Crucial for a manager, and a useful life skill for everyone

My parents’ relative lack of financial literacy was passed on to me, and had a negative effect on me. Make sure that you and your family don’t make the same mistake.

Managing for profit by Peter Hughes

Mine was a secure, loving home, but one where the word ‘money’ was seldom heard. For some perverse reason, it was frowned upon to openly raise financial issues.

My mother was a nurse, midwife, radiographer and matron at the local hospital; my father was the principal of an agricultural college. They were both highly competent in their chosen careers, but when I look back, the level of financial literacy in my home was at the low end of the scale.

“What’s inflation?” asked the high school guidance councillor when I said I wanted to become a farmer. “What do you know about insurance? Have you ever sold anything for profit?”

I can still see her look of pity as I stammered and stuttered. When I was finished, she looked down at the sheet of paper in front of her and ticked the box with ‘Teacher’ next to it, and that was that. My future was decided.

Thank goodness my teacher training included subjects covering plants, fungi and insects, and I was able to become semi-qualified in a few farm-related subjects.

No doubt you’re wondering why I’m recalling this long-past stage of my life. It’s simple; the lack of financial literacy in my family affected me for many years, and I don’t want you to make the same mistake, which is why I’ve devoted the past few columns to the subject.

The wrong careers
When I was young and impressionable, an inexpert career guidance officer directed me into a career for which my wife and children will tell you I am totally unsuited. Later, my illiteracy in matters financial, commercial and economic trapped me in a limited agro-technical career for which I was almost as badly suited.

It was the insight of a friend who understood commerce, backed by the support of my boss at the time, that kick-started my move to seek some business and financial training. And only then did the career I had dreamt of start becoming a reality.

You cannot be a successful manager today if you do not understand the language of basic accounting. Commercial activity all around the world is measured in accounting terms, and without a reasonable level of understanding you simply won’t make it to the top.

It doesn’t stop there. In addition to understanding the language, you need to come to grips with the difference between ‘PBIT’ (profit before earnings and tax), ‘EBITDA’ (earnings before interest, tax, depreciation and amortisation), ‘headline earnings’ and SOTP (sum of the parts analysis). You need to know what items of costs come into the calculation when determining ‘cost-of-goods sold’, and which are considered part of the ‘operating cost’ and part of ‘capital cost’.

Once the words on a set of accounts are understood, and it’s clear how the figures were derived, you can analyse them. This is when phrases such as ‘cost of capital’ and ‘hurdle rate’ are used. Concepts such as ‘marginal cost’ and ‘opportunity cost’ come into play, and the relationships between the figures on the accounts – the financial ratios – become important in measuring the financial health of the business.

The meaning of all these terms is fully explained on various websites, and the Oxford Dictionary of Accounting is an exceptionally useful tool.

Do your family a favour
A final word before leaving this subject behind (for now). Financial literacy is much more than a necessary tool for business managers. It’s a necessary life skill for all members of your family.

Every day decisions are made about money, and the sooner they understand something about insurance, demand and supply, and the time value of money, the better. Don’t leave it too late!