Review of Karen Berman and Joe Knight’s book that helps you ‘understand what your income statement and balance sheet are telling you’.

I recognized that I had to work on my financial literacy in Rich Dad, Poor Dad, this was one of the books highly recommended in Personal MBA, which I started reading right after Rich Dad. So I got it, and read it in late October until the middle of November 2020. After reading it, I started organizing my finances with beancount, and even started writing my own plugins.

Content

The book is all about an approachable way to the foundations of finance. I really appreciated it – the newfound knowledge is quite valuable.

Part One: The Art of Finance (and Why it Matters)

The first two chapters were of introductory nature, which I really liked. First, it explains in short what Financial Intelligence consists of, and a number of potential roadblocks (as well as why they are not actually roadblocks).

The second chapter goes deeper in the art of finance: there are a number of rules, but they still leave a lot of leeway - it’s not as clear-cut as it might seem.

Part Two: The (Many) Peculiarities of the Income Statement

You need to be accurate about your Profit, but it will always be an estimate at best. The Income Statement shows Income and Expenses during a certain timeframe.

The Matching Principle specifies that the costs and expenses need to have been incurred for generating the sales in the time period of the Income Statement, even if they happened previously. Not all expenses are immediately visible, either.

Cash-based accounting has incredible volatility, accrual accounting (or, as I knew it, double-entry bookkeeping) creates a much more accurate picture of reality. Over time, profit will be turned into cash – but usually later than when it is being recognized.

Understand when revenue is being recognized - especially when bonuses depend on it or calculations change.

Generally, there are two categories for expenses: costs related to the ‘production’ of goods sold (machines, parts, most salaries, …) and operating expenses.

Be aware of depreciation assumptions, taxes and noncash-expenses.

Part Three: The Balance Sheet Reveals the Most

Those knowledgeable about finances start with the balance sheet, even though it is much less intuitive and requires a deeper understanding, because it provides much more insight into a business.

Assets can come in a number of different forms that are relevant to you. Keep an eye out for liabilities, and ensure that there is always enough cash at hand.

Part Four: Cash is King

Even if you are profitable, you need cash to continue operations eventually. Profits aren’t real money yet. Cash is.

There are more ways to get cash flow than just profits. Expenses do not reflect cash going out (especially not noncash-expenses), and capital expenditure does not count against profit. Expanding a business is usually cash-intensive.

A cash-flow statement is different from an income statement, and can be calculated from two balance sheets and an income statement.

Part Five: Ratios: Learning What the Numbers Are Really Telling You

Ratios are only indicators and different for each industry. Make sure your assumptions are correct, and your reference is good - they will always have biases regardless, keep this in mind.

Part Six: How to Calculate (and Really Understand) ROI

ROI is fundamental for capital investment decisions. Cash NOW is worth more than cash tomorrow - especially if you need it. Future value is a guess at best. Don’t disregard opportunity costs. Include technicians in cost estimation, they likely know best. Be conservative in your estimates, and don’t disregard the value of time.

Part Seven: Applied FI: Working Capital Management

Working capital has a number of levers. Unsatisfied customers will take their time paying. Ask your employees about the financial situation of customers. Try to keep days payable outstanding small. How fast is your cash conversion cycle (freed up again after being converted to inventory)? Always check distribution, not averages.

Part Eight: Creating a Financially Intelligent Company

Businesses tend to fare better with more financially intelligent people, especially among managers – since they make more educated decisions. Transparency and open communications are an antidote to politics. Be available for questions. Always communicate WHY changes are happening and consult affected individuals prior to implementing the change.

Financial Literacy is not a one-time training course. The material needs to become part of a companies culture. It takes time and effort, but it will be worth it. You might want to offer regular internal classes, but don’t try to make everyone an accountant.

Company growth should be a conscious choice, and needs to be planned for. Branch off in other areas later and focus on one area when small.

Lastly, there is a list of recommended ‘next step’ materials and books.

Review

Wow I’m so glad I read that book. But not just reading it, but also implementing and using the newfound knowledge. Look at that, I’m now somewhat capable of reading financial statements of public companies! My friends looked at me real weird for that.

I also got around to tracking my personal finances in more detail as well, and I have a much better knowledge about how my wealth is distributed, and open liabilities (and when they are due!).

Recommended for everyone with little financial knowledge, but wants to improve. A lot applies to personal finance, but most information is meant for small and medium-sized businesses.

Main Takeaways

My main takeaway is exactly as expected: a better understanding of the art of finance. And, just like I intended, not just personal finance, but especially deeper insights in what companies have to look out for, and care about.

My next steps include reading and learning more about finance in general, and investing strategies. I got myself a mentor for that recently – maybe you should too?

Criticism

While I try to mention both the good and bad about a book in this section, there’s nothing bad I could mention. It exceeds expectations while being well-written, clearly structured with good explanations, and easy to read. It would also work quite well as a reference, and skimming it will give you a good overview hat is being talked about specifically.

The only downside I could think of would be that I could have probably skipped the chapters about ratios – though the insight was useful, their knowledge is not something I have used since reading the book. Of course, this might very well be different for you, and I will revisit the chapter soon, when I will need its knowledge.

Favourite Quotes

If your company is profitable, you can run it the way you want to. (page 25)

Profit is an estimate - and you can’t spend estimates. (page 29)

The power of ratios lies in the fact that the numbers in the financial statements by themselves don’t reveal the whole story. (page 133)

[..] debt allows a company to grow beyond what its invested capital alone would allow […]. (page 140)

It seems like this book does not have many sentences for good quotes - or, I simply did not notice them.

You can find a lot more books I have read and reviewed here.