An intuitive understanding of finance is an indispensable part of any leader’s toolkit. Knowing how to create and measure value can not only lead to smarter decision-making in the workplace, but professional advancement and improved communication with stakeholders.
If you’re aiming to be more financially minded in your role and help your company thrive, here are the skills you need to develop, no matter your industry.
FINANCE SKILLS EVERY LEADER NEEDS
1. An Understanding of Financial Statements
Financial statements are valuable resources for measuring the overall health of a company. If you’re seeking to evaluate the performance of your department or organization, there are three key reports you should know how to read and interpret. They are the:
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Balance Sheet: A statement that shows the financial position of your company at a specific point in time. It provides a snapshot of the resources owned or controlled by the business and lays out how those resources were financed.
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Income Statement: A document that summarizes the earnings (revenues minus expenses) of your organization over a period of time.
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Statement of Cash Flows: A report that shows how much cash your company generated and used during a designated timeframe, which breaks down cash flows into three sections: operating activities, investing activities, and financing activities.
By understanding the data contained in these reports, you can gain a more complete picture of your organization’s financial position and make better business decisions.
2. Ratio Analysis
Effectively leveraging your company’s balance sheet and other statements calls for more than knowing how to decipher the financial terms they include—you need to examine the meaning behind the metrics.
Ratios provide a toolkit for doing that. In financial analysis, ratios make numbers meaningful by providing comparability across companies and time, and they fall into four main buckets:
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Liquidity: Ratios that measure the risk of your business running out of cash
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Profitability: Ratios that can be used to assess your company’s earnings
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Leverage: Ratios that examine how much of your organization’s assets are financed by debt
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Productivity: Ratios that gauge how well your firm uses its assess to produce output
Determining which ratio to employ in a given situation is dependent on what needs to be measured. A profitability ratio, such as return on assets (net income divided by total assets), can show your company’s earnings relative to its resources, while a productivity ratio, such as inventory turnover (cost of goods sold divided by inventory), can reveal how many times your business sells out of inventory over a specified period.
With a keen understanding of ratios, you can gain insight into your organization’s strengths and weaknesses, and make adjustments that enhance future financial performance.
3. Cash Flow Management
In finance, cash is king. Rather than focusing on profits, like accounting, finance looks at how much cash a company generates to measure its economic returns.
A recent study by CB Insights found that 29 percent of startup founders cited running out of cash as one of the top reasons for their company’s failure, underscoring the importance for business leaders to know how to track and manage cash inflows and outflows.
To help ensure financial success at your organization, you should understand the following cash measurements:
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EBITDA: An acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization, this measurement provides a lens for looking at your company’s returns before the effects of interest and taxes, along with non-cash charges, such as depreciation and amortization.
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Operating Cash Flow: The first section on the statement of cash flows that details all cash generated and used in business operations. It’s useful for considering how working capital—the money available for daily operations—can have cash flow consequences.
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Free Cash Flow: A key measure of corporate performance that looks at how much money is available to distribute to investors, or reinvest in the business, after all expenses have been covered. It’s a strong indicator of your company’s profitability, and can provide a blueprint for improving operational efficiency.
Each of these cash measurements have a place in corporate analysis. While free cash flow is largely considered the most important measure, it’s important to know how each metric can be applied to monitor cash and drive growth at your organization.
Related: Word of the Week: Cash Conversion Cycle
4. Forecasting
Finance is intrinsically forward-looking. In order to determine the present worth of projects and assets, it examines how those values might change in the months and years ahead.
If you’re aiming to make business decisions that will benefit your company over the long term, you need to know how to use available data and assumptions to forecast financial outcomes.
With forecasting, you can weigh the benefits and drawbacks of a project by using existing earnings metrics and other factors, including taxes and depreciation, to calculate what it might be worth in the future.
From there, a process of discounting can be employed to bring that figure of free cash flows to its present value.
Once you know the project’s present value of future cash flows, you can compare it against your company’s initial investment and determine whether it’s a worthy endeavor.
This exercise of discounting cash flows can provide an in-depth look at how your company should allocate its resources, enabling you to be more strategic in the daily decisions you make.
UNDERSTANDING YOUR INDUSTRY’S FINANCIAL LANDSCAPE
For leaders of all levels, financial know-how can inform sound decision-making and drive business success. By bolstering your skill set with an intuitive understanding of finance, you can better understand your industry and move both your organization and career forward.
Are you interested in deepening your knowledge of financial principles? Explore our six-week online course Leading with Finance and learn how you can develop a toolkit for making intelligent financial decisions.
