Lagging indicators –Using Financial Statements to unearth dysfunction

Unfortunately financial statements being a record of the past may or may not represent the future. As such we refer to financials and their related interpretation measures as lagging indicators.

On the other hand we can create a set of financial statements that represents a future that we wish to perform to. Some call it a budget.

The failure with “the budget” is not in the final product but more in the preparation process. Budgets are usually not the most favorite pastime for those who are involved in the preparation. Normally it takes a lot of work WITH VERY LITTLE FEEDABCK except for the not acceptable stuff people get from senior management.

More critical are the situations where senior management believes that their design of the budget process is highly participatory and they have as many people involved in the process as possible. Only in very few instances do people actually participate (apart from doing what they have to do) normally there is nothing in it for them except more work. Management even solicits proposals but they go nowhere and at the end of the day it becomes a spread sheet nightmare with a whole lot of number crunching and very little thinking

Once again we will be controversial. The budget is very important but the effort is not in the numbers it is in the thinking. Preparing the numbers should be about 5% of the total effort. In fact we will prove that a summarized income statement, balance sheet and cash statements at the very macro level are as effective if not more effective as the mass detailed line by line outputs.

We bet a $1 that when a detailed budget is reviewed against actual and there is a reasonable variation between the budget amount and the actual amount that the standard reaction is

      The budget was wrong

      We accounted for that in another area or it does not matter as that category is intact.

      It’s a timing difference (the amount will correct itself in the future)

      There is a good reason for this difference we had no real other choice alternatives

      And so on

 Next time please observe how these detailed line items are managed if we are wrong the $1 is yours.

Our philosophy is based on getting the foundation in place. The base of this foundation is the knowledge of the fundamentals.

Fundamental	Change agent
1. Where did we do well	What decisions combined with good execution produced the expected result.
2. Where we did well, can we do more of it	How sustainable and replicateable are the superior performance activities. Can we convert their activities in core competencies?
3. Where is the opportunity	As defined by our gross potential
4. Where  are we sub par	Is it worth while investing to change

These fundamentals become the basis for our lagging indicators. These lagging indicators in turn become the driver to our leading indicators or core competencies

Let’s use our financials to assist in defining these fundamentals

Figure 8 some examples that are revealed by the financial statements that have a direct connection to the way we do business

A greater understanding of these dysfunctions will be gained in the next part 3 of our blog – The 5 chapters of financial statement communication.

Remember a dysfunction can also be a superior value added function if this is the case it would fit under fundamental 1 and possibly be part of fundamental 2.

For example fundamental 1 is about where we did well. If EBIT (operational profit growth percentage) growth % was 10% and revenue growth % was 8% we have a dysfunction although be it in the right direction. I realize this sounds crazy but it is quiet often under this circumstance that I ask the question “what did you do to get this result or outcome”. What would you suspect the 6/10 answers are!

“We not exactly sure… we increased prices on certain services, we focused on some defined segments and we made some dramatic people changes but at the same time input costs increased and we also had to drop our pants to keep 2 key customers”

Great so what’s in there is a core competency that we can replicate and what was due to a couple of stars that happen to be in alignment at the time.

 The moral is that we often look over the signals that could give us superior performance.  It’s amazing how our numbers can give us these signals all we have to do is know what we did that created the result and then replicated like crazy.

We are now ready to start the budgeting process. Our budgets are prepared on a macro level at least at the first run stage. The budget will be driven by the 4 fundamentals. For those environments where only fundamental 1 applies we will be most conservative with our projections. Where fundamental 1 and 2 applies we will be very aggressive with big performance improvements expected. Fundamental 3 is the tricky one as the ability to extract large amounts of value here requires a lot of good thinking, the right decisions, good execution and an excellent feedback system. In other words the management focus here must be pristine.

Create the budget clearly showing which fundamentals are implanted where. Prepare the income statement balance sheet and cash flow statement at the minimum of 4 90 day or quarterly cycles.

Now comes the fun part connecting these lagging indicators to the leading indicators or core competencies. Before we do so let’s make sure we have a foundation in what these leading indicators are and how important it is to identify and describe them appropriately

Global Financial Bridge is a great tool to identify these areas of dysfunction simply by looking at about 30 numbers in your One page scorecard.

Business Case Sales People

What customers want

The recent economic conditions may have changed the way that business is conducted either permanently or for a very long time. What worked before may very well work against you today.

Yes, the customer wants a solution; that is a competitive necessity. What they really want is clarity.

How does this solution impact my financial performance?

And

The more substantive evidence you can provide the better.

Here lies the challenge. Financial performance is an integrated discipline, about how a solution will impact the whole.  By the whole we mean the income statement, balance sheet and the cash flow statement.

 Financial statements are the only universally recognized way to measure how and if value has been created or destroyed. Real advantage is created when we connect the solution we are selling with how it impacts the customers financial statements.

This is the Global Financial Bridge Mission … to connect people to their financial statements. The ability to start and end the communication process through the lens of the customer’s financial statements creates a whole new dimension in sales leadership.

Our answer is the ONE PAGE FINACIAL SCORECARD. Why? The total process can be explained with some 30 numbers in an interactive real time way.  AND it is….

$   Informative

$   Fun

$   And Engaging

 Using Global Financial Bridge motivates non financial people to want to connect to financial statements. This is the secret to ensuring interest and ongoing desire in an area which is difficult to impart into the frontline culture.

Our real value is more apparent in the experience of a real time WEBEX presentation for 30 minutes.  The high impact value offer is delivered visually in an informative, fun and engaging way.  We use technology to deliver a story that negates fear and inspires adoption; real time.

Figure 1 the One Page interactive scorecard numbers in $’000

The power of the one page score card allows people to do what if based on any strategic scenario. Then to measure the impact on the various decisions simply by isolating the financial consequence of the decision through the net change feature. This net change feature shows how the income statements, the balance sheet and cash flow statement are impacted all in a one page environment.

Non financial people are drawn to the scorecard as it is fixed formatted and tells the financial story based on the 5 Chapters.  (See right hand side of scorecard)

Chapter 1 – Growth quality

Chapter 2 – Synchronizing operational profit with changes in growth

Chapter 3 – Working capital 

Chapter 4 – Cash impact and the road to sustainable cash flow

Chapter 5 - Creating value through the return on the invested $ (Return on Net Assets)

The fixed format dramatically enhances the learning curve creating confidence with repetition.

Figure 2 Expanded view numbers in $’000

  We encourage people to grow with their learning progress the expanded view portrays a far more detailed explanation of each of the 5 chapters. These detailed views are introduced as the person expands their learning capability.

What we offer

Our solution is education. We know that people can make a more compelling proposition when they relate to the ultimate scorecard being the customer’s financial statements. Where we provide unique and sustainable advantage is by combining theory with technology to create a real time experience that is engaging and fun.

The pathway to financial statement connection establishes the 4 phases of experiential learning. Each phase creates a more intimate alignment with what is being sold to how this offer could impact the customer’s financial statements.

The freely availability of listed company financial statements takes this learning to a whole new level as the One Page Scorecard can provide a instant diagnostic source where a potential solution may be the most appropriate. 

We take dedicated participants to the phase of the development program that is right for them. We can provide online testing if required in order to assess an individual’s progression path.

In addition the One page scorecard can be placed on each qualified person’s laptop to use and practice on if required. The software can be branded if required to enhance the customer experience.

We train on WEBEX or in traditional classroom environments. Each phase takes between 2 half day sessions to 3 days sessions.

Please contact us

agien@gfbridge.com

How we make decision around our pricing policies can have significant impact on profitability. This table shows the amount of additional sales that are required to counter the potential price reduction. For example if your current gross profit margins are 20% and your pricing policy allows for a 2% discount you have to increase total sales by 11%.

What should also be considered is the working capital impact that the price discount creates. the additional revenue absorbs additional working capital which can only be funded by cash (or more debt). Keep in mind that if you increase your revenue in the above example by 11% you are not  creating more profit so your cash flow is not supported by any income statement improvement.

This table can be a great way to challenge the sales or marketing team.

You can also use Global Financial Bridge One Page Scorecard to identify the total impact on the income statement, balance sheet, cash flow and key management metrics contact Andre Gien at agien@gfbridge.com and we will show you how to revitalize your financial or board meeting for as little as $600.00

Decreasing your Prices

If Your Present Margin Is…..

                        20%    25%    30%    35%    40%    45%    50%    55%    60%

And you discount your price

by:           Your sales must INCREASE by the amount shown below to keep the same margin…

2%                  11%     9%       7%       6%       5%       5%       4%       4%       3%      

4%                  25%     19%     15%     13%     11%     10%     9%       8%       7%

6%                  43%     32%     25%     21%     18%     15%     14%     12%     11%

              

8%                  67%     47%     36%     30%     25%     22%     19%     17%     15%

10%                100%   67%     50%     40%     33%     29%     25%     22%     20%

12%                150%   92%     67%     52%     43%     36%     32%     28%     25%

14%                233%   127%   88%     67%     54%     45%     39%     34%     30%

16%                400%   178%   114%   84%     67%     55%     47%     41%     36%

18%                900%   257%   150%   106%   82%     67%     56%     49%     43%

20%                -           400%   200%   133%   100%   80%     67%     57%     50%

25%                -           -           500%   250%   167%   125%   100%   83%     71%

30%                -           -           -           600%   300%   200%   150%   120%   100%

The table above indicates the increase in your sales that are required to compensate for a price discounting strategy. For example, if your margin is 40% and you reduce your price by 10%, you would need your sales volume to increase by 33% to maintain your profit. Rarely has such a strategy worked in the past and it’s unlikely it will work in the future!