Finance for Managers
This domain tests financial literacy for non-finance managers: reading the three statements, judging an investment, and explaining a variance without hiding behind the numbers. Items are usually short calculations or interpretation questions rather than full accounting problems.
Three statements, three questions
- Income statement - profitability over a period, on an accrual basis (revenue when earned, costs when incurred).
- Balance sheet - what is owned and owed at a point in time: assets, liabilities, equity.
- Cash flow statement - cash actually moving, split into operating, investing and financing activities. Profit is not cash: a sale on 90-day terms lifts profit today and cash in three months, which is why growing businesses can run out of money.
Investment appraisal
- Payback - years to recover the outlay; simple, ignores time value and returns after payback.
- NPV - discounted future cash flows minus the outlay; positive NPV adds value at the given discount rate.
- IRR - the discount rate at which NPV is zero; can mislead when comparing projects of different size or with non-standard cash flows.
- Break-even - fixed costs divided by contribution per unit (price minus variable cost).
Worked example
A training programme costs 60,000 up front and is expected to save 40,000 a year for three years. At a 10% discount rate: 40,000/1.10 = 36,364; 40,000/1.21 = 33,058; 40,000/1.331 = 30,053. Total present value 99,475; NPV = 99,475 - 60,000 = 39,475, so the project creates value at that rate. Payback is 1.5 years. Reasoning: payback alone would favour a faster but smaller project; NPV converts all three years to today's money so the comparison is like for like.
Traps that cost marks
- Comparing cash flows across years without discounting.
- Including sunk costs in the decision; only incremental cash flows count.
- Mixing profit and cash, or forgetting working capital and tax timing.
- Using IRR to rank mutually exclusive projects of different scale; use NPV.
- Reporting a variance as a percentage without saying whether it is favourable, and why.