Finance: What Managers Need to Know
Summary
TLDRIn this interview, Joe Knight, co-owner of the Business Literacy Institute and author of the 'Financial Intelligence' book series, discusses his practical approach to teaching finance, emphasizing the importance of understanding financial statements without delving into complex accounting principles. Knight highlights the distinction between finance and accounting, stressing the need for transparency and the role of financial literacy at all levels of an organization. He also addresses the difference between profits and cash flow, the significance of key performance metrics, and the increasing demand for financial transparency in businesses.
Takeaways
- 📚 Joe Knight emphasizes a practical approach to teaching finance, focusing on what's important for non-financial professionals to understand.
- 🏆 His book 'Financial Intelligence' was listed as one of the best 100 by 800 CEO read, indicating its practical value for business leaders.
- 🤝 Joe's discussion with Bob Kaplan highlights the difference between academic teaching of finance and practical, on-the-job financial literacy.
- 👩🏫 Finance education should be accessible and relevant, not requiring an in-depth knowledge of complex accounting principles like double-entry bookkeeping.
- 🎨 The 'art' of finance refers to the estimates and assumptions made in financial reporting, which can vary based on the preparer's judgment.
- 📊 Finance is about analyzing numbers for decision-making, while accounting is recording transactions to create historical financial information.
- 🔑 Transparency in financial reporting is increasingly valued, especially in light of corporate scandals like Enron, for building trust with investors.
- 💡 Sharing financial information with employees can lead to 'psychic ownership', where they feel a personal stake in the business's success.
- 💼 Employees don't need to become accountants or financial analysts; they need to know key metrics that drive their business's success.
- 💵 Cash flow is now more critical than ever, especially in a tightened credit market, and it's distinct from profit as it involves the timing of cash收款.
- 🔍 Questioning financial numbers is encouraged to ensure accuracy and prevent fraud, as those familiar with finance are more likely to detect discrepancies.
Q & A
What is Joe Knight’s approach to teaching finance, and how does it differ from a typical academic approach?
-Joe Knight's approach focuses on practical, real-world application of finance principles. Instead of delving into technical details like the double-entry accounting system, he teaches essential financial concepts that employees on the shop floor need to know to drive business success, such as gross profit per hour. This contrasts with the academic approach, which is more detailed and theoretical, often including concepts like credits and debits.
Why does Joe Knight believe it’s unnecessary to teach credits and debits to non-accountants?
-Joe believes non-accountants, especially those working directly in the operations of a business, don't need to know the intricacies of credits and debits. Instead, they need to understand key metrics that affect their work and the business's success, like gross profit per hour, which can impact their bonuses and the overall success of the company.
What does Joe Knight mean by 'psychic ownership,' and why is it important in business?
-'Psychic ownership' refers to employees feeling a sense of ownership in the business when they understand its financial health and key numbers. When employees see how their actions affect the company’s success, they are more likely to behave as if they are owners and contribute to the business’s profitability and performance.
How does Joe differentiate between finance and accounting?
-According to Joe, accounting is about recording historical financial transactions and maintaining the integrity of financial records, while finance is about analyzing those numbers to make informed decisions about managing a business. Accounting provides the data, and finance uses it to make strategic choices.
Why does Joe think understanding finance is important for all employees, not just finance professionals?
-Joe believes finance is a universal language in business. He likens it to playing a game without knowing the score. Understanding finance allows employees from all departments to see how their work contributes to the company's success, making them more effective and aligned with the company’s goals.
What role does transparency play in finance, according to Joe Knight?
-Transparency in finance means making financial information clear and accessible, so stakeholders, including investors and employees, can understand the true state of the business. Joe highlights the increasing importance of transparency, especially in the wake of corporate scandals like Enron, where a lack of transparency led to fraudulent practices.
What are some key financial metrics that Joe suggests are important for most businesses?
-Joe mentions two key metrics that are important for project-based businesses like his: the percentage of labor directly applied to projects and the dollars generated per direct labor hour. These metrics help determine the profitability and efficiency of the business.
Why is cash flow becoming more important than profit in recent years, according to Joe Knight?
-Joe explains that in the current economic environment, having strong cash flow is crucial for business survival because credit markets have tightened. While profit measures long-term performance, cash flow is a more immediate measure of a company's ability to pay its bills and invest in its operations.
How can understanding finance help prevent fraud in an organization?
-Joe points out that fraud is often discovered by employees who understand finance and notice irregularities in the numbers. When more people in the organization are financially literate and involved in reviewing the numbers, it becomes harder for fraud to go unnoticed.
What are some reasons why cash and profit do not always align in a business?
-Joe highlights three reasons: (1) Sales are recorded when a product is shipped or a service is completed, not when payment is received. (2) Businesses use cash to purchase large assets but depreciate them over time, creating a mismatch between cash outflow and profit recognition. (3) Expenses are recorded when services are incurred, not when payments are made, further disconnecting cash flow from profit.
Outlines
🧑🏫 Introduction to Joe Knight’s Practical Finance Approach
The conversation starts with an introduction to Joe Knight, co-author of the Financial Intelligence book series and a financial educator. Joe discusses his unique approach to teaching finance, which contrasts with traditional academic methods. He focuses on practical, real-world applications for non-financial professionals, like shop floor workers, rather than emphasizing detailed accounting concepts like credits and debits. Joe recounts a story involving Bob Kaplan, a renowned academic, highlighting the difference between teaching finance in an academic setting versus a practical business environment. His goal is to help employees understand key financial metrics relevant to their roles, such as gross profit per hour, and to simplify financial literacy to drive business success.
🏢 Empowering Employees Through Financial Transparency
Joe Knight explains the concept of 'psychic ownership,' where employees who understand the financial health of their company feel a sense of ownership and responsibility. By sharing key financial data with employees, businesses can foster a culture where everyone feels accountable for the company's performance. Joe argues that even though specialization is essential in modern economies, understanding basic financial metrics is crucial for all employees, regardless of their department. This awareness allows them to make informed decisions that positively impact the business. He emphasizes the importance of identifying one or two key performance indicators (KPIs) that drive success and linking these metrics to employee rewards, such as bonuses, to motivate and align everyone with the company's goals.
💸 Understanding Cash Flow vs. Profit and the Importance of Financial Transparency
Joe delves into the differences between cash flow and profit, emphasizing that while profit is recognized at the point of sale, cash flow reflects the actual movement of money, which may lag due to delayed payments or investments in capital assets. He outlines three reasons why profit and cash flow can differ: the timing of sales versus payments, capital expenditures like buying equipment, and the timing of expense recognition. Joe highlights the growing emphasis on transparency in business, especially post-2009, where companies are expected to be open about their financial situations. He discusses how transparency can help detect fraud and increase trust among stakeholders. Joe points out that financial transparency has become a critical focus in the business world, helping to prevent scenarios like the Enron scandal, where a lack of openness led to massive corporate fraud.
Mindmap
Keywords
💡Financial Intelligence
💡Double-entry Accounting
💡Gross Profit per Hour
💡Estimates and Assumptions
💡Psychic Ownership
💡Key Metrics
💡Transparency
💡Cash Flow
💡Fraud Detection
💡Profit vs Cash Flow
Highlights
Joe Knight's approach to teaching finance focuses on practical applications, helping non-financial professionals understand key metrics without delving into the complexities of the double-entry accounting system.
Knight emphasizes teaching employees on the shop floor about the importance of gross profit per hour and how it impacts business success and their bonuses.
Knight's book 'Financial Intelligence' was recognized as one of the top 100 by 800-CEO-Read, highlighting its unique approach to simplifying finance for non-specialists.
Bob Kaplan, author of 'The Balanced Scorecard,' questioned how finance could be taught without covering credits and debits, leading to a debate on academic vs. practical finance teaching.
Knight's experience in teaching finance stems from explaining the importance of specific metrics to employees who do not necessarily need to know the intricacies of accounting.
The concept of 'psychic ownership' arises when employees understand the company’s financials, leading them to take initiative and act like business owners, despite not having actual ownership.
Knight argues that finance should not be seen solely as a specialized area, as understanding key numbers is crucial for everyone in a business, regardless of their department.
Finance involves analyzing historical accounting information to make business decisions, while accounting focuses on recording and reporting past transactions.
In Knight’s business, two key metrics drive success: the percentage of labor applied to projects and gross profit per hour for direct labor.
Knight highlights the importance of transparency in finance, especially after events like the Enron scandal, where lack of transparency led to significant fraud.
Understanding cash flow is more important than ever, especially for small businesses, where generating cash flow is key to surviving tight credit markets.
Knight explains the distinction between cash and profit, noting that profit can be recognized without immediate cash inflow due to delayed payments or depreciation.
He stresses the need for general managers to ask financial analysts questions and challenge the numbers, especially in light of the estimates and assumptions that go into financial reports.
Transparency has become a critical focus in American business, with many companies now requesting training on the topic to ensure stakeholders have a clear view of financial performance.
Knight's insights reveal that finance, while often considered a rigid science, actually involves a lot of estimates and assumptions, making it somewhat 'artistic' in nature.
Knight advocates for businesses to share their financials widely within the organization to foster a sense of ownership and drive better performance from employees.
Transcripts
hi I'm Sarah green from Harbor business
org I'm joined today by Joe knight
co-owner of the business literacy
Institute and author with Karen Berman
of the financial intelligence book
series he's also the author of a blog on
Harvard Business or called financial
intelligence Joe thanks so much for
joining us today thanks for having me
Joe how is your approach to teaching
finance different than the typical
academic approach you know one of the
things I had to learn when I taught
finance is that I had about 40 minutes
and I had a bunch of people that were
technical that weren't that interested
and I had to figure a way to get at
what's important and teach them why they
need to know the numbers and how they
affect them recently our book was listed
as one of the best 100 by 800 CEO read
and as part of that I was involved in a
session where several authors got
together and on a panel and presented
their books and I happen to be sitting
seated next to Bob Kaplan who was picked
as one of the best 100 with his with his
a well known book the balanced scorecard
and at the end of the session after we
presented to the Harvard alumni in this
session the moderator mentioned why he
liked each of the books and when he got
to my book he said you know the reason
why I like Joe's book financial
intelligence is because he taught us how
to read the statements without bringing
up credit or debit once and everybody
laughed and the session was over and as
people were coming out of the audience
Bob Kaplan was sitting next to me leaned
over and said Joe how can you teach
finance without going over the
double-entry accounting system and
credits and debits and and we started
debating about it and after that
experience I kind of reflected on that
and I realized that Bob Kaplan's
teaching academic people people at the
Harvard Business School getting an MBA
and he has a full semester and he has
these people for two hour blocks and he
should be teaching a lot of detail and
the double-entry accounting system
I learned to teach finance by telling
the people on the shop floor that are
making machines in our company what they
need to know to drive success in the
business and they don't need to know
credits or debits they need to know why
girls profit per hour is so critical and
they need to know when their gross
profit per hour is high enough
how much profit we'll make because that
will affect their bonus and affect the
success of the business and so I come at
it from for more of a practical position
where these people just need to know
what they need to know some of these
people don't want to be accountants they
don't want to be full-time financial
analysts but they do need to know what
score's need to be said certain levels
to be successful and that's all that I'm
trying to do is help them understand
what scores are important and why they
need to know them and that doesn't
require a lesson on the double-entry
accounting system and credits of debits
no matter how exciting that may appear
to be Joe you talk a lot about the art
of Finance but what's so artistic about
a P&L and do we really want finance to
be artistic isn't that what got the
Enron guys in trouble well actually we
don't want our our finance to be
artistic the challenge is is accountants
have to take transactions that happen in
many different ways and fit them into a
month a quarter of a year so there's a
lot of estimates and assumptions that go
into creating a statement and some of
that becomes very artistic if you will
we think of accounting as a science but
in reality there's a lot of estimates
and assumptions and a lot of the
statements can come from the personality
or the opinion of the person creating
the numbers consequently when management
goes to look at those numbers they find
out that they might not be exactly what
they thought they were because it's
based on estimates and assumptions in
art what's the difference between
finance and accounting because you use
both those terms there we do and and I
think you should understand that
everyone needs to understand that
finance is actually analyzing and
looking at numbers and making decisions
about how to run a business how to get
the numbers how to manage cash flow and
understand those kinds of things
accounting on the other hand their task
is to take transactions and figure out
how to create historical information
about what's happening with the business
finance people take that historical
information and use it to make business
decisions if you don't have good
accounting that you can rely on and buy
good accounting I mean accounting that
is consistent considerably applied and
accurate then you're not going to have
good financial analysis so the basis of
any good system is a good solid
historical accounting system and a lot
of that relies on the integrity and the
competency of the accountants putting in
the numbers
and to think of finance as a specialized
area finance and accounting both and I
think most general managers want to
leave the numbers to the numbers guys or
women is that is that a problem I think
it is a big problem I come from a world
where we shared our numbers I own a
small business called set point Systems
Incorporated and we do manufacturing
automation we built a few rollercoasters
in fact and in that business we learned
that when we shared the numbers with the
employees and show them how the business
would perform was performing they turned
around and did tremendous things for our
business in fact I coined kind of a
little phrase I call it psychic
ownership when the employees understand
the numbers and they can see what's
going on the business financially they
feel like it's their business and they
feel like when the numbers aren't right
they're going to figure out a way to
turn them around and make things better
and even though they're not owners they
still act like owners and they behave
like owners in the way they perform and
I think getting the numbers out to the
people in an operational way and finding
those one or two key numbers that drive
success in your business and bringing
them to everyone is very powerful in a
business it should go way beyond just
the accounting and Finance people but in
some sense our whole economy is built on
specialization right otherwise we would
still be hunting and gathering so how do
you find that balance well I think it's
the business is like a game and if you
don't understand the finances you're
basically playing a game where you don't
know score and so I believe that no
matter what your background is you know
whether you're an engineer or if you're
in sales and marketing or you're in
operations or if you're almost on the
floor putting a product together if you
don't know how score is kept you're
going to get in trouble and so I think
that finance is one of those things that
you need to be universally understood in
any business and when I say any business
I say that very broadly we use the term
not for profit but guess what not for
profit businesses also have to make a
profit in other words even
not-for-profits have to generate more
income than what goes out or they won't
survive I like to use the term not for
tax because that's really what
not-for-profit means but every
organization has to generate more in
flow than outflow and that's a simple
thing that everyone has to understand in
a business so what
least that a general manager or employee
in a business needs know about finance
well I think at the very minimum any
employee should understand one or two
key metrics or numbers that will drive
success in the business and one of the
things we find is that it's easy to
teach these metrics if there's one or
two one of the problems that finance
people have is they want to share all
the numbers and we could get into 20 or
30 metrics and it confuses people but if
you find one or two maybe three key
numbers that define success in your
business and then you link that to key
key drivers that bring that bring
rewards to the employees through bonus
and you train them on those numbers
it becomes very powerful as long as you
don't go too far with it so every
business is different industries are
different but if you can find those few
key metrics and really drive them
through your organization it's going to
make a big difference what's an example
maybe of some metrics that you think are
probably universally applicable across
most businesses well you know I would
say that there there are very few that
are totally Universal because every
business is different but I can tell you
about setpoints key numbers a couple of
numbers we focus on because we're a
manufacturing business that works on big
projects is the percentage of our labor
that's directly applied to projects
number one and number two the dollars we
generate for every direct hour we spend
now that in our business that drives
success and in those two numbers gross
profit per hour and percentage of labor
direct is a great metric for a
project-based business any project-based
business if those two numbers are in the
right range you're going to be
profitable and our people know that so
in their businesses how do you how do
general managers and employees know what
the right questions aren't to ask of
their financial people well first of all
I think there are no bad questions and I
think because finance does have that
estimate or that art to it that we
talked about earlier it's a
responsibility the management group to
ask questions of the numbers and to
understand where the finance person got
the numbers when they put them together
one of the things that people might not
realize is as a financial analyst there
is an accountant early in my career for
example when I was at Ford Motor Company
if the numbers didn't balance and it was
7:00 at night and I was really tired I'd
worked on it for another few hours and
then it was 10 then 11 at about midnight
I
the numbers balance and I just go home
now the next morning when we had our
meeting I wouldn't raise my hand and say
guess what I just made up that number
last night so you need to understand
that we're making estimates when we
prepare those statements and it's okay
to ask questions and to challenge the
numbers and to question things because
if not you're making decisions business
decisions based on the analyst numbers
that were maybe plugged or maybe
estimate estimated or even in some cases
fraudulent and so it's really important
that everyone get involved in the
numbers and understand the numbers
another thing that's important about
understand the numbers is if everyone
looks at the numbers and watches them on
a weekly basis it becomes very difficult
for fraud to creep into a business
because everyone's seeing that and
involved in the numbers and so that's
another reason why finance should be
viewed by many people one of the things
we learned is in fraud cases virtually
every one of them were discovered by
someone in the organization who
understood finance and noticed something
was wrong so it makes sense that if more
people understood the numbers there
would be more people that were on top of
the numbers and could understand and
find cases of fraud let's talk a little
bit about cash and profits because we've
been hearing a lot about those in 2009
maybe because no one seems to have very
much of either of them what's the
difference there and and just talk to me
a little bit about those elusive goals
okay
well first of all the shift has been to
cash flow in this environment everyone
knows that if you have cash you're going
to survive the credit markets have left
have tightened up now I'm in a small
business and especially for small
businesses it's very difficult to raise
money right now so there's a big premium
on generating cash flow the problem is a
lot of people don't understand this
profit and cash flow are two different
things
there's three primary reasons why that's
the case first profit is recognized when
you make a sale unfortunately we count
sales when we ship a product or when
we've done the work or completed the
project not when we collected the money
so consequently we might have invoiced
millions of dollars but we might not see
that money for 60 days and in a tough
economy it could be as long as 90 days
and so you could have a lot of sales
which generate profit and wait 90 days
60 days to to receive the cash a second
reason why cash and profit don't match
because sometimes in business we take a
lot of our cash and use it to buy big
pieces of equipment a truck a building
and those trucks and buildings eat up
all our cash but we depreciate the cost
of those over several years and so our
cash is gone but we appear profitable
because of depreciation so that's
another reason and then third we don't
incur expenses on the income statement
when we actually pay the expense we
incur the expense when we receive the
service an example of that would be
payroll when we when we pay our
employees on June 1st we're actually
paying them for work they did in May so
we're going to charge the income
statement in May for payroll we paid in
June so again cash went out in June the
expense was charged in May so all of
these moving parts are happening we
could have profit at the bottom here and
cash could be here or here or anywhere
and so it's very hard to track the two
side-by-side consequently the cash flow
statement has become more and more
important over the last few years let's
talk about another emerging trend at
Transparency that's a word that we maybe
didn't hear very much 10 years ago now
it's everywhere whether you're talking
about ethics or sustainability or
finance how have you seen that playing
out you know it's interesting I trained
a lot of big corporations in over the
last few years I have not or like if I
go back three or four years ago I never
heard the word transparency now several
of my clients ask if we'll teach a
module on transparency and the issue is
is is we believe now that a company
that's publicly traded should be
transparent financially so the thinking
is is an outsider an investor can go
online to Edgar gov or to a typical
government site go through the SEC look
up the numbers on that company and get
some indication of what's really
happening in the business a company like
Enron was the opposite of transparency
Enron spent tremendous amounts of effort
and time trying to figure out ways to
keep the real numbers from getting
public and so the opposite would be
let's let the news go out as it is let's
share the numbers as they are really
happening let's be transparent to our
investors to our out to the outside
stakeholders in the business and and in
the case with fraud and with
he's going bankrupt and all these
problems we've seen in the banking
system
transparency is becoming a very very
important topic and one that is a big
focus in American business today Joe
thanks so much for joining us today
you're very welcome that's Joe Knight
co-author of financial intelligence the
book series and the blog on Harvard
Business org
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