Three Financial Principles Every Professional Should Understand

Finance can be intimidating to someone who does not have a financial background. Finance's true significance can be lost among the formulas, financial statements, and spreadsheets.  

Financial principles can enable business professionals across industries to gain a deeper understanding of their companies’ financial health, how to measure created value, and how to best communicate with shareholders.

Here are three financial principles business professionals should know, no matter their industry or role.

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Why Learn Financial Skills as a Non-Finance Professional?

As a business professional in a non-finance role, learning finance basics can help contextualize your work within your company's broader benchmarks and goals.

With knowledge of financial principles, you can advocate for projects' expected return on investment (ROI), articulate the financial impact of your team’s work, and make strategic business decisions with maximum value creation in mind.

Additionally, it can make for more productive interactions with your firm’s finance and accounting department. Finance is often called the “language of business,” and speaking it can increase collaboration and communication across teams.

3 Financial Principles All Professionals Should Know

1. Cash Flow

Cash flow—the broad term for the net balance of money moving into and out of a business at a specific point in time—is a key financial principle to understand. There are several types of cash flow:

Operating cash flow: The net cash generated from normal business activities

Investing cash flow: The net cash generated through investment activities

Financing cash flow: The net cash generated from financial activities, such as debt payments, shareholders’ equity, and dividend payments

Taken together and detailed on the cash flow statement, these cash flow types paint a picture of the net cash flow that occurred over a specific period.

There’s one more type of cash flow that’s important to know: free cash flow. Free cash flow is the net amount of cash left over after taxes are paid; depreciation, amortization, and changes in working capital are accounted for; and capital expenditures (property, equipment, and technology investments) are subtracted. In short: It’s the cash left over that doesn’t need to be allocated anywhere.

Understanding cash flow types can help conceptualize which buckets your expenses fall into, provide context for budgeting, and offer insight into how your expenses and revenue factor into your company’s financial health.

2. Time Value of Money

Finance is inherently forward thinking and describes a company’s current position based on its trajectory. The time value of money (TVM) is a core financial principle that states a sum of money is worth more now than it will be in the future.

Because of this, a specific sum of money’s value is dependent on how long you must wait before using it. The sooner you can use the cash, the more valuable it is.

The longer you must wait to use it, the more chances you miss to return your investment. To account for this when valuing a company, discount future cash flows to reflect their present-day values. Desai calls this the “gold standard of valuation.”

To calculate TVM for a sum of money, use this formula to solve for its future value (FV):

FV = PV x [ 1 + (i / n) ] (n x t)

In the TVM formula,

FV = the future value of cash

PV = the present value of cash

i = interest rate

n = number of compounding periods per year

t = number of years

If you’re in a non-finance role, chances are you won’t need to calculate TVM or discount cash flows yourself, but understanding the time value of money can enable you to make decisions based on it.

3. Risk and Return

One central question finance tries to answer is “How do you create value?” Both the time value of money and cash flows add perspective to this question: Value is created in the relationship between money and time, and when all allocations are accounted for.

An alternative perspective on value creation comes from another financial principle: risk and return. It’s a concept you’re likely familiar with: To see returns, you often need to take calculated risks. This is closely related to the concept of return on investment, which is the net amount of cash after the initial investment has been subtracted.

The level of risk associated with investing in an asset dictates the level of return you can expect from it. The minimum viable return on an asset in relation to its cost and risk is called cost of capital.

Imagine your business is considering purchasing a cutting-edge piece of technology that would increase production speed and quality. The only problem: It’s incredibly expensive. You predict the ROI will be worth it and use loans and equity from outside sources to purchase the technology. The sources that provided your company with the capital to make this purchase take on a fair amount of risk. What if the technology doesn’t improve quality enough to increase revenue and justify the purchase?

The cost of capital is your financing sources’ minimum requirement for the return on their investment; it’s what they demand in return for taking on a high level of risk. When pooled together, the cost of capital for all of your capital sources is called the weighted average cost of capital (WACC).

Again, if you’re not a finance professional, you likely won’t need to calculate these values. However, understanding the costs associated with higher-risk projects and the need to deliver a minimum ROI to stakeholders can be valuable as you budget, request funding for projects, and strategize around long-term investments.

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Launching Into Finance

Each of these financial principles provides a piece of the puzzle for conceptualizing a company’s financial health, the direction it’s headed, and how you can create value. By understanding how these pieces operate and fit into the larger whole, you can have conversations with key stakeholders and make informed decisions regarding your business’s future.

After learning about these basic principles, what questions arise regarding how your company is valued, tracks finances, and makes decisions? Use this primer as a launch pad to explore more of what finance can offer to your career.

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