Newsletter January 2001B

FINANCIAL RESPONSIBILITY: Flying Blind

Traveling Blind Not to be arrogant, but I must ask this question; How many of our readers can understand an Income Statement or a Balance Sheet? Surprisingly one might easily guess, and rightly so, that few are qualified on the basics. Whether it's an educational problem or a time problem, there is no excuse for failing to learn the basics. Your business (and personal) existence depends on it, (venturing a guess that everyone who reads this newsletter works for a living.)

If an individual runs a manufacturing plant with 250 employees, coordinates an service enterprise with 2000 employees or even works as a sole practitioner, the same knowledge is invaluable. The main reason for operating a business is not only to survive in business but to make a profit. Far too often, as managers, we become so concerned with what we do as an ongoing routine that it's easy forget that launching an ad campaign is ultimately for the purpose of generating profits, cleaning up hotel rooms is to generate profits and scraping the road with a dozer to save tires in a rock quarry is to generate a profit.

Understandably, learning finance or accounting can, for many, be a chore and one not worth making the time for. In our educational systems, we have gaps in educating individuals on how to even manage their own monies, so how do we expect them to understand using someone else's. Robert Kiyosaki and Sharon Lechter have become famous with 3 books on the best seller list starting from the Rich Dad Poor Dad release. The fundamentals of the book teach basic beliefs that people who invest in assets that generate revenue without working, called "passive income," can become richer faster. They're making their money work for them. Businesses do the same, yet the separation of accounting as a function that is different from other aspects of a corporation makes no sense. The fact is, accounting is part of everyone's business and should not be feared. Accounting departments don't help by asking for budgets or just printing reports. A better name for their role might be Financial Coaches. Their jobs should not be to ask for information (such as budgets), but to educate everyone on how to understand and make money.

In the end, in our culture, we find out how we are doing by financial reports. Let's make it simple to understand. Xerox has not produced winning products nor great customer service, and they are not making money. AOL Time Warner created a merger to increase mixed talents to create a larger enterprise that would generate better returns. Boeing created the X-32 fighter while Lockheed Martin created the X-35 fighter to win orders and make more money. There is no reason in business to create new jobs. That's a result of profits not a prelude. It should be the opposite; we generate profits and in return, hire to keep pace with growth. At the same time, Montgomery Ward, a 135 year-old business, laid off 25,000 employees, because there were no profits.

Two lessons are found by looking at the two main reports and where some profits may be derived.

1. Income Statement: Everyone in business must understand that a business without an income statement (I/S) is flying blind. I/S tells a story of the company in numbers. The top part of the statement illustrates income sources: from where is money being generated, such as sales. Some firms have licensing revenue, others have over-the-counter. Firms may keep track of divisions or product lines, services or products. The end result of the top of the I/S is that all the money generated including areas like interest from deposits in mutual funds or savings accounts.

The second half of the form dictates where the expenses come into play. (Many managers never realize this is where they tend to be on paper and only a select few contribute to profits) Who is consuming what within the firm? If the I/S is designed properly, one may find that payroll in a particular area might be too high compared to the income generated. With current technology, an individual in the firm should be able to see where they are at any point in time.

When learning to fly, there are gauges in a plane that tell the pilot the height, speed, direction and detailed data about the conditions of the plane that if not in real time, could be devastating. The income statement is 1/2 of the knowledge one needs to use to be successful. Management can make necessary modifications in all sorts of areas from personnel to purchasing, advertising to design just by getting a feel for the business's financial stability or lack thereof.

2. Balance Sheet: To many, the balance sheet (B/S) is the most confusing part of the two major reports. Simply, it provides an overall picture of your company from it's inception to the present time. Years ago, we could use the balance sheet to understand what had already transpired and this often took days, or weeks to compile. For some firms, the balance sheet may be so late that the firm could never use it accurately. Today, a progressively faster work environment has given rise to software programs that provide a daily current balance sheet (understanding that accounting still might need to do some hocus pocus). The tool gives any manager, CEO, or employee a quick feel for the company.

The balance sheet, in a nutshell, measures assets against liabilities. A strong company is one with more assets than liabilities. The traditional balance sheet measures assets as inventory, cash in bank, outstanding monies due your firm (accounts receivable), cash in other places (investments, deposits on orders), equipment and buildings. It measures liabilities as outstanding monies due to vendors and balances due to lenders/leasors.The traditional balance sheet fits the brick and mortar businesses that once comprised most businesses. Some accountants argue that modern day businesses need modern day balance sheet updates, that items such as trademarks, patents and other intangibles must some how find their way into the balance sheet equation.

A traditional balance sheet may not accurately measure their assets. For example, we have no line listing for key employees who are invaluable to the success of our businesses or certain customers who provide us with mailing lists with which we can use to barter. There is also no line listing for relationships developed with vendors who may extend payment terms from 30 days to 90 days when we experience a cash flow crunch or who will ship orders to meet just-in-time deliveries to our customers. Just the same, it's vital that we understand the income statement and balance sheet and so that we can (1)know if they are set up accurately and provide a true report of our activities and (2)use them to strategically plan our next moves.

That picture described earlier helps management, in any role, to understand quickly items such as what one owes to others, what one has a cash available and what the firm owes other people. Quick math might tell an advertising or sales manager that we need to bring in more business. Accounts receivable might realize that there will be a cash crunch as customers are holding too much or your funds. The balance sheet will also tell a lender how the company operates overall.

The bottom line: It's always unsettling to know that you're making decisions on hunches or on pieces of information. The odds are you will be wrong more often than right, assuming that even a positive decision may have not been the most advantageous decision. The gambling resorts of Nevada, New Jersey and Indian Nations know this all too well. Without all the information the house wins and you don't. Have you ever walk away from purchasing a large ticket item and thought you saved a bundle, only to find out that your friend saved more! Get a better handle on what each team member's role is within a corporation so that you may lead appropriately. The game in business is to win ...and it helps for everyone to know the score..

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David & Lorrie Goldsmith are founders of the Syracuse based MetaMatrix Consulting Group Inc. Their firm specializes in consulting and speaking services. They can be reached at 315-476-0510  888-777-8857 or emailed at dgoldsmith@davidgoldsmith.com

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