What are the most memorable Financial Intelligence quotes? How hard is it to learn basic accounting?
In Financial Intelligence, published in 2006 and updated in 2013, Karen Berman and Joe Knight define the titular term as a set of learnable skills that let you understand and effectively use financial information in your business. They argue that financial intelligence is something that anyone can develop, regardless of background or aptitude for numbers.
Read below for the best quotes from Financial Intelligence.
Quotes From Financial Intelligence
Understanding accounting can be a challenge. Even in the business world, executives and entrepreneurs find it hard to interpret complex financial statements. Nevertheless, in Financial Intelligence, Karen Berman and Joe Knight argue that basic financial knowledge is something you can learn, regardless of your educational background or your aptitude for numbers. Developing financial intelligence lets you analyze your company’s performance, spot potential issues, and make stronger cases for your business ideas.
Below are three Financial Intelligence quotes that encapsulate Berman and Knight’s ideas.
“Cost of goods sold or cost of services is one category of expenses. It includes all the costs directly involved in producing a product or delivering a service.”
You have flexibility in how to report expenses on your income statement. Different expenses may be included in the cost of goods sold or as operating expenses, and the dividing line isn’t always clear. Berman and Knight explain that operating expenses are spread out over time, but the cost of goods sold must be reported in the same period as the revenue from those goods. For instance, in the sample income statement above, the cost of goods can include inventory purchased prior to the month it was sold. How expenses are classified can affect key metrics like gross profit (revenue minus the cost of goods), so shifting an expense from one line to another can impact how profitable a good or service appears on the statement.
Berman and Knight also discuss noncash expenses, such as depreciation and amortization, that have a major impact on reported profits. Depreciation is the cost of a physical asset, such as a building or a piece of equipment, divided across its projected lifetime. Amortization is the same basic concept but applied to intangible assets such as patents. Companies have discretion in estimating the useful life of assets and how quickly to depreciate them. If your accountants change depreciation assumptions, such as deciding that a fleet of trucks will last seven years instead of five, that can significantly alter the income statement’s profit line. Therefore, managers should know what assumptions are being used for all their major assets.
“Earnings per share (EPS) is a company’s net profit divided by the number of shares outstanding. It’s one of the numbers that Wall Street watches most closely. Wall Street has ‘expectations’ for many companies’ EPS, and if the expectations aren’t met, the share price is likely to drop.”
While managers view their businesses from a different perspective than Wall Street investors, Berman and Knight say that it’s important to analyze your financial statements the same way that potential investors will. This is especially crucial if your business wants to finance itself by bringing in shareholders rather than by taking on debt. To make your business more attractive to investors, you need to know what they’re looking for and, if needed, find ways to improve your performance in those areas.
First off, investors expect to see a business’s revenue expand over time. The authors note that sustainable growth rates vary by industry and company size, but consistent growth is key. Another measure investors expect to increase is the amount of earnings per share (EPS), which is the net income on the income statement divided by the company’s total number of shares. This is a metric that investors want to see going up even during economic downturns. Also of value to investors are a company’s ability to generate cash beyond its operating needs and how efficiently a company uses its capital to generate returns for its owners. The latter is reflected in the return on investment (ROI), which we’ll cover in more detail next.
“Revenue should be recognized when (and only when) it is actually earned. Deferred revenue is money that has come in but is as yet unearned. So it can’t go into the income statement. Instead, accountants put deferred revenue on the balance sheet as a liability—that is, an amount that the company owes to somebody else.”
The balance sheet consists of three main sections—assets, liabilities, and how much equity the owners have in the business. The fundamental equation behind the balance sheet states that assets always equal liabilities plus equity. Assets are what the company owns, including cash, equipment, and intangibles like brand names and intellectual property. Liabilities are what the company owes in the form of outstanding debts. Lastly, equity shows what the company’s owners’ stake is worth. To conceptualize this, think of owning a house. Your asset would be the assessed value of your home. Your liability would be the balance left on your mortgage. Your equity, therefore, is the amount left over—how much your ownership of your home is worth.
Many of the line items on the balance sheet involve estimates and judgments similar to those on the income statement. For example, whatever methods you use to place value on unsold inventory, depreciate your assets, and estimate payments on outstanding debt will all require assumptions that can significantly impact the numbers. Berman and Knight warn that faulty assumptions can lead to bad decisions or even to disaster, as seen during the 2008 financial crisis with mortgage-backed securities.
