1 THE PROGRAMEXECUTIVE’S SESSION 10 FINANCIAL ANALYSIS FOR EXECUTIVES
Why, what and how to read your financial statements as an executive
Learning
PURPOSE AND LEARNING OBJECTIVES
The important calculations (ratios and margin) that all executives
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should calculate • To start doing it… 2
Purpose: To learn why and how top executives read financial statements to understand their company and drive growth. Objectives: learn…
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AGENDA 1. Orienteering and recap 2. Why do financial analysis 3. What is, and how to do financial analysis 4. Breakout 5. Summary 6. Reflection and assignment 3
4 Private Equity Q&A Session RENEW is giving you the chance to ask questions you have about private equty and the investment process on Wedendsay,April 14 starting from 2 PM. REGISTER
SECTION ORIENTEERING1 5
HOW TO THINK 6 Supplies The Machine Market Thinking that your business is the product Technician Entrepreneur Manager
Because you are the CFO! 7 OK the co-CFO. But think like a CFO!
ManagementTeams
SessionTopics
What I would expect you to do…
Meeting Run great meetings! Use them to drive execution. Use meetings to drive execute. Have P, O and A for every meeting.
Finance Part 1:The CFO Close your books by the 10th and hold your finance meeting on the 15th . DO NOT ABDICATE this work.You are the co-CFO.
Reporting Start measuring 5-10 KPIs for your company.Weekly or monthly.As you measure it, you will see improvements.
ORIENTEERING: STEP-BY-STEP
Strategic plan is the input. Use the AMP to set quarterly and monthly OKRs. Chop up your goals into bite-size work that ultimately becomes weekly projects and I Musts.
The AMP Write down you AMP. Look to the Left!
The Habits Have a morning routine! Use your calendar. Set 3 “I Musts” each week and map them to your calendar.
Strategic Planning Write down your 5-year plan.
Start with your Guiding Statements, and KISS and use it (Coffee Stains) to set your annual plans.
Have an org chart and use it to organize your company. Write PAs for those connected to you (your management team).
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Have a diverse group with authority (ideally a board) to give you feedback and holds you accountable to your plans. Ask for their feedback! Follow your own rules – set the example. Everyone is watching you.
Intro to Execution Build your binder! “I should write that down.” Write SOPs. They are the treasure. Plan + Organized Team + PAs + SOPs + Battle Rhythm = Results!
Governance
THE EXECUTION SYSTEM 9Proprietary and Confidential to Renew LLC The Execution System Organizational Structure For organizing Position Agreement For unit managers Role and Purpose (why) Accountable for List of StandardsResponsibilities(KPIs) Standard StandardsPersonForProcedureOperatingfunctionsStepsAccountablePeopleResponsibleateachStepKPIs Battle Rhythms For ReportingaccountabilityMeetings/Targets A Planning QuarterlyStrategicSystemPlanAMP-OKRs-OKRsMonthly-KRsWeekly-LegendDaily-Calendar You should be thinking “I should write that down.” You should be thinking “I should write that down.” AND “As measured by…” AND “As measured by…”
HOW REPORTING FLOWS 10 1 Operational KPIs 2 Financial KPIs CFOManagement OperationalActivities ActivitiesFinancial (PA,KPIsSOPs) StatementsFinancial ManagementReport FinancialReport CEO Report AMP Budget Board Report Steps in the SOPs Accounting
ACCOUNTING VS FINANCE Accounting Finance • About the past • Controls the current inflows and outflows of cash • “Is that approved?” • Very disciplined • Close the books every month • KPI:Timely and accurate financial statements • About the future • Analyzes the future investments of capital • Forecasts cashflow • “Is that a wise investment?” • Very analytical • KPI:TvA, ROE, FCF 11
THE BASIC STEPS 1. Step 1:Tighten the ship. Prepare a finance manual. 2. Step 2: Have a plan: Budget & 13 WCF. 3. Step 3: Collect the monthly financials on the 10th 4. Step 4: Review your financials by the 15th 5. Step 5: Drive a finance battle rhythm (weekly and monthly meetings) 12
STEP 2:YOUR FINANCIAL PLANS 13 5-year Plan Financial Model Annual Plan Annual Budget Quarterly Plan 13-week CF forecast • Owner: CEO and Board • What: Shows the financial performance for 5 years. Used for valuation. • Why: Need to know if we need to raise capital. • Example Uses: Capital budgeting and valuation. • Looks like: IS, BS and CF in years • Owner: CEO, CFO • What: Shows the target financials performance for the year. • Why: Need to have a financial plan to mirror the AMP. • Example Use: How profitable will we be if we pursue these initiatives? • Looks like: IS, BS and CF in months. 12 columns. • Owner: CFO, Controller • What: Shows cash flow needs by week • Why: Bills are paid on a weekly basis • Example Use: Do we need to delay any payments? • Looks like: Cash Start. Cash In. Cash Out. Cash End. End is the start for the next week. Each week updated and extended. 13 columns. Critical to haveMust haveShould have this
STEP 4:THE FINANCIAL STATEMENTS: ACCOUNTING BASICS 1. Balance sheet:What do you have, owe and own? How strong is your company? How wealthy are shareholder? Are you strong? 2. Income statement: How did your company use its assets? Are you profitable? Are you performing? Improving? 3. Statement of cash flows:Where is cash coming from and going to? Are you healthy? 14
3. Monthly Finance Meeting: Budget Targets vs.Actuals. Review ratios (and 13-week CF). Ask “why” 7 times. Make decisions – changes in management, approach, etc.You need to hit those targets!
1. Annual Budget Planning Meeting: Set the company targets (AMP). Build the budget with the CFO.
4. Weekly 13-Week Cash Flow Meeting: Review the end cash position with the forecast.Any difference? Problem is there is.
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STEP 5:YOUR FINANCE BATTLE RHYTHM
2. Quarterly Board Meeting: Show budget Targets vs.Actuals. Show key ratios, cash position and 13-week forecast.
• DO NOT abdicate accounting and finance:You are the co-CFO.
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• Hold a monthly finance meeting every month: one of your two monthly management battle rhythms.
• Close your books every month.Ask for the financial statements.
FINANCE AND ACCOUNTING 101 SUMMARY
• Employ a very disciplined accountant:Their main job is to deliver accurate and timely financial statements to you every month (this is their KPI), and to control the cash in and out of the company.
• Enjoy reading your financial statements: BS, IS, CF - and see what they tell you.
• Have, read and implement the finance manual:This is the accounting and finance SOP for the company.
• Have a financial plan:The financial model (i.e., strategic plan), the budget (i.e., the numeric version of your AMP) and the 13-week CF (i.e., your quarterly OKR / Cash plan).
ASSIGNMENT 1. Use your calendar: Set your three I Musts for the week and map all your time to your calendar. Set one of the I Musts to work ON the business. 2. Schedule 3 hours: For your ON the business “I Musts,” 1) collect your financial statements from your accountant. Read them.Write down three things that see. 2) Ask for the financial manual and read it. If you do not have one, spend another 3 hours to sit with your finance manager, and begin writing it together. 3) Tell your finance manager you want them to close their books on the 10th . 3. Upload your most recent financial statements and three observations. 17Proprietary and Confidential to RENEW LLC
SECTION 2 WHY DO FINANCIAL ANALYSIS? 18
YOU NEED TO KNOW WHAT IS GOING ON 1. To understand why something is happening 2. To understand which levers are having an impact 3. To make better decisions 4. To strengthen your credibility 5. To unlock new ideas and find creative solutions to growth 19
SECTION 2 WHAT IS FINANCIAL ANALYSIS AND HOW DO I DO IT? 20
FINANCIAL ANALYSIS: NEEDS Spreadsheet Or, printed financial statements and a calculator Two hours of uninterrupted time per month Access to your accountant (good to have them with you, so you can ask “why?”) A place to take notes 21
FINANCIAL ANALYSIS: BUCKETS OF ANALYSIS 22 2 Trend / Common Size Analysis (Past Financials) 1 Targets(Budget)Actualsversus 3 Ratio Comparison)(IndustryAnalysis Ask “why” 7 times:Why are we hitting our targets? Why not? Get the real answers. Spot trends Any outliers? What are my margins? What are trends?the EvaluateYourself How am I doing? How are we compareddoingtoothers?
BUCKET 1:TVA
Target vs.Actuals
The Accountability Metric 23
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TARGETS VERSUS ACTUALS
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• Example:We
Targets Versus Actuals (TvA) Presented as a chart and percentage or values in a table (next page) Explanations for variances are usually brief and direct. Two- or three-sentence written explanations for variance explanations. experienced a $5,000 favorable variance on office supplies, because we received an unexpected 25 percent discount from a new supplier, resulting in cost savings.We experienced a $25,000 unfavorable variance in machine cost, because a machine broke midway through the month. http://smallbusiness.chron.com/explain-variances-monthly-financial-statements-31931.html
EXAMPLE BAR CHART:TVA example way to present TvA sales and profit.
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Ask “Why” 7 times. 26
Common / AnalysisTrend
BUCKET 2: COMMON / TREND ANALYSIS
The Wise Executive 27
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Two-types: Do both.
– Common Size Analysis or Vertical: Compares all IS items to sales (IS account over total sales). Use to study trends in cost and profit margins.Also, key for ratio analysis.
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Trend or Horizontal: Divides all numbers by the first year’s values or month’s values (i.e., first year or month will be 1.0 or 100% for all accounts). For spotting trend analysis.
TREND ANALYSIS
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TREND ANALYSIS Trend Analysis Explanations for trends are generally explained by changes to the company’s operations, strategy or market dynamics. Example:We saw month-on-month sales growth of 25% due to an increase in marketing efforts which caused a slight decline in operating profit.Year on year sales are down due to increase competition in the market with the entrance of 3 new competing companies.To address this, we are developing new products with longer shelf life to enter markets beyond Addis metro area. Gross and operating margin may go down in the coming month as sales goes up.
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1. Have multiple years (months or quarters) of data aligned in the same rows 2. Divide all figures by the first year/month (Use $$ to lock cell –Command T) 3. Drag the cell across 4. Observe the % changes 30 NOTE: Common size on the IS gives you your margins.
HOW TO COMMON SIZE ANALYSIS Common Size (Vertical) 1. Create a column to the right of the figures 2. Divide all figures by sales (Use $$ to lock cell – Command T) 3. Drag the cell down 4. Observe the % - GPM, OPM, NPM
Trend Analysis (Horizontal)
Total Operating Revenues 100.0% 82.4% 63.1% 66.8% 78.0% Other Income 100.0% 363.7% 667.7% 327.7% 371.5% Total Revenue 100.0% 85.4% 69.5% 69.6% 81.1%
Other Operating Revenues 100.0% 130.4% 126.6% 134.2% 140.1%
Depreciation And Amortization Expenses 100.0% 113.1% 128.9% 162.0% 152.7% Other Expenses 100.0% 92.6% 83.1% 96.1% 95.7%
Revenue From Operations [Net] 100.0% 82.2% 62.8% 66.5% 77.7%
Cost Of Materials Consumed 100.0% 80.4% 60.5% 65.4% 71.7%
Expenses:
Purchase Of Stock-In Trade 100.0% 91.1% 78.5% 89.6% 81.7%
Goes Horizontal. Spots trend or patterns over a period of time. ANALYZE DATA:TREND ANALYSIS
Finance Costs 100.0% 113.9% 109.8% 132.3% 121.5%
Common-size analysis Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Less:Amounts Transfer To Capital Accounts 100.0% 105.1% 111.2% 123.3% 114.0% Total Expenses 100.0% 87.4% 72.9% 78.8% 83.1%
Changes In Inventories Of FG,WIP And Stock-In Trade 100.0% 23.0% -59.6% 140.9% -3.7% Employee Benefit Expenses 100.0% 105.4% 106.9% 114.9% 112.5%
Less: Excise/Service Tax/Other Levies 100.0% 92.7% 70.6% 65.7% 87.0%
Operating And Direct Expenses 100.0% 181.8% 183.0% 186.8% 181.3%
Revenue From Operations [Gross] 100.0% 83.0% 63.4% 66.4% 78.5%
Goes Horizontal. Spots trend or patterns over a period of time. ANALYZE DATA:TREND ANALYSIS Common-size analysis Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Revenue From Operations [Gross] 100.0% 83.0% 63.4% 66.4% 78.5% Less: Excise/Service Tax/Other Levies 100.0% 92.7% 70.6% 65.7% 87.0% Revenue From Operations [Net] 100.0% 82.2% 62.8% 66.5% 77.7% Other Operating Revenues 100.0% 130.4% 126.6% 134.2% 140.1% Total Operating Revenues 100.0% 82.4% 63.1% 66.8% 78.0% Other Income 100.0% 363.7% 667.7% 327.7% 371.5% Total Revenue 100.0% 85.4% 69.5% 69.6% 81.1% Expenses: Cost Of Materials Consumed 100.0% 80.4% 60.5% 65.4% 71.7% Purchase Of Stock-In Trade 100.0% 91.1% 78.5% 89.6% 81.7% Operating And Direct Expenses 100.0% 181.8% 183.0% 186.8% 181.3% Changes In Inventories Of FG,WIP And Stock-In Trade 100.0% 23.0% -59.6% 140.9% -3.7% Employee Benefit Expenses 100.0% 105.4% 106.9% 114.9% 112.5% Finance Costs 100.0% 113.9% 109.8% 132.3% 121.5% Depreciation And Amortization Expenses 100.0% 113.1% 128.9% 162.0% 152.7% Other Expenses 100.0% 92.6% 83.1% 96.1% 95.7% Less:Amounts Transfer To Capital Accounts 100.0% 105.1% 111.2% 123.3% 114.0% Total Expenses 100.0% 87.4% 72.9% 78.8% 83.1% Same analysis works well for gender-smartyourKPIs –Try it out! Same analysis works well for gender-smartyourKPIs –Try it out!
Use conditional formatting for effective viewing ANALYZE DATA: HORIZONTALANALYSIS Common-size analysis Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Revenue From Operations [Gross] 100.0% 83.0% 63.4% 66.4% 78.5% Less: Excise/Service Tax/Other Levies 100.0% 92.7% 70.6% 65.7% 87.0% Revenue From Operations [Net] 100.0% 82.2% 62.8% 66.5% 77.7% Other Operating Revenues 100.0% 130.4% 126.6% 134.2% 140.1% Total Operating Revenues 100.0% 82.4% 63.1% 66.8% 78.0% Other Income 100.0% 363.7% 667.7% 327.7% 371.5% Total Revenue 100.0% 85.4% 69.5% 69.6% 81.1% CostExpenses:OfMaterials Consumed 100.0% 80.4% 60.5% 65.4% 71.7% Purchase Of Stock-In Trade 100.0% 91.1% 78.5% 89.6% 81.7% Operating And Direct Expenses 100.0% 181.8% 183.0% 186.8% 181.3% Changes In Inventories Of FG,WIP And Stock-In Trade 100.0% 23.0% -59.6% 140.9% -3.7% Employee Benefit Expenses 100.0% 105.4% 106.9% 114.9% 112.5% Finance Costs 100.0% 113.9% 109.8% 132.3% 121.5% Depreciation And Amortization Expenses 100.0% 113.1% 128.9% 162.0% 152.7% Other Expenses 100.0% 92.6% 83.1% 96.1% 95.7% Less:Amounts Transfer To Capital Accounts 100.0% 105.1% 111.2% 123.3% 114.0% Total Expenses 100.0% 87.4% 72.9% 78.8% 83.1% To be viewed horizontally
Goes vertical and compares everything to current sales. Gives you margins. Spots anomalies in the current period. ANALYZE DATA: COMMON SIZE OR VERTICAL Common-size analysis Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Revenue From Operations [Net] 98% 95% 89% 94% 94% Other Operating Revenues 1% 1% 1% 1% 1% Total Operating Revenues 99% 96% 90% 95% 95% Other Income 1% 4% 10% 5% 5% Total Revenue 100% 100% 100% 100% 100% CostExpenses:OfMaterials Consumed 62% 58% 54% 58% 55% Purchase Of Stock-In Trade 12% 13% 13% 15% 12% Operating And Direct Expenses 0% 1% 1% 1% 1% Changes In Inventories Of FG,WIP And Stock-In Trade -1% 0% 1% -2% 0% Employee Benefit Expenses 5% 6% 8% 8% 7% Finance Costs 2% 3% 4% 4% 3% Depreciation And Amortization Expenses 3% 4% 5% 7% 6% Other Expenses 15% 17% 18% 21% 18% Less:Amounts Transfer To Capital Accounts 2% 2% 3% 3% 2% Total Expenses 96% 99% 101% 109% 99% ywvboTeieedverticall
BUCKET 3: INCOME STATEMENT RATIOS
Performance 35
IncomeRatiosStatement
RATIO ANALYSIS Profitability Ratios (Margins) – Gross Margin = (Sales – Cost of SalesSales) – Operating Margin = (Gross Profit – Operating Expenses) Sales – Pre-tax Margin = Earnings before Taxes Sales – Net Profit Margin = Net IncomeSales NOTE: Pull from your Common Size Analysis of the Income Statement Rule of Growth Next slides
RATIO ANALYSIS Gross Margin = Sales – Cost of Sales Sales NOTE: Pull from your common size Income Statement The Strategy Metric
RULE OF GROWTH10%Pre-Tax Profit Margin Your New Breakeven 38 Pre-Tax Profit Margin Rule ofThumb 5% Your business is on life support 10% Doing OK but has untapped potential 15% Doing good! >15% Wow…But watch out. Dig the moat.
4. BALANCE
BalanceRatiosSheet
Strength 39
BUCKET SHEET RATIOS
Working Capital = Current Assets – Current Liabilities 40 From the Balance Sheet
RATIO ANALYSIS Liquidity Ratios • Current Ratio = Current Assets Current Liabilities • Quick Ratio = Current Assets – Inventory Current Liabilities • Cash Ratio = Cash + Cash Equivalents Current Liabilities Higher the better. Should be above 1 1.5 –Higher3xthe better. At least 1x Higher the better. 1x is good
RATIO ANALYSIS Return on Equity (ROE) = Net Income Avg. Shareholders Equity NOTE:When you use an IS and BS item, you need to use the average of the BS item Warren Buffett’s CEO Metric
Health 43
BUCKET 5. MARGINS
CashflowMetricsStatement
44 EQUATION:THE CASH CONVERSION CYCLE CCC = DSO + DIO - DPO CCC = Cash Conversion Cycle DSO = Days Sales Outstanding DIO = Days Inventory Outstanding DPO = Days Payable Outstanding
45 EQUATION:ACCOUNTS RECEIVABLE TURNOVER & DSO SalesSales Average Accounts ReceivableAverage Accounts Receivable ReceivablesReceivables365365turnoverturnoverDSO Step 1: Step 2: ADD = Receivables Turnover=
46 EQUATION: INVENTORY TURNOVER & DIO Cost of goods soldCost of goods sold Average InventoryAverage Inventory InventoryInventory365365turnoverturnoverDIO ADD = Inventory Turnover = Step 1: Step 2:
47 EQUATION:ACCOUNTS PAYABLES TURNOVER & DPO Cost of goods soldCost of goods sold Average accounts payableAverage accounts payable turnoverturnoverPayables365365PayablesDPO SUBTRACT = Payables Turnover = Step 1: Step 2:
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EQUATION: EXAMPLE
49 EQUATION: SOLUTIONS DIO = $1,500 / ($3,000/ 365 days) = 182.5 days DSO = $95 / ($9,000 / 365 days) = 3.9 days DPO = $850 / ($3,000/ 365 days) = 103.4 days CCC = 182.5 + 3.9 - 103.4 = 83 days Read more: http://www.investopedia.com/articles/06/cashconversioncycle.asp
EQUATION: DELL AND THE CCC
BUCKET 6. BENCHMARKING ComparisonIndustry Benchmarking 51
• Example: Our gross margins are 30% higher than the industry average due to proximity to raw materials, lower labor and electricity prices and a shorter supply chain. Our ROE is lower due to higher costs of capital good and higher depreciation.
DEVELOP COMMENTARY & RECOMMENDATIONS
• Tells you how you are doing compared to others (apples to apples. Or as close as you can.)
Industry Comparison • Analyze the company’s ratios and margins with others in the industry.Try to find comparable size or geographic profile.
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2. Securities and Exchange Commission (www.sec.gov/edgar.shtml):The SEC makes annual reports and other financial filings of publicly traded companies available for review at its website.
Source: https://www.discoverbusiness.us/resources/business-plans/
1. BizStats (www.bizstats.com): It offers statistics and financial data on businesses in a variety of industries as well as tools to calculate business valuation and cost of goods sold.
INDUSTRY ANALYSIS RESOURCES
3. Hoover’s Online (www.hoovers.com):This is a product of Dun & Bradstreet that offers a searchable database of financial information and profiles of public and private companies.
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4. Thomas Register (www.thomasnet.com): Originally published in book form, the Thomas Register is a searchable database of product information and market trends for a variety of industries. It publishes an annual survey it calls its “Industry Market Barometer” that shows where reporting companies are, where they have been and where they are heading.
GREAT FINANCE RESOURCES
• Investopedia: http://www.investopedia.com/articles/06/cashconversioncycle.asp
• Strategic CFO – 13 WCF: https://strategiccfo.com/thirteen-week-cash-flow-report/
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• Accounting: https://www.accountingcoach.com/
• Accounting Podcast: https://www.accountingtools.com/podcasts/
SECTION 4 BREAKOUT 55
2. Did you know that IS, BS, and CF statements are connected? Do you now feel like you understand what the three statements tell you?
3. Which Financial Statement is your favorite? Why and how do you interrelate the rest of the statements for your business to get a better view?
BREAKOUT DISCUSSION
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1. Are you independently checking your Financial Statements?
SECTION 5 SUMMARY & ASSIGNMENT 57
SUMMARY • Close your books on the 10th . • Get the financial statements and do analysis on the 15th . • Analyze your financial statements to understand your key performance, strength and health metrics. 58
HOMEWORK ASSIGNMENT 1. Use your calendar (I Musts, map all your time, set aside 3 hours for ON the business work) 2. Schedule 3 hours: – Collect your IS – Perform a common size and trend analysis of your income statement. 59
Take 5 minutes to fill out your module question: –What did you learn? –What will you immediately apply to your company? 60Proprietary and Confidential to RENEW LLC
61 Thank you! www.renewstrategies.com
62 Backup www.renewstrategies.com
RATIO ANALYSIS Financial Leverage Ratios • Debt Service Coverage Ratio (DSCR) = Net Operating IncomeTotal Debt Service • Capitalization Ratio = Long Term Debt LT Debt + Shareholders Equity • Debt to EBITDA = Total EBITDALiabilities
RATIO ANALYSIS Coverage Ratios • Interest Coverage Ratio= Earnings Before Interest & Taxes (EBIT) Interest Expense • Cash Coverage Ratio = EBIT + non-cash expenses Interest Expense • Current Liability Coverage Ratio = Cash Flow from Operations (CFO) – Dividends Paid Current Liabilities
THE ADVANCED STEPS Time for Growth 5. Step 6: Clear distortions 6. Step 7: Set the right profit target 7. Step 8: Use labor efficiency to drive profitability 8. Step 9: Manage the four forces of cash flow Source: Mastering the Rockefeller Habits 65
STEP 5: CLEAR DISTORTIONS a. Add your salary to management expenses i. You are an expense for the company. ii. Management’s job is to assign tasks to others and maximize output. b. Use “Modified Gross Margin” dollar as revenue: i. Modified Gross Margin = Revenue – NONLABOR Direct Costs ii. Why? NONLABOR expense are pass-through costs.“Other people’s product” 66
STEP 7: USE LABOR EFFICIENCY TO DRIVE PROFITABILITY a. Calculate labor efficiency ratios i. Direct labor efficiency (DLR) = Gross margin dollar (GM) / direct labor cost (DLC) • Gross margin dollar = Revenue – NONLABOR direct costs • Direct labor spends 50% or more delivering products or services ii. Sale labor efficiency (SLR) = Contribution margin dollar (CM) / sale labor cost (SLC) • Contribution margin dollar = Gross margin dollar – DIRECT LABOR. • If you have a dedicated sales team iii. Management labor efficiency (MLR) = Contribution margin dollar (CM) / management labor cost (MLC) • Labor costs that are left after direct and sale labor deducted 67
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STEP 7: USE LABOR EFFICIENCY TO DRIVE PROFITABILITY: THE MAGIC
1. Calculate current labor efficiency ratios, 2. Calculate your pre-tax profit margin = Revenue / Pre-tax profit.
4. Hit 10%, rest the target to 15%. 5. Hit 15%.Add labor to the category you see “stress”.Adding labor can be raises or bonuses. Doesn’t just need to be people. Pre-tax margin will drop down below 15%, temporarily. Do not drop below 10%. 6. Drive growth back up to 15%. 7. Repeat.Track the LERs to see which categories are doing best.
3. Set your sale needed to get to 10% pre-tax margin by holding all costs excluding direct material constant.
EXAMPLE 69 Step 1 Step 2 Step 3 Step 4 Pre-tax Profit Margin Target 10% 15% 10% 15% Income Statement Starting Month Revenue $450,000 $492,195 $534,402 $531,633 $578,919 Direct cost excluding labor $130,000 $142,190 $154,383 $153,583 $167,243 Modified gross profit $320,000 $350,005 $380,019 $378,050 $411,676 Modified gross margin dollar 71.1% 71.1% 71.1% 71.1% 71.1% Direct labor $90,000 $90,000 $90,000 $98,333 $98,333 Contribution Margin $230,000 $260,005 $290,019 $279,717 $313,343 Management labor cost $75,000 $75,000 $75,000 $83,333 $83,333 Sales labor cost $35,000 $35,000 $35,000 $43,333 $43,333 Other operating costs $100,000 $100,000 $100,000 $100,000 $100,000 Pretax profit $20,000 $50,005 $80,019 $53,051 $86,677 Pre-tax profit margin 4.4% 10.2% 15.0% 10.0% 15.0% Contribution margin 51.1% 52.8% 54.3% 52.6% 54.1% Other operating costs margin 22.2% 20.3% 18.7% 18.8% 17.3% Labor Efficiency Ratios: DLR (GM/DLC) $3.56 $3.89 $4.22 $3.84 $4.19 SLR (CM/SLC) $6.57 $7.43 $8.29 $6.46 $7.23 MLR (CM/MCL) $3.07 $3.47 $3.87 $3.36 $3.76 • This is work you need to perform on your Income Statement. i.e., PeachTree or QuickBooks will not do it automatically. • Blue is hard entered numbers. • Orange are the labor categories. • Green is our main target and focus. • LERs are below.These are our performance levers. • Highlighted yellow is what we are changing.
Force #1 – Save forTaxes: Make sure to set aside money to pay your taxes Force #2 – Manage Debt: Debt is generally not your friend. If not carefully managed it will enslave your business. Rule of thumb: Don’t use lines of credit.
STEP 8: UNDERSTAND THE 4 FORCES OF CASH FLOW
70 You
Force #3 – Hold a Core Capital Reserve: Save 2 months of operating expenses in cash. Force #4 – Harvest Profits: Once Forces #1 - #3 are set aside, distribute profits and bonuses. made it!
SUMMARY • 10% is the new breakeven • Drive your company to 10% pre-tax margin without changing costs, except direct material costs • Once you hit 10%, push to 15% • Only at 15% add costs beyond direct material • Repeat this exercise • Manage cash like a hawk: 1) Always pay your taxes, 2) always pay your short-term debt, 3) hold 2 months of opex in cash in reserve, 4) then pay dividends…you did it! 71
• Perform cash analysis – Analyze the Free Cash Flow (FCF) = Cash flow from Operations (CFO) – Capital Expenditures • Look at the Y-O-Y, Q-O-Q, M-O-M and CAGR growth rates • Compute FCF as % of Cash flow from Operations – Look at the Operating Cash Flow ratio CASH FLOW = Cash Flow from Operations Sales
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1) tools: Budget: How you wanted to do how you plan to do for the coming months – Financial Statements: IS, BS and CF. How you did last month(s) – How you must do over the coming weeks
Monthly
Know your calculations: Growth (MoM,YoY), Margin (GPM, OPM, NPM), Ratios (Current, ROE), & CCC
in the PAs and SOPs 73
2)
QUICK FINANCE REFRESH
13-week Cash Flow:
Collect reports – Monthly Financial Report:TvA and “why?” – Monthly Operational Report - Dashboard: Each managers’ KPIs,
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3) which are documented
Know your financial
REPORTS TRACK EXECUTION QUALITY LINK TO SOP AND PA 74 Your Business System Execute StatementsGuiding & Strategic Plan Vision, Mission, Strategy, Values and high-level 5 year goals and plan AMP and Budget 5-10 SMART goals for the year, monthly plans and budget Plan Organizational Structure Position AccountablePurposeAgreement(why),forKPIsandoutcomes,Responsibilities,Standards Standard Responsible,Accountable,ProcedureOperatingKPIs,Workflow/Steps,StandardsC EO Operation s BU D v is on BU BU BU Admin
Return on Assets (ROA) = NetAvg.IncomeTotalAssets
RATIO ANALYSIS Ratios
Profitability
RATIO ANALYSIS Efficiency Ratios: Measures a company's ability to use its assets to generate income. • Total Asset Turnover =Avg.SalesTotal Assets • Fixed Asset Turnover = Avg.SalesFixed Assets You should compare these with those in your industry. You should compare these with those in your industry.
RATIO ANALYSIS Financial Leverage Ratios • Debt Ratio = TotalTotalDebtAssets • Debt to Equity Ratio = Total Liabilities Total Shareholders Equity You should compare these with those in your industry. You should compare these with those in your industry.