Early in my career in manufacturing operations, I received advice that it was important to develop financial acumen. The concept of acquiring acumen felt intimidating. Where would I start? When would I have enough financial acumen?
Thankfully, a few key exercises in my master’s in engineering coursework grew my confidence. My professor called it “taking a walk across the financial statements.” She explained that it meant learning about the three fundamental financial statements: the income statement, the cash flow statement, and the balance sheet. (Find a sample below.)
Income statement. Also known as profit and loss or P&L, its purpose is to show managers and investors whether a company has made or lost money in a period of time, usually during a quarter or a year. The basic equation is revenue or sales minus expenses equals profit or income. The costs of running different departments, such as sales, research and development, and operations, are outlined in the income statement.
Cash flow statement. This statement captures the sources and uses of cash over a period of time. The three types of cash are cash from operations, cash from investing, and cash from financing. Investing includes activities such as buying new equipment or improving facilities.
Balance sheet. The balance sheet captures the assets (things of economic value), liabilities (also known as debts), and shareholder equity on a specific date in time. The balance sheet provides a snapshot of a company’s financial strength. Both assets and debts are categorized as either current (which means they can be converted to cash within a year) or long-term (greater than one year). Investors often look at various ratios on the balance sheet such as the debt-to-equity ratio or the current ratio (current assets to current debt) to assess the company’s financial health.
How do I walk the financial statements?
My professor called connecting the financial statements “taking a walk.” Read each statement from top to bottom. The first line on the income statement is revenue; the last line is net income. Net income is the first line reported on the next financial statement, the statement of cash flows. Again, read from top to bottom, and you’ll find cash and cash equivalents as the last line on the statement of cash flows. Open up the balance sheet. You will find this value of cash as the first line under assets on the balance sheet. You’ll conclude your “walk” with the last line on the balance sheet: Equity — the company’s value.
Once you know how to walk, you can start accelerating your understanding by examining each line in the financial statement. The income statement revenue line will show customer activity. Is revenue increasing or decreasing? Beneath revenue, you will find the cost of goods sold — the measurement of how much it costs to make a product or deliver a service.
Critical thinkers will compare the cost of goods sold to revenue to discern if making the same amount of product across different reporting periods is getting more expensive. You can compute some simple ratios, too. Use the balance sheet to calculate the debt ratio, which is the total liabilities divided by the total assets, or the debt-to-equity ratio, which is total debt over shareholders’ equity. The rule of thumb for a healthy debt ratio will vary slightly by industry.
Where can I access financial statements?
The Securities and Exchange Commission requires publicly traded companies in the United States to publish a 10-K form — a comprehensive annual financial report — and it must include all three financial statements. Some companies may also publish an annual report that provides context to the financial statements and often includes a letter from the CEO to shareholders. Look for these statements in an investor relations section on the company website. I recommend downloading the financial statements from the company you work for or selecting a company you admire and “take the walk.”
All engineering roles connect to a financial statement. Locate research and development on the income statement under the operating expenses section. Anyone in technical sales or marketing will also find that line item under operating expenses. Perhaps you work as a project manager. Your work on internal projects might connect to the company’s long-term property and equipment assets on the balance sheet. If you work on external projects, you are helping generate total revenue, which appears on the income statement.
Understanding financial statements is an essential business skill. Zooming in on the costs associated with your department and zooming out to frame your work within the business will help you create financial context for new ideas. If you are a job seeker, financial statements provide insight into a company’s priorities and financial position. To gain practical experience or learn more about financial statements, consider volunteer opportunities within the Society of Women Engineers, such as section treasurer or the SWE finance committee.
How does my role fit within the financial statement?
I started to notice financial information in new ways after practicing reading financial statements. I also noticed these statements in places I hadn’t previously recognized: companywide presentations, investor relations statements, and news articles about my industry. I realized that having financial acumen isn’t about speaking the language of finance as much as it is communicating the financial aspects of decisions in my work.
While I may not have forums to talk about finance frequently, I can convey the depth of my financial understanding with thoughtful calculations in an Excel spreadsheet or by organizing them in a presentation summary.
In the lean manufacturing space, I am frequently asked to calculate how projects reduce operating expenses. Before a project begins, I loosely quantify the current state of expenses, which come through direct labor, indirect labor, materials, and service expenses. This process makes it easier to identify which category of expenses will improve if we proceed with the project.
Often, at this point, leaders will ask for an ROI, or return on investment, which is a ratio of the amount of investment to the amount of projected savings or revenue. Sometimes, leaders will want to know the payback period, or how much time it will take for the investment to pay for itself. At this stage, I might fret about the business justification of a project; my advice is that despite math and internal company standards, the desired ROI time frame can be an individual preference.
