Naturally, each prong works to different degrees in each company, but if you use all four of them, I can guarantee you will see amazing results. The first prong I discussed with specific examples was: “Understand fully an entity’s operations and develop the key financial metric that truly makes it ‘tick’.”
Here is the second ingredient in my approach:
PRONG #2 - Educate the management team members about finances and have them “take ownership” of their operations.
I am a great believer that in order to maximize a company’s profits and its enterprise value, the other senior managers must develop a thorough understanding of finance. Also, it is imperative that these key company officers fully understand how their “piece of the pie fits the entire pie”.
Many non-financial senior managers like the Chief Information Officer, the Director of Sales, the Director of Marketing, etc. have an amazing grasp of their areas of expertise but do not really grasp their company’s finances or understand the financial consequences of various transactions. Sometimes, even a CEO who comes from a heavy sales background does not have a complete understanding of the company’s net worth, enterprise value, etc.
In a public company, the financial knowledge needed is far greater. Besides understanding the entity’s finances, all officers must become conversant in the various SEC rules and filings, the Company’s stock activity, what one can say and not say to stock analysts or at public presentations, etc.
I have worked hard with all of my employers to provide the key managers with a general understanding of finances as well as the specific financial nuances of the company and its various types of transactions. This ongoing process includes both one-on-one and group training sessions. At most of my companies, we had top level monthly or quarterly management meetings. In addition to reviewing all the numbers, a major portion of each meeting would always be to teach additional facets of finance to the other key senior managers (e.g. fixed versus variable costs, contribution margin, leverage, scalability, etc.).
To assist the senior management team in utilizing their new appreciation of finance, I always create a series of important tailored reporting mechanisms. These reports are used by the management team to better understand the business trends and/or to quickly “stop any bleeding”.
The first of these specialized reports I call “flash reports”. They are produced as often as the company produces billings. In the case of a manufacturer or distributor, these reports are generally produced daily. They contain the previous day and month to date sales, gross profits, credits, etc. by company, country, division, and major product class. Where possible, I try to include, where possible, the entity’s key metric(s) which I thoroughly discussed in prong #1.
In many circumstances, while the monthly standard GAAP financials are useful to the financial department, the CEO, the Board of Directors, the commercial bankers, and the auditors, they might not tell the needed story to the senior operations officers. For them, I attempt to create tailored reports which give them important trend analysis to run their operations. For example at a distributor of medical supplies and equipment, the margin to several customer types was very thin and thus, it was of most importance to control overhead costs very closely and to keep these costs as variable as possible. On a monthly basis, I distributed a series of reports which showed detailed monthly, trailing three month, trailing six month and trailing twelve month fixed and variable costs by category and customer type as a percentage of sales. From these reports, one could clearly see trends as to the efficiency of the operations, whether the operations were becoming as scalable as hoped, etc.
Once I feel the other managers are gaining more of an understanding of the given company’s finances, I introduce a formalized “bottom-up” budgeting system in which the divisional and department senior managers become truly responsible for developing and meeting their annual budgets. The “bottom-up” process is tedious and while most companies say they use this process, they really do not do so. Rather, the budgets or the overall corporate targets are mandated by the top corporate officers and then, the detailed budgets are in reality built on a “top-down” approach.
The amount of cost savings and efficiencies from a “bottom-up” budgeting system have always been substantial once the managers truly “take ownership” of their budgets. Generally to reap the maximum benefits of this important corporate tool, the full implementation process takes at least two years.
In year one, I work closely with the divisional and departmental managers to teach them how to construct a budget and how to truly use historical data combined with the corporation’s current situation to project the upcoming year’s revenues, costs and expenses. Time after time, when undergoing this initial process, I hear from the CIO, the purchasing manager, the warehouse manager, etc. “I never realized all the overhead costs that were allocated to my department/division.” Then, they give me a list of services, employees, etc. that are either not necessary or duplicative. I would guestimate that this initial “bottom-up” process takes at least double the normal time and errors will still occur but it is certainly worth the effort.
At least quarterly during the first year of implementing a “bottom-up” process, I conduct budget-to-actual meetings with the entire group of departmental and divisional managers. Prior to the meeting each responsible manager must distribute a written report to all attendees explaining the major variances as well as a reforecast of the remainder of the year for major projected variances. At the meeting, each attendee is required to discuss his or her report and accept questions and comments from others. Generally in the first of such quarterly meetings, the CEO and I are usually the only ones asking questions or making comments. Slowly in future meetings, the other attendees begin asking questions and making suggestions. Once the “peer pressure” begins and everyone is making comments on others’ reports, the energy in the room grows to such an extent where you can almost guarantee that excellent revenue generating or cost saving ideas will come to light at each and every quarterly meeting.
In year two of the implementation, the managers become much more adroit in preparing their budgets. Once again, because of the “peer pressure”, they will work very diligently to prepare what they consider the most accurate budget incorporating many revenue enhancement and cost containment ideas (i.e. they will truly “take ownership” of their respective budgets). Then, the quarterly process will become an even more effective tool in maximizing profits and increasing enterprise value as each manager becomes more comfortable with this “bottom-up” process.
I hope you can visualize the huge additional profits (primarily from reduction of costs and expenses) that can be derived by educating the management team about finances and having them “take ownership” of their operations. The benefits from your efforts in this area will be appreciated by all. The senior management team will be especially happy come bonus time and the investors will be thrilled with the increase in enterprise value.
Stay tuned for the next installment and the third prong to profitability which will be published shortly.