In chapter 3 of Fit In, Stand Out, we discussed financial acuity as the key component in decision making and implementation in business. Even if you are not in the accounting or financial function of your company, you will need to ask key questions to exhibit and develop your financial acuity.

To develop your financial acuity, Here is a quiz to rate your current mastery of this FISO Factor agent by answering the following questions and checking with our own answers on the next screen.

Questions:

1. Which questions are important for you to ask when you are interviewing for a mid-level position at a company?
2. Which factors would lead you to sell a company’s shares?
3. What should you read in the annual report before you join or invest in a company?
4. How should you react to negative news about your company in which you are invested?
5. Where do you learn about the management of a company to evaluate the leadership talents?
6. What’s the difference between generating revenues and generating profits and which is a more important indicator of the health of the company?
7. What metrics are important in deciding to invest in a cable company?
8. Why is it important to understand the rules of expensing and capitalizing certain costs at a company?
9. What is the effect of a Wall Street industry analyst on the financial statements of your company or one you want to learn more about?
10. When do you know that you have mastered financial acuity?

Answers to questions about mastering this FISO Factor: financial acuity.

1. When you are interviewing for a position at a company, you must first do your homework. First, read the most recent financial press releases (available on company websites and ask about the financial results. Do they seem reasonable? Is the company growing faster or slower than competition or what you would expect? How does its PE multiple (Price of the share price divided by the Earnings per share) compare to the industry and historical results? Understand why the Price Earning multiple might be unusually high or low. (PE multiples are published daily in the Wall Street Journal.) Second, ask anyone you know who deals with the company about the management. It’s amazing how much you can learn by asking people who are suppliers, customers, competitors or consultants to the company.
   
   
2. There are some red flags that might lead you to sell your shares. Have there been financial-reporting issues such as regulatory investigations and accounting restatements? Has the company responded promptly and with open disclosure? If so, it may not be an issue but make sure you understand if this is an industry attack or the company is standing alone. Have the top management positions been a revolving door? This is another red flag to suggest strategy will not be implemented and confusion will reign for quite a while.
   
   
3. When reading the annual report, first look at the board of directors. Determine if these are the type of men and women you want to be influencing the strategy and direction of the company. Second, read the footnotes. Some are more technical, but lawsuits will be disclosed, competitive information will be discussed and any adjustments to financial results must be reported. Third, read the CEO’s letter to the shareholders. This is a chance to see what the leadership thinks is important about the past and future results. Fourth, read the financial statements, first the highlights and then more detail. They will seem more understandable after you have read the footnotes.
   
   
4. Negative news must be considered carefully. The source of the negative news must first be evaluated. Most investors overreact to negative news. Find out more about the problem. Is this something that can be handled without a major product recall or without a change in management? It may be an opportunity to buy more shares rather than dumping the ones you have. Is it something that will drag on for a long time in the courts and will it affect the rest of the industry? This type of negative news may have a longer depression on the share price than you are willing to wait.
   
   
5. Management leadership is the key to success at a company. Have you ever tried to use Google with management names? It’s remarkable what you will learn. Ex-employees are one of the best sources to really learn about personalities, processes and general thinking of the leadership. Don’t forget many Wall Street industry analysts do most of their research by meeting and questioning the key leaders of a company. The analyst reports are quite helpful in explaining perceptions of the management given the company and industry comparisons.
   
   
6. Generating revenues explains how healthy the future growth prospects in terms of penetration of a market and frequency of the customer purchases. For example, if the revenues are growing 2%, but the company only operates in a small portion of the country, there may be room to grow geographically as they penetrate more markets. The customers may only buy the product once a month. Is there a way to have the customers buy more frequently? If either are discussed by the company, then more top-line growth may be part of its strategy. Generating profits shows how well the company can translate top-line growth into meaningful returns to the shareholders. Both are important. But they must be evaluated in terms of other metrics. For example, Krispy Kreme continued to show the number of stores and total sales growing through November 2004 and yet the percentage change in comparable store sales system-wide went down for 8 quarters before that date. One of the most important indicators of the health of the company is the cash flow statement. It shows how much cash is generated and used. No company can last without a positive cash flow over a long period of time. (Airline companies might be the only exception, but many have declared bankruptcy or emerged from bankruptcy after restructuring their debt and other liabilities to free-up cash flow.)
   
   
7. Cable companies and other technology companies have industry-specific metrics that must be evaluated in order to build financial acuity. For example, capital expenditures per subscriber is a key indicator of the company’s investment in its infrastructure. Too much and the company might go bankrupt before it starts the revenue stream and earnings flow. Too little and it may be subject to the whims of competitors who control the pipeline to customers. This is why understanding the cash flow statement as discussed in answer 6 is important.
   
   
8. Frauds have survived in companies when certain costs should have been expensed and exposed in the income statement, but instead were capitalized. The WorldCom scandal of a $7 billion fraud was alleged to have resulted from the Chief Financial Officer capitalizing items that should have been expensed. Also, in the Enron scandal, company accountants classified items as property, plant and equipment rather than expensing them directly to the Income Statement which would have been proper accounting. Know your rules of expensing and capitalizing costs so you can evaluate what your company is doing before it turns into a WorldCom or Enron situation.
   
   
9. A Wall Street industry analyst has NO effect on the financial statements of your company. His or her job is to research the company and its management and provide reports for others to decide whether or not to invest. One lawmaker during the House committee hearings on WorldCom asked the telecom industry analyst Jack Grubman if he ever advised an investor to sell WorldCom stock,not understanding that research analysts do not advise individual investors.
   
   
10. You know you have mastered financial acuity if most of these answers seemed simple and straight forward to the simple and straight forward questions. Don’t be afraid to ask questions, do some reading and even meet with a Certified Public Accountant to test your knowledge.

Another exam? Take a leadership self-assessment exam using the FISO Factor® Assessment Tool, developed by Blythe McGarvie.

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