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Hi, and welcome to Be The Flagship with our podcast host, Jeff Parsons.

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This is where we tackle the day-to-day talent management challenges you face.

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And now, over to our host.

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Take it away, Jeff.

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Hello, and welcome to my podcast, Be The Flagship.

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I'm your host, Jeff Parsons.

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Today is a special day.

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This is episode eight of our series, Finance and Operations, where we discuss the impact

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of finance on operational excellence and business success.

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Our featured guest speaker for these past couple of months, really, is Jeff Smith.

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He's my friend, and he's a financial expert.

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So we're glad to have Jeff back again.

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And Jeff will be continuing our discussion on financial metrics so that our operations

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leaders and our listeners will better understand what metrics are out there and how they're

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used to help achieve business success.

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So again, Jeff, thank you again, and welcome.

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Always a pleasure talking to you, Jeff.

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So, Jeff, in last week's episode, we closed the episode with discussion regarding liquidity

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and the importance, obviously, of business liquidity.

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What else besides liquidity?

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So the other part of the balance sheet is focused on asset management.

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Gotcha.

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What do we talk about?

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Asset management is, how well am I using my investments?

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And so one of the metrics is called return on assets, which is really simple.

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It's your operating income over your total assets.

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And that kind of gives you an indication it's a very high level, how am I utilizing my

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investment in my assets?

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Okay.

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So if you want to get more granular about it, then return on capital employed is, capital

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employed is your total assets minus your current liabilities.

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It's how much cash have I put out in order to operate the business.

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And so my earnings before interest in taxes over my capital employed is my return on capital

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employed.

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Okay.

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So it's how much money am I making on my overall investment?

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Gotcha.

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Yeah, I've heard that used and referred to when the powers that be want to increase efficiencies,

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you want to increase equipment speeds and productivity and that sort of thing because

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they're getting a lower return on their assets or capital employed there.

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Yes.

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Yeah.

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Okay.

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Then there's ROI, return on investment.

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That a lot.

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Yeah.

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Yeah.

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Which is your net return, your net income over the cost of your investment.

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So on a particular investment, for example, you would calculate how much return you use

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yet on that investment over the cost of the investment.

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Like stock market purposes, if I invested a dollar in, let's say, flagship enterprises.

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And at the end of the year, that $1 was now worth $1.10, then my net return is $0.10.

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Over my initial investment of $1 is 10%.

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So we can look at, we can do that same sort of calculation for an investment in assets

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in an operation.

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If I go and buy a piece of equipment, how much money is that piece of equipment going

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to generate for me over the cost that I've invested in that piece of equipment?

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Gotcha.

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Okay.

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So although I will say, I was hoping that you would invest more in a dollar in flagship,

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but okay, I got you.

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So then there's another one that you might have heard of is called net present value.

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Present value is basically the present value of all your future cash flows minus your initial

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investment.

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So and then this gets more complicated.

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The reason why I include this is because it's often used when doing an analysis on investing

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in a piece of equipment.

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So basically, your investment today is worth, there's an opportunity cost of tying up your

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cash in an investment, which is the future cash flows.

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And so you have to include the interest rate that you will incur and use that to discount

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your future cash flows.

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So in simple terms, if I have a $100,000 piece of equipment that's going to last me

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two years or 10 years, and I'm going to get $10,000 extra revenue per year over those

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10 years, is that a good investment?

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And the answer to that is it depends.

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And in today's environment where interest rates have increased $10,000 a year, that

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that 10th year of $10,000 returns is only worth a fraction of $10,000 today.

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So if you add up all those $10,000, the net present value of each of those, it's less

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than the $100,000 that you invested in the piece of equipment.

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And so chances are management is not going to want to take that investment.

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Is they could better use their money elsewhere.

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Right.

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And they're always making those types of decisions, right?

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If I'm giving the money to a business entity versus placing it in a bank account or that's

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or that sort of thing, right?

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Yeah.

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So, kind of when you're dealing with investments in fixed assets, you often use more than one

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measure.

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And though another measure that you would use is called the payback period, which is

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how much time is it going to take me to get the cash back on the investment that I've

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made?

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So again, we take $100,000 piece of equipment.

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Let's say that for sake of argument that we're going to get $40,000 a year of net cash back

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from that investment.

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So our cost of our investment over our annual cash flows is going to provide the payback

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period.

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So if we have $100,000 divided by $40,000 a year, we would get a two and a half year

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payback period.

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Right.

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Which is a good payback period because then you've got that cash back in the bank account

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and you can then start utilizing that cash for other investments.

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Based on your experience, what would you determine to be the average payback period, expectation

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at least or at least best practices in terms of payback periods?

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Or is there a best practice there?

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I know it varies.

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It does vary, but companies that I've worked for have looked for anything under three years.

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Yeah.

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That's been my experience as well.

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And that's been...

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We've talked about this in earlier episodes, Jeff, but that's been the shock when you're

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acquired by a different company, when you're acquired by a private equity firm or those

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types of things where that payback period is a little more aggressive than what they're

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accustomed to.

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But yeah, I was thinking the same thing about three years or less.

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The final one that we would look at is what's called fixed asset turnover, which is basically

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your revenue or your sales divided by your average fixed assets.

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And that's how much value am I getting from my overall investment in assets?

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So is buying that new car really going to be additive to my sales?

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Is buying that piece of equipment going to be additive to my sales?

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And so we want to make sure that we're generating extra revenue when we make investments in

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our assets.

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As we talked about in the past, there's some things that are just you have to make the

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investment because it's what's expected.

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You have to buy a new car for your company if the old one is worn out.

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It's not necessarily going to generate any additional.

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It's not going to have a payback or a return on capital, but it's a necessary part of your

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business.

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Putting a new roof on the building is not going to generate additional sales.

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Right.

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No, that's right, but it's just a business decision and it has to be made in terms of

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how you utilize your capital.

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And capital, right?

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Correct.

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All right.

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So I think we've covered the balance sheet and some of the metrics there.

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And again, liquidity is so important.

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And so is asset management.

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Well, what about the income statement?

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Yeah, the income statement is, again, measure of the activities of the business.

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So you're looking at, there's kind of two ways to look at it.

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There's your strictly financial metrics and then there's mixed metrics, which take into

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account non-financial information to add into the income statement.

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And so from a strictly financial point of view, you've got your gross profit percentage,

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which is gross profit, and we'll define gross profit.

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Gross profit is your revenue minus your cost of goods sold.

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So that's what gross profit is.

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Right.

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You want gross profit as a percentage.

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You take your gross profit and you divide it by your revenue to get a percentage of sales.

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So again, you would compare that to your peers.

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You would compare it to budget.

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You would compare it to prior periods to get an indication as to whether it's favorable

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or unfavorable.

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You've got your contribution margin percentage, which we didn't talk about a contribution

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margin statement, but it's a different way of presenting your income statement, where

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the income statement is kind of traditional.

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It goes down from revenue down to net income.

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The contribution margin statement will take your revenue minus all of your variable costs

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to come up with your contribution margin and then subtract your fixed costs to come up

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with your net income.

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And so contribution margin is revenue minus variable costs.

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And then if you want to take it as a percentage, it's revenue minus variable costs all over

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revenue to come up with your contribution margin percentage.

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So what that tells you that's different than your gross profit is that largely the fixed

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costs are not controllable.

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Your variable costs are more controllable.

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And so if you want to understand what's controllable in your product costs, then you do your contribution

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margin percentage.

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Okay.

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You want to be able to understand your investment in the future of your business.

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So often we'll look at research and development as a percentage of revenue.

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How much of my revenue am I allocating to developing future products, future business?

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Right?

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And then you want to look at your operating income as a percentage of revenue.

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And all of these things, typical financial statement, typical income statement would

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have a column for your dollar results and then a column for your percentages.

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So it's really easy to pull out those percentages.

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So some of the ones that incorporate non-financial metrics into that is something called a product

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line P&L, which segregates your revenue and cost of goods sold by product line.

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So let's say if I have different product lines, say in a manufacturing company, I have widgets

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and digits and something else.

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And they all carry with them a different profitability, different average selling price, a different

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margin.

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I want to be able to segregate those.

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So I separate them by product line so that I can look at if there's a particular product

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line that looks more profitable than the others, I can then focus my attention and my resources

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on building that out.

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Or I could look at the ones that are not performing well and either improve the performance

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or make a decision to deemphasize them.

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Right.

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Right.

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So that makes sense and I'm sure you wonder sometimes why companies make a decision to

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sideline a particular brand that you seem to like and maybe other people like or a model

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of a vehicle or that sort of thing.

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They sideline that.

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But it probably goes back to your comments around product line P&L.

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I might like it, but is it generating the profit compared to a new brand or the other

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existing brands and should we take the money that we're investing in and that one with

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a poor P&L and just reinvest that money in the stronger P&L businesses to strengthen

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that or create new brands and that sort of thing.

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Yeah.

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Yeah.

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Okay.

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All right, Jeff.

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Yeah.

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So, revenue per employee.

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You know, it's a good metric to look at because, you know, I've talked about my wife's business.

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There's a theoretical maximum to the number of clients that she can personally look after.

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And so, once we hit that theoretical maximum, then we had to hire an employee.

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Right?

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And just to clarify, your wife's business is basically a home health type of business,

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correct?

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Yeah.

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It's in the same year services.

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Yes.

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And so, then, you know, we've got an employee.

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Once we hit that theoretical maximum that she's able to take on, then we expand further.

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And so, understanding your average revenue per employee is very good to being able to

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make decisions and understand how you're performing, you know, whether you're maybe

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you're overburdened with employees or underburdened with employees.

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Right.

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Right.

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Right.

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And I guess that also, you know, the decision, we need to add another employee, another

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FTE, then you got to fill that person's plate, right?

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That's right.

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So, then you have, then your strategies on how can we increase our capacity to make sure

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this new employee has a full plate.

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Yeah.

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And is generating the right amount of revenue.

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Okay.

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All right, sir.

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Average selling price, revenue over the number of units.

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It's a good metric to have so that you can understand, you know, product mix, the value

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that's being added.

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And then customer acquisition costs.

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You hear that a lot, especially with high tech companies.

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Okay.

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People ask all the time, what's your cost of acquisition?

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Your customer acquisition cost is your sales and marketing expense over your net new customers.

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I see.

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So how much does it cost me to generate one additional customer?

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And so that's an important function, important metric to measure from a sales and marketing

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standpoint.

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And you mentioned that was a little more prevalent with the high tech type of businesses.

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Yeah.

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A lot of the subscription type of businesses is once you get a new customer, they tend to

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be pretty sticky with the subscriptions.

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Yeah.

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But how much does it cost you to get that customer in the door?

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I see.

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Okay.

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Thanks for that clarification, Jeff.

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How about the cash flow statement?

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Are there any metrics that are connected with the cash flow that are important to you?

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Yeah.

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There's four of them that are related and they are cash flow from operations ratio,

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which is your cash from operations over your average current liabilities.

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And that's how much cash am I generating versus how much do I owe in the next little

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while?

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And so it's how am I covering my liabilities?

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Am I going to be able to stay liquid?

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Okay.

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Cash flow coverage ratio is cash from operations over debt.

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And that's am I going to be able to pay all of my debts over the long haul?

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Free cash flow is something that you might hear a lot of when you're dealing with operations

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reviews.

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And that's cash from operations minus your capital expenditures.

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Okay.

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And so cash that you generated from the operations minus what you've invested in that period

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in capital equipment.

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Okay.

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And then the free cash flow ratio is your free cash flow over your revenue to understand

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it as a percentage of sales.

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I see.

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So how?

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And as a bonus, there's two other metrics that don't appear on any financial statements

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that they're really important.

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Okay.

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What are they?

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One of them is backlog, which is total orders not yet delivered.

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Right.

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The other one is open quotes, which is the quotes that have not turned into an order

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yet.

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I see.

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They're really important because they're predictive.

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And everything else that we've talked about has been things that have already happened.

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Okay.

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Backlog, you can be predictive about it.

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Just say that you've got a six week delivery time on your product and you have 12 weeks

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of backlog.

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Right?

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That means you're not going to be able to make your six week commitment.

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Right.

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But it also means that you've got filled up.

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You've got your whole quarter filled up with revenue already.

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You can accurately predict what your sales are going to be every month.

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You can do that with a full backlog, but with a backlog, there's also that downside because

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then on the other end, are you getting orders to customers?

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Are you delivering orders on time to customers because you have this backlog and is that

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going to create a longer term issue for you?

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Right.

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Exactly.

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And the other thing is you can then identify its early identification of things that are

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changing.

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And let's say your average backlog is $30,000.

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It's been $30,000 for the last 18 months and then this month it's $20,000.

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Well, what happened?

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Right.

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Do you have a problem brewing?

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Therein is the predictive part of it.

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It's an early indicator to changes in the environment that you can then investigate and

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react to.

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No, that's right.

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No.

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The same thing goes with open quotes is quotes that haven't yet turned into an order.

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If you understand your conversion rate, let's say you have a 30% conversion rate and you've

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got $100,000 in quotes out there, well, you know that $30,000 of it is going to turn into

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orders on average.

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And so you can buy your quoting activity is that one step earlier predictive and able

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to be able to identify if there's changes in your environment.

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I would imagine that's an important metric for the sales group.

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Yes.

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Yeah.

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Any other bonuses, Jeff?

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No, that's about it.

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Well, if there are no more bonuses, let's take a quick break and then we'll come back

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and wrap up, Jeff.

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At Flagship Talent, we work with our clients to find and place the right talent.

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What do we mean by the right talent?

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We mean we find talent who will commit to your organizational goals and align with your

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values and behavior expectations.

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Talent who will perform to your expectations.

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Talent who will stay and grow with your organization.

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How are we different from our competitors?

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We offer the lowest fee structure in the industry.

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00:25:53,880 --> 00:25:56,720
We offer the best talent guarantee in the industry.

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00:25:56,720 --> 00:26:01,560
We provide selection and interviewing support to our clients at no additional fee.

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00:26:01,560 --> 00:26:06,680
We want to save you money, deliver high quality talent, become an extension of your organization

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00:26:06,680 --> 00:26:10,520
and be your preferred provider of talent acquisition solutions.

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To learn more, contact Jeff Parsons by email at jeff at flagshiptalent.com or by phone at

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00:26:16,400 --> 00:26:21,240
1-800-530-4189-Extension101.

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Okay, we're back with Jeff Smith.

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Well, I think we've come to the end of our discussion and the end of our series in finance

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and operations.

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And, Jeff, thank you so much for your contribution and your commitment to this.

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I really do appreciate your time and the expertise you've brought to bear.

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And I appreciate you, but thank you so much for all that you've contributed to make this

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successful.

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It's my pleasure, Jeff.

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And I hope you can tell that I really enjoy talking about this stuff.

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I do.

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I can tell.

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And I really enjoy helping other companies to understand it.

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So it's absolutely my pleasure to do it.

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Yeah.

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I can sense the enthusiasm as a wonderful thing for an HR person when a person is passionate

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about what they're speaking about.

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I get that way in talking about leadership.

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It's just something I'm passionate about.

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So again, I really appreciate it, Jeff.

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Now, I am going to hold you.

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You always have an open invitation, but I'm going to get you back along with another friend

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00:27:36,560 --> 00:27:38,240
of mine who's a lean expert.

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00:27:38,240 --> 00:27:41,720
And we're going to talk about lean and we're going to talk about lean and finance.

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So that's on my list.

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So don't wander too far down the road.

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I'll be calling you back again.

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But that'll be one conversation.

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It will be a lot of fun.

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It'll be eye-opening, I think, for a lot of listeners.

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And speaking of that, before we go, talk to them one more time about what you do, your

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business dynamic strategy LLC, and the types of support you provide your clients, and then

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how our listeners could reach you.

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Should they want to discuss things with you?

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Absolutely.

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And in this series, we've been talking a lot about strategy.

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And that's what I do is I help businesses to focus on strategy and help them to understand

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their activities today that will help them to achieve those strategic goals in the future.

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And so it's really about focus.

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It's about accountability and it's about leadership development.

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I can be reached at jeff.goff.smith at dynamicstrategyllc.com or my phone number is 805-813-0600.

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You can always reach out to me the old fashioned way.

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All right, Jeff.

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Well, again, thank you so much.

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And I can't wait for our next discussion.

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00:29:01,240 --> 00:29:02,240
Excellent.

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Looking forward to it, Jeff.

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Take care, Jeff.

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00:29:04,880 --> 00:29:10,960
Well, this is a wrap on our eight part series, Finance and Operations with Finance Expert

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Jeff Smith.

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I hope you enjoyed it.

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I hope you found value in it.

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I can't wait for next week as we begin a new series.

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And it's a series that's near and dear to my heart.

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Again, it's focused on a group that supports operations and is essential to assisting operations

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and achieving success.

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And that would be human resources.

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So join me next week for episode one of the series, HR and Operations.

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Thank you again.

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Work hard to be the flagship in your industry.

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00:29:46,560 --> 00:29:48,480
And I look forward to you joining us next week.

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Bye now.

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Thank you for listening to this episode of Be the Flagship with Jeff Parsons.

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We hope you enjoyed it.

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If you did like it, please subscribe and share with others.

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00:29:58,480 --> 00:30:05,480
Until next time, take the step to become the flagship in your marketplace.

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Thank you.