Exec's Program #10: Financial Analysis Part 1

THE EXECUTIVE’S PROGRAM SESSION 10 FINANCIAL ANALYSIS FOR EXECUTIVES

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PURPOSE AND LEARNING OBJECTIVES Purpose: To learn why and how top executives read financial statements to understand their company and drive growth.

Learning Objectives: To learn…

• Why, what and how to read your financial statements as an executive • The important calculations (ratios and margin) that all executives should calculate • To start doing it…

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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

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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 4

SECTION 1 ORIENTEERING

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HOW TO THINK Thinking that your business is the product Entrepreneur Manager

Supplies

The Machine

Market

Technician

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Because you are the CFO! OK the co-CFO. But think like a CFO!

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ORIENTEERING: STEP-BY-STEP Session Topics

What I would expect you to do…

The Habits

Have a morning routine! Use your calendar.

Strategic Planning

Write down your 5-year plan.

Set 3 “I Musts” each week and map them to your calendar.

Start with your Guiding Statements, and KISS and use it (Coffee Stains) to set your annual plans.

The AMP

Write down you AMP. Look to the Left!

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.

Governance

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!

Management Teams

Have an org chart and use it to organize your company.

Write PAs for those connected to you (your management team).

Meeting

Run great meetings! Use them to drive execution.

Use meetings to drive execute. Have P, O and A for every meeting.

Reporting

Start measuring 5-10 KPIs for your company. Weekly or monthly. As you measure it, you will see improvements.

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. 8

THE EXECUTION SYSTEM The Execution System A Planning System

Organizational Structure For organizing

Position Agreement For unit managers

Strategic Plan

Standard Operating Procedure For functions

Role and Purpose (why) AMP - OKRs

Battle Rhythms For accountability Meetings

Steps Accountable for

Quarterly - OKRs

Reporting / Targets Person Accountable

List of Responsibilities Monthly - KRs

People Responsible Standards (KPIs)

Weekly - Legend

Standards at each Step

Daily - Calendar

KPIs

You You should should be be thinking thinking “I “I should should write write that that down.” down.”

AND AND “As “As measured measured by…” by…”

Proprietary and Confidential to 9 Renew LLC

HOW REPORTING FLOWS Board Report

1

CEO Report

Operational KPIs

AMP

2 Financial KPIs

Management Report

Financial Report

KPIs (PA, SOPs)

Financial Statements

Operational Activities

Financial Activities

Steps in the SOPs

Management

Budget

Accounting

CFO 10

ACCOUNTING VS FINANCE Accounting

Finance

• About the past

• About the future

• Controls the current inflows and • Analyzes the future investments outflows of cash of capital • “Is that approved?”

• Forecasts cashflow

• Very disciplined

• “Is that a wise investment?”

• Close the books every month

• Very analytical

• KPI: Timely and accurate financial • KPI: TvA, ROE, FCF statements

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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)

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STEP 2: YOUR FINANCIAL PLANS 5-year Plan Financial Model • •

• • •

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

Should have this

Annual Plan Annual Budget • •

• •

•

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.

Must have

Quarterly Plan 13-week CF forecast • • • • •

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 have 13

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?

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STEP 5: YOUR FINANCE BATTLE RHYTHM 1. Annual Budget Planning Meeting: Set the company targets (AMP).

Build the budget with the CFO.

2. Quarterly Board Meeting: Show budget Targets vs. Actuals. Show key ratios, cash position and 13-week forecast.

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!

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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FINANCE AND ACCOUNTING 101 SUMMARY • DO NOT abdicate accounting and finance: You are the co-CFO. • 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.

• 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).

• Close your books every month. Ask for the financial statements.

• Hold a monthly finance meeting every month: one of your two monthly management battle rhythms.

• Enjoy reading your financial statements: BS, IS, CF - and see what they tell you.

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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 10 th.

3. Upload your most recent financial statements and three observations.

Proprietary and Confidential to RENEW LLC

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SECTION 2 WHY DO FINANCIAL ANALYSIS?

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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?

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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

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FINANCIAL ANALYSIS: BUCKETS OF ANALYSIS

1

2

3

Targets versus Actuals (Budget)

Trend / Common Size Analysis (Past Financials)

Ratio Analysis (Industry Comparison)

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 the trends?

Evaluate Yourself How am I doing?

How are we doing compared to others?

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BUCKET 1: TVA

Target vs. Actuals The Accountability Metric

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TARGETS VERSUS ACTUALS 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.

• Example: We 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 24

EXAMPLE BAR CHART: TVA An example way to present TvA sales and profit.

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Ask “Why” 7 times.

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BUCKET 2: COMMON / TREND ANALYSIS

Common / Trend Analysis The Wise Executive 27

TREND ANALYSIS

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.

– 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.

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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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HOW TO COMMON SIZE ANALYSIS Common Size (Vertical)

Trend Analysis (Horizontal)

1.

Create a column to the right of the figures

1.

2.

Divide all figures by sales (Use $$ to lock cell – Command T)

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

3.

Drag the cell down

4.

Observe the % - GPM, OPM, NPM

NOTE: Common size on the IS gives you your margins.

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ANALYZE DATA: TREND ANALYSIS Goes Horizontal. Spots trend or patterns over a period of time.

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%

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%

Expenses:

ANALYZE DATA: TREND ANALYSIS Goes Horizontal. Spots trend or patterns over a period of time.

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%

Same analysis works well for your gender-smart KPIs – Try it out!

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%

100.0%

85.4%

69.5%

69.6%

81.1%

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%

Total Revenue Expenses:

ANALYZE DATA: HORIZONTAL ANALYSIS Use conditional formatting for effective viewing 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%

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%

Expenses:

To be viewed horizontally

ANALYZE DATA: COMMON SIZE OR VERTICAL Goes vertical and compares everything to current sales. Gives you margins.

Spots anomalies in the current period.

Common-size analysis

Mar-13

Mar-14

Mar-15

Mar-16

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%

Cost Of Materials Consumed

62%

58%

54%

58%

55%

Purchase Of Stock-In Trade

12%

13%

13%

15%

12%

0%

1%

1%

1%

1%

-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%

15%

17%

18%

21%

18%

2%

2%

3%

3%

2%

96%

99%

101%

109%

99%

Revenue From Operations [Net]

Expenses:

Operating And Direct Expenses Changes In Inventories Of FG,WIP And Stock-In Trade

Other Expenses Less: Amounts Transfer To Capital Accounts Total Expenses

To be viewed vertically

Mar-12

BUCKET 3: INCOME STATEMENT RATIOS

Income Statement Ratios Performance 35

RATIO ANALYSIS Profitability Ratios (Margins) – Gross Margin = (Sales – Cost of Sales) Sales – Operating Margin = (Gross Profit – Operating Expenses) Sales – Pre-tax Margin = Earnings before Taxes

Rule of Growth Next slides

Sales – Net Profit Margin = Net Income Sales NOTE: Pull from your Common Size Analysis of the Income Statement

RATIO ANALYSIS

The Strategy Metric Gross Margin = Sales – Cost of Sales Sales

NOTE: Pull from your common size Income Statement

RULE OF GROWTH 10% Pre-Tax Profit Margin Your New Breakeven Pre-Tax Profit Margin

Rule of Thumb

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.

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BUCKET 4. BALANCE SHEET RATIOS

Balance Sheet Ratios Strength 39

Working Capital = Current Assets – Current Liabilities

From the Balance Sheet 40

RATIO ANALYSIS Liquidity Ratios • Current Ratio = Current Assets Current Liabilities • Quick Ratio = Current Assets – Inventory Current Liabilities

Higher the better.

Should be above 1 1.5 – 3x

Higher the better.

At least 1x

• Cash Ratio = Cash + Cash Equivalents Current Liabilities

Higher the better.

1x is good

RATIO ANALYSIS

Warren Buffett’s CEO Metric 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

BUCKET 5. MARGINS

Cashflow Statement Metrics Health 43

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 44

EQUATION: ACCOUNTS RECEIVABLE TURNOVER & DSO Step 1:

Sales

Receivables Turnover =

Average Accounts Receivable 365

Step 2: DSO

ADD

= Receivables turnover 45

EQUATION: INVENTORY TURNOVER & DIO Cost of goods sold

Step 1: Inventory Turnover

= Average Inventory 365

Step 2: DIO =

ADD

Inventory turnover 46

EQUATION: ACCOUNTS PAYABLES TURNOVER & DPO Cost of goods sold

Step 1: Payables Turnover

= Average accounts payable 365

Step 2: DPO =

SUBTRACT

Payables turnover 47

EQUATION: EXAMPLE

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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 49

EQUATION: DELL AND THE CCC

BUCKET 6. BENCHMARKING

Industry Comparison Benchmarking 51

DEVELOP COMMENTARY & RECOMMENDATIONS Industry Comparison • Analyze the company’s ratios and margins with others in the industry. Try to find comparable size or geographic profile.

• Tells you how you are doing compared to others (apples to apples. Or as close as you can.)

• 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.

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INDUSTRY ANALYSIS RESOURCES 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.

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.

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.

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.

Source: https://www.discoverbusiness.us/resources/business-plans/ 53

GREAT FINANCE RESOURCES • Investopedia: http://www.investopedia.com/articles/06/cashconversioncycle.asp

• Strategic CFO – 13 WCF: https://strategiccfo.com/thirteen-week-cash-flow-report/

• Accounting: https://www.accountingcoach.com/

• Accounting Podcast: https://www.accountingtools.com/podcasts/

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SECTION 4 BREAKOUT

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BREAKOUT DISCUSSION 1.

Are you independently checking your Financial Statements?

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?

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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?

Proprietary and Confidential to RENEW LLC

60

Thank you! www.renewstrategies.com

61

Backup www.renewstrategies.com

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RATIO ANALYSIS Financial Leverage Ratios • Debt Service Coverage Ratio (DSCR) = Net Operating Income Total Debt Service • Capitalization Ratio =

Long Term Debt LT Debt + Shareholders Equity

• Debt to EBITDA = Total Liabilities EBITDA

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

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STEP 5: CLEAR DISTORTIONS a.

b.

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.

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”

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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

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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.

3.

Set your sale needed to get to 10% pre-tax margin by holding all costs excluding direct material constant.

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.

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EXAMPLE Step 1 Pre-tax Profit Margin Target Income Statement

10% $450,000

Direct cost excluding labor

$130,000

Modified gross profit

$320,000

Direct labor Contribution Margin

71.1% $90,000 $230,000

Management labor cost

$75,000

Sales labor cost

$35,000

Other operating costs Pretax profit

Step 3 15%

Step 4 10%

15%

Starting Month

Revenue

Modified gross margin dollar

Step 2

$100,000 $20,000

Pre-tax profit margin

4.4%

Contribution margin

51.1%

Other operating costs margin

22.2%

Labor Efficiency Ratios: DLR (GM/DLC)

$3.56

SLR (CM/SLC) MLR (CM/MCL)

$492,195 $534,402 $531,633 $578,919 • This is work you need to perform $142,190 $154,383 $153,583 $167,243 on your Income $350,005 $380,019 Statement. $378,050 i.e., $411,676 71.1% 71.1% will not 71.1% PeachTree or71.1% QuickBooks $90,000 $90,000 $98,333 $98,333 do it automatically. $260,005 $290,019 $279,717 $313,343 $75,000 $83,333 $83,333 • Blue is hard$75,000 entered numbers. $35,000 $43,333 • Orange are$35,000 the labor$43,333 categories. $100,000 $100,000 $100,000 $100,000 • Green main target $50,005 is our $80,019 $53,051and focus. $86,677 10.2% 15.0%These 10.0% • LERs are below. are our 15.0% 52.8% 54.3% 52.6% 54.1% performance levers.

20.3% 18.7% 18.8% 17.3% • Highlighted yellow is what we are changing. $3.89

$4.22

$3.84

$4.19

$6.57

$7.43

$8.29

$6.46

$7.23

$3.07

$3.47

$3.87

$3.36

$3.7669

STEP 8: UNDERSTAND THE 4 FORCES OF CASH FLOW Force #1 – Save for Taxes: 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.

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.

You made it!

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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!

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CASH FLOW • 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 from Operations Sales

QUICK FINANCE REFRESH 1) Know your financial tools: – Budget: How you wanted to do / how you plan to do for the coming months – Monthly Financial Statements: IS, BS and CF. How you did last month(s) – 13-week Cash Flow: How you must do over the coming weeks 2) Know your calculations: – Growth (MoM,YoY), Margin (GPM, OPM, NPM), Ratios (Current, ROE), & CCC 3) Collect reports – Monthly Financial Report: TvA and “why?”

– Monthly Operational Report - Dashboard: Each managers’ KPIs, which are documented in the PAs and SOPs

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REPORTS TRACK EXECUTION QUALITY LINK TO SOP AND PA Your Business System

Plan Guiding Statements & Strategic Plan Vision, Mission, Strategy, Values and high-level 5 year goals and plan

AMP and Budget

Execute Organizational Structure

Position Agreement

Standard Operating Procedure

CEO

Purpose (why), Accountable for KPIs and outcomes, Responsibilities, Standards

Accountable, Responsible, KPIs , Workflow/Steps, Standards

5-10 SMART goals for the year, monthly plans and budget

Admin Operation s BU

BU

BU

BU

Div is ion

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RATIO ANALYSIS Profitability Ratios

Return on Assets (ROA) =

Net Income Avg. Total Assets

RATIO ANALYSIS Efficiency Ratios: Measures a company's ability to use its assets to generate income.

• Total Asset Turnover = Sales Avg. Total Assets • Fixed Asset Turnover = Sales Avg. Fixed Assets

You You should should compare compare these these with with those those inin your your industry. industry.

RATIO ANALYSIS Financial Leverage Ratios

You You should should compare compare these these with with those those inin your your industry. industry.

• Debt Ratio = Total Debt Total Assets • Debt to Equity Ratio =

Total Liabilities

Total Shareholders Equity