What your boss expects HR to know about business
November 13, 2009 by Jim GiulianoPosted in: Communication, Special Report
If you don’t know what “free cash flow” means, maybe you should – if you want to get ahead in your organization.
What if someone told you he had a key piece of knowledge that would give you an edge on most of the other managers in your company? You’d probably jump at it, right?
Well, consider that business owners and CEOs routinely expect their managers and supervisors to have an understanding of the basics of business, especially money and finances. A survey by the Harvard Business Review shows that owners’ expectation might be too high.
Asked to take a basic financial-literacy exam, a representative sample of 300 managers — from all company sectors, including HR — scored an average of only 38%. Get this: Over half didn’t know the difference between “profit” and “cash.” Many didn’t know the difference between an income statement and a balance sheet. Nearly two-thirds thought that discounts offered by sales reps had no effect on gross margin.
Does it matter? When delivering the results of the test, Harvard presented scenarios in which that lack of knowledge could cripple a business. For instance, imagine you’re hiring an inventory manager who doesn’t understand the relationship between inventory on hand and cash flow. Worse, imagine you don’t know what the applicant doesn’t know.
Here are three sample questions from the test (answers at the bottom):
1. You should be pleased about your company’s financial results if –
a. There is a negative trend in operating margin.
b. There is an increasing trend in COGS.
c. Cash flow is coming from company investing.
d. Cash flow is coming from company operations.
2. A company has more cash today when –
a. All customers pay their bills sooner.
b. Accounts receivable increases.
c. Profit increases.
d. Retained earnings increases.
3. To investors and analysts, free cash flow is a key number because –
a. It reflects the cash that is “free” — that is, your company doesn’t have to pay interest on it.
b. It is the cash that can be used to pay shareholders their dividends.
c. It reflects the operating cash that has flowed into the business that year.
d. It is the cash that investors put into the business.
Answers:
1. d.
2. a.
3. b.
Tags: Harvard Business Review, HR
November 16th, 2009 at 2:35 pm
The answer to number 2 should be c.
Why not a? All customers paying their bill sooner is only good if AP has not gone up exponentially, diminishing the value of the AR benefit.
Why not b? AR increasing is a corollary of A, which is to say by itself it sounds great, unless there’s another factor that minimizes its impact. For example, all the AR in the world has not helped cash flow if it’s gone from 30 to 120 days our.
Why not d? Retained earnings is a positive thing, but it doesn’t necessarily mean a company would have more or less cash today versus any other day, although retained earnings are far better that retained losses.
November 16th, 2009 at 3:38 pm
The answer to number 2 is correct as stated.
Why not a: Even if A/P were to increase, if ALL customers were paying their bills in a more timely fashion, then cash increases.
Why not b: Even if A/R increases, that does not mean there is an increase in cash. A customer has to pay the bill first. If not, the A/R can be written off as bad debt
Why not d: Retained earnings is the net income or loss that is transferred from the income statement to the balance sheet at the end of the calendar or fiscal year. This is not a cash transaction.
November 16th, 2009 at 4:12 pm
Thanksfully I do not have to know these things – not saying I couldn’t learn them if needed just that it isn’t necessary for me.
November 16th, 2009 at 4:18 pm
Eric you have it wrong. An increase in profit does not equal an increase in cash because it has to be collected first before that can happen and it is really no different than an increase in AR. Hopefully with good collection of AR with an increase in profit equals more money over time but does not mean more cash today like the question asked.
November 16th, 2009 at 4:28 pm
The key term in #2 that makes the answer b is “cash today.” Profit is related to Income and Expense. Income does not necessarily mean cash. On an accrual basis it related to AR. Customers paying their bills brings cash into business.
November 16th, 2009 at 4:29 pm
Number 2 should not be C. If customers buy items on account, profit will increase but A/R will increase instead of cash. The key word in the question is “today”. Profit has no direct relation to immediate cash flow under Generally Accepted Accounting Principals.
Of course you could make the question more complicated than it really is by throwing in assumptions about things like repayment of debt, purchase of assets, etc., but if you read the question on its own “a” is the correct answer.
November 16th, 2009 at 4:30 pm
Eric, the answer to # 2 is a because customers paying their bills sooner increases the amount of cash in the company’s checking account today. Profit increasing does not mean they have the cash on hand today. The key to the question is the cash today part of it.
November 16th, 2009 at 4:38 pm
Sorry Eric, I don’t agree with you…the answer is A. Cash flow is literally the flow of “Cash”. The company has more available cash today when customers pay their bills early. Accounts Payable only affects your cash flow today in that it means you have more cash because you still have not paid those payables. None of the other answers increase cash on hand. A company can certainly increase their profit (c) without having more cash in hand. Accounts receivable is money (cash) that you are loaning to customers because they haven’t paid you yet. Retained earnings are just profits that are being “retained” or reinvested in the business.
November 16th, 2009 at 4:45 pm
I did misunderstand # 3 though…
November 16th, 2009 at 4:49 pm
We should all know the basics. I know that if I take the time to put numbers, charts, basically quantitative data into my analysis that it does assist “me” in getting some of the tools that I need to assist my employees and do my job better.
Melissa
November 16th, 2009 at 4:50 pm
The answer to number 2 is correct as stated.
Why not a: Even if A/P were to increase, if ALL customers were paying their bills in a more timely fashion, then cash increases.
Why not b: Even if A/R increases, that does not mean there is an increase in cash. A customer has to pay the bill first. If not, the A/R can be written off as bad debt
Why not d: Retained earnings is the net income or loss that is transferred from the income statement to the balance sheet at the end of the calendar or fiscal year. This is not a cash transaction.
November 16th, 2009 at 5:07 pm
I am just very pleased that I did know the answers . . . that BSBA finally did something for me, lol! ; )
November 16th, 2009 at 5:12 pm
Gordon, you have to read my caveat as to answer A. Without more, I’d agree, but there are always other issues to factor in.
November 16th, 2009 at 5:19 pm
Sorry Eric, I disagree. B, C, and D cannot be the answers because they are non-cash transactions. In this context, “a” is the best answer. Customers paying their bills sooner is a direct cash transaction (Debit cash, credit Accounts Receivable).
November 17th, 2009 at 6:27 pm
I don’t understand Mary Pineda’s answer..
November 18th, 2009 at 7:44 am
The correct answer for number 2 is a. Customers paying bills sooner means the company has more cash in it bank account. Customers paying later increases the amount due in accounts receivable, and means less cash in the checking account. Neither have any bearing on profit as both cash and account receiveable are considered “assets”, until customers fail to pay their billsl. Profits are impacted only after the past due balances are “wrtitten off”.
When companies purchase assets, they have less cash. But the value of the asset stays on the books, so it is still possible for a company to be profitable with little or no cash, because of their non-cash assetts. For example, they have a huge amount in accounts receivealbe, or in inventory.