Most business leaders understand how to read financial statements; they’re familiar with terms like “profit margins” and “annual recurring revenue” and they know the numbers.
But few have mastered the art of financial fluency: understanding how to interpret and use financial data to make strategic decisions. To have a data-driven competitive advantage, business leaders need to deliver actionable insights from their data. Knowing the numbers is not enough.
Businesses often fall prey to problems like stalled growth, margin erosion, or cash-flow surprises because they’re not leveraging their data to drive organizational planning. Financial data is only useful if it leads to action.
This five-step framework helps business leaders move from basic financial literacy to a fuller, more powerful financial fluency.
Jon Fay and Bryce Bow, instructors from Harvard DCE’s Professional & Executive Development, shared their ideas on why financial fluency is critical for executives, regardless of department.By decoding financial statements, identifying value-driving metrics, translating insights into an operational plan, monitoring and adjusting with data dashboards, and institutionalizing continuous improvement, leaders can build a full-scale understanding of how to get from data to results.
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Step 1: Decode Your Financial Statements
The first step to financial literacy is to understand what the financial documents measure and how to calculate some basic metrics based on what they say. Once you have a clear picture of what each document is saying about the business, you can use the statements collectively to gather even more information about business performance.
The following financial statements are incredibly useful in building a complete picture of a company’s financial health.
The profit & loss statement (P&L)
Sometimes called an income statement and often referred to as simply the P&L, the profit and loss statement measures how much money a company made and spent over a given period of time, like a quarter or a year.
Key metrics
- Revenue (Sales): The total amount of money earned selling products or services.
- Cost of Goods Sold (COGS): Direct costs of producing what was sold.
- Gross Profit: The amount of money the company made after the direct costs are accounted for. (Revenue – COGS)
- Operating Expenses: Costs not directly tied to production, like administrative work.
- Operating Income, or Earnings Before Income and Taxes (EBIT): Measures the revenue generated after subtracting COGS and operating expenses (Gross Profit – Operating Expenses)
- Net Income: The income left after all expenses, taxes, and interest are paid (the so-called “bottom line”)
The balance sheet
This financial document shows both what a company owns and owes at a given moment in time.
Balance sheet elements
- Assets: What the company owns. Includes current assets like cash, inventory, and receivables and non-current assets like equipment and property.
- Liabilities: What the company owes. Includes current liabilities like accounts payable and short-term debt and long-term liabilities such as loans and bonds.
- Equity: What remains after subtracting liabilities from assets.
The cash flow statement
This financial document shows the actual flow of cash coming into the company and going out. These flows are divided into 3 areas:
Cash flow types
- Operating activities: Cash from daily operations (generally cash flow is positive).
- Investing activities: Buying/selling assets, investments (typically negative when growing).
- Financing activities: Loans, stock issuance, dividends.
All these documents can be used to spot early trends signifying potential issues down the road.
For example, signs of margin compression can indicate that costs are rising faster than income. If the gross margin (Gross Profit / Revenue) or the net margin (Net Income / Revenue) are declining over time, it’s a sign that the company is likely experiencing margin compression.
If one or both of the margins are increasing along with revenue, it means costs are also increasing — just at a faster rate. If costs outpace revenue, at some point, the business will go under. Margin compression is a sign that cuts may be necessary to keep the business viable in the long-term.
Liquidity shifts measure a company’s ability to measure its short-term financial commitments. To gain insight into liquidity, use the current ratio (current assets : current liabilities). If this ratio is declining over time, it could indicate a liquidity issue, meaning the business could soon struggle to pay its short-term bills.
Step 2: Identify the Value-Driving Metrics
Every business will need to identify the KPIs that are most significant for them depending on their goals and broader strategy. For example, if a business has an annual goal of lowering their customer acquisition cost (CAC) by 10 percent, that metric may become more significant than others during that calendar year.
Common metrics
- Lifetime Value (LTV): This measures a customer’s lifetime value to the company. It’s an estimate of the total revenue a customer will generate over the duration of the relationship.
- LTV/CAC: The lifetime value / customer acquisition cost measures the cost efficiency of customer acquisition. For example, if it costs $50,000 to acquire a customer and their lifetime value is expected to be $150,000, the LTV/CAC would be 3:1 and the business would have generated $100,000 in revenue. Healthy LTV/CAC ratios are typically between 2:1 and 3:1.
- Return on Invested Capital (ROIC): A company’s return on invested capital measures how efficiently a business turns its investments into returns. ROIC is calculated by dividing the net operating profit after taxes (NOPAT; a company’s possible cash earnings if it has no debt) by the amount of capital invested. The ROIC offers visibility into a business’ actual performance by cutting out the effects of financing.This metric describes a business’ operating efficiency.
While most metrics are broadly applicable to every business, understanding the meaning behind the metrics is important for business leaders so they understand which ones will be most important for them.
Business leaders need to avoid focusing on metrics that don’t drive value. All metrics aren’t created equal, and just because something is measurable doesn’t mean it matters. Business leaders should focus on the metrics that offer visibility into the engine that drives their company’s success.
Step 3: Translate Insights into an Operational Plan
Generating insights is critical, but it’s just as important for these insights to inform operational plans. Too many business leaders are comfortable with simply reporting on financial metrics rather than using them to build a coherent business strategy.
Business leaders can use the above metrics to take informed, strategic action to spur growth or avoid a potential crisis.
For example, a company may notice that the LTV for customers in a certain segment is declining — businesses aren’t delivering the same amount of value over the course of the relationship.
This information could prompt business leaders to do several things: they might decide they need to pursue new customers to cover the gap; they might explore upselling opportunities with current customers to reverse the decline in LTV; they may also begin to do a forensic analysis to understand why LTV is declining among this segment, pulling data from the customer success, sales, and marketing teams.
And a company with a sluggish LTV:CAC ratio of around 1.2:1 will need to find ways to acquire customers more cheaply to have a lower CAC. Alternatively, they could try to raise LTV by increasing baseline prices (potentially running the risk of losing customers and prospects), by strategically upselling existing customers, or by increasing the length of their contracts.
Step 4: Monitor and Adjust with Data Dashboards
An ROIC above 10 or 15 percent is generally considered strong, depending on the industry. For a company with a lower rate of return — around 5 or 6 percent — they will need to explore why their investments into the business aren’t yielding returns. Chances are, there are places to trim the fat to promote greater operational efficiency. Alternatively, it may suggest poor capital allocation, meaning the business is investing in projects or assets that aren’t yielding returns.
Keeping a finger on the pulse via cross-functional dashboards is important for tracking results. Once an operational plan is implemented, business leaders need to see how it’s actually performing. More often than not, reality doesn’t precisely align with the planned outcome — which is why it’s important to monitor results via a constant stream of data.
There are many options for building cross-functional dashboards. Tools like Power BI from Microsoft and Tableau offer integrated dashboards so leaders can quickly check in on performance metrics. These tools make it easier to monitor data, but nevertheless, closely monitoring performance on specific operational goals can quickly fall by the wayside.
Maintaining a regular reporting cadence is critical for measuring success. Weekly pulse checks among leaders help make sure the day-to-day data is trending in the right direction. By checking in regularly, leaders can identify potential negative trends and take action. Quarterly deep dives into the data allow leaders to look under the hood to see what’s going on on a granular level.
Coupling weekly checks with quarterly intensive sessions ensure that operational plans are on track to meet objectives.
Step 5: Institutionalize Continuous Improvement
Forecasting variances — the difference between expected performance and actual results — should prompt strategy tweaks. Closely monitoring performance allows leaders to make timely adjustments and establish internal feedback loops for continuous improvement.
Financial Fluency for Business Leaders equips executives with the language and toolkit to understand the business financial logic that drives their business’ performance and generates ongoing improvement.
“You have to know the language. You have to know what a contribution margin is,” Fay says. “But you also need to have a toolkit. You need to have the tools and know how to use them — you need to be able to do things like breakeven analysis and margin analysis.”
Bow and Fay also shared a case study from a previous class.
One student was a senior sales leader with. Fay and Bow led an exercise that entirely changed his way of thinking about sales and business. As part of the exercise, Fay and Bow shared a chart of 10 companies and their major financial data.
But that chart didn’t tell you which companies’ data was which. Based on what they know about the companies and their understanding of business financial logic, students need to match the logos with the correct financials.
The sales lead was blown away. He not only loved the exercise, but found it so useful that he brought it back to his sales team. Now, he pulls up their top 10 customers’ financial data and has his AEs and SDRs try to match the companies to the financial information.
This exercise showed his team how their customers made money, so they could build strategies and messaging around how they could best help their customers. By understanding their customers’ financials, they could better position themselves.
How You Can Level Up Your Financial Literacy
Harvard DCE’s Professional & Executive Development course Financial Fluency for Business Leaders is designed for those who are committed to improving their strategic decision making and financial accumen. Secure your spot today!
