Understanding the numbers...

Have you invested time this year? Back in May last year, I posted on the importance of being able to understand business financials. You do not have to be an accountant, however you must be able to interpret the story behind the numbers. Industries and organisations will have different metrics, language and acronyms, you will need to learn. Do this early, when joining a business, or as you career evolves. Whether delivering on your job to the best of your ability, or positioning yourself for the next role, the earlier you understand, the easier you are going to make for yourself. Regardless of the intricacies, or language common to a particular business or industry, there are a number of core financial metrics that you will see in a P&L (Profit and Loss), financial statement or within business reporting.

There are 3 core financial statements that are critical to every organisation. The balance sheet, the income statement and the cash flow statement. Understanding the fundamentals, is something you must do.

It may not sound like weekend fun, however reading and comparing company annual reports, is something I recommend. Why not target just one annual report a quarter? Your skills and understanding will build over time and you will grateful you have spent the time. You never know, you might actually enjoy it!

When you work for a large organisation, more relevant and important to your day to day role, is understanding your divisional or department, profit performance reports. The P&L or performance report, will typically be provided monthly, to the profit centre manager.

In a small business, these reports will naturally capture the entire business result.

Depending on where in the business you work and /or the size of the business, the documents you will see will vary, however common numbers will include;

• Sales - revenue received by the business.

• Cost of sales/cost of acquisition – purchases, commissions

• Expenses – Capital expenditure being major purchases designed to be used over long term (CAPEX) or Operating expenditure, which are the day to day expenses incurred to keep the business operational (OPEX)

• Expense allocation – group costs that have been allocated to the profit centre (This particular expense line can be a source of irritation, as it is typically not a cost that can be influenced)

• Net Profit – the amount the business makes after deducting the cost of sales and expenses from revenue received.

You will also see numbers and results expressed in ratios. There are a number of ratios that you will see in a company annual report, that you will not see in a divisional/profit centre financial report. In a divisional report you will typically see, profit and expense margins/ratio's. It will all come down to the detail of the reporting provided.

So what do you do, when you have the numbers? In isolation they tell a story, as there will always be at least a budgeted amount to compare the figures against, whether monthly or annually.

Questions to ask yourself. Is the business growing revenue (top-line), income vs budget? Are the operating expenses being held to / under budget? Have there been costs incurred that were not budgeted for? What is the impact to business and its profit? Was a loss or gain made for the period?

No one set of figures, will tell you the complete story, however core actual vs budget across these variable metrics, will inform you as to the current situation.

The next step is particularly important. Find the trend. This will tell you whether the current year is unusual or impacted by a specific event. It may show the impact of a large technology investment or expanding a team, with staffing costs increased beyond budget.

Ideally using at least 3 years of data, how does the data compare to prior years? Is there an upward or downwards trend of sales?

Does the final profit figure appear stable? If you delve further, are sales deteriorating and in fact the profit is being held steady, by reducing expenses? Declining sales, being held up by expense reduction, is an important trend to look for. There is a point where you cannot really shrink the expense line any further, without greater ramifications.

When you look at the ratios, how do they compare to your competitors' or the rest of the business? If your expense ratio is particularly high vs industry or divisional average, for example, you are not going to be running your business efficiently. The more inefficient, the more you will need to grow your sales to manage your overall profit.

Once you start to really look “under the hood” so to speak, the full picture will evolve. It is quite fascinating, once you start digging beneath the pure numbers.

Then of course, there are the non-financial metrics that are critical for a business that you will need to understand. A topic for another day.

Finally and as suggested previously, find a finance buddy in the organisation, who is happy to spend some time with you, stepping through the numbers. Regardless of the help you receive, it’s always nice to spend time with colleagues from another division.

Maybe there is something, they would like to learn about your business area?

Until next time

Lisa