Module 4: Operational Excellence – Delivering and enhancing organisational outcomes
Topic 4.2: Essential Financial Skills and Key Indicators
Now that you have revised your understanding and expertise with financial terms, here are some suggestions for how you and your team might ensure that there is an appropriate level of financial intelligence within your context. A specific set of skills is required to achieve this (Berman and Knight, 2013)[1].
These skills are:
- Understand the foundation: knowing the basics of financial measurement, including being able to read an income statement, a balance sheet and a cash flow statement. This includes why does a balance sheet balance, and what is the difference between profit and cash.
- Understand analysis: being able to use that information and knowledge to analyse the numbers in more detail, including applying ratios, and using these analyses to inform decisions.
- Understand the big picture: being able to put the financial statements and results within the context of the organisation – so that the impact of the big picture – the various external trends and influence – is considered.
The following financial instruments are essential to your understanding.
- Understand the three major financial statements – the Income Statement, the Balance Sheet, and the Cash Flow Statement. Be sure that you appreciate any nuances that apply to your particular context.
- Understand the concept of capital expenditure – the purchase of an item that is considered a long term investment. This is different to operating expenditure, which is an operating expense. Capital expenses show up on the balance sheet, while operating expense show up on the income statement, and thus reduce profit. The depreciation of a capital item shows up on the income statement.
- Understand the investment decision – the allocation of resources in the expectation of future financial outcomes.
- Understand the financing decision – decisions relating to the source of the financial resources.
- Understand the risk management decision – identifying the direct and indirect exposure to given risks.
Non-profit organisations and most/many government entities use the same financial statements as corporations, including the income statement. They also report the difference between revenue and expenses. Terminology may be different, but the statements will essentially report these key indicators. Be sure that you are aware of and compliant with the reporting requirements that apply in your context.
Many organisations have developed efficiency dashboards that are based on specific efficiently ratios.
Required
20 mins
Ask your financial managers what ratios are key indicators in your organisation. Here are some discussion guidelines:
- What are those key ratios?
- Why they are so important?
- How are they changing over time?
- What is potentially an ideal set of ratios for your context?
- Does your organisation use dashboards?
- What is reported, and why?
- If it doesn’t, should it?
Recommended
Ratios and Dashboards
As well as the specific financial statements and their contents, there are additional analyses that help you to be financially intelligent. These include a set of financial ratios. These can be called ‘a window into a company’s financial statements’ (Berman and Knight 2013). Ratios indicate the relationship between one measure and another. One example might be the ratio of green Smarties to the total of Smarties in a jar. Another might be the number of kilometres per litre that a car might travel. A third might be the ratio of debt to equity that a firm holds.
Whatever they are, ratios help the financially intelligent to reveal more insights from the financial statements, and also to make comparisons, such as the change in ratios over time, the comparison of achieved to projected, and comparisons say with other agencies and jurisdictions.
Of the many ratios that exist, perhaps a key one for governments, particularly when considering public sector value, may be the return on assets (ROA) ratio. This tells us what percentage of every dollar invested was returned as profit, or delivered outcome. Every operating entity uses assets – cash, equipment, facilities, inventory, vehicles etc – which are utilised to generate profit.
It can be used in any context to compare the performance of organisations of different sizes and scope. An interesting insight from an ROA is that if an organisation’s ROA is significantly higher than its peers, it may be an indication that it is not investing in its future, in the form of new technologies, equipment etc.!
Important too, are efficiency ratios. These might explore how quickly an organisation’s inventory turns over, or the number of days between invoices being issued, and revenue collected.
The point here however is that the ratios must be relevant to your context!
Ratios can also be incorporated into dashboards, a collation of an organisation’s performance indicators. These dashboards can be used to compare performance over time, and also compare to other entities. Consider the importance of such indicators when contemplating contestability factors.
- Berman, K. & Knight, J. (2013). Financial intelligence: A Manager’s Guide to Knowing What Numbers Really Mean (2nd Rev Exp ed.). Harvard Business Review Press. ↵