How To Explain Finance In Simple Terms

Davide Falco, Vice President Of Finance At Nexans

Davide Falco, Vice President Of Finance At Nexans

Davide Falco is a Finance Executive currently covering the position of Vice President of Finance at Nexans Transmission. After graduating in Economics and Business Administration, Falco started his career with General Electrics, where he developed as a Finance professional over more than 20 years, covering several global roles, including Internal Audit, Financial Planning and Analysis, Project Controlling and Regional CFO.

Recently, I had the great opportunity to hold a teaching session at the Finance Academy for all GE employees in the Baden office. The majority of the audience had an engineering background, so I challenged myself to explain the basics of Finance in a straightforward way that anyone could understand while also trying not to get them asleep.

So, I came up with an idea. Explain the three financial statements (Income statement, Balance sheet and Cash Flow Statement), making an analogy with a very simple physics principle of the communicating vessels. Precisely, the communicating vessels! You might recall that primary school experiment: put two containers on the same base level, connect them with a tube and no matter how much water you pour into one vessel vs. the other, the water will always flow from one to another until balancing out to the same level in the two containers so that at the end you will have the same quantity of water in each vessel. Well, I thought, this is exactly how the financial statements interact between them! So, I scratched on a piece of paper a diagram like the one you can see in the picture: On the left-hand side, you have the Income statement vessels (Revenue and Expenses) and, on the right-hand side, the Cash Flow statement vessels (Cash-in and Cashout). Both are connected by a system of connecting tubes (Revenue connected to Cash-in; Expenses connected to Cashout) representing the balance sheet.

“A Company Must Carefully Manage The Flow Of Money Between Revenue, Balance Sheet Accounts And Cash—Just Like Ensuring Water Doesn’t Stagnate In Davide Falco One Part Of A System”

I put some bubbles on these tubes to represent the main balance sheet accounts. And the game is on. A company recognizes revenue (representing pouring water in the Revenue vessel). Revenue will start flowing through the balance-sheet accounts (those bubbles positioned through the tubes) until they end up in the Cash-in vessel. The flowing process might take some time until it settles, but in the end, you will have the same amount of Revenue and Cash-in perfectly balanced in the two vessels. The Revenue will have a first stop in the bubble called Deferred Assets (at this stage, let's say the revenue is recognized, but the company hasn't yet received an invoice). Then, they will flow to the second bubble called Account Receivable (now the invoice is received) and finally into the cash in the bank (once the invoice is paid). The analogy works perfectly with any flow between Profit, Balance and Cash. Simple.

The session went very well. The audience got very engaged, and the communicating vessels diagram helped me make them understand the importance of a company managing the water flow between the vessels and avoiding stagnant water in one of those bubbles. The conversation gradually elevated to more technical topics like the importance of inventory management, past due reduction, coordinated payment terms between suppliers and customers, the consequences of a too-aggressive revenue recognition policy and so on.

So, here is my humble suggestion: When explaining a concept that appears complex to people who don't have the same knowledge as you, avoid technical vocabulary and acronyms and always start with an analogy from a very different domain more familiar to the audience. Put yourself in their shoes and speak their language. Afterward, as Einstein said, “If you can't explain it, you don't understand it well enough.”