Financial Statement Literacy for Directors & Executives

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The tale of the tape: Financial Statement Literacy for Directors &

By: Vijay Mistri

For executives and directors who come from a finance or accounting
background, the ability to read and review financial statements is second
nature; these individuals have been inundated with so many financial
reports that they can immediately identify problems or inconsistencies
within these documents. This provides a substantial advantage as it relates
to financial management because they are able to process information
more quickly than those without this experience.

One of the key reasons for this ability to quickly process data is because
executives with these types of backgrounds KNOW EXACTLY WHAT THEY
ARE LOOKING FOR. This, in a nutshell, is the key to literacy as it relates to
financial statements and financial reports. To train a person; be it an
executive or assistant manager, to effectively review and analyze financial
data, they must be able to ascertain what they are looking for and how to
find it in an expeditious nature.

To initiate this process a reviewer must determine why they are being
asked to analyze the financial reports of the organization. Generally
speaking these tasks are ongoing (in that they will be asked to review these
financial documents on an ongoing periodic basis), and they fall into one of
the following categories:

   1. Reviewing the Financial Reports for inaccuracies
   2. Reviewing the Financial Reports to ascertain the financial status of
      the company or an individual department
   3. Reviewing the Financial Reports to determine operational bottle-
      necks that are negatively affecting the financial output of the
      organization or department.
   4. Reviewing the Financial Reports to Determine or Analyze key ratios
      (i.e. inventory turnover, liquidity, gross margin, profitability,
      Marketing ROI, capital burn rate, etc.)
   5. Reviewing the Financial Reports as a way to evaluate key personnel
      or key programs

To effectively obtain the pertinent information necessary for the above; a
person must have a thorough understanding of what is provided in each
financial statement. Having this understanding the reviewer is more apt to
understand where each piece of information is located, and more
importantly they are more apt to understand why the information is
located in that particular report.

A very simple overview of the financial reports would focus on the three
primary reports that are produced by all organizations:

   1. The Profit and Loss Statement – This report is used to detail the
      operational activity of the organization, and is a great barometer of
      how the company is doing from a sales position, market penetration
      perspective, capital responsibility standpoint, a costing standpoint,
      and an overall efficiency standpoint. As it relates to the derivatives
      of this report the following are some of the most common outputs:
          a. Sales
          b. Sales Efficiency (Through an analysis of Gross Profit or Net
          c. Operational Expenses
          d. Key Expenditures
          e. Tax Position
          f. Profitability

   2. The Statement of Cash Flows – This report does EXACTLY what it says
      it does; analyze how and where cash is flowing in and out of the
      organization. While it may not get as much publicity as the Profit and
      Loss statement or the Balance Sheet; this report can easily be
      referred to as the most important when analyzing the financial
      health of an organization. Cash is the life source of any company;
      without it YOU ARE DEAD. Regardless of whether your sales are
      strong or weak; whether your assets are appreciating or
      depreciating, whether the company is profitable or not; without cash
      the company is NON-EXISTANT. From a corporate strategy
      standpoint or a corporate decision standpoint, this report will guide
      how decisions are made and how aggressive the company can be


         from a growth standpoint. The key outputs relating to this report
            a. A/R Effect on the Business
            b. Effect of Debt on the company
            c. Liquidity
            d. Relationship between cash and profits within the organization
            e. The amount of actual cash that has been derived from ALL
               business activities; not just Operations.

   3. The Balance Sheet – This report simply provides a fundamental
      understanding of the net worth (from a purely mathematical
      perspective, not taking opportunity or potential into consideration)
      of the company for all stakeholders through an analysis of assets and
      liabilities. The importance of this report is that it allows everybody
      from the board of directors to the executive team the ability to take
      an objective look at the company from a valuation and vulnerability
      standpoint. The key outputs relating to this report include:
          a. Value of all assets; physical and proprietary
          b. The useful life (from a financial standpoint) of all applicable
          c. The liabilities of the organization
          d. The value of debts (both owed and receivable)
          e. The abstract valuation of the company from a shareholder

While all of these reports show more than what is listed above; most of the
other information can be derived from one’s knowledge of the above
stated outputs. From a literacy standpoint; the primary goal should be to
develop an understanding of these basic outputs; from there (with
consistent exposure) most reviewers should be able to quickly be able to
acquire the necessary information from these reports; and more
importantly they will understand the “why”; which provides a much more
stable analytical base as it relates to financial management.

Author : Vijay Mistri
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