FINANCE cash – decreasing inventory, for example,

or reducing days sales outstanding.

Are Your People Financially Literate? We recently worked with a health care
services company seeking to increase its
by Karen Berman and Joe Knight
gross margin, and the first thing we had
to do was help the sales force un-
SENIOR EXECUTIVES ROUTINELY share caught off guard by financial derstand the difference be-
and discuss financial data with market- shenanigans, as many tween making a sale and
ing directors, operations chiefs, and employees at Enron making a profitable
other direct reports. But how much do were. They will be sale. Unfortunately,
those managers really understand about unable to gauge the that’s a widespread
finance? We recently investigated this health of a prospec- problem. Nearly
question, and the news is not good. tive employer. One two-thirds of our
Asked to take a basic financial-literacy of us, Joe Knight, test takers thought
exam – a test that any CEO or junior serves as the chief that discounts
finance person should easily ace – a financial officer of a offered by sales
representative sample of U.S. managers small manufacturing reps had no effect
from C-level executives to supervisors company. He often asks on gross margin. If you
scored an average of only 38%. A major- candidates for engineering don’t understand what
ity were unable to distinguish profit from positions whether they would goes into a number, you can
cash. Many didn’t know the difference like to review the past two years of the hardly know how to improve it.
between an income statement and a company’s financials. None yet have Why don’t people tell their bosses that
balance sheet. About 70% couldn’t pick taken him up on the offer – knowing, per- they don’t speak finance? It’s the usual
the correct definition of “free cash flow,” haps, that they could make neither head human reluctance to admit ignorance. In
now the measure of choice for many nor tail of the statements. a survey of a different sample of manag-
Wall Street investors. (See the sample Financial illiteracy in the managerial ers, we asked what happens in meetings
questions on this page.) ranks can be a crippling weakness for when people don’t understand finan-
Does this lack of financial literacy the organization, as well. Imagine a cial data. The majority chose answers
matter? From individual managers’ point business that is attempting to increase reflecting that reluctance, such as “Most
of view, it surely does. Those who operating cash flow, as many firms are at people don’t ask because they don’t
can’t speak the language of business the moment. Even experienced execu- want to appear uninformed in front of
can’t contribute much to a discussion tives, accustomed to managing a P&L, their boss or peers.”
of performance and are unlikely to may be unaware of the many balance- Karen Berman (kberman@business-
advance in the hierarchy. They may be sheet levers they can pull to affect literacy.com) and Joe Knight (jknight@
business-literacy.com) are principals at the
Business Literacy Institute and the authors
Financial IQ Test (with John Case) of Financial Intelligence:
We developed a 21-question exam called the Financial IQ Test with colleagues at A Manager’s Guide to Knowing What the
Alliant International University’s Marshall Goldsmith School of Management and Numbers Really Mean (Harvard Business
then administered it to a random sample of more than 300 U.S. managers. Press, 2006). For tools that help boost
Here are selected questions, along with the answers given by respondents (pie financial IQ, visit www.financedog.com.
slices indicate proportion of respondents giving each answer). Reprint F0910D

You should be pleased about your A company has more cash today when: To investors and analysts, free cash
company’s financial results if: flow is a key number because:

A) There is a B) There is an A) Custom- B) Accounts A) It reflects B) It is the

negative trend in increasing trend ers pay their receivable the cash that cash that can
operating margin in COGS bills sooner increases is “free” – that be used to pay
is, the company shareholders
doesn’t have to their dividends
pay interest on it
D) Cash flow C) Cash flow D) Retained C) Profi t
Jesse Lefkowitz

is coming is coming earnings increases

D) It is the cash C) It reflects the operat-
from company from company increases
investing operations that investors ing cash that has flowed
have put into into the business in the
Indicates correct answer the business current year

28 Harvard Business Review | October 2009 | hbr.org

1524 Oct09 FT layout.indd 28 9/4/09 12:30:04 PM