STUDY SESSION 7: FINANCIAL LITERACY

7.1 Introduction

In this study session, you will be introduced to the concept of financial literacy and, particularly,

how it relates to startup entrepreneurs. It is very important that startup entrepreneurs have a basic

knowledge of financial concepts, understand the risks associated with finance, and have the

confidence to apply same financial knowledge for informed financial decision-making. Even

though the subject of personal finance is considered important, neither home-based nor school-

based financial education is prioritized. This Study Session seeks to fill existing gaps by exposing

you to different definitions of financial literacy, approaches to promoting financial literacy, the

importance of acquiring financial capabilities for informed understanding of the elements of a

financial report, as well as the usefulness of financial performance ratios. Considering the

importance of the extant dimensions of financial literacy, you will learn how to interpret financial

statement, how to develop a draft of the financial report, and also, how to interpret some basic

financial performance ratios.

7.2 Learning Outcomes for Study Session 7

At the end of this study session, you should be able to:

1. Define financial literacy and its dimensions;

2. Describe the approaches to promoting financial literacy, especially among young

entrepreneurs

3. List and explain some of the basic financial ratios

4. Explain the process for obtaining financial resources for an early-stage venture

7.3 Definitions of Financial Literacy

The recognition of the use of money gained prominence following the realization that trade-by-

barter has numerous disadvantages. For many centuries now, the knowledge of the use of money

has grown significantly so much that we all have a belief in the saying that “money answereth all

things.” Despite knowing that the usefulness of money is immense, there is a growing perception

among men that the ability to make money and count money is not enough. Truly, making and

counting money is not the same as having a sound knowledge of financial management. This was

affirmed in the “Parable of the Talent.” Thus, it is necessary for you as an aspiring entrepreneur

to commit to having a sound financial management knowledge and skill.

What is financial literacy? On the surface, financial literacy can be defined as being financially

literate. In other words, when an individual possesses the basic understanding of money, its

attributes, its associated risks, and how it can be better used for a given purpose, then he/she can

be said to be financially literate. In the days of the Mercantilist, gold was the norm and nations

paid so much attention to the accumulation of gold. In fact, the volume of gold stock determines

the wealth of a nation. After the World War II, nations around the world created their individual

currencies and the coming of the World Trade Organization (WTO) diminished numerous barriers

to trade. Consequently, financial liberalization came to be and investors traded both within and

across borders. The occurrence and reoccurrence of financial crises buttressed the need for more

informed understanding of financial resource management, especially within entrepreneurial

ecosystems.
Financial literacy connotes having financial knowledge. That is, being able to identify existing

financial resources required for the creation of a new start-up. Generally, financial resource is

assumed to be nothing short of capital. In fact, many who are in search of financial resources do

say that they are looking for capital. This should not be a surprise to you at all. Do you remember

the discussion of the factors of production when you were in the Secondary School? You were

taught, then, that there are four (4) factors of production including land, labour, capital, and

entrepreneur. Capital was described to you as the money which an entrepreneur uses to mobilize

both land and labour for the purpose of doing business. Today, the relevance of capital far

outweighs just mobilizing land and labour. It is also used for the acquisition of technology, which

is an important element of production. Indeed, financial knowledge is an important tool for the

sustainability of start-ups.

Talking about the sustainability of start-ups, it is important for aspiring entrepreneurs like you, to

have the requisite financial skills. This is why we also define financial literacy as the acquisition

of the necessary financial skills for improved financial decision-making. Making informed

financial decisions can be very tough. Yet, starting a new venture and managing it effectively

depends on the ability of the entrepreneurs to make informed financial decisions, among others.

Such decisions may include: initial capital requirements, sources of funding (formal or informal),

diversity of equity, etc. As an aspiring young entrepreneur, it is important that you acquire up-to-

date financial skills. This will enable you to know how to explore “other peoples’ money.” In

other words, when you are equipped with requisite financial skills, meeting with potential investors

to discuss funding matters will not be a challenge for you at all.

At this juncture, let us summarize the definition of financial literacy. First, financial literacy means

having the right financial knowledge. Second, it means having the requisite financial skills. It also
means developing appropriate financial competencies, especially with respect to writing draft of

financial feasibility studies, financial performance analysis, and financial reports. When these are

achieved consistently, one can now say that he/she has financial self-efficacy. Besides, a sound

financial knowledge, skills, and self-efficacy helps aspiring entrepreneurs like you to imbibe

positive and progressive financial habits.

7.3.1 In-Text Question (ITQ)

What is financial literacy?

7.3.2 In-Text Answers (ITAs)

Financial literacy is a multi-dimensional subject with at least one definition. It can be described as

the acquisition of financial knowledge for the purpose of making informed financial decisions. It

can also be described as the possession of requisite financial skills in order to be able to manage

scarce financial resources effectively. Financial literacy can also be defined as the development of

financial self-efficacy. In other word, it is the development of broad financial competencies that

can be used to identify financial opportunities, negotiate with potential investors, and seal

profitable financial contracts with interested investors. Overall, financial literacy fosters positive

and progressive financial habits among aspiring entrepreneurs.

7.4 Approaches to Promoting Financial Literacy

Recall that financial literacy is a concept with diverse meanings. In a similar manner, there is a no

unique approach to the promotion of financial literacy. In short, financial literacy can be promoted

through the following mechanisms:

 The use of interactive games

 The use of tutorials and relevant Smart Money Management Tools (SMMT)

 Peer-to-peer mentoring

 The organization of financial literacy contest

 Reformed financial education in schools, etc.

The use of interactive games

Are you aware that the 4th Industrial Revolution (4IR) has come stay? The 4th Industrial Revolution

is the latest among the existing industrial revolution and it stands out for a few reasons. First, it

combines digital tools with machine learning and artificial intelligence (AI) for improved

provision of innovative solutions to lingering challenges confronting man, especially in the

developing world. Second, the 4th Industrial Revolution is also changing the workplace features

and aspirations. Prior to the coming of the 4th Industrial Revolution, desktops and analog working

tools were in vogue. Today, the advancement in technology and increased awareness that task can

be completed within and outside of the office space, several jobs are being threatened. These

notwithstanding, technology is also driving the acquisition of financial knowledge and skills.

Game-based learning tools have been used to enhance the financial capability of teenager and

young adults across the globe. This involves the use of Artificial Intelligence (AI) and other

programming language for the design of specialized tools for simulating financial education and

experiences on the platform of technology. Common game-based learning tools include Bite Club,

Gen i Revolution, Financial Football, etc. The Bite Club for example focuses on promoting

saving habits, debt management, as well as consumption management skills among aspiring

entrepreneurs. The Gen i Revolution seeks to promote personal finance skills among aspiring
entrepreneurs. It has 21 lessons put together and a Financial Rescue Mission engraved in the

Programme. Unlike the two previous games, Financial Football is highly competitive and seeks to

inculcate in aspiring entrepreneurs the essence of money management skills by providing

answers to scenario-based financial questions.

Game-based learning tools are highly interactive and are built on simulation platforms. In the

University of Lagos, we have been using the Global Management Challenge (GMC) to facilitate

entrepreneurship education through simulation. The essence of the GMC is to deepen students’

understanding of the financial ecosystem, improve their financial capabilities, and expose them to

the intrigues of managing firms across borders. The GMC is more matured and it engages students

actively. To be able to participate, students are expected to form teams and together they face the

rigor of managing a firm. So far, participants of the previous editions of the GMC in 2018 and

2019 respectively affirm the benefits derived from the programme. In all, they admit that the

simulation-based learning has, indeed, enhanced their financial literacy.

Smart Money Management Tools (SMMT)

Just like the interactive games, Smart Money Management Tools also seek to promote healthy

financial habits. These tools place premium on orderliness, life-long learning, and healthy financial

choices. They incorporate diverse elements of financing into a wholesome package, that is easy to

use by learners and other aspiring entrepreneurs. Irrespective of a learner’s background, Smart

Money Management Tool is user-friendly. More importantly, they include asset inventory and

liabilities, tracks of living expenses, intrigues of budgeting, debt management skills, finance

advisors, saving, and investment diversification. Common examples of Smart Money

Management Tools include Mint, You Need A Budget, Venmo, Wally, Acorns, etc. Locally,
COWRYWISE is empowering young people like you, to be financially competent through

SMMT (aka Cowrywise App). This is an indigenous company created by a young Nigerian with

a passion to liberate several other young Nigerians from financial illiteracy.

Peer-to-peer mentoring

Financial literacy can also be promoted via peer-to-peer mentoring. This is a form of informal

learning approach to financial literacy. Peer-to-peer mentoring encompasses trusted friendship

where young people of similar age group guide and encourage themselves through choice

experiences. Peer-to-peer mentoring has proven implications for the development of soft skills

among young people. Notable soft skills include reasoning, social, and organizational skills can

be acquired via peer-to-peer mentoring. This can also boost young people’s self-esteem, empathy,

and self-efficacy. Financial self-efficacy is another area that is gaining a boost through the use of

peer-to-peer mentoring.

For instance, in the University of Lagos, the Investment Society is an emerging Association that

uses the peer-to-peer mentoring philosophy to promote financial literacy among undergraduate

students in the University of Lagos. Particularly, undergraduate students teach themselves

financial education and other related financial skills needed to excel in the corporate business

world. Members learn about the capital market, global market, and the application of related

investment concepts in reality. Thus, building the financial self-efficacy of undergraduate student

through peer-to-peer mentoring is the focal point of this Association.

Organization of financial literacy contest

Are you aware that every year, October 31st is celebrated as World Savings Day? This day is set

aside for the purpose of promoting financial literacy education all over the world. In Nigeria, just

like in several other countries, corporate firms organize financial literacy contest on this with a

view to creating awareness. For instance, in 2019, the TrustFund Pensions sponsored a financial

literacy contest where secondary school students in Nigeria were required to discuss “Savings” as

a virtue and followed by practice. The goal of the competition was to promote early saving habits

among young people. This was based on the premise that early savings habit is the password to

financial security in future. Stanbic IBTC Holdings Plc is another corporate firm that has chosen

to promote financial literacy education in the country through financial literacy competition. In

2019, it also organized the maiden edition of the MoneyBee Financial Literacy Competition for

Secondary School students in Nigeria.

Overall, promoting financial literacy through financial literacy competitions is increasing

popularity. It exposes the participants to the basic principles of finance. The interaction with

finance industry experts also exposes the participants to the realities of financial literacy “nuggets.”

Given increasing evidences that teenagers and youths at large are imbibing financial principles

through financial literacy competition, more stakeholders are calling on the government to reform

the educational system and include financial literacy education. Many stakeholders have expressed

concerns that the inclusion of financial literacy education will not only inculcate financial

competencies in young people, it will also help them to appreciate the importance of effective

financial practices.

7.4.1 In-Text Questions (ITQs)

List four approaches to promoting financial literacy among young people

7.4.2 In-Text Answers (ITAs)

Financial literacy education can be promoted among young people through diverse ways. Notable

among these approaches include:

(i) Game-based learning approach

(ii) Peer-to-peer mentoring & informal learning approach

(iii) Sponsored financial literacy competition

(iv) Reformed educational curriculum

7.5 Understanding Basic Financial Ratios

In this section, you will be introduced to four broad financial ratios and their respective types of

ratios. These include: liquidity ratio, solvency ratio, profitability ratio, and efficiency ratio (see

Table 6.5.1). As the names connote, ratio is a mathematical jargon that brings together two

X
different variables with one as the numerator and the other as the denominator. For instance; .
Y

In this case, X is the numerator and Y is the denominator and combined, we can call this “ratio X

to Y.”

Liquidity Ratio

Liquidity ratio is also known as the current ratio. This, in particular, focuses on the short-term

survival of a venture. It provides answers to the question: how well does a venture manage its

short-term bills? Whether we like it or not, there are bills to paid and how well a venture is able

to manage these bills in the short-term also speaks volume. It does not only guarantee the safety

of ventures, it also affirms the flexibility of the venture. As shown in Table 6.5.1, there is only
liquidity ratio and this is the current ratio, which is defined as the ratio of the current asset to

current liabilities. The rule of thumb is that current ratio must be greater than 1 (i.e.

CurrentAsset
 1 ). Please note that this ratio is also called the working capital ratio.
Currentliabilities

Solvency Ratio

Unlike the liquidity ratio, the solvency ratio focuses on how solvent a venture is. Solvency, in its

right, is a measure of cash flow. When the cash flow is steady, it represents stability. As such, one

can say that solvency ratios are measures of a venture’s state of financial stability. There are two

Debt Debt
types of solvency ratios. The first is the ratio and the second is the ratio. In short,
Asset Equity

these ratios are measures of how well a venture can manage its cash flows. These ratios are also

known as leverage ratios. They show how well a venture is using long-term debts to finance its

assets. Ventures with lower solvency ratios are generally preferred because they are deemed to

have the ability to manage their debt.

Profitability ratios

Where does the cash flow of a venture come from? Did you say “from sales?” Yes, the cash flow

of venture comes from its sales. Without sales, there cannot be cash inflow and neither will there

be cash outflows due to purchases of already sold items. In view of these, profitability ratios are

also called margins because they examine the relationships between gross profit, operating profits,

and even net income and the sales of the venture. These imply that there are three ratios involved

Gross Profit
when examining the profitability ratio. The first is the ratio. The second is the
Sales
Operating Profit NetIncome
ratio. And the third is the ratio. Using these ratios, a venture is
Sales Sales

empowered to assess its financial viability as well as its performance relative to other ventures

within the same industry.

Efficiency ratios

This is generally employed to assess whether the operations of a venture are yielding efficient

results. This comprises both inventory turnover and receivable turnover. The inventory turnover is

CostofGoodsSold
defined as the ratio of cost of goods sold to inventory (i.e. ), while the receivable
Inventory

CreditSales
turnover is defined as the ratio of credit sales to account receivable (i.e. ).
Account Re ceivable

These ratios are particularly important. For instance, the inventory turnover demonstrates how long

goods and other commodities stay on the shelf within the venture and these have implications for

the gross profit, purchase habits, and inventory management potentials of a venture. On the other

hand, the receivable turnover focuses on how well a venture tracks its credit sales. When this is

high, it connotes successful management of credit sales and this influences the rating of venture

positively.

So far, we have examined the basic financial ratios, which aspiring entrepreneurs like you are

expected to know. However, we have not discussed the importance of these ratios. Financial ratios

play fundamental roles in the examination of the venture’s performance relative to other ventures’

performance in a given industry. A knowledge of these financial ration helps to boost the financial

self-efficacy of aspiring entrepreneurs in several ways:

(i) It helps aspiring entrepreneurs to appreciate the importance of historical data. Usually,

these ratios are calculated using historical data.

(ii) It helps aspiring entrepreneurs to have better insight of financial statement items, which

are a core of these financial ratios

(iii) It helps aspiring entrepreneurs to analyze the strengths and weaknesses of their ventures.

This is not the same as the SWOT analytical technique. Unlike SWOT techniques, financial

ratios focus on the internal strength and weakness of a venture

(iv) It also helps aspiring entrepreneurs with the estimation of the future performance of a

venture

(v) Finally, it helps to compare a venture with other ventures in the same industry.

Looking through these ten (10) items, did you observe that the four components of the feasibility

studies are included in the Business Plan. This affirms extant views that a business plan is better

written after one has completed the feasibility studies or midway through the stages of

entrepreneurial process.

7.5.1 In-Text Questions (ITQs)

Why are the financial ratios important?

7.5.2 In-Text Answers (ITAs)

(i) It helps us to appreciate the importance of historical data.

(ii) It helps us to have better insight of financial statement items.

(iii) It helps us to analyze the internal strength and weaknesses of their ventures.

(iv) It also helps us with the estimation of the future performance of a venture
 (v) It helps us to compare a venture with other ventures in the same industry.

7.6 Summary of Study Session 7

In this study session, you have explored the concept of financial literacy and its dimensions. We

define financial literacy as having the knowledge, skills, and competence to use financial data for

informed decision-making. As young and aspiring entrepreneurs, a knowledge of financial

resources is key to the sustainable development of a new venture. We also identified a few

dimensions of financial literacy. These include: financial knowledge, financial skills, and financial

self-efficacy. In addition, we examined four broad sets of financial rations – profitability ratios,

solvency ratios, efficiency ratios, etc. The significance of each items of these financial ratios were

also discussed.

7.6.1 Self-assessment Questions (SAQs)

1. The current ratio is also known as ____________

A. Account receivable days

B. Acid test ratio

C. Debt-to-equity ratio

D. Operating test ratio

2. ___________ helps early stage ventures to measure their debt capacity.

A. Debt-to-equity ratio

B. Earning before tax

C. Earning before debt

D. Quick ratio
3. When aspiring entrepreneurs have knowledge of basic financial ratios, they will be able to

_______________.

A. Manage their own business

B. Assess company’s internal strength

C. Use raw financial data

D. All of the above

4. Which of the following is not a common game for financial literacy education? ________

A. Smart I Revolution

B. Bite Club

C. Gen i Revolution

D. Financial Football

5. The ability to use financial data for informed decision making is called ____________

A. Finance expertise

B. Data analyst

C. Financial literacy

D. Auditor

7.7.2 References/Suggestions for Further Reading

Barringer, B.R. (2008). Entrepreneurship: successfully launching new ventures, Pearson-Prentice

Hill, New Jersy, USA, 2nd Edition.

Huston, S. J. (2010). Measuring financial literacy. Journal of Consumer Affairs, 44(2), 296-316.
Liebowitz, J. (2016). Financial literacy education: addressing students, business, and government

needs, CRS Press, New York.

Leach, J.C., & Melicher, R.W. (2009). Entrepreneurial Finance. South-Western Cengage

Learning, USA. 3rd Edition.

Meredith, G.G., Nelson, R.E., & Neck, P.A. (1991). The practice of entrepreneurship. University

of Lagos Press, Lagos, Nigeria.

Stokes, D., Wilson, N., & Mador, M. (2010). Entrepreneurship. South-Western Cengage Learning,

United Kingdom.

Should you require more explanation on this study session, please do not hesitate to contact

your e-tutor via the LMS.