Categories: Managing for Profit

Financial literacy – what you need to know

Business performance is measured with accounting scorecards. If you don’t understand them, give up all hope of ever becoming a…

I became a farmer because of tea parties. When I was a child, my parents would pile us into the family Chev and drive out of town to have tea with a local farmer. After greetings and some home-made ginger beer, we children would head for the farm shed.

It was always a magical place, with its ploughs, mowers, hay rakes, half-dismantled engines and – holy of holies – tractors.

I remember walking with my father and a farmer on the rich soil of one of the latter’s recently ploughed lands. I was about four at the time. As I write, I can still smell that special, fresh, earthy aroma. It was a beautiful afternoon, and that day – for all the wrong reasons – I decided to become a farmer.

Farming vs the business of farming
I went on to study agriculture, and got along fine in my first farm job. After all, I understood crop production, how to raise beef and chickens, and produce milk – all in theory. I had a few tough practical lessons to learn, like how to set a plough, survey a contour and weld a broken implement. But I got by, and never doubted that this was the life for me.

As time went by, I became drawn into the commercial end of the business. This was truly foreign territory. I understood words such as ‘income’, ‘expenditure’ and ‘profit’, but when I heard my boss talking about ‘depreciation’, and the bookkeeper saying that it had to be added back to profit in order to calculate cash flow, I was mystified.

When ‘accrue’, ‘amortisation’, ‘current ratio’ and ‘headline earnings’ entered the discussion, I started to panic. I had landed on Planet Accountancy, where they really do speak a different language! With agriculture I at least had a patchy knowledge of what was required; with finances, I was simply illiterate.

Learning the ropes
Yet, whether we like it or not, accounts are the scorecards of business. If I didn’t understand the score, or how it was measured, how was I ever going to make a success of my farming career?

My vision of farming was a world of fresh moist soil, gamboling newborn lambs and thriving mealie plants. But the harsh reality was that I needed to know how to do an operating and capital budget, how to calculate cash flow, what depreciation meant, and what opportunity and marginal costs were.

So off I went on a financial literacy course, and learnt about the three main scorecards of accountancy:

Income statement
This sounds as if it measures only income, but it actually measures costs as well. I was relieved to hear that this was the old ‘profit and loss account’, which I’d heard about before. I learnt that this scorecard reports on the performance of the business over time – usually a year, but sometimes more often.

A further revelation was that while it might show a good profit, a business could actually be on the brink of collapse. A profitable business collapsing? Talk about confusing!

Balance sheet
This can be considered a snapshot of a particular point in time. If you put a sequence of balance sheets together, each provides a solitary image that has some value, rather like a series of photographs of a person growing up. But it’s the comparison between them that really tells the story of the changes taking place.

Cash flow statement
This is extracted from both the income statement and the balance sheet, and it tells you whether the business is likely to survive or not. It is by far the most important of the three scorecards, and the one I was told to pay most attention to.

Those are the basics. Please join me on my journey towards financial literacy next time!

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