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By Ellen Pearlman
Strategic Thinkers: Karen Berman and Joe Knight
Credentials: Berman is founder, president and co-owner of the Business Literacy Institute; Knight is co-owner of the Business Literacy Institute and co-owner of Setpoint Systems where he works as its CFO.
Big Idea:Boosting your financial intelligence will increase your success and help you speak the language of business with confidence.
Book: Financial Intelligence for IT Professionals: What you really need to know about the numbers, published by Harvard Business Press, May 2008
If you're like many IT professionals, finance is not what you excel at. But if you want to avoid the stigma of being seen as a big spender who doesn't know the nuances of costs and profits, then you'd better learn to speak the language of business so you can be seen as a savvy business professional who contributes to improving the company's performance.
Karen Berman and Joe Knight, co-owners of the Business Literacy Institute, have set about explaining the ins and outs of finance expressly for IT professionals. Having financial intelligence, they say, boils down to four skill sets:
- Understanding the basics of financial measurement.
- Understanding the art of finance and accounting when rules, estimates and assumptions need to be applied to numbers.
- Understanding analysis.
- Understanding the big picture so numbers are viewed in context.
Non-financial types might not realize that accounting and finance are as much art as science. Data is used to "come as close as possible to an accurate description" of how your company is performing, say the authors. As such, accounting and finance are a "reflection of reality." So it makes sense that if you understand that as well as the basics of financial measurement then you can ask better questions, use better assumptions, make more informed decisions and provide better guidance to those in financial roles at your organization.
Now all you need to do is tackle the details. (You'll be relieved to know that you're not alone if you do not comprehend financial jargon. The authors report that the directors in a sample of Fortune 500 companies scored an average of 32 percent on a financial-literacy test a few years ago.) I won't try to explain all the financial knowledge that is packed into this book-the authors do a good job of making finance accessible by explaining it clearly and using examples to illustrate their points-but I will pick a few nuggets that could be helpful.
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Today's hot metric-closely followed by Wall Street and Warren Buffett-is free cash flow (although Buffett calls it "owner earnings"). Free cash flow is the cash generated by operating the business minus the money invested to keep it running. To calculate it, look at your company's cash flow statement. Then take "net cash" from operations and subtract the amount invested in "capital equipment." That gives you your free cash flow. It's important for IT executives to understand this because IT spending represents a significant percentage of a company's capital investments. The authors suggest checking out capital expenditures from the cash flow statements over several years. "Decreasing capital expenditures may imply that the company feels bearish about the future. Increasing capital expenditures may indicate that it feels bullish." And if available cash is low then the company may not want to invest heavily in equipment. A low level of free cash flow will present a "real challenge" to IT, the authors note, "that's when senior executives are most likely to cut back on IT investments."
Ratios are another powerful tool for understanding what the financials are telling you. They indicate the relationship of one number to another and allow you to make comparisons over time, with previous projections, and with industry averages. There are different ratios that companies watch. IT may use specific internal metrics, such as hours billed, efficiency of resources, utilization of assets, etc. But the most important metric for IT is how efficiently the company is using its assets to generate profits. IT may also use project management metrics, such as earned value method, to track the progress of its initiatives and how that progress, or lack of it, translates into financial performance.
Also, there are different methods for measuring project success. The authors recommend picking the method that works best for your organization and using it consistently.
Return on investment (ROI) is frequently used in IT to determine whether or not investments in technology improve the value of the company. There are three methods generally used: payback, net present value, and internal rate of return. The authors explain each in great detail and note that depending on which method you use, you might arrive at different decisions. The authors say that when the various methods conflict, you're best off with net present value, even if it is harder to explain to others. But what's most important is that you have a repeatable process. The reason, according to the authors, is obvious but important: "The more you do something, the faster and more effectively you do it." But since projects differ, you may need to weight the numbers to reflect the various factors.
One other bit of advice to consider when evaluating IT projects is they don't have a direct impact on the bottom line. "IT is applied to business processes, and it is those business processes that increase revenue or reduce expenses," the authors say. "That means you can't conduct an ROI analysis within the confines of the IT silo. And once outside your silo, you need to speak the language of business: numbers."
And, of course, once you as an IT executive understand the numbers, the next step is to help those in your department understand it. The more people know, the better decisions they can make. If that interests you then you'll need to create a financial literacy strategy. The authors recommend several steps that will be key to your plan: repeated training that is applied to real-life situations; weekly numbers meetings where your key metrics are reviewed; and dashboards or other visuals that let employees track the performance of the business. And, finally, the authors say, "Adults learn best if they are doing something themselves. So don't just announce or post the numbers-ask people to do the calculations themselves." But, of course, first you must gain the knowledge to lead the effort.
Reprinted by permission of Harvard Business Press. Excerpted from
Financial Intelligence for IT Professionals: What you really need to know about the numbers, Copyright (c) 2008 Business Literacy Institute; All Rights Reserved.
Also of interest:
CIOZ Question: What financial metrics work best for your IT department?
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