A Balancing Act

Managing profit, position, and cash is a constant balancing act. The final part of knowing what keeps Senior-level managers (and, therefore, everybody else) awake at night requires that you understand how the organization maintains an optimal balance among these three imperatives. Senior managers monitor balance by using ratios. Ratios are a comparison of how large one type of profit, position, or cash measure is in relation to another. Examples of common ratios are inventory turnover ratio, return-on-assets (ROA), and contribution profit margin ratio.

Ratios consist of two types: operating ratios and financial ratios. Operating ratios tell a Senior manager if the organization’s day-to-day activities are staying within acceptable boundaries. Financial ratios tell a Senior manager if the organization is maintaining the appropriate returns for its efforts.

Important Creating value chains that reach from the language of performance to the language of finance requires a connection to profit, position, cash, as well as the balance that must be maintained among these three imperatives.

Making the connection between what WLP professionals do and what those who manage the financial side of organization do during the week is sometimes not easy to see. To help you see the connection, this article uses a fictitious medical manufacturing and services company: ABC MediCompany. ABC manufactures a line of products, offers some services related to its products, and has an established customer base.

Let’s Review:
Financial information is often treated very confidentially. The amount of data you may have access to will vary depending on whether you are internal or external to an organization.

In general, executives value three broad categories of financial impact. These categories are their financial imperatives: profit, position, and cash.

It is important to know the basic types of financial statements and what they describe, so that you can explain what you are looking for when researching financial data. Profit is shown in the income statement, position is shown in the balance sheet, and cash is shown in the cash flow statement.

Executives value solutions that can be shown to help maintain or improve the balance among their financial imperatives. In the language of finance, balance is described in the form of ratios. There are two types of ratios: operating ratios and financial ratios.

This article uses a hypothetical case involving a hypothetical company ABC MediCompany to help explain financial value concepts and demonstrate financial value communication.

The Top Line: Revenue

But, not all revenue is created equal. Senior managers and high-level sales and marketing managers spend a great deal of time making sure that they have the right sales mix of products and services, price and volume. In a manufacturing business, too high a price for a product drives customers to the competition. Too low a price raises volumes but will also raise the corresponding expenses needed to produce that volume. The lower price may bring in more volume, but that volume may also raise expenses to the point where the business loses money on every sale.

The appropriate sales mix is also critical in maintaining or improving the very important measure of market share. The organization with the largest share of the total market for an industry enjoys considerable power within that industry. Many companies are very concerned about any slip in market share and will constantly adjust their sales mix to protect or improve their market share position.

Important Every WLP professional needs to understand the revenue of his or her target organization because so much of the rest of the financial language around profit is discussed in terms of how much of the original revenue the organization gets to keep for its efforts. If you are a WLP professional working with sales or marketing, it is also critical to understand the desired sales mix to make sure the correct knowledge and behaviors are supported by your interventions. A small miscalculation in behaviors can create a big difference in final profit. Move behavior to the optimum mix, and you enhance revenue at minimal cost. Encourage suboptimal behavior, and the organization may struggle mightily with controlling costs and maintaining market share. Struggle too long or too much and the organization no longer exists.

For further discussion of the advantages and disadvantages of various sales mix scenarios for product or service businesses, see John Tracy’s article Budgeting à La Carte: Essential Tools for Harried Business Managers. It’s listed in the Additional Resources section of this article.

Another way in which revenue is not created equally is when the organization records revenue from a one-time transaction such as the sale of a large asset or division of the company. For this discussion in communicating the value of WLP interventions, the focus is on renewable revenue generated by ongoing sales or other continuing activities.

Where to Place Your Value

The closer you get to the Individual level of your audience the longer and more varied the list of possible measures and interventions becomes. The list of measures and possible interventions in this example are not restricted to what our fictitious ABC MediCompany might use. The list of measures and possible interventions is also by no means exhaustive in covering every type of organization in every industry.

Finding Your Value

In the ABC MediCompany example, let’s assume that the salespeople are negotiating discounts that exceed the industry average and that ABC is in danger of losing too much profit if this trend continues. The sales training manager for ABC has done an excellent job of determining the root cause of the problem. An investigation has determined that the company’s salespeople lack confidence in their sales skills and jump to offering a discount much too quickly in order to get the sale. This issue is widely spread across ABC’s sales regions. The practice is bringing down the total net sales for the company. Negotiation skills training with a subsequent reinforcement program is the selected intervention.

The connection from negotiation skills to revenue and the contribution profit margin may seem a little too obvious for some. But, using an easy example allows you to focus on the format of the example itself.

Profit Line #3: Earnings Before Income Taxes

The next profit line is known as earnings before income taxes.

For ABC MediCompany, interest charges are now removed from operating earnings. ABC’s interest charges are an aggregate of all of the various interest rates that ABC is paying for its different types of loans or other debt. ABC had $150,000 of interest charges. Senior managers must closely watch this line to ensure that they are getting the best use of the money for the cost of any debt they incur. CEOs value any reductions in interest charges. One of the most overlooked areas that can have a huge impact on these expenses is the cost of capital or the finance charges an organization must pay to get the cash to cover payroll, seasonal fluctuations between revenues and expenses, or other extraordinary items.

Important As a WLP professional, if you can show how your WLP interventions reduce the cost of capital for an organization, you have a great story to tell when communicating your value. CEOs and CFOs value programs that cut costs or raise revenues not only for the obvious effect on profit margins, but also because these interventions save interest charges that the organization does not have to pay. It improves the overall credit rating of the organization if it does not have to rely on as much credit! When calculating the value of your interventions, services, or programs, don’t overlook the cascading effects of cutting costs or raising revenues on other parts of managing an organization.

In reality, there are also often accounting changes or other adjustments that also need to be accounted for. This is also sometimes referred to as earnings before interest, taxes, depreciation, and amortization (EBITDA). It is calculated just as the name implies, by looking at earnings after COGS, other sales-driven expenses, and fixed operating expenses have been removed from revenue, but before interest, taxes, depreciation, and amortization are taken into account.

Calculating EBITDA is especially helpful when a company has a large amount of depreciation, such as for machinery-intensive manufacturing organizations, or a large amount of amortization, such as for purchases of patent rights or other intangible assets. Removing depreciation and amortization reduces the distortion of these numbers and allows creditors, investors, and industry analysts to compare within and across industries. EBITDA is more likely to be used in large companies with significant assets or debt financing (Investorwords.com, 2003). EBITDA may be a term you hear used by senior executives. A WLP manager at a large company reported that when his firm was bought by outside investors, EBITDA became the new buzzword. Everyone’s measures were aligned to improve EBITDA.

An income statement is where the organization tracks how well it is doing in meeting the financial imperative of profit. Income statements can go by several different names, but they all display the same basic information about a company’s profit picture.

Revenue (or the top line) of the income statement is an important piece of information for the WLP professional to know because so much of the rest of the income statement is judged in terms of how much revenue is left at certain points in the calculations on the statement.

For WLP professionals who support sales or marketing functions, understanding the goals of the sales mix is critical to understanding the appropriate goals for WLP interventions.

The four key profit lines on an income statement are the contribution profit margin, the operating margin, earnings before income tax, and net profit. Executives will spend their time proportionately to the impact each of these profit lines has on the health of the organization.

Financial value chains can be drawn for every line on the income statement.

Knowing how to calculate profit ratios such as the contribution profit margin ratio or the net profit ratio is important because executives may sometimes refer to the ratios of the numbers instead of directly to the profit lines on the income statement. You may want to draw financial value chains that point to ratios instead of to profit lines.