How to talk confidently to your CFO

9 practical finance tips that you must know


Vipin Khandelwal is an entrepreneur, a discoverer, a voracious reader. He is constantly evaluating ways to enable learning in innovative ways. Before entrepreneurship, he was involved in doing business and financial analysis and headed a financial planning services firm.

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Accounting vs Finance…………………….….…6 The First Principles……………..………………..7

The 3 Key Financial Statements……….…..10
Income and Expenses…………….……….….16 Assets and Liabilities...………….……….……18 Is Profit = Cash?...………….……….…………20 Did you Budget for it?…………………………25

Cost marginally –>Break Even.……………28
True Cost of Capital…..……………………….32

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Now imagine you are in a meeting with the CEO and the CFO who are discussing with your division or units performance with you. say China.INTRODUCTION What happens when you go to a different country. Here we go! 5 . How do you feel there? Very similar to the China experience. Right? To manage business profitably. ready. and you ask a local for directions? You hear some mumbling in Chinese which you don’t understand and you are left all confused. For this you need to know the language. And that language is Finance. So. you need to measure and evaluate your business decisions effectively. You can know these secrets right now and talk confidently to your CFO. Now you don’t need to be an accountant or possess a famous finance degree to be smart and make sense of all that your CFO talks to you.

6 . It is like scorekeeping in a cricket match. there is a transfer of value from one party to another in return for another item of value. product or service. Finance is about using the information and reports produced by accounting to evaluate and review business and use them to make critical decisions. money.1 Accounting or Finance In a business transaction. Image credit: Wikimedia The job of Accounting is to record these transactions using rules of debits and credits.

2 The First Principles Source: flickr The first principles determine the way we treat our business and financial transactions and resultantly. There are 2 important principles that you should know:  Materiality and  Matching 7 . how they can impact our decisions about business.

Just that in business finance.HOW TO TALK CONFIDENTLY TO YOUR CFO Principle 1: MATERIALITY Materiality literally means importance. 8 . A financial transaction or data could be materially important if it has the capability to Source: flickr influence the decisions one way or Example: One rupee in the other. matching refers to incomes and expenses. a million units is highly material. year). Example: If a customer pays in March 2013 but the service is going to be delivered in June 2013. Principle 2: MATCHING It almost sounds like match making and in some ways it is so. Materiality changes from business to one million is not material but one rupee per unit for business. then you should count the sale /revenue only in the year pertaining to June 2013. All expenses should be matched to the incomes or products that cause them and also to the appropriate period (month. This is important because we want to know what was spent to earn that revenue.

the year is April to March.HOW TO TALK CONFIDENTLY TO YOUR CFO Accounting Period It is usually a period of 12 months for which the accounts are prepared and balanced. If you cannot measure it. At the end of this period. you cannot manage it. the financial statements are also prepared. The accounting period is either from January to December or from April to March. In India. either can be followed but for taxation purposes." 9 .

3 The 3 Key Financial Statements So. what is the end result of all financial transactions? How do we summarise the business activities in order to make sense of what happened? The end result for any business organisation are 3 Financial Statements: Balance Sheet Profit & Loss Statement 3 Key Financial Statements Cash Flow Statement 10 .

Revenue in business parlance is also called “Topline” and Profit/Loss the “Bottomline”. The incomes for the period and all expenses for that same period matched and the net result calculated. there is a profit. it is made for a period of time. A profit and loss statement helps you know what is the result of the business operations. there is a loss. quarterly. And it is important to measure it. If Expenses exceed revenues. Incomes – Expenses = Profit / (Loss) If Revenues exceed expenses. typically. 11 .HOW TO TALK CONFIDENTLY TO YOUR CFO PROFIT AND LOSS STATEMENT Any business exists to make a profit. yearly. Note. half yearly. The two important items in this statement are Incomes and Expenses. 12 .HOW TO TALK CONFIDENTLY TO YOUR CFO SAMPLE P & L – Infoedge India Topline Operating Income Bottomline Source: Infoedge.

Essentially. (More about that in the next guide) 13 . how would you do it? How would you know where the business stands today? Through a Balance Sheet! Like its name it provides the balances of your various accounts “as on a particular date or point of time”. It is also called the Statement of Sources and Application of Funds as it tells you from where all the business obtained funds/capital. The balance sheet helps you understand and analyse important financial information about a business. the balance sheet shows what the business owes (liabilities) to others and what it owns (assets). Read the emphasis. the sources and how did it use those funds or the application.HOW TO TALK CONFIDENTLY TO YOUR CFO BALANCE SHEET If you have to look at your business and evaluate its financial strength.

HOW TO TALK CONFIDENTLY TO YOUR CFO Infoedge India External liabilities Net worth = Total Assets – All External Liabilities What is the other way you could calculate Net Worth? 14 .

Cash from Operation The day to day operations of the business incl buying of raw material. payment of dividends. salaries. we sell a product or service and receive cash payment against it or we hire or buy a product or service and pay cash for its use. etc. Ultimately. in any business activity. etc. Cash from Investment Buying or selling of assets. 15 . etc. Loans. A Cash Flow statement typically shows cash flow changes from 3 types of activities. investment in stock markets. Cash from Financing Raising fresh money through stock markets or loans.HOW TO TALK CONFIDENTLY TO YOUR CFO CASH FLOW STATEMENT Cash is the lifeblood of business. sales. It is an important statement as it shows how and when cash resources will be available to carry out business operations. The Cash Flow statement therefore is a summary of how cash was received and in what ways it was sent out.

Count expenses which contribute to their economic usefulness within the period of measurement (typically a year). sales. . turnover and is a result of the normal business activity wherein products or services are provided in return for income. But how do we know which item would fall under income or expense and how should it be treated? An income is also called revenue.4 Income and Expenses So. It is also known as “cost”. not advances. 16 An expense is an outflow of money in return for a product or service. Count incomes against which value has been delivered within the period. we now know that a Profit and Loss Account summarises the Incomes and Expenses so that we can figure out if the business made a profit or a loss.

Put simply. cash will leave the business only after 30 days and hence it is an accrued expense. accounting is mostly done on the basis of accrual. This results in what we are discussing here. your vendor might send you a bill which has to be paid after 30 days. Similarly. Accrual is “an act or process of accumulating” (thefreedictionary. It has become due but not received. you might make a sale for which the cash will actually come in after 60 days. You record the transaction and it becomes an accrued income. 17 . it says that we should match incomes and expenses to each other as also the period to which they actually belong. So. In other words.HOW TO TALK CONFIDENTLY TO YOUR CFO The Concept of Accrual If you recall the matching principle. It has become due but not paid. they are non-cash. World over. In the world of finance. accrual reflects a recognition of an income or expense even before actual cash has been received or paid out. In that case.

5 Assets and Liabilities In the Balance sheet section. Computers. which has economic usefulness in business operations over several years. Goods sold on credit or accounts receivables)  Current Assets are those the value of which is exhausted within 12 months  Assets can also be tangible (Owned Office space) or intangible (patents). how do we know what is an asset or a liability? Asset An Asset is an outlay. Important points about Assets  Assets can be Fixed assets (Plant & machinery. movable (Cash) and immovable (Land) 18 . Land) and Current assets (Inventory. So. like a computer equipment. Stocks. you read that Assets are “what the business owns “ and Liabilities are “what the business owes”. Cash.

accrued expenses. creditors who sold goods to us on credit. expenses due but not paid)  Shareholders money (share capital. long term deposits) and short term (working capital borrowings. Current Liabilities are those which have to be repaid within 12 months (creditors. advance income). owners equity) is also shown on the liabilities side since it is the amount that the business has to pay back to the owners/shareholders. Working Capital Required to run day to day business operations. Liability A Liability is an obligation which provides economic resources for running the business operations like buying of equipment. = Current Assets – Current Liabilities 19 .HOW TO TALK CONFIDENTLY TO YOUR CFO Important points about Liabilities  Liabilities can be long term (like bank loans.

And that’s when you get your share of bonus. Means.6 Is Profit = Cash? PROFIT So. 20 . Note: Now as per the accrual rule. when it is time for the bonus. but not CASH. the sale is done and recorded so it increases topline and bottomline. not the cash! You sold the products on 60 days credit. your customer needs to pay only after 60 days. So the real cash arrives after 60 days. Why? Because you got the sale. you might wonder that for all the sales that you have brought into the company. you are told that there is no cash to pay.

Income up.HOW TO TALK CONFIDENTLY TO YOUR CFO There are several companies who show huge profits but there is no cash with them. The shareholders might feel cheated thinking that though the company has made record profits. not cash  Advance payments made for equipment / software  ________________________________(fill in a reason) 21 . why it is not declaring any dividends? Can you figure out why would that be the case? Let us see some of the reasons.  Sales happening on credit .

Hence cash is available but there would be low or no profit.HOW TO TALK CONFIDENTLY TO YOUR CFO Similarly. but revenues are lower than expenses and hence no profit  ________________________________(fill in a reason) 22 . a non cash expense.  A company which has raised capital (equity or debt) and hence has cash. there are companies who may have lot of cash with them but they are not profitable?  Depreciation or amortisation of assets charged to income.

The balance value of the asset (post depreciation) is shown under Assets in the Balance Sheet.000 and it is going to be useful for 3 years.HOW TO TALK CONFIDENTLY TO YOUR CFO The Concept of Depreciation Depreciation literally means by which something reduces in value. For example. Which means that for every period the value of the usage is deducted. To ensure that we match these uses of value with the right period. Remember. depreciation is a non cash expense. depreciation refers to The allocation of the cost of the assets to periods in which the assets are used (depreciation with the matching principle)” Typically assets offer useful value over a period of time. if you have bought a computer for 45. 23 .000 (45. means there is no outflow of cash. As per wikipedia. then you would depreciate it by 15. we depreciate assets.000 / 3 yrs) every year. This treatment is carried out in the Profit and Loss statement under the expenses side.

Depreciation /Amortisation 24 .HOW TO TALK CONFIDENTLY TO YOUR CFO Depreciation vs Amortisation While depreciation is used in reference to physical or tangible assets. Operating profit or profit from core operations or operational profitability EBITDA = Income (minus) all expenses except Interest. amortisation is used for intangible ones like patents. EBITDA Also. Tax.

And you finally come across this fabulous technology that will help the company achieve its objective.7 Did you budget for it? You are the head of the department. “Did you budget for it?” All your hopes suddenly fall flat on the ground. She listens to you patiently and asks. You rush to the CFO and talk to her about getting it. You had not provided for this new technology in the budget. 25 .

26 . sales. where every department (marketing.  It helps to put quantitative estimates to a set of intentions  It helps in channelising the resources available to the organisation in the right direction towards achievement of desired objectives  When compared with actual results.HOW TO TALK CONFIDENTLY TO YOUR CFO A budget is a very important document for you and for your organisation. it helps to evaluate and analyse the performance of the division/unit/organisation  When you perform better than the budgets. Budgets are a bottom up exercise. IT HR) makes its budget and sends it to the central business planning department which collates all of them to create a company wide budget. Typically budgets are prepared on a yearly basis. you get rewarded. production.

If someone else makes your budget. realities.  Ensure that you plan for all possible expenses.  Be actively involved in making your budget. Generously use adjust it to reflect the current inputs from the team. If there are business objectives and significant changes in the strategy.HOW TO TALK CONFIDENTLY TO YOUR CFO Important points to keep in mind while making a  Be realistic in estimating budget to save pain in the income. And after that. it will be their budget and not yours. 27 . future  Ensure that you understand the business objectives to be achieved with respect to your department or business unit. assumptions or market conditions from the time you  Start to prepare in made your budget. You will be able to defend your budget only in relation to the  Review your budget periodically. you should advance. fixed and variable. include a contingency reserve to provide for unexpected expenses that might come up including new initiatives.

” It is a given that there is a cost to produce and deliver a product or service.8 Cost marginally . 28 . The way we structure our costs can significantly impact our business results.Break Even The Cost of doing nothing is everything. Let’s look briefly at the role of various costs.

As business operations vary in size and scale.HOW TO TALK CONFIDENTLY TO YOUR CFO Costs are primarily of two types Fixed Costs These costs are incurred irrespective of whether the business has any running operations or not. 29 . Right! Examples: Raw materials. Variable costs change with the change in output. Think power plants. Manufacturing businesses tend to have a high fixed cost structure. You got the word. sales commission and contract employees. Service businesses are lot more flexible with respect to cost. permanent employees and related costs. Variable Costs Costs incurred as a result of business operations. Examples: Rent of office. Think Consultancy. vary. these costs vary too. They allow for suitable adjustments based on business climate and market demand. Fixed costs also do not change with the change in the output and hence put pressure on the business to perform specially in not so good market scenarios.

Marginal profit per unit of sale = Sales Price . 30 . B E Point is = Fixed Costs / Contribution Margin Contribution Margin Also. It is useful in evaluating whether a new project makes sense or not.HOW TO TALK CONFIDENTLY TO YOUR CFO Break Even Margin The point of business operations at which incomes are equal to costs is known as the break even point.Variable Cost If this is positive. it makes sense to take that bulk order at a discounted price.

" .HOW TO TALK CONFIDENTLY TO YOUR CFO As Henry Ford once put it. then you will ultimately find that you have paid for it and don't have it.Clayton Christensen 31 .' Thinking on a marginal basis can be very. 'If you need a machine and don't buy it. very dangerous.

For example. you know the cost of the loan. Remember: A business exists to make a profit. 15% per year. 32 . you have to deploy this money so as to be able to earn more than 15%. Now to be profitable. then you make a profit of 5% or a margin of 33% (5% / 15%). if you earn 20%.9 True Cost of Capital When you take a business loan from the bank at 15%. that is.

we will stick to the simpler definition. represents of the ownership in the business. On the previous page. I am sorry to break the bad news. The question now is “What is the cost of owner’s capital or equity”? Now if you are thinking there is no cost to equity (since there are no fixed returns). we went over an example where you borrowed debt at a defined fixed rate of interest. is money borrowed from third parties like banks. also known as the owner’s money. The returns are fixed and assured to the one who provides debt/loans.HOW TO TALK CONFIDENTLY TO YOUR CFO Businesses raise money in the form of equity and debt. individuals and other financing institutions. Equity Debt There are various forms and structure of equity and debt but for the purpose of this ebook. It is a risk capital in the sense that there is no fixed return and shares profit and/or losses in the business. You are mistaken ! 33 .

that the owner has a choice to lend her money at a fixed rate of interest than give it to the business. the true cost of capital would be (50% x 15%) + (50% x 20%) = 17.5% (weighted cost) The business will have to earn more than 17. say 20% (a 5% additional return for the risk premium). It is important to ascertain this for it will help us understand what returns do we need to target to have a profitable business. To this we would have to add a premium for the fact that the owner is taking a risk. For example sake again. Why? She is not going to get fixed returns and so she needs to be compensated for this uncertainty. the cost of equity capital would be. Now assuming 50% of the money comes through debt and 50% through owner’s equity. definitely.HOW TO TALK CONFIDENTLY TO YOUR CFO Equity has a cost. How do we do it? Now think for a while. Else the owner is better off giving a loan for a fixed return. 34 . Assuming that the owner is able to give away a loan at 15% (same as our debt example).5% to be truly profitable.

read CFO. ensure that the ROI calculation is in place. So. next time when you are proposing an investment to the company.HOW TO TALK CONFIDENTLY TO YOUR CFO Can you relate the concept of “true cost of capital” to “Return on Investment (ROI)” concept? ROI is used as one of the tools (along with payback period and Internal Rate of Return) to evaluate investment opportunities. Scarce organisational resources are directed towards opportunities which have the potential to provide the maximum return on investment. 35 .

" 36 .HOW TO TALK CONFIDENTLY TO YOUR CFO If you really want to impress your CFO. start talking metrics.

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