Learn the finance lingo to save your product

It has never been a better time for the tech product manager to learn finance!

TL;DR

Money is becoming more expensive, you have to understand your product’s Capex and Opex to keep it off the chopping block of the finance department.

Most tech product managers either don't know, don't care, or are afraid of a finance discussion. I always felt that is a miss. The only people I have met who can match and beat finance in their own games are developers or product managers.

Product managers prioritize for a living — be it qualitatively or by using scoring, that is what we do.

Developers connect modules and services and understand that every action has a reaction, every synchronous call has to be answered.

That is how accounting and finance work.

You are already doing this — your home or project budget

To understand the language all you need to do is compare the product’s budget to your day-to-day finances. If you manage a budget, at home or on the job, you are already doing it.

Fancy accounting language and financial terms were invented so investors would be able to compare companies and choose where to invest their dollars. To know how to use it, all you need to do is cover the basics.

As a PM, you don't have to be a designer, but need to know enough to talk with designers.

You don't have to be a developer, but need to know enough to have an intelligent conversation about implementation.

Understand the basics of Cash flow statement, balance sheet, and income statement and you are able to engage your finance department the same way.

The cash flow statement is your checking account

You use your checking accounts to make payments and receive payments. Each of these payments takes money out or puts money in — these are all impacting how much money (how much cash) you have in your checking account.

The checking account statement is the cash flow statement. Ins and outs. Your product has a checking account within your company (might be called a GL, or general ledger) and that is how its expenses are funded.

The balance sheet is what you own and what you owe

In most simple terms, whatever you owe and own will appear on the balance sheet.

A balance sheet is a dated statement of your assets and debts. A snapshot of the value of your assets and liabilities (the money you owe) at a given point in time.

For example, if you have a house with a mortgage on it and a car with a car loan, your balance sheet will show:

House + Car = Assets

Mortgage + Car loan = Liabilities

Because you put a downpayment on the house and have been making payments, your loans will be smaller than the value of the actual assets (your mortgage will be smaller than the value of the house and the car loan will be smaller than the value of the car).

So Assets>Liabilities. The difference between them is what you actually own, your net worth: Equity.

Equity + Liabilities = Assets

For your company, it works the exact same way. The company will have loans (from the bank) and will have equity (such as VC funds, angel investments, or funds it earned over time). Those will buy assets (computers, offices, intellectual property, etc.).

The developed product you are building and managing will appear on the asset side of the balance sheet —it might be the intellectual property of a long-term asset (software).

The income statement — a summary of all value changes in a given period

A cash flow statement is rather straightforward (you really cannot argue much about the transactions on your checking account, they are either there or not).

The balance sheet adds more complexity as it details estimated values of assets (your home price changes all the time, your car value drops constantly, market investments fluctuate, etc.).

To summarize the cash flow statement (actual cash transactions) and the balance sheet value changes, the income statement comes in as a summary.

If your house value increased by $20k from the last time the balance sheet was looked at to now, the income statement will show an “on paper income” of $20k from housing.

If your car lost $5k in value since the last time the balance sheet was looked at, the income statement will show an expense of $5k on cars during this period.

To all those value changes on the income statement, we add the cash flow transactions. There will be two ways to add them:

Operating expenses — Opex: these are copy-paste from the cash flow statement into the income statement.
Capital expenditure — Capex: these are things you bought with cash, and get the value over time.

Capex is important

Capital expenditure or Capex means “Investment”. It basically means “I spent the money now (cash), and get the benefit over time”. The best analogy I found to explain it is installment payments.

As an example:

Person A buys the new iPhone with one lump sum payment. They will use the iPhone for 2 years and then upgrade.

Person B commits to their wireless provider and pays the cost of the iPhone in steady monthly payments for 2 years.

If you look at both of their checking accounts, Person A will seem like they spent a lot of money in the first month, and then nothing for two years.

Person B will seem like they are spending regularly every month.

Both of them basically spent the exact same amount but they appear totally different.

Person A will seem very unreasonable when it comes to money in the first month; will appear as a big spender.

Person B will seem reasonable throughout the period with a smooth stream of regular expenses.

To close this gap, the “depreciation & amortization” of assets on the income statement were born. In less fancy terms: Installments.

If you build Person A’s balance sheet, you will put the iPhone in what they own, and every month reduce the value of that iPhone by 1/24 of its value (2 years, 24 months). On their income statement, you will show that as an expense of the same amount (1/24 of iPhone value).

For Person B you don't have to do much as every month they are spending hard cash for the iPhone for 2 years. That will appear as a “copy-paste” expense in their income statement.

What we just did there is make the lump sum an installment payment for Person A.

Person A bought an iPhone in one lump sum, but we “faked it” on the income statement and called it installments over 24 months— this is called Capex: taking an expense, calling it an investment to buy an asset, and then depreciating it (installment payments) over time.

Capex spreads the expense on the income statement over time (no single big iPhone payment) and avoids a large single drop in profitability as depicted on the income statement.

Relating it all back to your product

Your developers will build software. Your designers will design a great design. The impact on the cash flow (the checking account) will be their paychecks or any money you paid a 3rd party outsourced development or design shop.

These are all the “iPhone payments” of person A.

You pay in cash now, for an asset that will depreciate over time (let’s say 2 years till your product is obsolete, just like the iPhone).

If your finance department calls your expenses Opex (expense now), all of it will hit the income statement at once and your product will look more expensive. Your product will look like person A, unreasonable — not profitable for this period.

As profitability is back in vogue, it will risk your product’s viability.

As PM, you should convince your finance department to put as much of your product costs as possible as Capex.

Think of it as finance is the bank and you have limited a budget and want to pay in instalments for all your development work.

For example:

Your product requires an external development team to augment your current development team.
That SOW (statement of work) can be considered Opex or Capex.
If you call it Opex, it is “consulting fees” and will hit your product’s profitability all at once — making your product look less attractive than other products for this period.
Any other product that didn't have that SOW will look far more profitable for the period — if management needs to select a product to discontinue, it might be yours.

As an alternative to that scenario, convince finance that you are investing by spending these funds on the SOW — it is Capex. You can have them reflect it on the income statement as installments for 24 months and smooth out the hit on profitability.

At least 50% of your product’s development cost should be Capex. Your finance team will force you “to expense” (to call an expense Opex) when it comes to your QA and UAT work as will claim you are not generating an asset there.

If you build something innovative, you might be able to claim almost 100% Capex.

Finance requires you, the PM, the expert on the product, to give the proper guidance for each expense — if not, your product expenses will be set for you while another PM will be prioritized as their profitability will appear higher.

This article was originally posted on Medium.

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Money is more expensive — learn the finance lingo to save your product