Whether you’re a seasoned finance professional looking for a quick refresher on basic financial concepts or a newbie looking for a guide to breaking into a world full of financial jargon, this book is for you.
A classic HBR Press publication, this book does not disappoint for a single moment. As a commerce student and now a fresher CA, I have had almost 6 years of reading and studying various concepts like working capital, net present value, valuation models, etc. But only after reading this book have I been comfortable enough to understand an entire conversation on capital markets, finance and valuation of companies. While most of the syllabus I have been acquainted with focuses more on a theoretical understanding of concepts and the art of mugging lengthy formulae, “How Finance Works” teaches you about discounting factors by equating it to punishing money for reaching your bank account tomorrow and not today. How fun is that! Further, this book opened up my mind to various questions that I should be asking before punching numbers into a spreadsheet.
The subtitle of this book states that it is the HBR guide to thinking smart about the numbers. Mihir Desai achieves this objective by taking the reader on a steady boat ride through the many tributaries that make up a stream of financial information. We start off with Financial ratios by getting into why we calculate them and what story each financial ratio is trying to tell us about the company. Understanding a financial ratio is as important as deciding whether it is relevant for the specific company you’re trying to gain perspectives on. Financial ratios are more than just Excel formulae: they help you read the body language of the financial statements of a company and figure out whether something is fishy or an outlier. There is a comprehensive illustration in this chapter which can be solved till you feel comfortable enough about applying this knowledge practically.
The next chapter, “The Finance Perspective”, is about cash flows, and how metrics that denote true profitability have evolved over the ages. From solely focusing on net profits to looking at free cash flows, investors’ eyes keep darting around the financials for that one singular number that can give the best possible picture of a company’s future. For the same company, a different story will be told by the net profit trend, the operational cash flow trend and the free cash flow trend. Whose story should we believe then? Is there only a single truth, or are there multiple truths that can co-exist harmoniously? This chapter also contains a brilliant way of looking at working capital cycles which will completely change the way you appreciate DSO/DPO and working capital days figures.
“The Financial Ecosystem” makes a brilliant case for why the financial markets are so complicated, and why it would be foolish for small-time investors to directly get information about a company’s financial position and profitability from the company’s management themselves. I wouldn’t want to dilute the case presented by the author in this chapter, so I would urge you to read it on your own and let me know what you think.
“Sources of Value Creation” is your typical financial management class, but the USP of it is that the author has provided the correct logical flow to understand how CAPM and WACC are more than just formulae to score a quick 2-3 marks in your examination and instead are concepts that can make or break a company. I skimmed through this chapter a bit, having already been acquainted with the concepts in-depth, but I noticed that there was a very good value-add in this chapter in terms of a list of betas for various industries as of 2015 in ascending order. Spending some time over this list may help the reader explore why specific industries are riskier than others, and thus get a deeper understanding of the nitty-gritties of various industries.
“The Art and Science of Valuation” talks about the pros and cons of various valuation models we can all perform in our sleep using Excel. This chapter also draws attention to various mistakes we commonly make when valuing an investment / company / home. While discounted cash flow approach is the default approach to valuation, the author also points out that: “Only by thinking about the future, the cash flows, the capital intensity of a business, and the risk of the business can you truly understand that business.” And isn’t that what valuation is all about?
The last chapter, “Capital Allocation”, talks about a problem that mature companies face: what do they do about the cash that’s on their balance sheet? Give it away to shareholders? Perform a buyback? Invest in new projects? Acquire another company? The author gives a balanced perspective about why each of these ideas can be good ones or bad ones, and what are the factors to be considered when making this decision.
Insights from CEOs of top companies are accompanied with real-life case studies (for example, Michael Dell’s conflict of interest in the 2013 management buyout, Apple’s issue of iPrefs and many more) to make for a practical read. Each chapter ends with a quick 10 question MCQ based quiz, which tests your understanding of the chapter as well as gives you some more food for thought. The answers are detailed and justified in-depth, and make for a very good learning experience.
I used to feel disappointed with the books I had to study in my graduation days because they never really opened up my mind to new concepts and never made me feel like I was taking away something new other than an urge to drown myself in boiling hot coffee. I wish I had found this book earlier in my student life, it would have surely made financial concepts and scenarios much easier to imagine and play around with. I see myself revisiting this book regularly in times of doubt or confusion in my understanding of financial concepts or when I want to sit down and introspect about all the knowledge I could build on this solid foundation of information.
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