Hi, and welcome to Be The Flagship with our podcast host, Jeff Parsons.
This is where we tackle the day-to-day talent management challenges you face.
And now, over to our host.
Take it away, Jeff.
Hello, and welcome to my podcast, Be The Flagship.
I'm your host, Jeff Parsons.
Today is a special day.
This is episode eight of our series, Finance and Operations, where we discuss the impact
of finance on operational excellence and business success.
Our featured guest speaker for these past couple of months, really, is Jeff Smith.
He's my friend, and he's a financial expert.
So we're glad to have Jeff back again.
And Jeff will be continuing our discussion on financial metrics so that our operations
leaders and our listeners will better understand what metrics are out there and how they're
used to help achieve business success.
So again, Jeff, thank you again, and welcome.
Always a pleasure talking to you, Jeff.
So, Jeff, in last week's episode, we closed the episode with discussion regarding liquidity
and the importance, obviously, of business liquidity.
What else besides liquidity?
So the other part of the balance sheet is focused on asset management.
Gotcha.
What do we talk about?
Asset management is, how well am I using my investments?
And so one of the metrics is called return on assets, which is really simple.
It's your operating income over your total assets.
And that kind of gives you an indication it's a very high level, how am I utilizing my
investment in my assets?
Okay.
So if you want to get more granular about it, then return on capital employed is, capital
employed is your total assets minus your current liabilities.
It's how much cash have I put out in order to operate the business.
And so my earnings before interest in taxes over my capital employed is my return on capital
employed.
Okay.
So it's how much money am I making on my overall investment?
Gotcha.
Yeah, I've heard that used and referred to when the powers that be want to increase efficiencies,
you want to increase equipment speeds and productivity and that sort of thing because
they're getting a lower return on their assets or capital employed there.
Yes.
Yeah.
Okay.
Then there's ROI, return on investment.
That a lot.
Yeah.
Which is your net return, your net income over the cost of your investment.
So on a particular investment, for example, you would calculate how much return you use
yet on that investment over the cost of the investment.
Like stock market purposes, if I invested a dollar in, let's say, flagship enterprises.
And at the end of the year, that $1 was now worth $1.10, then my net return is $0.10.
Over my initial investment of $1 is 10%.
So we can look at, we can do that same sort of calculation for an investment in assets
in an operation.
If I go and buy a piece of equipment, how much money is that piece of equipment going
to generate for me over the cost that I've invested in that piece of equipment?
Gotcha.
Okay.
So although I will say, I was hoping that you would invest more in a dollar in flagship,
but okay, I got you.
So then there's another one that you might have heard of is called net present value.
Present value is basically the present value of all your future cash flows minus your initial
investment.
So and then this gets more complicated.
The reason why I include this is because it's often used when doing an analysis on investing
in a piece of equipment.
So basically, your investment today is worth, there's an opportunity cost of tying up your
cash in an investment, which is the future cash flows.
And so you have to include the interest rate that you will incur and use that to discount
your future cash flows.
So in simple terms, if I have a $100,000 piece of equipment that's going to last me
two years or 10 years, and I'm going to get $10,000 extra revenue per year over those
10 years, is that a good investment?
And the answer to that is it depends.
And in today's environment where interest rates have increased $10,000 a year, that
that 10th year of $10,000 returns is only worth a fraction of $10,000 today.
So if you add up all those $10,000, the net present value of each of those, it's less
than the $100,000 that you invested in the piece of equipment.
And so chances are management is not going to want to take that investment.
Is they could better use their money elsewhere.
Right.
And they're always making those types of decisions, right?
If I'm giving the money to a business entity versus placing it in a bank account or that's
or that sort of thing, right?
Yeah.
So, kind of when you're dealing with investments in fixed assets, you often use more than one
measure.
And though another measure that you would use is called the payback period, which is
how much time is it going to take me to get the cash back on the investment that I've
made?
So again, we take $100,000 piece of equipment.
Let's say that for sake of argument that we're going to get $40,000 a year of net cash back
from that investment.
So our cost of our investment over our annual cash flows is going to provide the payback
period.
So if we have $100,000 divided by $40,000 a year, we would get a two and a half year
payback period.
Right.
Which is a good payback period because then you've got that cash back in the bank account
and you can then start utilizing that cash for other investments.
Based on your experience, what would you determine to be the average payback period, expectation
at least or at least best practices in terms of payback periods?
Or is there a best practice there?
I know it varies.
It does vary, but companies that I've worked for have looked for anything under three years.
Yeah.
That's been my experience as well.
And that's been...
We've talked about this in earlier episodes, Jeff, but that's been the shock when you're
acquired by a different company, when you're acquired by a private equity firm or those
types of things where that payback period is a little more aggressive than what they're
accustomed to.
But yeah, I was thinking the same thing about three years or less.
The final one that we would look at is what's called fixed asset turnover, which is basically
your revenue or your sales divided by your average fixed assets.
And that's how much value am I getting from my overall investment in assets?
So is buying that new car really going to be additive to my sales?
Is buying that piece of equipment going to be additive to my sales?
And so we want to make sure that we're generating extra revenue when we make investments in
our assets.
As we talked about in the past, there's some things that are just you have to make the
investment because it's what's expected.
You have to buy a new car for your company if the old one is worn out.
It's not necessarily going to generate any additional.
It's not going to have a payback or a return on capital, but it's a necessary part of your
business.
Putting a new roof on the building is not going to generate additional sales.
Right.
No, that's right, but it's just a business decision and it has to be made in terms of
how you utilize your capital.
And capital, right?
Correct.
All right.
So I think we've covered the balance sheet and some of the metrics there.
And again, liquidity is so important.
And so is asset management.
Well, what about the income statement?
Yeah, the income statement is, again, measure of the activities of the business.
So you're looking at, there's kind of two ways to look at it.
There's your strictly financial metrics and then there's mixed metrics, which take into
account non-financial information to add into the income statement.
And so from a strictly financial point of view, you've got your gross profit percentage,
which is gross profit, and we'll define gross profit.
Gross profit is your revenue minus your cost of goods sold.
So that's what gross profit is.
Right.
You want gross profit as a percentage.
You take your gross profit and you divide it by your revenue to get a percentage of sales.
So again, you would compare that to your peers.
You would compare it to budget.
You would compare it to prior periods to get an indication as to whether it's favorable
or unfavorable.
You've got your contribution margin percentage, which we didn't talk about a contribution
margin statement, but it's a different way of presenting your income statement, where
the income statement is kind of traditional.
It goes down from revenue down to net income.
The contribution margin statement will take your revenue minus all of your variable costs
to come up with your contribution margin and then subtract your fixed costs to come up
with your net income.
And so contribution margin is revenue minus variable costs.
And then if you want to take it as a percentage, it's revenue minus variable costs all over
revenue to come up with your contribution margin percentage.
So what that tells you that's different than your gross profit is that largely the fixed
costs are not controllable.
Your variable costs are more controllable.
And so if you want to understand what's controllable in your product costs, then you do your contribution
margin percentage.
Okay.
You want to be able to understand your investment in the future of your business.
So often we'll look at research and development as a percentage of revenue.
How much of my revenue am I allocating to developing future products, future business?
Right?
And then you want to look at your operating income as a percentage of revenue.
And all of these things, typical financial statement, typical income statement would
have a column for your dollar results and then a column for your percentages.
So it's really easy to pull out those percentages.
So some of the ones that incorporate non-financial metrics into that is something called a product
line P&L, which segregates your revenue and cost of goods sold by product line.
So let's say if I have different product lines, say in a manufacturing company, I have widgets
and digits and something else.
And they all carry with them a different profitability, different average selling price, a different
margin.
I want to be able to segregate those.
So I separate them by product line so that I can look at if there's a particular product
line that looks more profitable than the others, I can then focus my attention and my resources
on building that out.
Or I could look at the ones that are not performing well and either improve the performance
or make a decision to deemphasize them.
Right.
So that makes sense and I'm sure you wonder sometimes why companies make a decision to
sideline a particular brand that you seem to like and maybe other people like or a model
of a vehicle or that sort of thing.
They sideline that.
But it probably goes back to your comments around product line P&L.
I might like it, but is it generating the profit compared to a new brand or the other
existing brands and should we take the money that we're investing in and that one with
a poor P&L and just reinvest that money in the stronger P&L businesses to strengthen
that or create new brands and that sort of thing.
Yeah.
Okay.
All right, Jeff.
Yeah.
So, revenue per employee.
You know, it's a good metric to look at because, you know, I've talked about my wife's business.
There's a theoretical maximum to the number of clients that she can personally look after.
And so, once we hit that theoretical maximum, then we had to hire an employee.
Right?
And just to clarify, your wife's business is basically a home health type of business,
correct?
Yeah.
It's in the same year services.
Yes.
And so, then, you know, we've got an employee.
Once we hit that theoretical maximum that she's able to take on, then we expand further.
And so, understanding your average revenue per employee is very good to being able to
make decisions and understand how you're performing, you know, whether you're maybe
you're overburdened with employees or underburdened with employees.
Right.
And I guess that also, you know, the decision, we need to add another employee, another
FTE, then you got to fill that person's plate, right?
That's right.
So, then you have, then your strategies on how can we increase our capacity to make sure
this new employee has a full plate.
Yeah.
And is generating the right amount of revenue.
Okay.
All right, sir.
Average selling price, revenue over the number of units.
It's a good metric to have so that you can understand, you know, product mix, the value
that's being added.
And then customer acquisition costs.
You hear that a lot, especially with high tech companies.
Okay.
People ask all the time, what's your cost of acquisition?
Your customer acquisition cost is your sales and marketing expense over your net new customers.
I see.
So how much does it cost me to generate one additional customer?
And so that's an important function, important metric to measure from a sales and marketing
standpoint.
And you mentioned that was a little more prevalent with the high tech type of businesses.
Yeah.
A lot of the subscription type of businesses is once you get a new customer, they tend to
be pretty sticky with the subscriptions.
Yeah.
But how much does it cost you to get that customer in the door?
I see.
Okay.
Thanks for that clarification, Jeff.
How about the cash flow statement?
Are there any metrics that are connected with the cash flow that are important to you?
Yeah.
There's four of them that are related and they are cash flow from operations ratio,
which is your cash from operations over your average current liabilities.
And that's how much cash am I generating versus how much do I owe in the next little
while?
And so it's how am I covering my liabilities?
Am I going to be able to stay liquid?
Okay.
Cash flow coverage ratio is cash from operations over debt.
And that's am I going to be able to pay all of my debts over the long haul?
Free cash flow is something that you might hear a lot of when you're dealing with operations
reviews.
And that's cash from operations minus your capital expenditures.
Okay.
And so cash that you generated from the operations minus what you've invested in that period
in capital equipment.
Okay.
And then the free cash flow ratio is your free cash flow over your revenue to understand
it as a percentage of sales.
I see.
So how?
And as a bonus, there's two other metrics that don't appear on any financial statements
that they're really important.
Okay.
What are they?
One of them is backlog, which is total orders not yet delivered.
Right.
The other one is open quotes, which is the quotes that have not turned into an order
yet.
I see.
They're really important because they're predictive.
And everything else that we've talked about has been things that have already happened.
Okay.
Backlog, you can be predictive about it.
Just say that you've got a six week delivery time on your product and you have 12 weeks
of backlog.
Right?
That means you're not going to be able to make your six week commitment.
Right.
But it also means that you've got filled up.
You've got your whole quarter filled up with revenue already.
You can accurately predict what your sales are going to be every month.
You can do that with a full backlog, but with a backlog, there's also that downside because
then on the other end, are you getting orders to customers?
Are you delivering orders on time to customers because you have this backlog and is that
going to create a longer term issue for you?
Right.
Exactly.
And the other thing is you can then identify its early identification of things that are
changing.
And let's say your average backlog is $30,000.
It's been $30,000 for the last 18 months and then this month it's $20,000.
Well, what happened?
Right.
Do you have a problem brewing?
Therein is the predictive part of it.
It's an early indicator to changes in the environment that you can then investigate and
react to.
No, that's right.
No.
The same thing goes with open quotes is quotes that haven't yet turned into an order.
If you understand your conversion rate, let's say you have a 30% conversion rate and you've
got $100,000 in quotes out there, well, you know that $30,000 of it is going to turn into
orders on average.
And so you can buy your quoting activity is that one step earlier predictive and able
to be able to identify if there's changes in your environment.
I would imagine that's an important metric for the sales group.
Yes.
Yeah.
Any other bonuses, Jeff?
No, that's about it.
Well, if there are no more bonuses, let's take a quick break and then we'll come back
and wrap up, Jeff.
At Flagship Talent, we work with our clients to find and place the right talent.
What do we mean by the right talent?
We mean we find talent who will commit to your organizational goals and align with your
values and behavior expectations.
Talent who will perform to your expectations.
Talent who will stay and grow with your organization.
How are we different from our competitors?
We offer the lowest fee structure in the industry.
We offer the best talent guarantee in the industry.
We provide selection and interviewing support to our clients at no additional fee.
We want to save you money, deliver high quality talent, become an extension of your organization
and be your preferred provider of talent acquisition solutions.
To learn more, contact Jeff Parsons by email at jeff at flagshiptalent.com or by phone at
1-800-530-4189-Extension101.
Okay, we're back with Jeff Smith.
Well, I think we've come to the end of our discussion and the end of our series in finance
and operations.
And, Jeff, thank you so much for your contribution and your commitment to this.
I really do appreciate your time and the expertise you've brought to bear.
And I appreciate you, but thank you so much for all that you've contributed to make this
successful.
It's my pleasure, Jeff.
And I hope you can tell that I really enjoy talking about this stuff.
I do.
I can tell.
And I really enjoy helping other companies to understand it.
So it's absolutely my pleasure to do it.
Yeah.
I can sense the enthusiasm as a wonderful thing for an HR person when a person is passionate
about what they're speaking about.
I get that way in talking about leadership.
It's just something I'm passionate about.
So again, I really appreciate it, Jeff.
Now, I am going to hold you.
You always have an open invitation, but I'm going to get you back along with another friend
of mine who's a lean expert.
And we're going to talk about lean and we're going to talk about lean and finance.
So that's on my list.
So don't wander too far down the road.
I'll be calling you back again.
But that'll be one conversation.
It will be a lot of fun.
It'll be eye-opening, I think, for a lot of listeners.
And speaking of that, before we go, talk to them one more time about what you do, your
business dynamic strategy LLC, and the types of support you provide your clients, and then
how our listeners could reach you.
Should they want to discuss things with you?
Absolutely.
And in this series, we've been talking a lot about strategy.
And that's what I do is I help businesses to focus on strategy and help them to understand
their activities today that will help them to achieve those strategic goals in the future.
And so it's really about focus.
It's about accountability and it's about leadership development.
I can be reached at jeff.goff.smith at dynamicstrategyllc.com or my phone number is 805-813-0600.
You can always reach out to me the old fashioned way.
All right, Jeff.
Well, again, thank you so much.
And I can't wait for our next discussion.
Excellent.
Looking forward to it, Jeff.
Take care, Jeff.
Well, this is a wrap on our eight part series, Finance and Operations with Finance Expert
Jeff Smith.
I hope you enjoyed it.
I hope you found value in it.
I can't wait for next week as we begin a new series.
And it's a series that's near and dear to my heart.
Again, it's focused on a group that supports operations and is essential to assisting operations
and achieving success.
And that would be human resources.
So join me next week for episode one of the series, HR and Operations.
Thank you again.
Work hard to be the flagship in your industry.
And I look forward to you joining us next week.
Bye now.
Thank you for listening to this episode of Be the Flagship with Jeff Parsons.
We hope you enjoyed it.
If you did like it, please subscribe and share with others.
Until next time, take the step to become the flagship in your marketplace.
Thank you.