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Understanding Financial
Statements: Making More
Authoritative Decisions
E xc e r p t e d fro m

Manager’s Toolkit:
The 13 Skills Managers Need to Succeed

Harvard Business School Press
Boston, Massachusetts

ISBN-10: 1-4221-0523-7
ISBN-13: 978-1-4221-0523-8

5238BC

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This chapter was originally published as chapter 14 of Manager’s Toolkit,
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14
Understanding
Financial Statements
Making More Authoritative Decisions

Key Topics Covered in This Chapter

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Balance sheets

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Interpreting financial statements

Income statements
Cash flow statements
Financial leverage
The financial structure of the firm

W

h at d o e s your company own, and what does
it owe toothers? What are its sources of revenue,
and how has it spent its money? How much profit
has it made? What is the state of your company’s financial health?
This chapter will help you answer those questions by explaining the
three essential financial statements: the balance sheet, the income statement,and the cash flow statement.The chapter will also help you understand some of the managerial issuesimplicit in these statements
and broaden your financial know-how through discussion of two
important concepts: financial leverage, and the financial structure of
the firm.
If you’re a line manager, you might be thinking “I don’t need
to know about that stuff.That’s for senior management, not me.” If
you believe this, think again.The ability to read and interpret financial statements has becomemore and more necessary as accountability and decision-making authority are pushed down to lower levels.
The language of financial statements is also important to managers at
every level. When the conversation turns to “current liabilities,”
“profit margin,”“financial leverage,” and “working capital,” you must
know precisely the meaning of these terms. Indeed, the language of
modern business drawsheavily on the accounting terminology used
in financial statements. Familiarity with the language and meaning of
financial statements will make you a valued colleague in the higher
circles of your organization. For the small business owner-manager,
this understanding of financial statements is an absolute must.

Understanding Financial Statements

3

Why Financial Statements?
Financialstatements are the essential documents of business. Managers use them to assess performance and identify areas in which intervention is required. Shareholders use them to keep tabs of how
well their capital is being managed. Outside investors use them to
identify opportunities. And lenders and suppliers routinely examine
financial statements to determine the creditworthiness of the companies withwhich they deal.
Publicly traded companies are required by the Securities and Exchange Commission (SEC) to produce financial statements and make
them available to everyone as part of the full-disclosure requirement
the SEC places on publicly owned and traded companies.Companies
not publicly traded are under no such requirement, but their private
owners and bankers expect financial statements...