EBITDA and Other Scary Words: What Did They Just Say?
"This article originally appeared on Financial Poise and is reprinted here with permission."
Michael Goldman, whose original series served as a source for material and inspiration for this series, wrote, “Most business people and professionals speak their own language. Lawyers use paragraph numbers and cite to section numbers of laws as short-hand for entire trains of thought. Doctors have long multi-syllable names for practically everything. Sales people often rattle off product codes, speaking in SKUs instead of product names. Arguably the most frustrating language of all in the business tower of babble is that of accountants and financial people.” We really like his analogy.
We have found that the average CPA has an issue with putting into written words what he or she would like to express. Our words are the numbers, and we would like to think that the numbers rarely lie. So for many of us writing an article is like asking an English teacher to calculate EBITDA.
As we stated before, the numbers rarely lie, but like the written word, they can be interpreted differently. For example, at the end of the year your company’s total sales were $10 million and your net income was $1,000,000. So you think, wow, the company did great this year. However, when you look at your cash account, it’s zero and you have no money to pay your creditors. Where did all my profit go? This can get even more confusing if you are using the wrong words to describe a number, such as, if you ask for gross profit and the person gives you net income.
If you are now concerned about having to learn two more languages, one for the words and one for the numbers, good. You need to. This is your business, your career, your children’s future, and possibly your legacy. Let’s give you the tools to help you grow, succeed, and make better business decisions based on accurate, up-to-date information.
Accountants typically prepare financial statements in accordance with accounting principles generally accepted (“GAAP”) in the United States of America based on information provided by you; the client. We act like that makes them generally understood by everyone. Hopefully with our help, you too can understand your financial statements, terminology used in the financial statements, and other financial information better.
Financial information is presented in standard formats — balance sheets, statement of operations, changes in equity, and cash flows, etc…. The footnotes to the financial statements give the reader a further understanding of the policies and procedures the company has adopted as well as a more robust description for certain numbers represented in the balance sheets, statement of operations, changes in equity, and cash flows.
There are many ways to analyze the numbers in financial statements. These include ratio analysis, benchmarking, comparing to industry averages, horizontal analysis, variance analysis, common-size analysis, etc…. Understanding which way to analyze an account is a critical part of understanding your financial information. A good analysis may raise a lot of questions, but hopefully it will answer more questions than it creates.
The numbers are all driven by the activity in the business. The financial statements are just one way of measuring what is happening in your company at a point in time. If you need to understand if your customers are happy, would you ask them once a year or would you ask them throughout the year? Once a year may only get you a piece of the information needed to make sure you are providing them with the services expected from your company and your employees. If you ask 10 customers in September if they were provided with excellent service and the answer is “Yes,” does that mean that same level of service is being provided in May? The same is true for your financial information. Would you make a decision in June based on financial information from last December?
The financial statements are great; especially if a reliable accounting firm helped you prepare them. However, you need to make business decisions every day. You cannot make decisions today based on numbers from the year-end financial statements from two or three months ago. The decisions should be based on what is going on now, and what will go on next week, month, year, decade. These are the decisions that will help your business grow.
If you want to understand the future, you also need to understand the past (We read that in a fortune cookie). Understanding the financial statements is just the beginning, and once you understand the words and the numbers, you can use that knowledge to apply it to the numbers you are receiving in real time.
So let’s summarize; you will need to learn a new language based on numbers, a new language for words based on those numbers, you need to understand the past, the present, and the future, and the lottery numbers for tomorrow night’s drawing! This series of articles will hopefully help you understand the financial information put in front of you on a day-to-day basis as well as from an aggregate yearly basis.
The authors thank Michael Goldman, whose original series for Financial Poise continues to serve as source material and inspiration for this series.