Ram Charan is an advisor to Fortune 500 companies and has lectured at Harvard and Northwestern’s Kellogg school of business. In his book What the CEO wants you to know, he explores what he describes as the “basic building blocks of a business”. Using comparisons from his family’s shoe shop in India he deciphers the day-to-day necessities of a business in order to describe the essential information you can use to determine whether a business is successful.
Here is a synopsis of some of the essential finances of a business as described in”What the CEO wants you to know”:
- Cash generation – The difference between all the cash that flows into or out of the business in a given time period.
- Margin – Margin is the percentage profit made on the products the company sells or services the company provides. As a meaningful statistic it usually refers to a company’s net profit margin after taxes.
- Velocity – Sometimes referred to as “inventory turns”, describes the concept of how frequently the company’s stock is moved off the shelves into the hands of it’s customers, and replenished by suppliers. It defined by how many times a particular product has to be restocked in a year. Additionally he measures “Asset velocity”, this is AV = Sales / total assets. This measurement is somewhat more interesting in terms of software companies that don’t have a physical product.
- Return on Assets (ROA) – The amount of money you are able to make with a given amount of fixed assets. Occasionally companies use slightle different measurements such as “Return on investment (ROI)” or “Return on equity (ROE)”. These measurements answer the questions of “How much money are you making with your investments, or with the money shareholders have invested in the company?”. ROA can be simplistically defined as a product of Margin and Velocity (R = M x V). Mr Charan describes the ROI of a business as a critical marker to the health of a business. Comparing this figure with competitors and the previous year can gauge whether a company is succeeding or failing.
- Growth – A company’s growth is the increase in a company’s size in terms of employees. The author argues that with a lack of sustainable, profitable growth, a company may not be able to attract the type of employees that the company needs to succeed in the marketplace. If a company stagnates, the amount of money it can afford to spend on research and development decreases, the opportunities for promotion within the company begin to dry up, and the ambitious employees move on for greener pastures. Even more dangerous is unnecessary growth, where the company expands at a rate which is not consistent with the return on the investment in the new employees/stores etc.
- Customers – A company must listen to it’s customers in order to succeed. In terms of e-business, neglecting user feedback to your software or website is detrimental. The prevalence of the internet means it is possible to promote your business globally, and if you don’t cater to the tastes of your customers they have little need to stay. The cost of attracting customers is relatively high, but in most cases the cost of switching for a customer is very low.
Using these measurements, you can get a summary of the business:
- What were the company’s sales?
- Is the company growing, or is growth flat or declining? How does this growth compare to competitors or the market segment?
- What is the company’s profit margin? How does this margin compare to the competition?
- What is the company’s inventory velocity? It’s asset velocity?
In terms of wealth the book delves into the business from the eyes of an investor:
- Price-earnings multiple (P-E Ratio) – How much profit the company made for each share of stock. For example, a P-E Ratio of 7 means that for every dollar of earnings per share the stock is worth seven times that much. It represents the expectations about a company’s current and future money-making abilities. When a company begins to miss it’s earnings-per-share expectation investors often decide to take their money elsewhere, resulting in sliding stock prices.
This is followed up with some notes on personnel management, coaching, and how to determine whether a person is suited to a job, though I’m not certain that this chapter belongs in the overall context of the rest of the book. Finally there is a personal check-list you can use to evaluate your own company on the metrics described previously. I found this a nice basic primer on business finance, I’m certain that each of the topics could have entire books devoted to them, but this is a good overview with enough detail to be interesting without getting too dry.
Check it out on Amazon here.