements and financial reports. To train a person; be it an executive or assistant manager, to effectively review and analyze financial data, they must be able to ascertain what they are looking for and how to find it in an expeditious nature.

To initiate this process a reviewer must determine why they are being asked to analyze the financial reports of the organization. Generally speaking these tasks are ongoing (in that they will be asked to review these financial documents on an ongoing periodic basis), and they fall into one of the following categories:

1. Reviewing the Financial Reports for inaccuracies

2. Reviewing the Financial Reports to ascertain the financial status of the company or an individual department

3. Reviewing the Financial Reports to determine operational bottle-necks that are negatively affecting the financial output of the organization or department.

4. Reviewing the Financial Reports to Determine or Analyze key ratios (i.e. inventory turnover, liquidity, gross margin, profitability, Marketing ROI, capital burn rate, etc.)

5. Reviewing the Financial Reports as a way to evaluate key personnel or key programs

To effectively obtain the pertinent information necessary for the above; a person must have a thorough understanding of what is provided in each financial statement. Having this understanding the reviewer is more apt to understand where each piece of information is located, and more importantly they are more apt to understand why the information is located in that particular report.

A very simple overview of the financial reports would focus on the three primary reports that are produced by all organizations:

1. The Profit and Loss Statement – This report is used to detail the operational activity of the organization, and is a great barometer of how the company is doing from a sales position, market penetration perspective, capital responsibility standpoint, a costing standpoint, and an overall efficiency standpoint. As it relates to the derivatives of this report the following are some of the most common outputs:

a. Sales

b. Sales Efficiency (Through an analysis of Gross Profit or Net Sales)

c. Operational Expenses

d. Key Expenditures

e. Tax Position

f. Profitability

2. The Statement of Cash Flows – This report does EXACTLY what it says it does; analyze how and where cash is flowing in and out of the organization. While it may not get as much publicity as the Profit and Loss statement or the Balance Sheet; this report can easily be referred to as the most important when analyzing the financial health of an organization. Cash is the life source of any company; without it YOU ARE DEAD. Regardless of whether your sales are strong or weak; whether your assets are appreciating or depreciating, whether the company is profitable or not; without cash the company is NON-EXISTANT. From a corporate strategy standpoint or a corporate decision standpoint, this report will guide how decisions are made and how aggressive the company can be from a growth standpoint. The key outputs relating to this report include:

a. A/R Effect on the Business

b. Effect of Debt on the company

c. Liquidity

d. Relationship between cash and profits within the organization

e. The amount of actual cash that has been derived from ALL business activities; not just Operations.

3. The Balance Sheet – This report simply provides a fundamental understanding of the net worth (from a purely mathematical perspective, not taking opportunity or potential into consideration) of the company for all stakeholders through an analysis of assets and liabilities. The importance of this report is that it allows everybody from the board of directors to the executive team the ability to take an objective look at the company from a valuation and vulnerability standpoint. The key outputs relating to this report include:

a. Value of all assets; physical and proprietary

b. The useful life (from a financial standpoint) of all applicable assets

c. The liabilities of the organization

d. The value of debts (both owed and receivable)

e. The abstract valuation of the company from a shareholder perspective

While all of these reports show more than what is listed above; most of the other information can be derived from one’s knowledge of the above stated outputs. From a literacy standpoint; the primary goal should be to develop an understanding of these basic outputs; from there (with consistent exposure) most reviewers should be able to quickly be able to acquire the necessary information from these reports; and more importantly they will understand the “why”; which provides a much more stable analytical base as it relates to financial management.

Source by Vijay C Mistri

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