A Crash Course in Financial Literacy
I hate math. That’s a pretty bold statement for a CFO who has built a career out of understanding numbers. But it’s true. Math and I just don’t get along. Luckily, the role of a finance leader is ever evolving, so my disdain for math doesn’t impact my ability to be successful as a chief financial officer.
Here’s what I do love about working in finance: the thrill (yes, the thrill) of breaking down financial concepts and helping others understand them. I call it financial literacy, and this knowledge is something that I believe every employee in every company needs to have.
Knowledge Is Power
Gone are the days when an employee can plead ignorance when it comes to understanding the financial state of a business. The financial success of a company is everyone’s job. And I mean everyone. If you’re responsible for a purchasing decision, even a small one, you need to understand how it fits in your budget. If you’re trying to make a sale, you need to understand profit margins. If you’re a client success manager who needs to thoroughly comprehend a customer’s pain point, you need to dig into their ROI. Give me a position, and I’ll give you a reason why having a fundamental knowledge of finance will benefit that role and the overall company.
Workers have more on their plates than ever before, so I can sympathize when I hear that someone feels they don’t have time for finance. Most feel it’s out of the scope of their work and not relevant to their position. But that couldn’t be further from the truth.
It’s also not surprising that employees feel this way. I’ve found that finance leaders need to do a better job at informing their employees. If leaders aren’t talking about their company’s numbers and they aren’t giving employees the proper information, everyone will continue to blindly assume that finance is not something they need to know or understand.
Here’s the good news: finance doesn’t have to be intimidating or overly complicated. If you master these three financial concepts, you’ll be well on your way to financial literacy and workplace success:
Revenue is not cash.
Revenue is the total amount of income generated by the sale of goods or services before expenses are deducted. For example, if you close a deal for $1 million, your company’s revenue for that sale is $1 million.
Here’s why it’s important to understand that revenue is not cash: too often we get overly excited about a big win. We see a million-dollar deal and we forget about the expenses that went into the goods or services we just sold. While we may be able to bill a customer for $1 million, we won’t see $1 million in cash after we’ve factored in the various expenses that are being tracked in our cash flow. And the amount of profit we will see is dependent upon our second topic, gross margins.
I frequently tell my sales team that gross margins are gray and squishy. For this reason, I’ve found that they make people nervous. They depend greatly on who you’re selling to and how much that customer is spending (your gross margin for a customer spending $500,000 is going to be different than a customer spending $5M). This is why it’s incredibly important for people, especially those in a sales organization, to understand this concept.
By definition, gross margin is the amount of money left over after a company subtracts its cost of products or services sold from its net sales. Essentially, gross margin represents the gross profit a company makes after a sale, minus the cost it incurred in producing a product or service. (Here’s a financial literacy tip: generally, the higher a company’s gross margins, the healthier the company is financially.)
Here’s how you determine gross margin for a sale. Let’s say you had a $1 million sale to Company XYZ in 2017. Your operating costs for that same deal are $750,000. Your gross margin would be $250,000. In 2018, your company was able to cut your operating costs without sacrificing your incredible service (nice job!) Because you delighted your customer last year, Company XYZ wants to invest even more with you, resulting in a $2M sale. Your operating costs stay at $750,000 even though your total sale has increased, so your gross margin is 1.25M.
These examples should make one thing crystal clear: if you don’t understand your company’s operating expenses, you’re never going to fully understand or excel at driving profitable gross margins.
Out of the three topics we’ve covered, this is the topic that is easiest to understand, yet the most frequently overlooked. We often take for granted operating expenses and don’t realize how quickly they add up.
Picture it: Lily and Ben are siblings who are trying their hand at their first business, a lemonade stand. They’ve chosen a bright sunny day and a busy corner in their neighborhood. After selling for a few hours, the duo brings in $45. Impressive! When they show their profits to their mom, she reminds them that $15 was spent on lemons and sugar, another $8 was spent on cups, and $4 was spent on the craft supplies they used to make their stand look appealing. In a matter of minutes, Lily and Ben’s profit has shrunk to just $12.
It’s a tough lesson, but Lily and Ben now know that they either need to be thriftier about their operating expenses (perhaps they reuse the signs they made and buy lemons when they’re on sale) or they need to increase the cost of each cup of lemonade they sell. By doing these things, they’ll ensure a greater profit margin in the future.
In business, operating expenses are really this simple, and your CFO is likely constantly acting like Lily and Ben’s mom, reminding you that they exist, and they are plentiful. Having a conversation with your finance team to understand the expenses that impact your role is vital in ensuring you have a clear understanding of your company’s financial situation.
I urge you to take a good look at your role and the decisions you’re empowered to make that include any type of cost to your organization. Once you see how you’re able to impact your company’s financial success it will become clearer and easier for you to make decisions that will positively impact your bottom line. Don’t be afraid to ask questions or do your own research. You may be surprised to find that finance can be fun, even if math isn’t your thing.