July 2013Finance

Do You Speak the Language of Business?

language-of-business

Some say it's English. Or Mandarin. Others contend it's the subtle, culture-spanning clues picked up by reading facial expressions and other physical movements. But most agree that the true language of business is accounting. The story of any company, no matter the size, the industry, or the country of origin, is told through its financial records and reports. Income, debt, revenue versus expenses, compensation, and cost of retaining customers can all be found on financial statements.

But if that's true, why are so few executives fluent in the language? Wharton accounting professor Christopher Ittner says the answer has to do in part with timing. "It might not be important in early stages of your career. You can get by without being able to read a financial statement. But at some point you have to provide financial justification for what you're doing, and you have to make decisions based on numbers that come from other people. If you don't know what you're looking at, and you don't know the right questions to ask, your effectiveness is diminished."

Ittner has been teaching executives the language of business with three other senior Wharton accounting faculty for over a decade in Finance and Accounting for the Non-Financial Manager.The week-long program improves participants' financial literacy and their confidence to enter into numbers-based discussions and ask the right questions of the right people. He explains, "We start with the language of the accounting system: balance sheets and income statements. You learn where those numbers come from, and what they're used for. It is important to understand that the primary purpose of a financial statement is for external reporting. It's put together using a set of accounting rules that can be applied in different ways by different people."

The program then moves into financial analysis. "We teach how accounting works and then overlay that knowledge with the financial decision-making process," says Ittner. "You need to make internal economic decisions, and what you have are financial accounting numbers that are driven by accounting rules. They may not make economic sense for internal decisions. You need to know how they're calculated and have a way to evaluate them before you consider basing a decision on them." 

A fundamental distinction, he says, is that decision-making is forward looking, and accounting is backward looking. Financial statements are snapshots of what has already happened. You may need to go beyond those numbers and get more data to get a more accurate picture of what you can expect to be true in the future.

Ittner provides an example that he's seen many times: "The question is should we make a product ourselves or outsource it? You get a quote from another company for $16 each. Now you need to know how much it would cost for you to make it. The accounting system says $18, so you decide to outsource. But the problem is the higher figure from accounting includes a charge for overhead, which may not change even if you don't make the product. You're paying for the factory, the computers, the salaries anyway. Overhead is the biggest cost for most companies. But how that overhead gets allocated can result in very different numbers. It can be arbitrary, and it prevents you from making a true comparison.

"You need to ask some questions. 'What is the change in total costs if I don't do this? How much is allocated and how much is money I can really save if I outsource? Where did you get that number? What are we trying to achieve? What do the numbers assume?' You need to be informed enough to ask the right questions and gather the right data. Don't blindly rely on accounting numbers."

Ittner stresses the importance of the program for participants who come with backgrounds ranging from marketing to operations to engineering. "Even if they've been exposed to finance and accounting before, they need more exposure. At some point you move up the hierarchy and you need this information. It's not trendy. Accounting isn't a hot topic. But it's the language of business, and you have to learn it."