What Every Entrepreneur Needs to Know About the Numbers: Financial Intelligence for Entrepreneurs by Karen Berman and Joe Knight
Financial Intelligence for Entrepreneurs by Karen Berman and Joe Knight Scribd
If you are an entrepreneur, you probably have a passion for your product or service, a vision for your business, and a drive to succeed. But do you also have a good understanding of your financial statements? Do you know how to interpret the numbers and use them to make informed decisions? Do you know how to communicate with investors, lenders, and other stakeholders about your financial performance and goals?
Financial Intelligence For Entrepreneurs By Karen Berman And Joe Knight Scribd
If not, you might be missing out on a crucial skill that can help you grow your business and achieve your objectives. That skill is financial intelligence.
Introduction
What is financial intelligence?
Financial intelligence is the ability to read, analyze, and use financial information to make better business decisions. It is not just about knowing the basics of accounting or finance, but also about understanding the meaning and implications of the numbers, and how they relate to your business strategy and operations.
Financial intelligence is not something that you are born with or that you can learn overnight. It is a skill that you can develop over time, by learning the key concepts and principles of finance, applying them to your own business situation, and practicing them regularly.
Why is it important for entrepreneurs?
Financial intelligence is important for entrepreneurs for several reasons:
It helps you measure your progress and performance. By tracking and analyzing your financial statements, you can see how well you are doing in terms of revenue, profit, cash flow, growth, and other indicators. You can also compare your results with your goals, budgets, forecasts, and industry benchmarks.
It helps you identify problems and opportunities. By digging deeper into your financial data, you can uncover the root causes of issues such as low profitability, high costs, poor cash flow, or declining sales. You can also spot potential areas for improvement or expansion, such as new markets, products, or customers.
It helps you make better decisions. By using financial information as a basis for your decision-making, you can evaluate the pros and cons of different options, such as launching a new product, hiring more staff, investing in equipment, or raising capital. You can also estimate the expected return on investment (ROI) and the impact on your bottom line.
It helps you communicate with others. By being able to explain your financial situation and goals clearly and confidently, you can build trust and credibility with your stakeholders, such as investors, lenders, customers, suppliers, employees, and partners. You can also persuade them to support your vision and plans.
How to develop financial intelligence?
To develop financial intelligence, you need to learn the key concepts and tools of finance that are relevant for your business. You also need to practice using them in real-life scenarios and situations. Here are some steps that you can follow:
Learn the basics of accounting and finance. You don't need to become an expert, but you should understand the main terms, concepts, and principles that are used in financial reporting and analysis. You should also be familiar with the three main financial statements: the income statement, the balance sheet, and the cash flow statement.
Read and analyze your financial statements regularly. You should review your financial statements at least once a month, and preferably more often. You should look for trends, patterns, anomalies, and changes in your numbers, and try to understand what they mean and why they happen. You should also compare your actual results with your budget, forecast, and industry standards.
Use financial ratios and metrics to measure your performance. You should calculate and monitor some key financial ratios and metrics that can help you evaluate your profitability, liquidity, solvency, efficiency, and growth. You should also know how to interpret them and use them to identify strengths and weaknesses in your business.
Apply financial analysis to your decision-making. You should use financial information as a basis for making strategic and operational decisions for your business. You should consider the financial implications of different alternatives, such as the costs, benefits, risks, and returns. You should also use tools such as break-even analysis, net present value (NPV), internal rate of return (IRR), and payback period to assess the viability and attractiveness of different projects.
Communicate your financial information effectively. You should be able to present and explain your financial information in a clear, concise, and compelling way to your stakeholders. You should use charts, graphs, tables, and other visual aids to illustrate your points. You should also tailor your message to your audience, depending on their level of financial knowledge and interest.
Key concepts of financial intelligence
The income statement
The income statement (also called the profit and loss statement or the statement of operations) shows how much money your business made or lost during a specific period of time, usually a month, a quarter, or a year. It summarizes your revenue (the money you earned from selling your products or services) and your expenses (the money you spent on running your business), and calculates your profit (the difference between revenue and expenses).
The income statement has three main components: revenue, expenses, and profit.
Revenue
Revenue is the amount of money that you receive from selling your products or services to your customers. It is also called sales or income. Revenue is recorded when you deliver your products or services to your customers, not when you receive the payment.
There are two main types of revenue: operating revenue and non-operating revenue. Operating revenue is the money that you earn from your core business activities, such as selling goods or services. Non-operating revenue is the money that you earn from other sources that are not related to your core business activities, such as interest income or gains from selling assets.
Expenses
Expenses are the amount of money that you spend on running your business. They are also called costs or expenditures. Expenses are recorded when you incur them, not when you pay them.
There are two main types of expenses: operating expenses and non-operating expenses. Operating expenses are the money that you spend on supporting your core business activities, such as paying salaries, rent, utilities, marketing, etc. Non-operating expenses are the money that you spend on other items that are not related to your core business activities, such as interest expense or losses from selling assets.
Profit
Profit is the amount of money that you have left after deducting all your expenses from your revenue. It is also called net income or earnings. Profit is calculated by subtracting total expenses from total revenue.
There are two main types of profit: gross profit and net profit. Gross profit is the money that you have left after deducting only the cost of goods sold (COGS) from your revenue. COGS is the direct cost of producing or acquiring the products or services that you sell, such as materials, labor, etc. Gross profit measures how efficiently you generate revenue from your products or services.
Net profit is the money that you have left after deducting all your expenses (both operating and non-operating) from your revenue. Net profit measures how well you manage all aspects of your business.
The balance sheet
The balance sheet
The balance sheet (also called the statement of financial position or the statement of assets and liabilities) shows what your business owns and owes at a specific point in time, usually at the end of a month, a quarter, or a year. It summarizes your assets (the resources that you own or control that can generate future benefits), your liabilities (the obligations that you have to pay or perform in the future), and your equity (the difference between your assets and liabilities, or the value of your ownership in the business).
The balance sheet has three main components: assets, liabilities, and equity.
Assets
Assets are the resources that you own or control that can generate future benefits for your business. They are also called resources or investments. Assets are recorded at their cost or fair value, depending on the type of asset and the accounting method used.
There are two main types of assets: current assets and non-current assets. Current assets are the resources that you expect to use or convert into cash within one year or one operating cycle, whichever is longer. Examples of current assets include cash, accounts receivable, inventory, prepaid expenses, etc. Non-current assets are the resources that you expect to use or convert into cash beyond one year or one operating cycle. Examples of non-current assets include property, plant and equipment, intangible assets, long-term investments, etc.
Liabilities
Liabilities are the obligations that you have to pay or perform in the future. They are also called debts or obligations. Liabilities are recorded at their face value or present value, depending on the type of liability and the accounting method used.
There are two main types of liabilities: current liabilities and non-current liabilities. Current liabilities are the obligations that you have to pay or perform within one year or one operating cycle, whichever is longer. Examples of current liabilities include accounts payable, accrued expenses, short-term loans, taxes payable, etc. Non-current liabilities are the obligations that you have to pay or perform beyond one year or one operating cycle. Examples of non-current liabilities include long-term loans, bonds payable, deferred taxes, etc.
Equity
Equity is the difference between your assets and liabilities, or the value of your ownership in the business. It is also called net worth or shareholders' equity. Equity is recorded at its historical cost or book value.
There are two main types of equity: contributed capital and retained earnings. Contributed capital is the money that you or other owners have invested in the business in exchange for shares or ownership rights. It is also called share capital or paid-in capital. Retained earnings are the money that you have earned and reinvested in the business over time. It is also called accumulated profits or earnings.
The cash flow statement
The cash flow statement (also called the statement of cash flows) shows how much cash your business generated and used during a specific period of time, usually a month, a quarter, or a year. It summarizes your cash inflows (the money that you received from various sources) and your cash outflows (the money that you paid for various purposes), and calculates your net change in cash (the difference between cash inflows and cash outflows).
The cash flow statement has three main sections: operating cash flow, investing cash flow, and financing cash flow.
Operating cash flow
Operating cash flow is the amount of cash that you generated from your core business activities, such as selling goods or services, paying salaries, rent, utilities, etc. It measures how well you manage your day-to-day operations and generate cash from them.
Operating cash flow is calculated by adjusting your net profit for non-cash items (such as depreciation, amortization, gains or losses from selling assets, etc.) and changes in working capital (such as changes in accounts receivable, inventory, accounts payable, etc.).
Investing cash flow
Investing cash flow is the amount of cash that you used or received from investing in long-term assets or other businesses. It measures how well you allocate your resources for future growth and returns.
Investing cash flow is calculated by adding or subtracting the cash payments or receipts from buying or selling property, plant and equipment, intangible assets, long-term investments, etc.
Financing cash flow
Financing cash flow is the amount of cash that you used or received from raising or repaying capital. It measures how well you manage your capital structure and funding sources.
Financing cash flow is calculated by adding or subtracting the cash payments or receipts from issuing or repaying loans, bonds, or other debts, issuing or repurchasing shares or other equity, paying dividends or other distributions, etc.
How to use financial intelligence to make better decisions
Analyze financial ratios
Financial ratios are numerical values that compare two or more financial items or indicators. They can help you evaluate various aspects of your business performance, such as profitability, liquidity, solvency, efficiency, and growth. They can also help you compare your results with your competitors, industry standards, or historical trends.
There are four main types of financial ratios: profitability ratios, liquidity ratios, solvency ratios, and efficiency ratios.
Profitability ratios
Profitability ratios measure how well you generate revenue and profit from your assets and equity. They indicate how profitable your business is and how much value you create for your owners and investors.
Some common profitability ratios are:
Gross profit margin: the percentage of revenue that is left after deducting the cost of goods sold. It shows how efficiently you generate revenue from your products or services.
Operating profit margin: the percentage of revenue that is left after deducting all operating expenses. It shows how well you manage your operating costs and activities.
Net profit margin: the percentage of revenue that is left after deducting all expenses (both operating and non-operating). It shows how well you manage all aspects of your business.
Return on assets (ROA): the percentage of net profit that is generated from your total assets. It shows how effectively you use your assets to generate profit.
Return on equity (ROE): the percentage of net profit that is generated from your total equity. It shows how much value you create for your owners and investors.
Liquidity ratios
Liquidity ratios measure how well you can meet your short-term obligations and needs with your current assets and liabilities. They indicate how liquid your business is and how easily you can convert your assets into cash.
Some common liquidity ratios are:
Current ratio: the ratio of your current assets to your current liabilities. It shows how well you can pay off your current debts with your current resources.
Quick ratio: the ratio of your quick assets (current assets minus inventory) to your current liabilities. It shows how well you can pay off your current debts with your most liquid resources.
Cash ratio: the ratio of your cash and cash equivalents to your current liabilities. It shows how well you can pay off your current debts with your cash.
Cash conversion cycle: the number of days that it takes for you to convert your inventory into sales and then into cash. It shows how efficiently you manage your working capital and cash flow.
Solvency ratios
Solvency ratios measure how well you can meet your long-term obligations and needs with your total assets and liabilities. They indicate how solvent your business is and how able you are to withstand financial shocks or crises.
Some common solvency ratios are:
Solvency ratios
Solvency ratios measure how well you can meet your long-term obligations and needs with your total assets and liabilities. They indicate how solvent your business is and how able you are to withstand financial shocks or crises.
Some common solvency ratios are:
Debt-to-asset ratio: the ratio of your total debt to your total assets. It shows how much of your assets are financed by debt and how leveraged your business is.
Debt-to-equity ratio: the ratio of your total debt to your total equity. It shows how much of your equity is financed by debt and how risky your business is.
Interest coverage ratio: the ratio of your operating profit to your interest expense. It shows how well you can cover your interest payments with your operating income.
Times interest earned ratio: the ratio of your earnings before interest and taxes (EBIT) to your interest expense. It shows how many times you can pay your interest with your earnings.
Efficiency ratios
Efficiency ratios measure how well you use your assets and resources to generate revenue and profit. They indicate how efficient your business is and how productive you are.
Some common efficiency ratios are:
Asset turnover ratio: the ratio of your revenue to your average total assets. It shows how much revenue you generate from each unit of asset.
Inventory turnover ratio: the ratio of your cost of goods sold to your average inventory. It shows how quickly you sell your inventory and how well you manage your inventory levels.
Receivables turnover ratio: the ratio of your revenue to your average accounts receivable. It shows how quickly you collect your receivables and how well you manage your credit policy.
Payables turnover ratio: the ratio of your cost of goods sold to your average accounts payable. It shows how quickly you pay your payables and how well you manage your payment terms.
How to use financial intelligence to make better decisions
Understand the difference between accounting and economic profit
Accounting profit is the amount of money that you have left after deducting all your expenses from your revenue, as reported in your income statement. It is also called net income or earnings. Accounting profit follows the rules and standards of accounting, such as the accrual basis, the matching principle, the historical cost principle, etc.
Economic profit is the amount of money that you have left after deducting all your explicit and implicit costs from your revenue. Explicit costs are the actual payments that you make for using resources, such as wages, rent, interest, etc. Implicit costs are the opportunity costs that you incur for using resources that you own or control, such as forgone salary, rent, interest, etc. Economic profit reflects the true economic value that you create or destroy by running your business.
Understand the difference between accounting and economic profit
Accounting profit is the amount of money that you have left after deducting all your expenses from your revenue, as reported in your income statement. It is also called net income or earnings. Accounting profit follows the rules and standards of accounting, such as the accrual basis, the matching principle, the historical cost principle, etc.
Economic profit is the amount of money that you have left after deducting all your explicit and implicit costs from your revenue. Explicit costs are the actual payments that you make for using resources, such as wages, rent, interest, etc. Implicit costs are the opportunity costs that you incur for using resources that you own or control, such as forgone salary, rent, interest, etc. Economic profi