Bay’s size, actual return on investment has been significantly neg- ative on an inflation-adjusted basis.
And recent performance indicates that the company’s man- agement still seems to have an inadequate understanding of cash flow. After spending a bundle to acquire Kmart of Canada, the company had little cash left for the major remodeling its aging stores required to appeal to today’s fashion consumers.
These buyers are critically attuned to their total shopping envi- ronment and experience. The Bay must also deal with the cash implications of keener competition in electronics, appliances and other product lines taken over by giant, low-margin spe- cialty retailers. The implications affect not only price but also inventory risk. What’s a company to do?
One response has been to beef up customer service at the retail-sales level. It may be too little too late, but at least the company is trying. One element of the plan is somewhat hit or miss, but it is moving in the right direction: The company is rewarding good service on the retail-sales floor, as identified by mystery shoppers, with cash bonuses.
Your company may not have the age or the size or the problems of the Bay, but the simplicity of immediate cash is still a well-understood concept at the most basic level of employ- ment. Those cash bonuses reinforce a simple truth: Better cus- tomer service generates more cash, and the company is willing to share some of that cash with deserving employees. Let’s now take a more systematic view of the relationship between cash flow and motivational systems.
Goals and Rewards
Bonuses, rewards, commissions and other compensation-plan elements have long been tied to traditional targets such as sales volume and output levels. Once the cultural shift to cash-flow thinking and cash-driver language begins to take hold, the next step is to begin setting cash-flow goals at the level of each sig- nificant organizational unit or individual in the company—and then to fully link the goals to the compensation system. People tend to produce what they are measured on and compensated for. As the cash-driver mindset begins to capture and redirect
some of your thinking in the course of reading this book, keep in mind this motivational aspect.
In organizations of all sizes, the cash-flow motivational shift is on. In 1998, Pepsico introduced a change for senior division- level managers whose long-term compensation had previously been tied to profit. Under the new
plan, the compensation linkage is tied more directly to three-year cash-flow targets in their divisions. The purpose in Pepsi’s case isn’t a survival issue, as it might be with smaller companies.
Rather, it is the conviction that share- holder value is really much more closely related to cash flow than to earnings. Entrepreneurs often under- stand this at a gut level, but they aren’t always very good at tracking it and liv- ing by it. Corporate-management peo- ple may not have that entrepreneurial gut instinct about cash flow that comes
from concern for the company’s survival, but they learn really quickly when the survival of their bonus is suddenly at stake.
The fact that a large conglomerate like Pepsico has shifted the compensation plan of division managers to reflect cash flow may not seem particularly relevant if your firm is a small one, but here is why it is: The Pepsi division manager has the best shot at making her numbers when she has learned how to get every key manager up and down the line to think in cash- flow terms. If those managers are effective, they pass that cash-flow mindset on throughout the organization. At some point, this could mean that there is a bonus for the accounts- receivable clerks responsible for following up on past-due invoices from bottlers. Getting those accounts receivable down by just one day’s worth from the division average might be worth 1.5% extra in next month’s paycheck. Keep it down for three consecutive months and there could be an additional 1.5% quarterly bonus. That’s a cumulative 6% raise for the quarter—maybe enough for the first and last month’s lease payment on the new car. The cultural transformation made
Once the cultural shift
to cash-flow thinking
and cash-driver language
begins to take hold, the
next step is to begin
setting cash-flow goals
at the level of each
significant organizational
unit or individual in the
company—and then to
fully link the goals to the
compensation system.
possible by combining new language with new incentive and goal-setting systems can create real value for shareholders at Pepsico, and it can do the same for your ownership group.
The shift toward cash-flow–based goals and incentive sys- tems isn’t just some faddish management technique. It is based on a major new understanding of company value that is permeating corporate America—
a recognition that cash-flow man- agement, throughout the organiza- tion, is linked even more closely to shareholder value than earnings are. The reasons have to do with issues that relate more to capital allocation and management motiva- tion systems than to mere survival.
When those corporate concerns are applied to smaller firms, they may be even more relevant because of the greater scarcity of capital and the greater risks inherent in the smaller business.
Ideally, if your people are given a basic education about the signifi- cance of the cash drivers—and if those cash-driver terms are integrat- ed into the language of your internal communications—things will begin to change. And as they do, more adaptation to cash- flow thinking becomes possible. Important documents such as job descriptions and performance reviews can be tied to the cash-driver model. Desired results come to pass as cash begins to flow more freely and rapidly instead of pooling and eddying in stagnant pockets, tributaries and backwaters. The final piece in the cultural transformation that your new cash-driver lan- guage creates falls into place when your company begins to cre- ate appropriate reward systems tied to cash-driver goals.
This chapter has introduced you to the basic vocabulary of cash-driver language, using several case studies to illustrate various points. The hypothetical CyberFun Co. provided a backdrop for seeing more clearly the difference between accru-
The shift toward cash- flow based goals and incentive systems isn’t just some faddish management technique.
It is based on a new
understanding of company
value that is permeating
corporate America—a
recognition that cash-flow
management, throughout
the organization, is linked
even more closely to
shareholder value
than earnings are.
al realities and cash-flow realities. Jones Dynamite continued to develop some of those points and added the relational dynam- ic of how better financial management rescued the company without really shifting its culture with regard to cash flow. At the Hudson’s Bay Co. there was a hint of some culture shift, and at Pepsico there was a clear and forceful move into a strongly cash-flow–oriented management culture.
Before going further in the development of your under- standing of cash flow and how it is basically set by your man- agement of the cash drivers, it is important for you to under- stand the basic context, or grammar, in which cash-driver lan- guage functions. That context is accounting, the sometimes dreadedAword, and in the next two chapters I will try to min- imize the pain as I introduce you to the essentials of account- ing. If you already have a good grasp of basic accounting the- ory, you can skip these chapters and move on to Chapter 5.
F YOU ARE NOT FAMILIAR WITH THE FUNDAMENTALS OF
accounting—the structure of financial statements, the debit and credit rules of the double-entry system, con- struction of a cash-flow statement and analysis of ratios—this chapter and the next are absolutely essen- tial. And for those whose understanding of these concepts may be a bit shaky, these chapters can get you up to speed.
This overview of basic accounting will make it far easier to grasp all that follows, starting with the ability to see that although many transactions will affect your cash account as either debits or credits, many others leave cash entirely unaf- fected. The frequency of each type of transaction, the amounts involved and the timing of each will all affect the degree to which the flow of value differs from the flow of cash. Accounting is the grammar system by which we evaluate and record all the events that ultimately find their way to the balance sheet and income statement. These two primary financial statements will be examined closely to develop the important insights that flow from their ratio analysis and cash-flow analysis. Once these basics of accounting grammar are in place, you will be ready to focus specifically on each of the seven cash drivers (Chapters 5 through 11).