The one main number is not found in the financials.
Businesses are used to collecting the financial information and with their accountants compiling financial reports. But the one main number that is driving the business is not found in the financials. The one main number that will predict where the future of the business is going is not in the financial data.
Because we are measuring the accounting data it is easy to be tempted to use this information to lead and manage the business. The accounting data though is a history statement and is useful to review but you will never find the engine of the business in these statements.
The one main number will be found in the operations. The operations of the business drive the future of the business. But be careful. It is imperative that we understand what is important to the customer to determine the engine of the business.
A great example from a few years ago is Contintental Airlines from 1997. Gordon Bethune became the CEO the airline had as the one main number as :- cost per airline mile. Now whilst this significantly impacts on the bottom line it is not what the customer sees as important. It lead to behaviour to reduce the quality of meals, fittings etc. Gordon changed this to :- on time arrivals. This changed the focus to something that the customer value. The airline went from worst to first.
The one main number was in the operations. Importantly though it was what the customer see as valuable.
What are the assumptions?
Whether we are talking politics, business, or life in general ideas are presented, statements are made and often there are underlying assumptions being made. We need to think about what these assumptions are.
For instance the discussion at the moment about the Emission Trading Scheme (ETS) makes the assumption that carbon is the evil greenhouse gas. However this is not universally held and even very authoritative scientists say that the methane may be the real villain. This is not an argument about climate change, rather it is about the assumption that carbon is the evil villain. Now I don’t know who is correct but my point is that assumptions matter. There is much debate about the ETS but the underlying assumption does not seem to be questioned.
Now this is just as applicable in a business context. We could be making decisions about whether a particular strategy or managment idea be implemented but have we considered the underlying assumptions that are implied.
So for instance if you were change the bonus structure (or implement a new bonus scheme) in a business then the assumption is that the financial bonus is the best way to motivate our team to achieve the result. This may be the case but we need to consider whether this correct.
We make assumptions about how customer or employees will behave every day. So in considering a new strategy re-examine the assumptions being made.
So what assumptions are you making in your business?
Photo by laurakgibbs
Are you making enough from your business – a way to measure this
A ratio that can be used to determine whether you are getting an adequate return from your business is Return on Capital Employed (ROCE).
ROCE is calculated as follows :
Let me ezplain further. EBIT means the net profit of a business before interest and taxes. The capital employed can have a number of different meanings however it is the capital necessary to make the business perform. It is commonly represented as total assets less current liabilities or fixed assets plus working capital.
Now before I go onto an example with every ratio it is not perfect. The assets figures in the financial statements are usually represented at cost or even depreicated. This means if the business is using assets purchased many years ago then the ROCE would be better than a business using assets purchased recently everything else being the same. Thus we need to be careful with this number but it is still very useful. We can make adjustments by valuing the assets at their current value to get a better idea of the true ROCE.
So lets look at an example:
|
|
ABC Pty Ltd |
XYZ Pty Ltd |
|
Operating Profit |
100,000 |
150,000 |
|
Total Assets |
500,000 |
1,200,000 |
|
Current Liabilities |
150,000 |
150,000 |
|
Capital Employed |
350,000 |
1,050,000 |
|
ROCE |
28.57% |
14.28 |
The return of both companies is above what could be obtained from investing the proceeds in shares etc but don’t get caught by a larger profit must be better. ABC has a small profit but is using the assets more effectively and thus is a better managed business.
What is the ROCE of your business? Is it sufficient? If not what are you going to do to look at ways to improve it?
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