Top 5 Ratios to Analyze A Balance Sheet for Professionals

Do you want to evaluate your company’s financial performance? Moreover, do you need a base for comparisons with rivals, tracking trend lines, or operational efficiency?

Fortunately, you can use a variety of ratios to help you in your quest.

However, while there are many financial ratios to analyze your balance sheet, here are the best five ratios from my personal experience.

Quick Ratios

Goal: Check the solvency of your company and how fast you can repay your short-term debts with your quick assets.

Formula: Quick Assets / Current Liabilities

(where Quick Assets = Current Assets – Inventory)

Inventory Turnover

Goal: Measure how many months of inventory you have on your balance sheet.

Formula: Cost of Goods Sold / Average Inventory

Note: Use the Cost of Goods Sold (COGS) of the last 12 months to measure how many months of inventory you have.

For example, COGS of 100m$ / Inventory of 25m$ means that on average, your inventory will last a quarter (3 months).

Asset Turnover

Goal: Check how much CAPEX you need for each $ earned. The higher the number, the less assets you need to make revenues.

Formula: Turnover / Net Tangible Assets

Cash Conversion Cycle (CCC)

Goal: Check how many days you need to convert your cash out (for inventory in cash in (from sales)).

Formula: Days of Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding

Note:

Days of Inventory Outstanding = Average inventory for a month / Cost of Good Solds * 365
Days Sales Outstanding = Receivables / Annual Revenue * 365
Payable Days = Payables / Annual COGS * 365

Working Capital

Goal: Measure the capital used to finance the daily operations.

Formula: Current Assets – Current Liabilities

Note: If you reduce it, you can free some capital to invest in CAPEX or new investments.

The Bottom Line – Financial Ratios Are Key To Success

In conclusion, financial ratios can help you evaluate your firm’s overall financial condition. In addition, you can measure your efficiency. Consequently, you can discover any red flags in your operation and resolve them timely.

Moreover, you can compare your position with relevant competitors and discover why they are better. Finally, you can compare your results over time, i.e., track trend lines. As a result, you’ll know which operations bring you better results.

Ultimately, if you want to learn more about financial ratios, you can take my course.

Finance

How Can You Analyze and Reduce Overhead Expenses?

Overhead expenses are the ongoing costs of running a business that is not directly related to the production of goods or services. These expenses include things like rent, utilities, insurance, and administrative costs.

They are also known as indirect costs or operating expenses. While they are necessary for the smooth operation of a business, they do not directly generate revenue.

Furthermore, it is important for businesses to carefully manage their overhead expenses in order to maintain profitability. This can involve reducing costs, negotiating better rates with suppliers, or finding more efficient operating methods.

By carefully controlling overhead expenses, businesses can ensure that they are using their resources effectively and maximizing their profitability.

Can You Reduce Overhead Expenses?

Overhead expenses are not enough challenged by finance. Why? Because we think that we can’t do much about it. I also thought that there was no possibility of improving overhead costs.
How to change group fees? How to reduce personal costs? This seemed impossible to me.

But one day, I was assigned to reduce structural costs. I had no other solution than… finding solutions. As a result, together with my other colleagues from management, we launched a project to improve the company’s competitiveness. And we succeeded in reducing costs despite inflation costs!

Why Did It Work?

I realized that reducing overhead expenses was like any project, and with a good methodology, you could achieve your goal. But many finance professionals are still struggling with the topic. That is why I decided to share with you, for free, the full lesson on “Overhead analysis.”

In this lesson, you can learn how to:

Analyze overhead expenses
Reduce personal overhead costs
Challenge group recharges
Decrease external services

The Bottom Line

You might think that decreasing your overhead expenses is a difficult endeavor, but you’d be amazed at how much even tiny cuts over time can add up to. Simply review your existing financial position and look for ways to decrease spending. It doesn’t necessarily need major budgeting or downsizing.

Here you can watch the first part of the lesson for free. Moreover, this lesson is part of my course, which I create to help finance people upskill themselves to help their career or transition into a new role.

Finance

What Is The Role of Finance in The Digital Era?

Every position and duty inside an organization, as well as everyday life in general, have an influence on the digitalization juggernaut. Finance in the digital era plays a far more strategic role than just being basic bean counters and fund managers.

Formerly considered “support” roles inside the firm, such as HR and Finance, are increasingly taking center stage and bringing the necessary professionalism to build a competitive advantage.

However, yesterday, somebody asked me for my opinion on the two following questions.

#1: Question

What is the finance role in the digital era because of any change in the environment?

My answer: Finance should be one of the leaders of digital change as it has access to many points of data and is involved in many processes. Moreover, it should use to lower the function costs.

What they can do:
Digitize and automate processes with high transactions but low value added (like accounts payable). Make better use of the data by improving data collection and consolidation for reporting and forecasting using new collaboration, planning, and BI tools.

#2: Question

Do you know the top 3 finance issues in a digital transformation company?

My answer:

Issue number one: Change management (make sure people are on the boat and understand + implement the change).

Problem number two: Skills make sure that you have the right skills in your people to lead and implement the change (could be done by a combination of training, external hiring, and help from third parties).

Issue number three: Take the opportunity of digitalization to challenge the status quo to streamline and standardize processes. Leadership must be an example of the culture shift.

What would you have answered?

The Bottom Line – Finance in the Digital Era Is The Future

The focus is more on the finance of the future than the financial future. To be able to add value to the bigger business, today’s financial professionals need to develop this approach.

Finance is ready to act as a global nodal agency for transformation and decision-making in all business areas. The leaders only need to give themselves an extra boost internally and wisely and extensively utilize the existing technology.

If you want to receive more finance tips like this, feel free to sign up for my newsletter. If you subscribe, every two weeks, you will receive an email from where I share best practices, career advice, templates, and insights for Finance Professionals.

Finance, Tips

The Rule of 72 for Finance Professionals

Imagine you could calculate how long it takes to double your money just with a simple formula. Have you heard about the Rule of 72?

The Rule of 72 is a simple, effective rule frequently used to determine how many years are needed to double an investment at a specific yearly rate of return. Also, it can figure out how many years it will take to double an investment by calculating the yearly rate of compounded return.

How to Calculate The Rule of 72?

You just need to divide 72 by the rate of return to determine the Rule of 72. Depending on how the interest rate is stated, you may use the method to get the doubling time in days, months, or years. If you enter the annual interest rate, for instance, you will see how many years it would take for your assets to double.

Example:

What is the doubling time for an investment with a compound interest rate of 8%?
A person using the Rule of 72 equation would find the doubling time equal to 9 years.
Then, calculate this by taking 72 and dividing it by 8.
By performing this, the investor can tell that it will take approximately nine years to double the principal.
It is fairly accurate as the exponential function yields an actual doubling time of 9.006 years.

How to Use It?

Anything that increases at a compound rate, such as the population, macroeconomic data, fees, or loans, might be subject to the Rule of 72. The economy will double in 72 / 4% = 18 years if the gross domestic product (GDP) rises at 4% per year.

Therefore, you can use The Rule of 72 to show the long-term implications of these charges concerning the fee that reduces investment profits. In around 24 years, a mutual fund with yearly cost fees of 3% will have cut the invested principal in half.

Therefore, a credit card user who pays 12% interest (or any other loan type that charges compound interest) will double their debt in six years.

The Bottom Line

In short, The Rule of 72 provides investors with a quick and simple technique to forecast the growth of their assets. Additionally, this Rule brilliantly illustrates the power of compounding for accumulating wealth. How? By demonstrating how rapidly you can double your money with little effort.

Finally, if you want to expand your financial knowledge with more tips, you can take my course.

Finance

Digital Technologies That Reshape Finance

Despite the fact that CFOs control and manage a large portion of the important business data that fuels such initiatives, the notion of the digital finance organization is still in its infancy in many businesses, and they remain distant from the core of digital technologies transformation efforts.

Moreover, today’s CEOs and boards state they expect CFOs and the finance department to deliver real-time, data-enabled decision assistance, giving them a clear mandate to take the lead.

Additionally, CFOs themselves stated that they wanted to spend more time on digital projects. Also, on the integration of digital technologies into financial duties in the most recent poll of finance executives.

The Four Digital Technologies

Here are the four digital technologies that reshape the finance function.

Automation and robotics – To improve processes
Data visualization – To give users real-time financial information
Advanced analytics for finance – To accelerate decision support
Advanced analytics for business – To uncover hidden shareholder value and growth opportunities

Source for the image McKinsey & Company

The Digital Agenda

By assessing the primary use cases and where they stand with each of the digital technologies, CFOs and their teams may jump-start the digitalization process.

First, they need to undertake a value scan. Value scan is the process of asking questions about the possible benefits of digitizing financial processes as well as the degree to which doing so is feasible. Second, they should have talks with business-unit executives about the problems with various financial procedures.

For example, delayed reporting and inaccurate data. Finally, together with employees of the IT department, they should conduct a thorough assessment of technological capabilities to determine system needs and financial commitments.

Conclusion

Access to financial services can be facilitated by new financial technology, which will increase the effectiveness of the financial system. By implementing these four digital technologies in finance you can speed up and improve the processes.

Infographic by McKinsey & Company (original article)

Finance

How Can A Finance Manager Manage Cash in Finance?

Cash is King, but do you know your King? Today, I will explain to you what I learned about cash and what you can do to manage cash.

Like most Finance managers, I bring a specific focus on reaching my targets and report on how well (or bad) I do in comparison with these targets. Most of the financial KPIs are P&L-oriented.

Therefore, balance sheet items like inventory, receivables, and payables are not the first priority. However, they play a significant role in the evolution of your cash balance!

Also, this year I learned how to monitor a cash balance. Furthermore, how to plan the cash flows and which action plan you can implement to obtain results.

How Can You Monitor Your Cash Balance?

You need to understand your cash flow. Therefore, from a theoretical point of view, you have two methods: the direct and the indirect methods. The direct method uses actual cash inflows and outflows from the company’s operations (think about looking at your bank statement).

On the other hand, the indirect method requires more accounting knowledge as it starts from the net income and involves different adjustments from P&L non-cash items and balance sheet movement with cash items.

As a financial manager, you need to understand and be comfortable with both methods. Most probably, the indirect method will be used for reporting as this is the one that has more consistency and can be mapped with the other types of reporting (P&L and Balance Sheet). Here you can improve your understanding of the indirect method for cash flow statements.

Above all, understanding the impact of the different components of your cash flow statement should be your priority in monitoring your cash balance. Also, as finance manager, it should be your responsibility.

How Can You Plan Your Cash Flows?

In theory, it is easy: plan your cash in and your cash out. However, in reality, this is more complex.

For cash-in, you need to use your revenue forecast combined with the payment conditions in place with your clients. If you are in an industry where there are advance and milestone payments not related to revenue, this brings another layer of complexity but can not be forgotten. Therefore, I recommend using the 80/20 rule and focusing on the main projects/clients to get a quick estimation of your cash-in.

Planning your Cash out can be easier thanks to the recurring costs having a monthly frequency with short payment terms (personal costs, utilities, recurring raw material). For non-recurring expenses, you need to focus on the biggest item and use the information from your procurement team to plan when a purchase order will be fulfilled and with which payment terms.

Finally, you need to be aware of exceptional events like financing or investing, which have significant impacts on your cash balance. Considering your role as finance manager, you need to involve yourself in these transactions or at least the significant ones.

Which Action Plan Can You Implement to Improve and Manage Cash?

Here is what you can implement.

Communicate, explain, repeat
Put it at the top of the management agenda
Breakdown the action plans specific to each department:

Sales: Improve payment terms with clients (negotiate down payments and short payment terms), accelerate the closing of deals
Procurement: Avoid down payment and push the payment terms as far as possible
Project: Compute and monitor the cash balance of each project
Collection of overdue: Automate the dunning process and escalate significant issues to management and key accounts/project managers
Inventory: Monitor the level of inventory against forecasted sales, reduce lead time, optimize stock buffer, reduce delays
Finance: Automate reporting and improve understanding of cash flow statements. Also, bring transparency to management and key business partners, escalate collection issues, use factoring to accelerate cash payment from receivables
Management: Translate cash objectives into the team and individual objectives and put cash in the management reviews agenda. Then, follow up cash as KPI, delay investments, and optimize the process between a cash milestone achievement and the issuance of the debit note to your client

The Bottom Line – It Is A Top Priority to Effectively Manage Cash

You can improve your financial management system, but it takes time and work. However, it will be worth it. Utilize these suggestions to estimate your financial requirements, hasten cash collections, and prevent taking out loans to run your organization.

Finally, you can learn about managing your cash and Finance by taking my course!

Finance

Are Controllers The Data Scientists of Finance?

A senior manager who is in charge of a company’s daily financial operations is known as a financial controller. Financial controllers manage the accounting department and are in charge of the business’s accounts and records. Depending on the size of the company, the financial controller’s function changes. I find that Data Scientists and Controllers share a lot of similarities in their work. As a result, we could even say that the controllers are the Data Scientists of Finance.

What Are The Similarities between Controllers and Data Scientists?

I found valuable insights in the article “What The Data Scientists Really Do” from the Harvard Business Review, which confirms the similarities.

Here are the most interesting parts of this article:

Sure, machine learning and deep learning are powerful techniques with important applications. But, as with all buzz terms, a healthy skepticism is in order. Nearly all of my guests understand that working data scientists make their daily bread and butter through data collection and data cleaning. And by building dashboards and reports, data visualization, statistical inference, communicating results to key stakeholders, and convincing decision-makers of their results.
The skills data scientists need are evolving (and experience with deep learning isn’t the most important one). „Which skill is more important for a data scientist: the ability to use the most sophisticated deep learning models or the ability to make good PowerPoint slides?.” He made a case for the latter since communicating results remains a critical part of data work.
One result of this rapid change is that the vast majority of my guests tell us that the key skills for data scientists are not the ability to build and use deep-learning infrastructures. Instead, the ability to learn on the fly and to communicate well in order to answer business questions and explain complex results to non-technical stakeholders. Then, aspiring data scientists should focus less on techniques than on questions. New techniques come and go, but critical thinking and quantitative, domain-specific skills will remain in demand.

Conclusion – The Data Science Revolution Will Bring Changes

The data science revolution is only getting started throughout industry and society at large. Therefore, the controllers of the future will be the data scientists of Finance. Also, they will be considerably more analytical and play a function as a business partner. Additionally, the quantity of analytical inquiries is increasing far more quickly than data scientists.

You can get the most out of the Excel functions by taking my course for Finance professionals.

Finance, Tips

Value Driver Tree (VDT) for Decision-Making in Finance

The connections between the financial statement items and the main value drivers of a firm are graphically shown in a value driver tree. The tree aids analysts in determining which factors are most crucial to the company’s total value and in monitoring the effects of changes to those factors. You can use the value driver tree to help the firm discover possible risks and opportunities.

How Can You Create A Value Driver Tree (VDT)?

The firm is broken down into its core business units or products, and then each business unit is further broken down into its primary value drivers to create the tree.

Most importantly, In his deep dive post “Value Driver Modelling“, Reuben Kearney lists the different uses of a Value Driver Tree (VDT) and offers a template to build your own VDT. Here are the different uses.

Identify where the biggest constraints are in an organization’s ability to create value.
You can use it in conjunction with sensitivity analysis to show which areas are at greatest risk for failing to deliver value.
Different investment options to find the optimal combination for creating value.
To provide transparency at the individual employee level to see how they contribute to the creation of value.
Allows you to benchmark operations that were previously too distinct to compare through traditional benchmarking methodologies.

Some software provide a tool to create a dynamic visualization of the VDT of a company. Therefore, here is an example from SAP :

And here is a concrete example with a comparison between two different scenarios:

The Bottom Line – VDT can Assist You in Many Ways

It takes time and effort to implement Value Driver Trees. But I’ve discovered it’s one of the best tools for developing a more comprehensive understanding of how your organization operates. This is a crucial component in developing product teams that can concentrate on value creation rather than just feature delivery.

Additionally, they serve as a communication artifact that will aid in creating alignment among your stakeholders.

Finally, if you want to learn more finance tools and techniques, you can take my course.

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Quick Ratios

Inventory Turnover

Asset Turnover

Cash Conversion Cycle (CCC)

Working Capital

The Bottom Line – Financial Ratios Are Key To Success

Can You Reduce Overhead Expenses?

Why Did It Work?

The Bottom Line

#1: Question

#2: Question

The Bottom Line – Finance in the Digital Era Is The Future

How to Calculate The Rule of 72?

How to Use It?

The Bottom Line

The Four Digital Technologies

The Digital Agenda

Conclusion

How Can You Monitor Your Cash Balance?

How Can You Plan Your Cash Flows?

Which Action Plan Can You Implement to Improve and Manage Cash?

The Bottom Line – It Is A Top Priority to Effectively Manage Cash

What Are The Similarities between Controllers and Data Scientists?

Conclusion – The Data Science Revolution Will Bring Changes

How Can You Create A Value Driver Tree (VDT)?

The Bottom Line – VDT can Assist You in Many Ways

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