Finance As A Foreign Language

Many of my friends are not “math” people.  They studied social sciences, have degrees in history, or went to law school because, throughout their experiences, there wasn’t an emphasis on math.  As such, their eyes gloss over whenever numbers come into the mix.  Imagine their response when the number phobic asks about that sure-thing stock tip they recently received, and I start talking about how a current ratio under one "gives me pause to how sustainable the growth is given its inventory heavy nature." This sounds complicated and possibly intimidating.

The jargon coupled with the numbers instills fear in people when it should not. Jargon is meant to make something seem difficult and even foreign. It is meant to create insiders and outsiders by simply speaking in tongues. Sadly, jargon in many respects comprises the basic building blocks of the language of finance. 

For instance the current ratio is measuring the firms ability to manage its working capital. What is this bizarre thing called working capital? Investopedia will tell you that working capital is, “...a measure of both a company’s efficiency and its short-term financial health. Working capital is calculated as current assets minus current liabilities.”  This definition presupposes that you know both what makes a firm financially healthy, and what current assets and liabilities are.  Working capital is the gas in the fuel tank of a company. It is a way of seeing if the firm has enough cash coming cash in to cover their day-to-day operations. If there is not enough gas (working capital) then the car(company) won’t run.

An asset is something a business owns. A liability is something a business owes. A current asset is something that you own that you can reasonably expect to consume during a business’s fiscal year. Conversely, a current liability is a debt a business will pay in that same fiscal year. 

Math simplified. Jargon demystified.

The complexity of the concept grows, as you may presume, when a deal attorney documents working capital requirements in a purchase agreement; or when an investment bank analyzes the impact of a firm's working capital on potential capital structures. Yet it all falls back on the fundamentals of what working capital is and how it impacts a business.

Learning a language can be difficult but there are tricks to it.  Native Japanese speakers often find it hard to learn a foreign language. The standard process of learning grammar rules and phonic sounds falls short in turning instruction into an actionable skill. Successful language teachers in Japan provide a third ,queue by instructing the placement of the tongue, which allows the student to learn the basics in a more easily applied manner.

The way Private Equity Primer sees it, when teaching the language of finance, a good instructor not only tells you to replicate the sounds and practice the grammar rules, but he or she will simplify things for applied practice. We walk our students through cases to demonstrate what the impact of working capital will have on the total valuation of a deal, in a technology business versus a mining business. We empower our students to see how the definitions of working capital affect potential clients by stripping away the jargon and seeing how the pieces fit together, and how the language of finance sounds in practice.

In the coming weeks Private Equity Primer will post more on the topic of networking capital and its considerations in transactions. Keep coming back to see how our Deal Sherpas lead deal professionals to the next summit of performance.

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