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"Outside of the accounting and finance departments, not many business people are interested in the finer points of financial reports. But every manager must have a thorough understanding of what their finance and accounting staffs do, why they do it, and what these reports really mean.
This indispensable book demystifies the role that accounting and finance play in a corporation and demonstrates how financial decisions are manifestations of company goals. The author’s crystal-clear examples show how managers can connect corporate financial information directly to their own strategies and actions. To demonstrate these connections, the author covers such essential topics as:
• Balance sheets and income/cash flow statements
• Reading and understanding annual reports
• Fixed-cost and variable-cost issues
• Financial analysis, budgeting and forecasting."
This is a book for businesspeople. All decisions in a business organization are made in accordance with how they will affect the organization’s financial performance and future financial health. Whether your background is in marketing, manufacturing a distribution, research and development, or the current technologies, you need financial knowledge and skills if you are to really understand your company’s decision-making, financial, and overall management processes. The budget is essentially a financial process of prioritizing the benefits resulting from business opportunities and the investments required to implement those opportunities. An improved knowledge of these financial processes and the financial executives who are responsible for them will improve your ability to be an intelligent and effective participant.
The American economy has experienced incredible turmoil in the years since this book was first published. Before U.S. government intervention, we were on the verge of our second ‘‘great depression.’’
We witnessed the demise of three great financial firms,
Bear Stearns, Lehman Brothers, and AIG. Corporate bankruptcies were rampant, with General Motors, Chrysler, and most of the major airlines filing. The U.S. government lent the banks hundreds of billions of dollars to save the financial system, while approximately seven million Americans lost their jobs (and most of these jobs will never exist again; see Chapter 6, ‘‘Key Financial Ratios,’’
for a discussion of employee productivity trends). The cumulative value of real estate in this country declined by 40 percent; combining this with the 50 percent drop in the stock market, millions of Americans lost at least half of their net worth. Accounting scandals caused the downfall of many companies, the demise of some major CPA firms, and jail time for some of the principals involved. (Enron would not have happened had its CPA firm done the audit job properly. Bernard Madoff’s Ponzi scheme could not have been maintained had his CPA firm not been complicit.) More than ever a business and organization managers require a knowledge of finance and accounting as a prerequisite to professional advancement.
It is for this reason that we have updated this book with additional accounting and regulatory compliance information and introduced the stronger analytical skills that are necessary to navigate the global economic turmoil.
This book is special for a number of reasons:
1. It teaches what accountants do; it does not teach how to do accounting. Businesspeople do not need to learn, nor are they interested in learning, how to do debits and credits.
They do need to understand what accountants do and why a so that they can use the resulting information—the financial statements—intelligently.
2. It is written by a businessperson for other businesspeople.
Throughout a lifetime of business, consulting, and training experience, I have provided my audiences with down-toearth a practical, useful information. I am not an accountant, but I do have the knowledge of an intelligent user of financial information and tools. I understand your problems, and I seek to share my knowledge with you.
3. It emphasizes the business issues. Many financial books focus on the mathematics. This book employs mathematical information only when it is needed to support the business decision-making process.
4. It includes a chapter on how to read an annual report that helps you use the information that is available there a including the information required by Sarbanes-Oxley, to better understand your own company. Sarbanes-Oxley is legislation passed by Congress and enforced by the Securities and Exchange Commission. The governance information required by this act is highlighted and explained a and its impact is analyzed. This chapter also identifies a number of sources of information about your competition that are in the public domain and that may be very strategically valuable.
5. It includes a great deal of information on how the finance department contributes to the profitability and performance of the company. The financial staff should be part of the business profitability team. This book describes what you should expect from them.
6. It contains many practical examples of how the information can be used, based upon extensive, practical experience.
It also provides a number of exercises, including a practice case study, as appendices.
Organization of the Book
This book is organized in four parts, which are followed by Appendices
A through D:
Part 1: ‘‘Understanding Financial Information,’’ Chapters
1 through 5
In Part 1, the reader is given both an overview and detailed information about each of the financial statements and its components.
A complete understanding of this information and how it is developed is essential for intelligent use of the financial statements.
The financial statements that are discussed in Part 1 are:
• The balance sheet
• The income statement
• The statement of cash flows
Each statement is described, item by item. The discussion explains where the numbers belong and what they mean. The entire structure of each financial statement will be described, so that you will be able to understand how the financial statements interrelate and what information each of them conveys.
Part 1 also contains a chapter on how to read and understand an annual report. The benefits of doing so are numerous. They include:
• Understanding the reporting responsibilities of a public company
• Further understanding the accounting process
• Identifying and using information about competitors that is in the public domain
Managers are always asking for more information about what they should look for as they read the financial statements. In response to this need, Chapters 1, 2, and 3 have been greatly expanded.
Along with a line-by-line explanation of each component of the financial statement, they now include a preliminary analysis of the story that the numbers are telling. For most of the numbers a the book answers the questions: What business conclusions can a reach by reading these financial statements? What are the key ‘‘red flags’’ that should jump out at me?
Each of these red flags is identified. Questions that you should ask the financial staff are included, and the key issues and action items that need to be addressed are discussed. This serves as an analytical bridge between reading the financial statements and the more comprehensive analysis of the numbers that appears in
Chapter 6, ‘‘Key Financial Ratios.’’
Part 2: ‘‘Analysis of Financial Statements,’’ Chapters 6
Part 2 focuses on the many valuable analyses that can be performed using the information that was learned in Part 1. Business management activities can essentially be divided into two basic categories:
• Measuring performance
• Making decisions
Chapters 6 through 8 explain how to measure and evaluate the performance of the company, its strategic business units, and even its individual products.
Financial ratios and statistical metrics are very dynamic tools.
This section has been updated and enhanced to include analyses that will help the businessperson survive in our more complex economic environment. Technology has changed the way we do business.
This section includes discussions of the customer interface a supply-chain management, global sourcing, and financial measurement and controls.
Now that we have learned how to read and understand financial statements, we can also understand how they are prepared and what they mean. Part 2 identifies management tools that can help us use the information in financial statements to analyze the company’s performance. The ratios that will be covered describe the company’s:
• Working capital management
• Financial leverage (debt)
• Profitability and performance
Financial turmoil from 2007 to 2010 has resulted in the loss of millions of jobs in the United States. Most of these jobs will not return in their previous form. Companies are focusing on measuring how much business revenue they can achieve with a minimal increase in the number of employees.
With the support of technology and improving business models a revenue per employee is becoming a key metric of a company’s effectiveness and its ability to compete and achieve.
Part 3, ‘‘Decision Making for Improved Profitability,’’
Chapters 9 and 10
Part 3 discusses the key financial analysis techniques that managers can use to make decisions about every aspect of their business.
Financial analysis provides valuable tools for decision making.
However, managers must still make the decisions.
Part 3 also explores and analyzes fixed-cost versus variablecost issues within the context of strategic planning. These include:
• Supply-chain management
• New product strategy
• Marketing strategy
• Product mix and growth strategies
Measuring the performance of profit centers is no longer a growing trend. It is now a necessary business practice. This is also true of investment decision making based upon cash flow forecasting techniques. The financial benefits of success are too valuable and the financial penalties for failure too severe for companies to make decisions without first extensively examining the cash flow issues involved in each proposal. Part 3 explains the technique called discounted cash flow. To determine the cash flow impact of proposed investment decisions, there are several measures using this technique:
• Internal rate of return
• Net present value
• Profitability index
The types of investments that are covered in this discussion are:
• Capital expenditures
• Research and development
• Acquiring other companies
• Marketing programs
• Strategic alliances
Part 4: ‘‘Additional Financial Information,’’ Chapters 11
Part 4 describes in considerable detail some additional financial information that will benefit the businessperson. It includes discussions of the planning process and the budget, and why they are so important. It also covers the many ways in which the company may obtain financing. While this is not a direct responsibility of most members of the management team, knowledge of debt and equity markets and sources of corporate financing will be very beneficial for the business manager.
Appendices A through D
In order to ensure that you have understood the information provided in this book, we have included four practice exercises in the appendices. One of the goals of this book is to make the information it provides really useful in your business management efforts.
An effective way to achieve this is to practice the lessons and analyses.
Appendix A provides practice in constructing the three financial statements. This ‘‘fill in the blanks’’ exercise will reinforce the knowledge gained in Part 1.
Appendix B is a glossary ‘‘matching’’ test. Seventy-nine financial terms are given, along with their definitions, but not in the same sequence. This will reinforce understanding of the many terms and ‘‘buzzwords’’ that businesspeople must understand when they communicate with accounting people and use the information that they produce.
Appendix C is a comprehensive case study of a company that is (in a financial sense) severely underachieving. The company’s past performance must be analyzed using the knowledge gained in
Chapter 6, ‘‘Key Financial Ratios.’’ The case study also includes the budget plan and forecasting techniques discussed in Chapters 10
The format and content of financial information is seriously affected by the business the company is in. Thus, Appendix D provides a list of 10 companies and 10 sets of financial information.
The goal is to figure out which set of financial information belongs to which of the 10 companies. Providing actual, recognizable companies provides the opportunity to understand how ratios behave and is another step forward in making the financial information really useful.
Answers are provided for all four appendices, but please give the exercises a try before you peek.
"Part 1: Understanding Financial Information
1. The Balance Sheet
2. The Income Statement
3. The Statement of Cash Flows
4. Generally Accepted Accounting Principles: A Review
5. The Annual Report and Other Sources of Incredibly
Part 2: Analysis of Financial Statements
6. Key Financial Ratios
7. Using Return on Assets to Measure Profit Centers
8. Overhead Allocations
Part 3: Decision-Making for Improved Profitability
9. Analysis of Business Profitability
10. Return on Investment
Part 4: Additional Financial Information11. Financing the Business
12. Business Planning and the Budget
13. Selected Business Readings
A. Financial Statement Practice
B. A Matching Exercise
C. Paley Products
D. A Matching Exercise
Answer Key to Exercises