We have written this book in hopes of increasing your financial intelligence and helping you become a more effective leader. We firmly believe that understanding the financial statements, the ratios, and everything else we have included in the book will make you more effective as the chief executive of your own company. Frankly, we also think that understanding the financial side of the business will make entrepreneurship more meaningful. You would never play baseball or backgammon without first learning how the game is played; why should business be any different? Knowing the rules—how profits are figured, why return on assets matters so much, and all the rest—lets you see your entrepreneurial endeavors in the big-picture context of business enterprise, which is simply people working together to achieve certain objectives. You’ll see more clearly how the company that you have started operates. You’ll be able to assess your business’s performance better than you could before because you can see which way the key numbers are moving and understand why they’re moving in one direction or the other.
Then, of course, there’s the fun of it. As we’ve shown, the financial report cards of business are partly reflections of reality. But they’re also—sometimes very much so—reflections of estimates, assumptions, educated guesswork, and all the resulting biases. (Occasionally, they reflect outright manipulation as well.) Your accountant or CFO knows all this but probably hasn’t done a good job of sharing that knowledge with you. Now you get to ask the finance types the tough questions. How do they recognize a particular category of revenue? Why did they choose a particular time frame for depreciation? Why is DII on the upswing? Of course, once they get past the shock of hearing that the boss speaks their language, they’ll almost certainly be willing to discuss the bases for their assumptions and estimates and to modify them when appropriate. Who knows? The financial folks may even start asking for your advice about such matters.
But we have another objective for this book as well. We also believe that businesses perform better when the financial intelligence quotient is higher among everybody—not just the owner but the managers and employees as well. A thriving business, after all, is a good thing. It offers valuable goods and services to its customers. It provides its employees with stable jobs, pay raises, and opportunities for advancement. It pays a healthy return to its owners. Overall, a prosperous business helps our economy grow, keeps our communities strong, and improves our standard of living.
Financially intelligent managers contribute to their companies’ health because they can make better decisions. They can use their knowledge to help the company succeed. They manage resources more wisely, use financial information more astutely, and thereby increase their company’s profitability and cash flow. They also understand more about why things happen and can lend their shoulder to the wheel instead of just carping about how misguided the owner or CEO is. We remember, for example, teaching a class of sales executives, using their company’s actual financials. When we got to the cash flow statement—and showed them how the company’s cash coffers had been drained to pursue growth by acquisition—one of the sales executives smiled. We asked him why he was smiling, and he laughed. “I’ve been fighting with the vice president of sales in my division for the better part of a year,” he said. “The reason is, they changed our commission plan. We used to be paid on sales, and now we’re paid when the sales are collected. Finally, I understand the reason for the change.” He went on to explain that he agreed with the strategy of growth by acquisition, and he really didn’t mind that the comp plan had been changed to support the strategy. He had just never understood the connection.
Financial intelligence makes for healthier business in another sense, too. A lot of companies today—even small ones—can be overcome by politics and power. They reward people who curry favor with their superiors and who build behind-the-scenes alliances. Common objectives get lost as individuals scurry to ensure their own advancement. At its worst, this kind of environment becomes toxic. At one company we worked with, employees thought that profit sharing was distributed only in years when employees complained loudly enough that they were unhappy. The purpose of profit sharing, they figured, was to keep them quiet. In reality, the company had a fairly straightforward plan that linked employees’ efforts to their quarterly profit-sharing checks. But the politics were such that employees never believed the plan was real.
There’s a simple antidote to politics: sunlight, transparency, and open communication. When everyone in the business understands the company’s objectives and works to attain them, it’s easier to create an organization built on a sense of trust and a feeling of community. In the long run, that kind of organization will always be more successful than its less open counterparts. Sure, an Enron or a WorldCom or a Sunbeam—not to mention their counterparts in the world of small business—can prosper for a while under secretive, self-serving leadership. But an organization that is successful over the long haul will almost invariably be built on trust, communication, and a shared sense of purpose. Financial training—an increase in financial intelligence—can make a big difference. At the company where employees thought that the purpose of profit sharing was to keep them quiet, those who underwent training learned how the plan really worked. Soon they were focusing their efforts on the numbers they affected—and soon they were getting a profit-sharing check every quarter.
Finally, financially savvy managers can react more quickly to the unexpected. There’s a famous book called Warfighting, prepared by staff members of the U.S. Marine Corps, that was first published in 1989 and since then has become a bible of sorts for special forces of all kinds. One theme of the book is that marines in combat are always faced with uncertainty and rapidly changing conditions. They can rarely rely on instructions from above; instead they must make decisions on their own. So it’s imperative that commanders spell out their broad objectives and then leave decisions about implementation to junior officers and ordinary marines in the field. That lesson is just as valuable to companies in today’s mercurial business climate. Your managers probably have to make a lot of day-to-day decisions without consulting you or anybody else. If they understand the financial parameters they’re working under, those decisions can be made more quickly and effectively. The company’s performance—like the performance of a marine unit on the ground—will be that much stronger.
There’s a next step here as well. If it makes a difference for managers to understand finance, imagine how much more of a difference it would make if everybody in a company understood it.
The same logic applies: people in offices, in stores and warehouses, on shop floors, and at client sites can make smarter decisions if they know something about how their part of the business is measured and about the financial implications of what they do every day. Should they rework a damaged part or use a new one? Should they work fast to get as much done as possible or work more deliberately to ensure fewer mistakes? Should they spend their time developing new services or cultivating and serving existing customers? How important is it to have everything a customer might possibly need? Like marines, frontline employees and supervisors should know the broad outlines of what the organization needs so that they can work smarter on the job.
Many companies understand this idea, of course, and in recent years have deluged employees and supervisors with performance goals, key performance indicators (KPIs), and other metrics. Maybe you have adopted some of these practices in your own business; if so, you know that there’s typically a good deal of eye rolling and head shaking, particularly if the KPIs this quarter are different from last quarter’s. But what if the folks in the field understood the financial logic of the KPIs or the performance goals? What if they understood that they are facing new KPIs this quarter not because you made some random decision but because the company’s financial situation had changed? Like the sales executive in the class, most people are willing to adapt to a new situation provided they understand the reason for the change. If they don’t understand, they may not know enough or care enough to do what the new situation requires.
Just as increasing your financial intelligence can boost your business’s performance, so can financial intelligence among the troops. The Center for Effective Organizations, for instance, conducted a study that looked at (among other things) many measures of employee involvement.1 Two measures in particular were “sharing information about business performance, plans and goals” and training employees in “skills in understanding the business.” Both of these were positively related to productivity, customer satisfaction, quality, speed, profitability, competitiveness, and employee satisfaction. The more that organizations trained their people in financial literacy, in other words, the better the organizations did. Other students of management—including Daniel R. Denison, Peter Drucker, and Jeffrey Pfeffer—have studied and supported the idea that the more employees understand the business, the better the business performs. All these findings should come as no surprise. When people understand what’s going on, the level of trust in the organization rises. Turnover drops. Motivation and commitment increase. Does anybody doubt that greater trust, motivation, and commitment lead to better performance?
One of us, Joe, has seen all these phenomena firsthand. He and his partners have spent years building a business, Setpoint, from the ground up. Like every start-up, it experienced periodic difficulties and crises, and more than once the company’s accountant told Joe that it couldn’t survive another period of turbulence. But somehow it always did. Finally, the accountant confessed to Joe, “You know, I think the reason why you get through these difficult times is because you train your employees and share the finances with them. When times are tough, the company rallies together and finds a way to fight through it.”
The accountant was right: the employees all do know exactly where the company stands. Sharing financial information and helping subordinates and coworkers understand it is a way of creating a common purpose in a company. It fosters an environment where teamwork can survive and prosper.
So if you buy into this vision, what do you do? Short of sending all your employees out for financial training, is there anything you can do to help your company reach this state? Sure: do the training yourself. Teach some of the basics of finance to everyone. Introduce them to the artful aspects. Help them see the numbers as the useful tools they can be. Assist them in applying their knowledge on the job, every day.
Plenty of entrepreneurs have done this and have found that the investment of time is repaid in productivity and employee satisfaction. Most people like to learn, after all, particularly if they see the connection between the learning and how they can affect the company’s results. The following chapter will offer some suggestions about how to teach them and how to make the learning stick. The toolbox at the end of this part provides an overview of a management philosophy based on financial literacy.