What is your Financial Intelligence Quotient? Every non-financial manager needs to understand the numbers generated by the accounting department, be aware of the assumptions and estimates accountants are making, and know how to use those numbers to improve the business.
Ratios are often the best way to understand the finances of a company. Using ratios, you can compare current results to past results (is the company getting better or worse?), to other companies, and to targets.
Some key ratios for general managers to understand and control:
- Gross profit margin (sales revenue less cost-of-goods/services-sold divided by sales revenue) trends will highlight increases in raw materials costs and decreases in selling prices.
- Operating profit margin (EBIT* divided by sales revenue) is an indicator of how efficiently your business is turning raw materials into finished goods. Increases in administrative costs, for example, will reduce operating margin.
- Days in inventory (average dollar value of inventory divided by cost per day) is a measure of how much money you have tied up in your warehouses. Every dollar tied up in inventory is a dollar that cannot be used to grow the business.
- Days sales outstanding (accounts receivable divided by revenue per day) is a measure of how quickly your customers pay you. As with inventory, these are dollars you cannot use to grow the business.
- Days payables outstanding (accounts payable divided by cost per day) is a measure of how quickly you are paying your vendors. Every dollar here represents a dollar of the vendors' money that you are using.
For more information, I recommend turning to Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean by Karen Berman and Joe Knight, with John Case (Harvard Business School Press, 2006). As a general manager with little formal financial training I have read several financial and accounting textbooks over the years. This is the only one that really seems written for folks like me. Wikipedia also has a fairly strong set of articles available as links from the financial ratios page.
*EBIT = earnings before interest and taxes are deducted