Financial statements put off most people and that’s where the trouble lies
Good finance management practices, which, if followed, can be extremely rewarding, and if neglected or violated, can extract a great price in terms of health of organizations, and can even be fatal. These articles will dwell upon demystifying financial statements, will deal with how to make sense out of your MIS and how to read balance sheets.
My observation, based on my interaction with corporations in the capacity of a practicing chartered accountant, and also years of experience imparting training to thousands of executives and CEOs (of large and medium scale companies) and owners (of SMEs) spread across several countries, is, that most people suffer from a tremendous sense of insecurity when it comes to understanding numbers. Financial statements do not make sense to a vast majority of these executives. They don’t know how to read balance sheets. And it is precisely these individuals who can ill afford to be ignorant of this subject.
It is an established fact that financial mismanagement is the single biggest factor responsible for industrial sickness. Not technological obsolescence, not marketing inability, not labour trouble or strikes and lockouts, but financial mismanagement. Which means a majority of companies go sick due to an avoidable reason of sickness. That is to say, is the owners, CEOs and executives of these companies had armed themselves, in addition to their technical and selling skills, also with finance management skills, their organizations need not have shut down.
It is my belief that in any organization there are no non- finance contrary to common understanding. Let me explain what I mean. Usually for the people dubbed as ‘non-finance’ a more appropriate tag would be ‘non-accounting’. In every organization there are several ‘non- accounting’ but no ‘non- finance’ persons. No production, marketing, stores or any other manager can say that he is a non- finance manager. Because, what is finance management? Again, contrary to popular perception, ‘finance’ is not the collecting, recording, and presenting of financial data on the form of various financial statements. All this comes under the realm of accounting. Finance management, in my opinion, is the ability of every individual in the organization to understand the financial implications of his/her actions on the organization’s bottom-line; whether these actions are going to hurt the bottom-line, or strengthen it; so that they do more of those actions which benefit and avoid doing those that harm.
For instance, a sales executive out on the field meets a potential customer, who asks him for a quotation for his product. The salesman quotes, say Rs. 1,00,000 per unit. The customer responds that he can buy maybe a 100 pieces, if the price can be reduced to Rs. 75,000. Now this sales fellow has to take a call to say yes or no to this offer. Whether he decided to say ’yes’ or to say ‘no’, has he taken a marketing decision or it is a financial decision? He may call it a marketing decision, but he has no right to take it without understanding the financial implication of this decision. If, by taking this order, the bottom-line of the company is going to be hurt, he will have committed a crime against the organization by saying yes, and if the bottom-line would have been inflated, it would be a crime to say no.
Therefore, I repeat, finance management is the ability of every individual in the organization to understand the impact of every decision on the organization’s bottom-line. And if this is what finance management is, then all those persons in the organization whose actions have the power to impact the bottom-line are finance persons. Viewed from this angle, the only non- finance persons then would be the so- called finance persons, because they are the only one whose actions do not affect the bottom-line. They merely do a post- mortem and tell you whether the actions of all the so- called non- finance fellows have resulted in a profit or a loss. Isn’t it ironical that the persons who calculate profit are called finance persons and not those whose actions actually bring the profits?
Yet again I repeat. There are no non- finance persons. Forthwith start calling yourselves finance executives. Because in doing so, you will assume financial responsibility for your actions. And it is only when all the key people in an organization take responsibility for the financial outcomes of their actions, that the organization as a whole, makes profits.
Next, what’s the whole mystery about profit and loss statements and balance sheets you may ask? Every organization is expected to maintain a record of all financial transactions that take place. These records are collectively called ‘accounts’. Every now and then, accounts are summarized, and the summarized picture is presented in the form of two financial statements viz. the profit and loss account (P/L A/C) and the balance sheet(B/S).
This fact reveals something very interesting to the layman who thinks accounting is very complex and making of a P/L statement and the B/S is not his glass of juice. This tells him that if all transactions eventually land up on the face of either the profit and loss account or the balance sheet, which between them record expenses and incomes and liabilities and assets, then he realizes that nothing can happen in an organization which will not be one of these four. This understanding will not only enable one to understand and appreciate financial statements, but if one wishes one can also make a P/L A/C and a B/S with no understanding of accounting except what I have said above.
How, you may ask, can one make these financial statements just by understanding this much?
Let me show you how. Imagine your organization decides that they will not record the transactions that take place in books of accounts, but will instead record them on chits of paper and put them in a cardboard box kept in the middle of the lobby. So when the next day the organization pays salaries to the staff, this fact is written on a chit and dropped in the box. Similarly the following day when rent is paid, this is also written on a piece of paper and put in the box. And so on, slips recording sale of goods, hardware purchased, raw material purchased, interest paid etc. are also dropped into the box. And, now I bring this box to you, which may contain a thousand chits, a hundred thousand chits or a million chits, and ask you to make a B/S and P/L A/C. Can you do it? Of course you can. All you have to do is, put your hand in the box, take out one chit after another, read what is written on it, and you will discover that whatever is written on that chit will either be an expense, then show it on the expense side of the P/L A/C, or it will be an income, then put it on the income side, or it will be a liability, then show it according on the B/S. A nd if it is neither of these three then think you can blindly record it on the asset side of the B/S (as there isn’t a fifth option). And your profit and loss account and balance sheet are ready.
