I expected this chapter would be either a snooze or a chore – having read accounting principles since I started learning about business, and having been through 1500 of 2200 ASX-listed small cap companies, I’ve read and interpreted more financial statements than some people have had hot dinners. But I found this chapter to be the most enlightening chapter in the book, and perhaps the only one I will review, because it yielded a simple insight.
The chapter starts out with the simple A = L + OE equation, then dovetails into financial ratios. The point is quickly established that while a CPA would follow a process to create accurate financial statements, an MBA’s skill is to use financial statements to understand the story that is being told. An example is given of a statement of cashflows, and the reader is then asked to read the financial statements to determine whether the business is living or dying. In other words, to interpret the financial data to determine what is really going on.
I have always thought financial ratios were a bit of a chore. While some ratios such as return on equity made perfect sense to me, were easy to figure out and were highly useful once applied, I never really understood the need for calculating asset turnover per period, or return on sales.
But what became clear to me through reading this chapter was that the life or death of a business is foreshadowed by the change in financial ratios.
It’s the way that the individual ratios change over time that is the best indicator of good management. One needs to calculate the ratios not just at one snapshot, but to view them across multiple sequential snapshots, in order to divine whether management and market conditions are determining success.
This goes to the heart of what I was actually trying to achieve by reading a book like this: is an MBA worthwhile? If I study an MBA, what will it teach me?
Good management effects a positive change in select financial ratios. That is the purpose of MBA training. That is what business administration actually hopes to achieve.
