Finance 101 for Sales and Marketing Professionals: Lesson 3 – Completing a Business Cycle

You have seen how a set of basic business transactions can be directed into buckets that we can track throughout a month.  Most of the transactions that companies will capture throughout a month will fall into the same buckets that we have been working with.  The difference being, that in the real world, each bucket has many compartments in it to capture a finer level of detail.  Management not only needs to know how much money was spent on overhead, but more specifically, how much was spent on marketing programs, and even more specifically, radio advertising.  Regardless of how many compartments or sub-compartments a company creates, overhead expenses are still overhead expenses.  That being said, we are not going to get bogged down with details.

We do need to add some more beef to our transaction set in order to give it a more realistic feel.  This may feel like a fire hose.  Don’t focus on the volume or the details.  Just look at one or two of the transactions and you will see that they are similar to what we have just done in the previous lesson.  Let’s start recording:

1. We bought more raw materials on credit so we owe the supplier some money (ACCOUNTS PAYABLE: +$100,000)
2. We now own more raw materials (INVENTORY: +$100,000)
3. We sold some machines to a customer on credit (REVENUE: +$180,000)
4. Our customer owes us the money for the machines (ACCOUNTS RECEIVABLE: +$180,000)
5. We shipped the machines to the customer (COST OF GOODS SOLD: +$80,000)
6. We no longer have the machines that we shipped (INVENTORY: -$80,000)
7. We pay our employees to build more machines (CASH: -$60,000)
8. Our work (labor) added more value to the inventory (INVENTORY: +$60,000)
9. We incurred some general business expenses on credit (SELLING, GENERAL & ADMINISTRATIVE: +$120,000)
10. We owe various suppliers for the business expenses (ACCOUNTS PAYABLE: +$120,000)
11. We use cash to pay some of our suppliers (CASH: -$100,000)
12. We no longer owe our suppliers what we paid (ACCOUNTS PAYABLE: -$100,000)
13. We bought more raw materials on credit so we owe the supplier some money (ACCOUNTS PAYABLE: +$100,000)
14. We now own more raw materials (INVENTORY: +$100,000)
15. We sold some machines to a customer on credit (REVENUE: +$250,000)
16. Our customer owes us the money for the machines (ACCOUNTS RECEIVABLE: +$250,000)
17. We shipped the machines to the customer (COST OF GOODS SOLD: +$100,000)
18. We no longer have the machines that we shipped (INVENTORY: -$100,000)
19. We can collect cash from our customers (CASH: +$180,000)
20. Our customers no longer owe us what they paid (ACCOUNTS RECEIVABLES: -$180,000)
21. We pay our employees to build more machines (CASH: -$60,000)
22. Our work (labor) added more value to the inventory (INVENTORY: +$60,000)

Hopefully you can see that patterns are beginning to form and while thousands of transactions will be recorded every month, they will all be similar, falling into and out of the same buckets over and over again.  Great, now that we have that all straightened out, let’s take a look at where our buckets ended up after all of that activity:

Revenues	$630,000	We have sold machines to several customers	Cash	$450,000	We paid more of our suppliers, but also collected more cash
Cost of Goods Sold	$260,000	We shipped the machines and recorded the cost	Accounts Receivable	$250,000	We collected some cash but more is owed to us
Selling, General and Administrative	$170,000	We have recorded different types of business expenses	Inventory	$220,000	We shipped some inventory to customers and built more
			Fixed Assets	$500,000	We still own our fixed assets
Equity	$1,000,000	We still owe the owners their investment	Accounts Payable	$220,000	We paid some of our bills but we still owe some of our suppliers

 

Most months don’t end on a perfect cycle of paying and collecting so it is common to see balances in all of the buckets.  At any point, the company will store raw materials, finished goods, and work that is currently in progress.  We are now at a pretty good point to call our month complete.

In my next post, I will show you how financial statements are built from the bucket balances and ultimately as a result of the operational transactions.

-Bruce A. Brien, CEO, Stratascope Inc.

Finance 101 for Sales and Marketing Professionals: Lesson 2 – Operational Transactions

In order to understand the financial performance of an organization, you have to build a basic knowledge of how the activities of the organization feed the performance metrics.  If that sounded a little bit like we are going to talk about accounting, we are, but I promise to keep it fairly simple.  I have already talked about all of the buckets that we will use to categorize the activities of the business.   We just need to walk through the basic activities of the business to see where the money goes.  We can do this by starting a fictitious company called AnyCo and following its activity.

In order to start AnyCo we need some money (also referred to as capital).  We can get the money from some investors (also known as owners).  We need to note two facts so far:

1. We got cash from our investors (CASH: +$1,000,000)
2. We gave our investors equity for their cash in order to record their ownership (EQUITY: +$1,000,000)

Next, we are going to need a plant, some equipment, computers, and other stuff (also called fixed assets or property, plant and equipment or PPE).  This activity will generate a couple of additional notes:

1. We will pay for the fixed assets with cash (CASH: – $500,000)
2. We now own some fixed assets (FIXED ASSETS: +$500,000)

Now we need to build some machines to sell.  Again we’ll keep it simple.  We are going to buy some raw materials, hire some workers and pay them to build the machines, and use some additional resources like electricity and heat.  The above activities need to be recorded:

1. We bought the raw materials on credit so we owe the supplier some money (ACCOUNTS PAYABLE: +$100,000)
2. We now own some raw materials (INVENTORY: +$100,000)
3. We pay our employees to build machines (CASH: -$50,000)
4. Our work (labor) added more value to the inventory (INVENTORY: +$50,000)
5. We pay for our electricity and other resources (CASH: -$10,000)
6. Our resources added more value to the inventory (INVENTORY: +$10,000)

Great, we got our business off the ground and even built something to sell.  At anytime, we should be able to step back and see how we are doing by looking at our buckets.  I will use the table below to show our progress:

Revenues	$0	We have not sold anything yet	Cash	$440,000	We paid for our fixed assets, our labor, and utilities
Cost of Goods Sold	$0	We have not shipped anything yet	Accounts Receivable	$0	We have not sold anything yet so no one owes us anything
Selling, General and Administrative	$0	We have not recorded any miscellaneous costs	Inventory	$160,000	We purchased materials, added labor and consumed resources
			Fixed Assets	$500,000	We bought a plant and equipment
Equity	$1,000,000	We still owe the owners their investment	Accounts Payable	$100,000	We still owe our supplier for the materials

 

Let’s continue on to just a few more activities and then we can call it quits for today.  We are ready to sell our products!  Again, let’s keep things simple.  We’ll launch marketing program to create awareness.  Our successful marketing program will lead us to our first sale which will be on credit terms.  Time to record the activity:

1. We launched a marketing program on credit (SELLING, GENERAL & ADMINISTRATIVE: +$50,000)
2. We owe the Marketing Services Company for the program (ACCOUNTS PAYABLE: +$50,000)
3. We sold some machines to a customer on credit (REVENUE: +$200,000)
4. Our customer owes us the money for the machines (ACCOUNTS RECEIVABLE: +$200,000)
5. We shipped the machines to the customer (COST OF GOODS SOLD: +$80,000)
6. We no longer have the machines that we shipped (INVENTORY: -$80,000)

Now let’s pay our suppliers for the raw materials that we purchased earlier and the advertising from above.  We can also collect from our customer at this time.  Let’s record:

1. We use cash to pay our suppliers (CASH: -$150,000)
2. We no longer owe our suppliers what we paid (ACCOUNTS PAYABLE: -$150,000)
3. We can collect cash from our customers (CASH: +$200,000)
4. Our customers no longer owe us what they paid (ACCOUNTS RECEIVABLES: -$200,000)

We are starting to look like a business, selling products, paying bills, and collecting cash!  Let’s step back again and see how we are doing by looking at our buckets:

Revenues	$200,000	We sold some machines	Cash	$490,000	We paid our suppliers, but also collected some cash
Cost of Goods Sold	$80,000	We shipped the machines and recorded the cost	Accounts Receivable	$0	We collected everything owed to us
Selling, General and Administrative	$50,000	We launched a marketing program	Inventory	$80,000	We shipped some inventory to a customer
			Fixed Assets	$500,000	We still own our fixed assets
Equity	$1,000,000	We still owe the owners their investment	Accounts Payable	$0	We paid all of our bills

 

OK, we are off to a great start.  We have covered all of the basic transactions of the operations of the business.  Hopefully, you were able to follow this, and you think it has been pretty simple.  Next time, we’ll turn on the fire hose and simulate the rest of the month.  Don’t worry; we’ll be analyzing financial statements in no time.

In my next post, I will take you through completing a business cycle.

-Bruce A. Brien, CEO, Stratascope Inc.

Finance 101 for Sales and Marketing Professionals: Lesson 1 – The Framework

I have been asked many times by a countless number of sales and marketing professionals to put the field of “Finance” in basic terms that they will understand.  Finance and accounting can be very complicated, extremely dry, and usually boring.  Sales and Marketing professionals don’t do very well with the combination of complicated, dry, and boring.  If they did, they wouldn’t be in sales.  In any event, I will do my best over the next month, through this blog, to help you build the basic financial and business acumen that you should have to carry a business conversation with your prospects or clients.  I’ll try to put everything into basic terms with examples.  When I can’t, I’ll try to provide you with a clear definition.  Up front, I apologize to the accountants in the audience (some of whom are in my employ) and would ask them not to quibble over my skipping areas that I don’t think are very relevant to sales and marketing professionals.

Let’s begin with the basic financial statements.  Different industries will use different models and formats to record their business.  In order to keep things simple, we will confine our discussion to commercial and industrial manufacturers, distributors, and retailers.  After we have a basic knowledge in place, we can discuss other financial models for professional services, general services, banking, and the non-profit public sector. For most industries, we need to focus on the Income Statement and the Balance Sheet.

The Income Statement tracks an organization’s performance over a period of time.  It tells us how the organization has performed in the past.  Remember, past performance does not guarantee future success, or failure, it only tells us what happened.  The Balance Sheet tracks how well an organization is prepared to address the future.  The Balance Sheet is a position document that shows where the organization is at a point in time, what assets and liabilities (responsibilities) it has available to address the challenges of its marketplace.  Performance and position are the keys to understanding a business’s operational success.

When business transactions occur, they can change both a company’s performance, and its position.  For industrial and commercial industries, the operational areas that can be affected are below:

The Income Statement (performance) breaks down into three operational components as follows:

• Revenues (Often called Sales or, in Europe, turnover) – representing the market value of goods and services that have been shipped or delivered to customers
• Cost of Goods Sold (Cost of Sales) – represents the costs incurred to procure, build, and deliver the products
• Selling, General, and Administrative Costs (Overhead) – represents the other costs to run the business, i.e. sales, marketing, accounting, legal, HR, research and development, and services

There are also other non-operational expenses like depreciation, taxes, and special items that are better left to the accountants.

The Balance Sheet (position) breaks down into five operational components as follows:

• Cash – Cash as well as any other liquid (easily accessible and convertible to cash) investments
• Accounts Receivable – What the customers owe for the products and services they have received
• Inventory – The materials, the work-in-progress, and the finished goods along with any labor and other resources that went into them
• Fixed Assets – The property, plant, equipment, computers, and patents of an organization would all be classified here.
• Accounts Payable – This is the amount that we owe our creditors under basic trade terms (not loans or any interest bearing stuff – leave that to the accountants)

The final non-operational component that we need to be concerned with is equity.  Equity is the beginning and the end of every commercial business.  The owners of the business put equity in to get the business started and any profits (income) left at the end of the period are moved to equity as well.  If the company loses money, it comes out of the equity as well.

That completes the framework that I’ll use to discuss each of the upcoming topics around finance for sales and marketing professionals.

In my next post, I will look at the basic operational transactions that drive a business.

-Bruce A. Brien, CEO, Stratascope Inc.