1 THE PROGRAMEXECUTIVE’S SESSION 11 FINANCIAL ANALYSIS FOR EXECUTIVES PART 2
Learning
PURPOSE AND LEARNING OBJECTIVES
and margin
statements • What those ratios and margins mean • To start doing it… 2
learn… • How to calculate key
Purpose: To continue to learn why and how top executives read financial statements to understand their company and drive growth. Objectives:To ratios using your financial
AGENDA 1. Orienteering and recap 2. How to do financial analysis (cont.) 3. Breakout 4. Summary 5. Reflection and assignment 3
SECTION ORIENTEERING1 4
Meeting Run great meetings! Use them to drive execution. Use meetings to drive execute. Have P, O and A for every meeting.
Close your books by the 10th and hold your finance meeting on the 15th. DO NOT ABDICATE this work.You are the co-CFO.
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!
Financial Analysis Part 1 Calculate your monthlyTvA and ratios and do a quick common size and trend analysis. Ask Why 7 times during your TvA meeting. Observe red flags in trends and common size.
Reporting Start measuring 5-10 KPIs for your company.Weekly or monthly.As you measure it, you will see improvements.
If you did just one thing…
The Habits Have a morning routine! Use your calendar. Set 3 “I Musts” each week and map them to your calendar.
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.
Management Teams Have an org chart and use it to organize your company. Write PAs for those connected to you (your management team).
The AMP
Session Topics
Governance
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ORIENTEERING: STEP-BY-STEP
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.
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.
Intro to Finance and 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 Lookstatementsatyourfinancial statements at least once per month; NOT only once a year • About the future • Analyzes the future investments of capital • Forecasts cashflow • “Is that a wise investment?” • Very analytical • KPI:TvA, ROE, FCF Look at your cash flow weekly (daily), budget monthly 6
• Enjoy reading your financial statements: BS, IS, CF - and see what they tell you.
• Hold a monthly finance meeting every month: one of your two monthly management battle rhythms.
• 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).
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• 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.
FINANCE AND ACCOUNTING 101 SUMMARY
• Have, read and implement the finance manual:This is the accounting and finance SOP for the company.
• Close your books every month.Ask for the financial statements.
• DO NOT abdicate accounting and finance:You are the co-CFO.
SECTION 2 HOW TO DO FINANCIAL ANALYSIS 8
FINANCIAL ANALYSIS: BUCKETS OF ANALYSIS 9 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 Evaluate Yourself How am I doing? How are we compareddoingtoothers?
The Accountability Metric 10
Target vs.Actuals
BUCKET 1:TVA
EXAMPLE BAR CHART:TVA example way to present TvA sales and profit.
11 An
Ask “Why” 7 times. 12
BUCKET 2: COMMON / TREND ANALYSIS
Common / AnalysisTrend
The Wise Executive 13
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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.
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– 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 ANALYSIS
Two-types: Do both.
1. Have multiple years (months or quarters) of data aligned in the same rows 2. Divide all figures by the first year/month (Use $$ to lock cell –Command T) 3. Drag the cell across 4. Observe the % changes 15 NOTE: Common size on the IS gives you your margins.
Trend Analysis (Horizontal)
HOW TO COMMON SIZE ANALYSIS Common Size (Vertical) 1. Create a column to the right of the figures 2. Divide all figures by sales (Use $$ to lock cell – Command T) 3. Drag the cell down 4. Observe the % - GPM, OPM, NPM
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%
Goes Horizontal. Spots trend or patterns over a period of time. ANALYZE DATA:TREND ANALYSIS
Cost Of Materials Consumed 100.0% 80.4% 60.5% 65.4% 71.7%
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%
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%
Common-size analysis Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Other Operating Revenues 100.0% 130.4% 126.6% 134.2% 140.1%
Finance Costs 100.0% 113.9% 109.8% 132.3% 121.5%
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%
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%
Expenses:
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%
Performance 17
BUCKET 3: INCOME STATEMENT RATIOS
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
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 21 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.
Strength 22
4. BALANCE
BalanceRatiosSheet
BUCKET SHEET RATIOS
Working Capital = Current Assets – Current Liabilities 23 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 Coverage Ratios • Interest Coverage Ratio= Earnings Before Interest & Taxes (EBIT) Interest Expense • Current Liability Coverage Ratio = Cash Flow from Operations (CFO) – Dividends Paid Current Liabilities
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
CashflowMetricsStatement
Health 27
BUCKET 5. MARGINS
28 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
29 EQUATION:ACCOUNTS RECEIVABLE TURNOVER & DSO SalesSales Average Accounts ReceivableAverage Accounts Receivable ReceivablesReceivables365365turnoverturnoverDSO Step 1: Step 2: ADD = Receivables Turnover=
30 EQUATION: INVENTORY TURNOVER & DIO Cost of goods soldCost of goods sold Average InventoryAverage Inventory InventoryInventory365365turnoverturnoverDIO ADD = Inventory Turnover = Step 1: Step 2:
31 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
33 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 35
DEVELOP COMMENTARY & RECOMMENDATIONS
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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.
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.
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.
INDUSTRY ANALYSIS RESOURCES
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• Investopedia: http://www.investopedia.com/articles/06/cashconversioncycle.asp
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GREAT FINANCE RESOURCES
Strategic CFO – 13 WCF: https://strategiccfo.com/thirteen-week-cash-flow-report/ Accounting: https://www.accountingcoach.com/ Accounting Podcast: https://www.accountingtools.com/podcasts/ 13WCF Video: https://www.youtube.com/watch?v=ddNBsBnek78
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SECTION 3 BREAKOUT 39
BREAKOUT DISCUSSION
2. What are the key components do you think you need to see and how are they presented to you?
3. How would you communicate the information to your stakeholders?
1. What do you look at and what are the pain points when you go through analyzing the statement and making decisions?
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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. • Ask “Why” 7 Times! • Get better at forecasting (budget and 13WCF) • Cash and cash flow are key! There are 7 levers to increase cash flow, which we will cover next class. 41
Use your calendar (I Musts, map all your time, set aside 3 hours for ON the business work) 2. Schedule 3 hours: – Collect your financial statements – Calculate your margins and your ratios
us
ASSIGNMENT
1. – Email if you want
HOMEWORK
a consultation 3. Do the prep work for next class on cash flow. 42
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44 Thank you! www.renewstrategies.com
45 Backup www.renewstrategies.com
TEAM EXERCISE • Time: 60 min • Goal:Try what you have learned on your own financial statements. • Topic: Calculating margins • Discussion Questions: – What is your gross profit margin? – What is your net profit margin? – What is your current ratio? – What does this tell you about your company? – Are you paying men and women fairly? • Report Out: Each team reports out 3 things they learned?. 46
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
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 48Proprietary and Confidential to RENEW LLC
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 other 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” 49Proprietary and Confidential to RENEW LLC
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 50
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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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.
EXAMPLE 52 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.
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!
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STEP 8: UNDERSTAND THE 4 FORCES OF CASH FLOW
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! 54
• 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
2)
QUICK FINANCE REFRESH
Know your calculations: Growth (MoM,YoY), Margin (GPM, OPM, NPM), Ratios (Current, ROE), & CCC
Monthly
in the PAs and SOPs 56
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
13-week Cash Flow:
Know your financial
3) which are documented
Collect reports – Monthly Financial Report:TvA and “why?” – Monthly Operational Report - Dashboard: Each managers’ KPIs,
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RATIO ANALYSIS Ratios
Return on Assets (ROA) = NetAvg.IncomeTotalAssets
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.