One of the biggest misconceptions that I run across when
training nonfinancial managers on finance and accounting is the perception that
there is such a thing as a “good” number or a “bad” number. To really understand the financial statements
of any business, and especially your own business, you really need to be able
to understand the story that your numbers are telling you - because that’s all financial
statements are. A set of financial
statements is like a good book, it’s the story of your business.
Depending on the knowledge, skills, abilities (and ethics) of
your finance and accounting personnel as well as top management your financial
statements should be a work of nonfiction, a story about how well your business
has performed during the past year, month, or other relevant time period.
It is critically important for us to be able to read the
numbers to know when what we’re looking at is a good result versus a bad result.
It is what we base our corrective action on. It is not accurate to look at a
set of financial statements reporting net income and say the company is doing
well any more so than it is to look at a company with a net loss and say that
that company is not doing well. The
real story our financials tell us is context dependent.
To illustrate the importance of context in interpreting
numbers in financial statements, I frequently start any finance and accounting
training with the following illustration.
“Imagine I’m standing on a scale. I
look down and I see a number. Am I happy or unhappy?”
Probably the funniest answer I ever received was the following:
“you’re a woman so probably not.” But then I start receiving the right answer
which is “it depends.” The bigger question is what does it depend on?
First, what did the scale read last week? This
reflects a look at my history or my trend. In business we use trend analysis
all of the time - especially during budget season. Where were sales last year
at this time? What has the trend been in sales? A trend analysis is one key
context factor that helps us interpret, or tell the story, of the numbers represented
on our financial statements.
Second, what was my goal? What was my goal weight? In
business we represent, or quantify, our goals in our budget. Again,
comparing actual performance to my goal/budget allows me to interpret our actual
performance in context.
From the standpoint of the number I see on the scale I might
want to compare that number to members of my gender, I might want to get even
more specific and narrow that down and look at the average weights of women who
are also approximately my height, and age. After all, my neighbor’s
three-year-old daughter is the same gender but I definitely should not be
comparing my weight with hers. With this additional detail I reach a more
rational conclusion as to whether that number should make me happy or unhappy. The
question then becomes, in business what are those equivalents?
Third, industry. To interpret my company’s
performance it makes sense to interpret my performance metrics in light of other
businesses in the same industry.
Fourth, competitors. While it does provide relevant
context to compare my performance metrics with others in the same industry, it
is even more relevant to compare my performance metrics to those members of my
industry that are my specific competition.
So in summary, remember there is no such thing as a “good” or
“bad” number. The story of your business as told by financial statements, and internal
financial reports needs to be told in context. A net loss in the current period
of $100,000 might be actually be a beautiful number, one that our business
should celebrate, if during the same period our competitors lost significantly
more.
As we tell the story of our business, and evaluate the performance
of each of our employees, it is in our best interest to have the most accurate
picture of our economic reality. For with this basis, we stand a much better
chance of making good business decisions moving forward.
So if we ever meet, remember it is never good enough to tell
me that “that” number is good or bad without telling me why. I will want to
hear how you reached your conclusion and that should be based on an analysis of
as many of the following factors as you are able to obtain information on:
(1) History/trend,
(2) Budget/goal,
(3) Industry, and
(4) Competitors.
Now get out there and paint the true picture of your
business.
