Financial Intelligence

KAREN BERMAN AND JOE KNIGHT WITH JOHN CASE

Reviewed by Todd

For as much press and as many op-ed columns as were dedicated to the collapse of Enron and WorldCom, the average American did not comprehend the magnitude nor the implications of those failures. If we are to truly understand business and the effects financial firms have on the world, we must understand the rules and the principles of accounting. What we need is Financial Intelligence.

Accounting is often likened to scorekeeping in the game of business, but that is a bad comparison. It perpetuates misconceptions about the role of bookkeeping. The 24/7/365 marketplace is much more complicated than a head-to-head matchup completed in 60 minutes of regulation time. A final score and the associated win or loss might be an able comparison to a company’s net income, but net income is not the binary function of each goal line crossed or basket made. Instead, net income is more holistic, a mathematical function of costs subtracted from sales.

The underlying question always present in accounting is “When?” and the fundamental rule of accounting is the matching principle—the idea that sales and their associated costs should be reported together. This is where authors Karen Berman and Joe Knight, with their writing partner John Case, begin. The cash register ringing at your local bookstore records a sale and an associated expense for the book sold, the difference reported as profit. An equipment purchase like a new computer for the front counter is recorded as a series of monthly expenses, with the intention of accurately representing use over time. When companies get into trouble, their interpretation of the matching principle, the authors point out, is likely the source. In the case of WorldCom, everyday expenses like office supplies were being treated like office buildings, with their financial recognition delayed for decades.

As a manager looks over a set of financial statements, his understanding of the underlying assumptions for how a company has chosen to interpret the proper matching of sale to expense is essential. Knowing, for example, whether the revenue from an extended warranty is recognized in its entirety on the date of purchase or spread out over the subsequent months of the contract can affect everything from commissions for salespeople to calculation of product profitability to the decision to offer similar products in the future. These distinctions are not trivial concerns, and Financial Intelligence offers us the know-how with which to make educated decisions about the basics of business.

“Financial information is the nervous system of any business.”

The authors use straightforward language throughout the book to explain income statements, balance sheets, and statements of cash flows. Terminology is defined, and common synonyms are provided, though the authors declare with pride that the words “debit” or “credit” do not appear anywhere within the pages of Financial Intelligence. They give the same plainspoken treatment to measurement ratios, such as return on assets and receivable days, that managers use routinely to assess the health of a firm.

The book’s subtitle, A Manager’s Guide to Knowing What the Numbers Really Mean, is the only misstep to be found in this well-constructed book. That positioning statement narrows too far the potential audience for Financial Intelligence. We wholeheartedly recommend this book for any employee, from service technician to shop floor manager, because it will allow every person to participate in a wider conversation about business. TS

Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean, Harvard Business School Press, Hardcover 2006, ISBN 9781591397649

WHERE TO NEXT? Here for the power of sharing numbers Here for the strategy that creates great numbers Here for the knobs to turn | EVEN MORE: How to Read a Financial Report by John A. Tracy; Managing by the Numbers by Chuck Kremer and Ron Rizzuto, with John Case