Measuring your financial literacy

Have you ever sat in a meeting and tried to bluff your way through the numbers? When the finance person starts talking about margins, right-of-use assets and return on equity do your eyes glaze over?

Do you struggle to explain the difference between profit and cash flow, capex and opex or depreciation and amortisation?

Having worked in banking and delivered financial training for over 35 years, my experience is that over 80 per cent of people working in organisations would answer “yes” to one or all of these questions.

A lack of financial literacy underpins poor financial acumen. Poor financial acumen undermines your business acumen. Strong business acumen across the organisation helps achieve success and avoid failure.

Let me explain what I mean. Business acumen is about making better decisions. To make better decisions you need to understand the four pillars of any organisation: people, operations, stakeholders and finance.

Whilst the first three can be learned through experience, intuition and observation; financial acumen requires you to understand numbers. This is financial literacy!

If you don’t understand what the numbers mean, where they come from or why they are important, then you are not realising your current potential and more importantly, limiting your future opportunities.

When starting a workshop on finance I get participants to take a quick, 10-question multiple-choice quiz to determine their level of financial literacy. Take the quiz to get an indication of how well you understand the figures.

Financial literacy quiz

Answer each of the following questions by selecting one of the multiple-choice answers.

1. The balance sheet measures:

a) Profitability
b) Cash
c) Assets, liabilities and equity
d) All the above

2. When you make a sale on 14-day payment terms it ends up on the profit and loss as revenue and as what on the balance sheet?

a) Accounts receivable
b) Non-current liability
c) Non-current asset
d) Accounts payable

3. What is most likely to happen when an organisation’s revenue exceeds its expenses but collections from clients are slower than payments to suppliers?

a) The organisation is okay because profits always become cash
b) The organisation needs to shift its focus to EBITDA
c) The cash flow statement will show a negative bottom line
d) The organisation stands a chance of running out of money

4. How is a return on equity % calculated?

a) EBITDA/equity
b) Gross profit/sales
c) Net income/equity
d) Sales/equity

5. Which statement summarises changes to the balance sheet?

a) Cash flow statement
b) Income statement
c) Neither of the above
d) Both of the above

6. EBIT is an important measure in companies because:

a) It is free cash flow
b) It subtracts interest and taxes from gross profit to get a truer picture of the business
c) It is the key measure of earnings before indirect costs and transfers
d) It indicates the profitability of the organisation’s day-to-day operations

7. Capital expenditure (Capex) includes all the following except:

a) Repairs required to bring a new item of plant into working order
b) The cost of preparing a site for a new item of plant
c) General repairs and maintenance to equipment
d) Both a) and c)

8. Equity in an organisation increases when the organisations:

a) Profits are greater than any dividends
b) Increases its assets using debt
c) Decreases its debt by paying off loans with cash
d) All the above

9. Which of the following will increase an organisation’s level of cash in the bank:

a) Accounts receivable days decreases
b) Profit increases
c) Accounts payable days decreases
d) Retained earnings increases

10. Which of the following is not part of working capital?

a) Accounts payable
b) Inventory
c) Plant and equipment
d) All the above are part of working capital

Financial literacy quiz answers

1. The balance sheet measures:

c) Assets, liabilities and equity

The profit and loss (aka income statement) measures profitability and the cash flow measures cash in and out of the business.

2. When you make a sale on 14-day payment terms it ends up on the income statement as revenue and as what on the balance sheet?

a) Accounts receivable.

Non-current liabilities are when the business owes money to others and it is not payable until after 12 months. A current liability is owed to others within the next 12 months. One such liability is an account payable – where you owe money to your suppliers. A non-current asset does not turn into cash within the next 12 months.

3. What is most likely to happen when an organisation’s revenue exceeds its expenses but collections from clients are slower than payments to suppliers?

d) The organisation stands a chance of running out of money.

Profits do not always become cash due primarily to the timing differences between sales and receipts and payments and expenses. EBITDA is a measure of profitability and does not impact collections or payments.

In this scenario the cash flow statement may show a positive bottom line due to cash from selling assets (this is not revenue) and/or cash related to the financing of the business (e.g., new loans or share issues).

4. How is a return on equity % calculated?

c) Net income/equity.

This is the formula that shows for every dollar of equity how much profit the business makes. It allows comparisons of returns between businesses and industries. When balanced with risk and potential it can drive shareholder decisions to buy or sell their shares.

5. Which statement summarises changes to the balance sheet?

c) Neither of the above.

The cash flow statement explains how one balance sheet item (cash) moved from its opening amount to its closing amount in the balance sheet. The income statement shows how the retained earnings amount in the equity section of the balance sheet moved because of the year’s trading. Neither summarises changes to the entire balance sheet.

6. EBIT is an important measure in companies because:

d) It indicates the profitability of the organisation’s day-to-day operations.

Earnings before interest and tax (EBIT) appear in the Income Statement, so it is related to revenues and expenses, not cash flow. It does not subtract interest and tax from anything, as the acronym says it is before interest and tax are subtracted.

The acronym makes no mention of indirect costs and taxes. Because interest and tax are not 100 per cent controllable by day-to-day decision-making inside the business, it is often used to show the performance of the organisation’s day-to-day operations.

7. Capital expenditure (Capex) includes all the following except:

c) General repairs and maintenance to equipment.

Capex includes the cost of acquiring and bringing into working order a non-current asset. This would include repairing, calibrating and installing that asset to get it working. It would not include general ongoing repairs and maintenance to that asset – they would be classified as Operating expenditure (Opex).

8. Equity in an organisation increases when the organisations:

a) Profits are greater than any dividends.

When profits are greater than dividends the retained earnings figure in equity will increase. Mathematically the balance sheet is a representation of the formula: Assets minus Liabilities = Equity.

An increase in assets matched with an increase in debt will not change equity. A reduction in the asset cash matched to a reduction in the liability of loans will not change equity. Equity could also be increased by issuing more shares or an upward revaluation of assets.

9. Which of the following will increase an organisation’s level of cash in the bank:

a) Accounts receivable days decreases.

An increase in profit may not translate to more cash primarily due to timing differences between revenues and expenses and cash inflows and outflows. A decrease in accounts payable days means you are paying your suppliers more quickly – this will reduce your cash.

Retained earnings are driven by profit – this is not cash. A decrease in accounts receivable days means you are collecting what is owed to you more quickly – resulting in more cash in the business.

10. Which of the following is not part of working capital?

c) Plant and equipment.

Working capital is the difference between the assets that will turn into cash in the next 12 months (current assets) and the liabilities that need to be paid in the next 12 months (current liabilities).

Plant and equipment in the normal course of business do not turn into cash in the next 12 months – they are non-current assets, hence not a part of working capital.

How did you go?

Having administered this quiz to hundreds of people, the average score before any training is 3 out of 10. With some good training, the average jumps by between 3 and 5 points.

This base level of financial literacy then encourages people to go back to the workplace and ask more questions, have better discussions and ultimately make better decisions. Depending on your needs, AIM WA offers three workshops that will improve your financial literacy:

Accounting Essentials
Finance for Non-Finance Managers
Accounting for Non-Accountants

Take the plunge and unlock your full potential by registering in one of them today.