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Evaluating Business Performance

Let me start with the following disclaimer – I am not an accountant, financial consultant, Chartered Accountant, or CPA. I am business owner who can read the balance sheet, who understands the impact of short-term expenditures on long-term financial performance.

However, I understand how growth needs to be measured financially, especially if your goal is to eventually sell the company or take it big time with investment capital. Everything you do – land new accounts, develop a new product, purchase equipment, hire people, etc. is measured against its impact on:
  • Market Value
  • Cash Flow
  • Revenue and Revenue Growth
  • Return on Invested Capital
  • Cost of Capital
Market Value:
The current quoted price at which investors buy or sell a share of common stock or a bond at a given time. The market capitalization plus the market value of debt. Sometimes referred to as "total market value.”

Cash Flow:
A revenue or expense stream that changes a cash account over a given period. Cash in-flows usually arise from one of three activities - financing, operations or investing - though they also occur because of donations or gifts in the case of personal finance. Cash out-flows result from expenses or investments. This holds true for both business and personal finance.

Revenue and Revenue Growth:
The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income. Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.Revenue is also known as "REVs"

Return on Invested Capital (ROIC)
A calculation used to assess a company's potential to be a quality investment by determining how well (i.e. profitably) a company's management is able to allocate capital into its operations. Comparing a company's ROIC with its cost of capital (WACC) reveals whether invested capital was used effectively.

Cost of Capital
The required return necessary to make a capital budgeting project - such as building a new factory - worthwhile. Cost of capital would include the cost of debt and the cost of equity.

Operationalize Growth Metrics by Managing Your Financials
  1. Create attractive gross margins early – target 60% or greater and maintain it through various growth stages – never sacrifice gross margin to buy market share
  2. Contain expenses to achieve 20+ EBITDA – total investment equals/never exceeds the difference between gross margin and 20+% of EBITDA (Earnings before Interest, Taxes, and Depreciation)
  3. Become cash flow positive early – deliver consistent cash in proportion to revenue growth
  4. Utilize incremental gross margins to self-fund incremental investments – provides a unique opportunity to self-fund a higher level of investment in sales and marketing as well as product development

………Profit at All Costs

However, you cannot successfully manage these metrics after the fact. Using financials or trailing indicators to run the business is like driving the car by looking through the rear view mirror or driving your boat by watching its wake.

Only by installing a predictive measurement can you decide what actions are on your short list (the principle of ONE THING) and then measured in the real time so you can drive business measures in the right direction.

1 comment:

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