In This Chapter
䊳Seeking the true simplicity of financial measures
䊳Figuring out how finance helps you understand performance 䊳Fitting it all together
F
inancial measures have been the backbone of companies for decades, consistently reporting on balance sheets, income statements, and cash flow. We see them in every industry, in every form of business — large and small. Financial measures are used by business leaders to make key deci- sions, and to determine the financial status of a company or business.When we ask CEOs and COOs what plans they are making for the long-term future, we get great answers, about having a shared vision, compelling mis- sions, clear direction — everything a growing company would need to suc- ceed. However, when we ask mid-level managers the same question — and especially when we ask the folks who make, buy, assemble and produce the products shipped to customers — we get answers more along the lines of
“We don’t know what the company has in mind for the future,” or “I’ve got no idea, I just work here.”
Startups never have this problem. They always know exactly where they are going, and they can’t wait to get there. Everyone is involved, and everyone has the same razor-sharp focus on where they are going, how they will get there, weaknesses they have to overcome, and a plan for their own path for the future. Such cohesiveness is indicative of shared clarity in direction, and a common understanding of the road it will take to achieve the organization’s goals, both by overcoming weaknesses, and by learning from others who have already been there.
As you might guess, there are countless considerations, criteria, and reasons for selecting specific financial measures. To be effective in planning and achieving your goals and objectives, we must determine what we need from this sea of financial confusion. In this chapter, we start by identifying key
aspects of financial measurement, the opportunities available, and how you ensure your measures align with the company’s strategy and direction.
Five Things You Must Know About Financial Measurement
Financial measurement—just those two (not so little) words can give us the chills, and even make some people break out in a cold sweat. Others simply run away in fear, or ignore them—hoping they will go away. But, we need not fear financial measures, and if we can learn not to fear them, we can discover their power, and use them to help us make crucial, strategic and tactical deci- sions for our business, and for the future.
Here’s the good news: Most of the financial measures we need involve only simple addition and subtraction, with some minor division thrown in every once in awhile to keep you on your toes. In fact, if the financials are toocom- plicated, they are probably not helpful to you anyway.
Your financial measures must be accurate and highly dependable
Well, duh! But, you would be surprised how often we have found actual finan- cial measures in use by companies that are not only inaccurate and even inconsistent, but calculated differently, and with wide variations in rules and assumptions about the numbers and what they are supposed to do.
For example, we have seen:
⻬Different assumptions in different countries and regions about what to include in gross profit calculations, and what determines a variable cost.
⻬Within a region, different definitions for the same terms, such as date of invoice, cost of capital, and even what constitutes a receivable or payable.
⻬Different operational assumptions region to region regarding cost of goods sold, and where to put accruals and depreciation, and what con- stitutes a capital asset.
This often happens when we acquire different companies and expect them to integrate seamlessly. It can also happen when we employ different leaders and managers with widely different backgrounds, and do not indoctrinate them into our financial measurement system. If you don’t teach what your system is all about, most employees will default to whatever they used at a previous
employer — which may or may not resemble your company’s approach. The result? Disparate systems, incongruent data, and an inability to make clear, meaningful decisions. Not exactly the outcome most of us would prefer.
For you to be able to make clear, unambiguous decisions based on depend- able data, you will need to first ensure your measures are accurate and highly dependable. If they are not, then you must resolve this issue first — before any other issue you might have. Without clean consistent measures, you will not be able to make key decisions about the business accurately or effec- tively. You can do this through several ways:
⻬You can ask each business unit leader to do this too, within his/her busi- ness unit, with each department, again for the same reason and desire to have consistent measures.
⻬Once the business unit leaders have provided assurances that their finan- cial measures are consistent across their units, you can get the general managers together — with their financial advisors — and conduct a work- shop to sort out what the standard way to calculate each financial measure should be. Have them convert to this new standard right then and there — together with their financial managers — documenting the changes they will need to make to ensure consistency across the business units.
⻬If there is huge time pressure, you can also ask for an explanation of the calculation of each of the business financial measures you are using, and with the aid of a financial expert, run a comparison to see where differ- ences are, how different they are, and the adjustment required to make them all consistent with what you need. If you do this, you will need to send it back out for agreement and approval from the business units, to ensure they will buy into and support and work with the standard finan- cial measures.
If you want the buy-in, support, and even the ownership by your company’s top management team, you will need to be sure to include them in the process of selecting financial measures. Many companies make the mistake here, defining the measures for the company without input or involvement of members of management, usually resulting in disconnects in measuring per- formance, and finger pointing, blame, back stabbing, and other nasty behav- iors all meant to justify why objectives were not met. Take our advice: It’s much better to get management involvement and engaged in developing the key financial measures you want everyone to use.
Your financial measures must truly reflect the value of your business
The ultimate goal is to make sure that the financial measures you are using reflect the total value your company is providing, in terms of speed, quality,
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Chapter 8: Understanding Your Role in Financial Management
and delivery, to result in higher sales, margin, and cash. It is easy to get off track, what with the different ways we can define revenue (usually at time of delivery, not necessarily when we get paid), cost (usually amortized instead of when actually incurred), and cash flow (easy to mistake for accounts receivable less accounts payable, cash management incorporates invest- ments as well as payments schedules.). Fortunately, there are some things you can do to help ensure your financial measures reflect the value your company is providing:
⻬First, be consistent in defining your assumptions and calculations. For example, date/time of delivery, invoice date, gross and net profit, and working capital. This does not preclude you from taking advantage of legal variations, just pick one and be consistent across your business.
⻬Demystify and simplify your financial measures, by selecting simple, effective and easy to understand terms.
⻬Be clear about what is included above and below the line, or the gross profit number. “Above” usually are sales, cost of goods sold (COGS) numbers. “Below” are the operating expenses, and interest and taxes.
Remember: Being consistent is key to managing those factors above the line, which usually vary a bit more than the others.
⻬Be clear about just what sales, COGS, cost of services (COS), and operat- ing expenses are. For example, operating expenses are those costs not directly related to making the product or delivering your services.