Core Values are Critical

Core Values are Critical

I am currently sick with COVID, so, killing time yesterday, I watched Downfall: The Case Against Boeing about Boeing’s issues with the 737 Max and how the focus and financial results versus anything else led to the problems with the plane. The company focused on production, and so it scrificed safety to meet financial performance. One of the documents in the documentary was a little like Ford’s one with the Pinto. They knew there was an issue but calculated that the odds of people dying were so small that they could figure a solution in the meantime. So over 300 people lost their lives. When the Lion Air accident occurred, Boeing blamed the pilots for not being correctly trained on a system it had not disclosed. When the Ethiopian crash occurred, the pilots had done everything Boeing recommended, and it still blamed them and their training. As a result of the Max crashes, Boeing’s reputation for safety and engineering excellence has been tarnished and will take many years to reclaim.

Whether or not, as the documentary claimed, the move of company headquarters from Seattle to Chicago to separate the engineers from the executives is true, the company sacrificed its core values of safety and engineering for a higher share price. The memos reveal the company’s effort to hide the MCAS system from pilots and regulators, so more certification by pilots would not be required. The company seems to have come a long way from Tex Johnson’s barrel roll of the 707 prototype over Lake Washington in August 1955. during the Gold Cup hydro races, where a crowd of 250,000, including airline executives from around the world, were attending. That sold the aircraft!

The company’s focus on financial performance and share price enabled the price to rise into the $300-$400 range; however, the Max took it below $100, and its performance over the last five years is a loss of 4%. Over the same period, Boeing’s most significant competitor Airbus has seen its share prices increase by 34%. Sacrificing your core values for profit is never the solution, and profit results from your core values, not the driver!

Furthermore, in speaking with an FAA-certified engineer, he said the Max had damaged the FAA’s reputation worldwide. Where once, if the FAA said something was good enough, other countries would follow along, no more.

Finally, one more sad indictment of current U.S. public corporations was when Dennis Muilenburg resigned as the CEO and board director after the two crashes of 737 MAX aircraft and the loss of 300+ people; he received $62.2m in stock and pension awards. But as we repeatedly see, if you are the CEO of a public corporation, accountability is different. You may be fired, but you will get paid very well, unlike anyone else.

(c) Copyright 2022, Marc A. Borrelli

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Profit ≠ Cash Flow

Profit ≠ Cash Flow

While I have known this for a long time, last week, it was brought home to me how many conflate the two. Profit and Cash Flow are not the same. I have known many profitable companies have negative cash flow and some unprofitable ones have positive cash flow. Knowing the difference is critical. 

As I have mentioned before, cash is the blood in a company. Without it, the company dies, regardless of how profitable it is. Many young companies that take off don’t appreciate the issue and believe that they will solve it with growth. However, this is similar to the old business joke, “Of selling at a loss but making it up on volume.”

How the Statements Connect

For non-accountants and finance people, the issue is that they look at the Profit and Loss Statement, Balance Sheet, and Statement of Cash Flows as separate entities without realizing the interconnectedness. Finally, the way a standard statement of cash flows is laid out, most don’t know what it is saying. 

It takes a while to realize that the P&L shows you the earning for the period, then the statement of cash flows shows the adjustments required to get to the cash generated from the different sources. Finally, the balance sheet is the statement at the end of the period of what is owned and what is owed. They flow in that order, generating the statement of cash flows from the profit and loss statement, and the balance sheet really cemented the relationships in my mind.

The Dates

Again, I was made aware of this when I was presented with a profit and loss statement and balance sheets, but all as of different dates. If the dates don’t sync, you can’t deduce much from them. The profit and loss statement must cover the same periods. The balance sheets must be as of the starting date and the ending date of the period. Sounds simple, but many look at these financial statements for different periods and don’t realize that you can’t tell much from them.

How to Determine Your Cash Flow

Now many people don’t understand the statement of cash flows, and I understand that. The key information is how much cash the firm generates or absorbs, what it will do with it, or how it funds the shortfall. For many entrepreneurs, here is an easy way of looking at Cash Flow. Assume your company has a Gross Margin and Net Operating Margin of 20% and a 10.15%, respectively. In addition, your Accounts Receivable, Inventory, and Accounts Payable are 80, 35.7, and 45 days respectively. If you grow revenue by $100, the effect is as follows.

Revenue + $100.00
Cost of Goods Sold 80.00
Gross Profit = 20.00
SG&A (Overheads) 9.85
Net Operating Profit = 10.15
Accounts Receivable (80 days) 21.92
Inventory (35.7 days) 9.78
Accounts Payable (45 days) + 12.33
Cash Shortfall = $9.22

Thus for every additional $100 of revenue, you need $9.22 of extra cash. This is why many fast-growing companies implode, they cannot get sufficient cash to fund their growth, and without cash, the company dies. Now some will argue that I have not added back depreciation etc. That is true; however, I have found that CapEx is equal to depreciation over time if you wish your company to keep functioning, so that is just a timing issue.

How to Improve Cash Flow?

So understanding your cash flow is a vital part of understanding the financial model of your business. If you generate a shortfall, you need to figure out how you will finance it. There are really three options,

  1. Arrange to finance for your working capital.
  2. Shorten your Cash Conversion Cycle
  3. Use the Power of One to change the cash generation of the business.

There are a number of companies that provide working capital financing, so if you need some names, let me know. If you don’t know your cash flow cycle, it is the time from when you start the sales cycle until you get paid. It is broken into four areas – Sales Cycle, Make/Production & Inventory Cycle, Delivery Cycle, and Billing and Payments Cycle. The Power of One, developed by Alan Mills, determines which of seven variables most influences increased cash flow.

I know many companies don’t have this information, and their accounting systems don’t know how to produce it. In that case, get a coach or adviser who can help you. The investment will be well worth the effort to understand how to drive your business without ongoing funding. If you want more information on how these work and how to implement them in your business, message me.

 

Copyright (c) 2021 Marc A. Borrelli

Does Your Financial Model Drive Growth?

Does Your Financial Model Drive Growth?

Working with many companies looking to grow, I am always surprised how many have not built a financial model that drives growth. I have mentioned before a financial model that drives growth? Here I am basing on Jim Collin’s Profit/X, which he laid out in Good to Great. So then we have to delve into what is Profit/X. This is the key financial metric that drives profitable growth by defining some profit number per some “X” that results in:

Passion. Your employees are passionate about the “X” and excited about increasing it.
Empowerment. Your employees are empowered to make decisions to ensure the baseline Profi/X is met.
Drive. It drives behavior to generate profit and growth.
Discipline. It provides the financial discipline to ensure that the organization remains profitable as it grows.

Thus is it is your Economic Engine that will enable profitable growth.

Many people look for a quick answer in determining Profit/X, but there is no quick answer. It is an iterative process that will get there, but no something you necessarily come up with on the first try.

Profit can be:

  • Gross Profit,
  • Operating Profit,
  • Net Profit,
  • Gross Margin,
  • Operating Margin, or
  • Net Margin,

to name a few.

“X” is very variable and can be:

  • “Product/Service,”
  • Customer,
  • Invoice,
  • lb,
  • pallet,
  • truckload, or
  • plane.

For a better understanding of Profit/X, my video below may help explain it better.

Profit/X

It is well worth your time to develop your Profit/X and get your employees to understand it and embrace it. The discipline it provides combined with the drive and empowerment it delivers makes a very strong economic engine and ensures continued profitability through your growth.

 

Copyright (c) 2021 Marc A. Borrelli

 

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