If you want employees to make decisions like you make decisions, they’re going to need access to the same data you have and they’re going to need to know how to make sense of that data. That includes a big dose of financial literacy.
Rudimentary financial literacy doesn’t require that everyone in the organization take an accounting class and it doesn’t mean that everyone knows what everyone else makes. Basic financial literacy rallies everyone in the organization around common goals, gives them a common language and increases their value to the organization.
This week’s One Year, Thirty Minute Challenge lays out the first financial literacy concepts that everyone in your organization should understand and gives some ideas on how to begin financial literacy education in the organization.
Profitability is built on creating an economic value surplus. The formula is –
Revenue (units sold * cost per unit)
– Cost of Goods Sold (materials + labor)
– Fixed Costs
It’s important for your team to understand each of these components. Revenue is a combination of two things – volume and price. The price for your good or service must be enough to cover the cost of goods sold (the materials and labor required to make the product). The remaining money, in aggregate, must be enough to cover the fixed costs of the business (rent, utilities, insurance, phones, desks, trucks, office supplies and more). Volume represents the number of people that are interested and willing to pay for your good or service at the price you’ve established. The money left over after paying the cost of goods sold and the overhead expenses is profit. The accumulated profit must be enough to build a surplus so the business can survive temporary downturns in volume or can capitalize on emerging opportunities.
The real magic happens when team members see how their day-to-day responsibilities drive each of these components. Price must be high enough to cover the fixed and variable costs and must also create a favorable value proposition for the customer (the price paid must be equal to the benefit derived by the customer). Pricing plays into decisions on marketing and advertising.
Cost of goods sold represents an incredible opportunity for inviting team members into financial literacy. If they can streamline the creation of the good or service, it drives the labor cost per unit down – allowing the company to make more units in the same amount of time. That increases profitability. If they can negotiate more favorable rates with suppliers, driving the cost of materials down, that increases profitability. If they can obtain higher quality materials for the same price, thus increasing quality and lowering the defect or warranty rate, that increases profitability. Greater profitability enables the company to create a larger surplus and be more prepared to weather economic storms. The COVID-19 crisis has shown us the importance of financial resilience. A report by JP Morgan Chase showed that only half of all small businesses have enough cash on hand to survive for 27 days.
Fixed costs are those incurred by the business just by being open – rent, utilities, insurance and more. When team members understand how co-working or working from home can lessen the need for office space – pushing rents down or how staying healthy can help push down insurance costs, they begin to get an understanding of the financial calculations that you are making every day. That understanding leads to engagement and empathy.
These actions move team members to the same side of the equation as owners. Instead of owners being adversaries – the employee’s loss is the owner’s gain – team members are now rowing in the same direction as the owners because they understand the owner’s endgame – building a viable, sustainable, and stable enterprise – one that can continue to offer employment and opportunity for years to come.
So, where do you start? First, I’d convene a meeting with all employees (if the company size allows it, if not, do several meetings) and explain the economic value surplus equation above. Explain that from this time forward, you’re going to share some of the company’s financial information so they can see how these pieces work. Then ask for their help in increasing revenue and decreasing expense. Finally, explain what’s in it for them. I’d suggest giving them skin in the game. If revenue increases, expense decreases, profitability increases (whatever information you’re willing to share), give them a cut of the savings or increased profits. You’ve now created common goals and explained it with, what is now, common language. You’re on your way.
Reconvene the meeting each month and report results.
Where do you go next? I’d suggest explaining double entry accounting – every financial transaction is recorded in two ways – when you sell a product, cash is debited and revenue is credited, when you buy copy paper, cash is credited and office supplies are debited. This prepares team members for the next, very important step.
Introduce the three primary financial reports – the Profit and Loss Statement, Balance Sheet and Cash Flow Statement.
The Profit and Loss Statement reports income and expenses for the business for a time period.
The Balance Sheet shows the organization’s financial health by tracking what the company owns and owes.
The Cash Flow Statement shows the movement of money in and out of the business. It differs from the income statement because all money coming into a business might not be income. For example, if a company takes out a loan, it receives money but did not generate any income. Conversely, if a company pays back a loan, it spent money but did not incur an expense. Instead it decreased a liability.
In your thirty minute exercise this week, decide how you can best engage your team in financial literacy by inviting them into some of the difficult decisions you make on a daily basis.