124: The 5 Most Important Finance Skills You Double Down On

In this episode of Boosting Your Financial IQ, I delve into the five essential finance skills you need to become a value creator in any business. Drawing from my extensive career as a CEO, CFO, and investor, I share practical insights into understanding the fundamentals of finance, analyzing financial statements, forecasting, valuing companies, and strategic thinking. These skills, which transcend any background, are crucial for driving profitability and growth. Join me as I break down complex concepts into a cohesive framework, helping you transform financial data into actionable strategies. Don't miss out—tune in, apply the lessons, and consider joining my mastery program for deeper learning.

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Transcript

Speaker 1: 0:15

This podcast, boosting your Financial IQ, is about business, financial literacy, strategies for profitability and the principles taught at byfiqcom. My hope is that you will apply the lessons learned and that we can work together soon in my mastery program. Enjoy the show and don't forget to subscribe. I've spent my entire career turning around and growing companies, and I've served as a CEO, cfo and investor of multiple businesses of all different sizes across various industries, and during this timeframe, I've also had the unique opportunity of rubbing shoulders and working closely with leaders and helping them to become value creators. And that's what I want to talk about today in this episode are the five finance skills that you need to develop in order to become a value creator yourself. Now, it doesn't matter if you have a finance background or not. You can develop these skills regardless of your starting point. So let me walk you through these five skills. I wish I would have known these things earlier or at least been able to tie it together in one cohesive framework, and that's what I'm going to reveal today in this episode.

Speaker 1: 1:19

Okay, so let's start with number one. The first skill set to develop is just an understanding of the fundamentals of finance. So, when it comes to the fundamentals. I'm talking about how to read an income statement, balance sheet and statement of cash flows. And I'm not talking about being a nerd being able to do debits and credits and tick and tie the general ledger and trial balance. I'm not talking about that. Instead, I'm talking about understanding the flow of these financial statements, specifically how the income statement and the balance sheet connect together. Because when you combine the income statement and the balance sheet, guess what you get? You get a baby. The baby is called the statement of cash flows, and cash flow is what it's all about, because cash flow drives the intrinsic value of a firm and also it shows you how much cash is available to pay dividends to equity providers, to pay down debt or to reinvest in the business and propel growth. So, with the fundamentals of finance, you have to understand where are all the components of these financial statements. For example, where do you find debt? Where do you find capital expenditures? Where are dividends? What about cost of goods sold?

Speaker 1: 2:26

In addition to identifying these items, you also have to understand the financial levers to pull. For example, what if gross margin is dipping? How do you increase gross margin? Okay, it's through volume, it's through pricing or it's through cost and capital efficiencies. So those are just some examples. But it's understanding the story behind the numbers. I emphasize that all the time in these episodes, because it's not about just reading a financial statement and being like yep, here are my assets, here are my liabilities, here's my equity or this is my net income or whatever it may be. It's not that. It's understanding the story behind the numbers which leads into the next skill set, which is analysis.

Speaker 1: 3:07

Being able to analyze the financial statements is really, really critical, but you have to first know how they work. You have to know how the income statement works, the balance sheet and the statement of cash flows in order to analyze them. Now, when you analyze a financial statement, if you could look at the income statement and then the balance sheet and you can start computing metrics and ratios and other KPIs, that will be a great starting point, because understanding the historical trends will then enable you to build out the forecast, which is the third skill set, which I'll talk about here in just a minute. Now, in order to analyze a business appropriately, you have to understand the drivers of value, specifically return on invested capital and growth, and how those two things combine together with weighted average cost of capital ultimately drives free cashflow, then if you understand the value drivers, what I like to do is I draw out a logic tree, a value logic tree where I break down the component parts. So, for example, I may take free cash flow and I'm like, okay, free cash flow is derived from net operating profit after tax, working capital, capex and depreciation and amortization, and you could break these down into their component parts as well, like you could take net operating profit after tax and say, okay, that's a derivative of revenue, cost of goods sold and operating expenses and so on and so forth. And when you break out this logic tree, then you can start performing your analysis, because the last thing you want to do is just Google or use ChatGPT to say, okay, what are the top metrics that I should be measuring? Because then you're going to just come up with a bunch of random metrics like return on assets or return on equity, or current ratio or asset turnover, whatever it may be. These may be good metrics to compute, but if there's not a sequence to them or a bigger order which comes from the value tree that I'm talking about, then you're just going to be analyzing a bunch of random parts of the business and, once again, you're not going to understand the story behind the numbers, the bigger picture. So it starts with value, breaking down value into its component parts and then analyzing those parts of the business, while also benchmarking performance. And all this will help you to understand how's the company performing and how can you extrapolate that performance into the future to build a forecast, which is skill number three forecasting.

Speaker 1: 5:28

Now look, there's budgeting and there's forecasting. There's a huge difference between the two. I'm not going to get into all the nitty gritty, but let me just say this Too many companies are stuck in budgeting, which is where they'll create an annual budget at the end of the year, they'll roll it out to their teams. And it's kind of this command and control type mechanism where leaders believe okay, if I create this budget and I put the numbers down on a piece of paper, and then if I hang this little dangling carrot in front of my management's face and say, look, if you get these numbers, then I will pay you some type of bonus, or if we measure variances and they equal this, then we're going to reward you in some way. Well, guess what? That doesn't drive behavior and, in fact, budgets often create unintended consequences. So instead, I'm a big believer in forecasting and about predicting the future and driving continuous improvement, instead of playing this game of like gotcha. Right, we measured this variance. You said this and you actually did that.

Speaker 1: 6:27

That's not super helpful, so it's all about building a forecast and having that forecast rolling. I like to have forecasts that are rolling 24 or 36 months out in advance, so every month when a period drops off, another period is forecasted and another month is added to the forecast and therefore you never have to go through that annual budgeting process again. You always have this rolling forecast. So being able to build out a forecast, a solid forecast, and build up the components of that forecast for example, doing a solid forecast and build up the components of that forecast for example, doing a revenue buildup and getting down to the component parts price times, quantity is a really important skill set, and this includes being able to do financial modeling, like being able to model this all out in Excel or Google Sheets or whatever you choose to do, but being able to build this in a structured manner that's easy to communicate, easy to follow and that's scalable. So that's all part of forecasting and this is a really, really critical skill to develop.

Speaker 1: 7:27

So those are the first three. Let me say this again it's number one, understanding the fundamentals of finance. Number two, being able to analyze the financial performance of a company. And number three, being able to forecast. All two, being able to analyze the financial performance of a company. And number three, being able to forecast. All right, let's move on to number four and that is being able to value a company. Now there are three main approaches to valuation the income approach, which includes building a discounted cash flow model and forecasting out the future cash of the business and the continuing value of the company. Second, there's the market approach, where you're using multiples of similar transactions that have occurred in the market to value a company. Or the asset-based approach, where you may look at the market value of the assets or the liquidation value or the replacement cost of certain assets, and that's how you value the business. So, understanding how to perform a valuation and to take the forecast from skillset number three and use that to create an as-if valuation, meaning this is the base case if the company continues down this path, but then also to build an optimized valuation model where you say, okay, if the company pursues this strategy in these initiatives here's the upside and then looking at the difference between the two, can be super powerful. So that's skillset number four being able to do valuation.

Speaker 1: 8:49

And then the last skillset skillset number five is strategy right, or strategic thinking. And that's where you take all this stuff. You take the fundamentals of finance and analysis skills, your forecasting, your valuation model and you combine it all together. And this is where I say you connect the mission of the business with its money. And when you can do this successfully and you can put in place the right strategy. I'm not talking about hocus pocus strategy where you're just putting up a bunch of marketing slogans or you think mission, vision, values is your strategy. Instead, I'm talking about a real strategy where you define where are we gonna compete, how are we gonna compete and how are we gonna win and how do we connect that to the financial performance of the business to drive real value. When you can do that and you can combine that skillset with all the other four that I just mentioned, you will become an absolute powerhouse in business because you will know exactly how to drive value in a company and you won't get distracted by all the other complications and all the other noise that is so commonplace in the business world today.

Speaker 1: 9:54

So those are the skills that I wish somebody would have just said right from the get-go hey, steve, develop these five skills in a sequential manner so you can produce this outcome, and if I would have learned that early on, I would have skipped a lot of years of wasted time. So that's what I wanted to roll out to you. We have a program at Boosting your Financial IQ where I walk you through these five steps. If you're interested, you can check that out. But whatever path you decide to take, please, please, please, develop these five skills Understanding finance, learn how to do an analysis of a business, understand how to do financial modeling and build out a forecast. Definitely learn how to do valuation and how that works, and then finally combine that with strategy and you will see rich financial rewards. All right, that's all I have for today. Thanks for joining me and until next time, take care of yourself. Cheers.