Busting Financial Management Myths

Busting Financial Management Myths

The forthcoming Professional Managers’ Award programme from Aston Business School features a wealth of topics, such as the intricacies of financial management – the area overseen by Matt Davies, one of the programme’s expert trainers.

Matt DaviesHaving spent the past 25 years as an accountant, trainer, university lecturer and consultant working with hundreds of managers in a wide variety of organisations, I have come to realise that there are many common myths relating to the subject of financial management.

Dispelling these myths is an important part of developing financial literacy.

Managers often need to invest time and effort to ‘unlearn’ misconceptions before they can develop the appropriate financial skills and knowledge to communicate financial concepts more confidently and to exercise their management responsibilities more effectively.

The following are four of the most widely held misconceptions:

Myth 1: The balance sheet provides a reliable measure of the value of the business

The balance sheet (or statement of financial position as it is now referred to) provides information about the financial state of the business rather than its value.  Many valuable assets are not recoded on the balance sheet (such as people and internally generated brands) and those that are recorded are generally shown at their original cost (and for longer term assets depreciation is then deducted).   Value is determined by the future performance potential of the business whereas the balance sheet is based on past transactions and events.   Generally, therefore, the balance sheet significantly understates the true worth of a business.

Myth 2: Profit is a reliable measure of financial performance

It is important that managers recognise that profit is merely an ‘opinion’ on the business’ financial performance and should not be regarded as an entirely reliable measure.  There are several choices and judgements involved in the measurement of accounting numbers.   Examples of such items include depreciation, accruals and provisions, none of which can be measured with 100% accuracy.

Myth 3: Profit is the same as cash flow

It is perfectly possible for a business to have positive profits and negative cash flows.  The reasons why there is a difference between profit and cash flow include the following:

  • Sales made on credit are recorded in the income statement when the sale is made, not when the cash is received.
  • Expenses are recorded as they are ‘consumed’ and not when they are paid for.
  • The cost of inventory is only recorded as an expense when inventory is sold and not when it is bought or manufactured.
  • Cash spent on capital expenditure is not recorded in the income statement whereas depreciation (a non-cash expense) is.

Myth 4: It is possible to measure the ‘true cost’ of a product or service

Many managers place far too much faith in the accountants’ measure of ‘cost’.  Whilst some costs (‘direct costs’ such as materials and labour) can be accurately related to a product, there are many costs (‘overheads’) which are much more difficult to deal with.  Many businesses use very arbitrary systems for sharing the overheads across the product range.  These systems might appear to be reasonable but they may not necessarily provide a guide to a product’s ‘true cost’.  Care is therefore needed when making pricing and product mix decisions using cost information which may not be very reliable.

Aston Business School’s Professional Managers’ Award career development programme gets underway this autumn. To find out more and to discover how the award could help you and your organisation, please visit:www.aston.ac.uk/prof-mgr-award/ or call 0121 204 3160.