The Language of Business

Feb 23, 2016
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Understanding the Language of Business: A Primer for HR Professionals

What HR Professionals Should Know About Financial Statements

  • The types of accounts used to record financial transactions, which will ultimately be part of the financial statements, are assets, liabilities, capital, revenue, expenses, and withdrawals/dividends.
  • Financial statements are interconnected because the final number of one statement flows down to the other.
  • Income statements are always done first, and net income flows down to the statement of owners’ equity.
  • The statement of owners’ equity tells the owner how much is invested (not worth) in the business.
  • The ending capital from the statement of owners’ equity flows down to the balance sheet. The balance sheet must balance and have the assets equal total liabilities and capital (equity).
  • The statement of cash flows often stands alone, but the first line of the statement is net income, which comes from the income statements.
What HR Professionals Should Know About Company Finances

  • Don’t look at any aspect of the financials superficially.
  • Look at the income statement first.
  • Human resources affects, and is affected by, the “bottom line.”
  • Trend analysis is important because financial trends tell a story and show a pattern. It is better to have several years of financial statements rather than just one year; a trend can tell management the direction sales and individual expenses are going.
  • Focusing on the statement of cash flows is important in understanding how cash is spent or collected by the organization. Cash is critical.
  • Human resources needs to ask what allocation method is used to “push” part of overhead costs into department budgets. The allocation method must make sense for that type of organization and must be applied consistently.
  • Sometimes, the financial statements do not tell the whole story because they are a summary of past events and use original costs vs. current costs.
  • Human resources must be aware of the important differences between W-2 employees and independent contractors/consultants. There are financial responsibilities, such as benefits and tax obligations, associated with W-2 employees.
What HR Professionals Should Know About Financial Reporting

  • Accrual based accounting is more relevant than cash basis bookkeeping, and it records transactions regardless of when cash changes hands.
  • Accrual accounting is designed to match revenues and expenses and has nothing to do with cash changing hands.
  • Accrual accounting more accurately reflects the financial transactions of the organization, but it is more complex and requires a more thorough understanding of accounting.
  • Accounting often consists of estimates that should be made based on reasonable assumptions. Examples of estimates include employee vacation benefits, depreciation, and warranty expenses.
  • Depreciating a tangible asset means writing off the cost of the asset gradually. The straight line method is the simplest method, but the double declining method is often used by organizations.
  • Overlooking an accrual distorts the financials.
What HR Professionals Should Know About Cash Management

  • Effective cash management can mean the difference between a company thriving or not surviving
  • Human resources is often a key player during organizational restructuring and uses the many of the SHRM competencies during reorganizations.
  • The statement of cash flow has three sections: operating, financing, and investing.
  • The statement of cash flow’s ultimate goal is to explain how cash changed from last year to this year (per last year’s balance sheet compared to this year’s balance sheet)
  • The starting place to begin calculation of the statement of cash flow is a comparative set of balance sheets. Each account is analyzed on how it either was a source or use of cash.
What HR Professionals Should Know About Capital

  • Companies have numerous decisions to make when deciding the best way to finance the organization. Balancing debt and equity (stock) can be challenging, and that balance should be constantly monitored.
  • There are numerous advantages and disadvantages of debt.
  • Bonds are debt. Bond interest expense is paid to bondholders semi-annually.
  • There are two main components of stockholders’ equity: contributed capital and retained earnings.
  • Stock is equity ownership of the organization. Dividends may or may not be paid to shareholders depending on many things, including dividend policy, the board of directors’ strategic plans, and mostly the level of retained earnings available to pay dividends.
  • Horizontal and vertical integration relate to either purchasing a company’s competition or purchasing a supplier.
What HR Professionals Should Know About Budgeting

  • Budgeting is challenging since many assumptions must be made.
  • There are many types of budgets, and organizations need to decide which ones are necessary and work best for them.
  • Forecasted sales are the starting place for many other budgets.
  • Pro forma means projected.
  • Time value of money analyzes present value vs. future value of money. You must know the interest rate, number of periods, and either present value or future value to do a calculation.
  • Capital budgeting equates to long-term planning for items such as property, plant, and equipment.
  • There are three accepted methods of analyzing the cost-effectiveness of capital budgeting projects: payback method, net present value method, and internal rate of return (IRR).
  • IRR is typically the best way to analyze whether or not to invest in a capital project.
  • Flexible budgets are created if the actual level of activity is different from the budgeted level. They are more useful and show current instead of proposed levels of production activity. A variance is the difference between actual costs and expected costs.
What HR Professionals Should Know About Financial Ratios

  • Interpreting ratios is often more important and valuable than being able to calculate them.
  • If you start with incorrect financial numbers the financial ratios will also be wrong.
  • Many people, including auditors and management, are interested in seeing financial ratios.
  • Ratios are divided into categories.
  • Profitability ratios assess a business’s ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.
  • Liquidity ratios measure a company’s ability to pay off short-term debt. They reflect the company’s ability to cover its expenses. The current ratio and the quick ratio are two ratios that provide an indication of the company’s liquidity.
  • Working Capital—Current assets minus current liabilities. This shows the liquidity level or ability of the organization to pay its short term financial obligations. Manipulation of this ratio can take place and should be recognized.
  • Operational Efficiency/Employee Productivity ratios measure the efficiency of employees and corporate resources in earning a profit.
  • It’s important for both employees of the organization and potential investors to understand EPS (earnings per share) and P/E (price-to-earnings) ratios.
  • Leverage (capital-structure) ratios reflect the extent to which the company uses debt to finance its operations. The debt ratio and the debt-equity ratio are used for this purpose.
  • Break-even analysis is important because variable costs and fixed costs must be covered before any profits can be recognized. When an organization covers all costs with sales dollars, the company has achieved break-even and there is neither a profit nor a loss.
  • Analyzing financial ratios helps management of all levels understand trends.
  • Financial statement ratios support informed judgments and decision making most effectively when the trend of entity data is compared to the trend of industry data.
Excerpted from Regan W. Garey, Business Literacy Survival Guide for HR Professionals (SHRM, 2011).
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