Invest in your financial knowledge

Invest in your financial knowledge
Published: 19 September 2013
It's no secret - finance is not everybody's strong-suit. Many of us prefer to tune out whenever numbers and figures are mentioned and hope that our strong, creative business ideas will carry us through. This week's newsletter shows us how just a little bit of financial knowledge can set successful ideas apart from those that fail.

Investing in financial knowledge
Do you think that financial knowledge should be left to accountants? Ask yourself whether the following scenario sounds familiar:

You wake up in the middle of the night with a fantastic idea relating to your job. You know instinctively that this idea could change the way your organisation does business, and you also know that your employers prize innovation highly. Fuelled by unbridled excitement, you work through the night, fine-tuning your brainchild. The next day, barely able to contain your enthusiasm, you charge into your executive manager's office and begin blurting it all out.

The wind is knocked out of your sails when your manager asks a simple question - what is the ROI? You are stumped. Your mind races - what does ROI stand for? (No - it's not Roy, the new guy from accounts.) Next, your manager wants to know about required resources, timeframes, payback and the sensitivity of these assumptions. Right before your eyes, you watch your great idea disintegrate under the crushing force of figures and unfamiliar terminology. The worst part is that you may even begin to doubt the validity of your own, perfectly good idea.

So it seems that, while we can't all be Suze Orman, a little financial knowledge is indispensable to anyone who wants to get ahead in business. To help you out, the rest of this article will shed some light on some important financial concepts.

For one thing, ROI stands for 'return on investment' and encompasses two things. The first is that there is an amount that needs to be invested and, second, that we will receive something called return. And return is profit. So, basically, what your manager wanted to know was how much money your idea would make for the business. But, before you present any figures to your manager, be sure that you are clear about whether this will be profit before tax or profit after tax - it makes a huge difference.

What you are essentially trying to do is get your manager to approve the investment of money, time and other resources into your idea. And no one is going to invest in anything without a return, which they won't be too happy to wait very long for either. This is why your manager wanted to understand how quickly you planned on making money so that he could assess the payback period. When he asked you about sensitivity, what he was really inquiring about was the risk underlying the business model for this type of investment. And he would have wanted to know how confident you were in those profit projections.

In a nutshell, your manager wanted to know how you would move your idea from just an idea to a practical business model and how you would use your budgets, targets and general management skill to turn this into a return for investors.

All of this may seem excessive when all you want to do is present a simple idea to your boss, but remember that, at any given point in time, a business has a multitude of different investment options from which to choose and if yours shows the greatest potential return to investors, it is so much more likely to be the idea they choose.

What do businesses use to weigh up all of these different ideas?

Many businesses use a tool called the required rate of return. This tool gives insight into the return that is required from new initiatives to satisfy investors' expectations, inflation and should (at a basic level) be sufficient to convince investors to take their money out of the bank and entrust it to management to invest. If investors feel that a company's energies are being focused on projects without the required return, they will move their capital elsewhere. If no investment that will yield the required rate of return can be identified, investors' money will go straight back into the bank. While this is a highly oversimplified explanation of the process - this approach is a very deeply ingrained principle in business.

When you are trying to sell a business idea, you are asking people to part with their money in the hopes of making more money. Of course it is important for you to understand some basic financial concepts!

It all begins with understanding the accounting side of things - you need to sell something to people:

    The amount of sales is called turnover
    To get the product to the customer involves a cost of sales
    The difference between sales and cost of sales is gross profit
    After all your other expenses - you have net profit
    Net profit gets taxed
    Net profit after tax gets distributed to investors

This is very basic accounting and once you understand it, you can move on to very basic finance:

    Cash Flows
    Income Statements
    Balance Sheets
    Trial Balances
    Cash Flow Statements
    Ratio Analysis

Everything that we have seen so far looks at the past and sets the stage for starting to look towards the future. In the next step, you will need to come to grips with cost and managerial accounting, financial management and finance:

    Cost accounting looks at how much each aspect will cost and also how much it will generate
    Managerial accounting looks at how to evaluate profitability of different options in the business
    Financial management looks at the controls within a business and how to ensure that there is governance, compliance and accurate reporting. The auditors give management an overview of the health of these functions
    Finance looks at the decisions related to capital allocation, capital raising and optimising the use of capital across the business

There is, within each of these disciplines, a plethora of further disciplines and specialisations. So, what, at face value, seems to be a basic function that can be grouped under the general heading, 'Finance', turns out to be a complex set of functions, skills and disciplines that is instrumental in making a business work.

While it is not critical that you do all the work yourself, you benefit greatly as a manager from an understanding of finance and an ability to interrogate the numbers effectively.

In closing, consider this interesting finance trivia: Did you know that the first shares ever issued were to finance shipping missions by Dutch traders on risky missions to get spices, gold and other commodities in foreign markets? Can you imagine having to pitch that idea to a potential investor? History would prove many such ventures to be lucrative beyond investors' wildest dreams.

Great ideas become successful when they are invested in and when potential shareholders can see that there is a worthwhile return on the other side. So innovation is not only about waking up in the middle of the night with an epiphany about a new product or process. This is only the beginning of innovation. Your idea will only begin to matter once you have translated it into facts and figures so that investors can envision the same bright future that you have been imagining all along. 
- Regenesys
Tags: Financial,


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