Friday, July 27, 2012

5 Reasons NOT to Use the Olympics for Business Lessons

A lot of people in the world will begin devoting some of their focus and attention towards London as the Olympic games begin this week. My wife and I have our own particular favorites – Gymnastics, Swimming, Archery, and Rowing among them.
There is a lot we can learn from Olympic athletes. For example, in the prior Treasury Café series on the “Power of 10,000 Hours” we examined the need to devote serious focus and time practicing if we want to achieve excellence in our field. Over the next several weeks we will see plenty of examples of the results of these efforts. The Olympic competitor is certainly a role model in this regard.
However, we are also at risk of taking home lessons during these games that are not applicable to our organizations for the following reasons.

It Ain’t So Simple
The definitive results that games and sports provide is naturally appealing to us. Given a set of rules and structure, people compete and at the end we are able to determine an undisputed winner - Runner A’s time was 1:42:05, and Runner B’s was 1:42:06, so A wins.
Yet, we must remember that this is an artificial construct that has been established precisely so that there can be an objective determination of a winner.
In real life business is not so simple. There is neither a definitive structure nor a standard set of rules everyone follows. Company A operates internationally while Company B pursues a local niche strategy. Company A operates according to Brazilian law while Company B is subject to Hong Kong’s. The practice of business is quite different in the Middle East than it is in the United States.
Determining who a “winner” is in business is also not clear or definitive. There is no single metric that determines success like there is in the 100m backstroke, where whoever reaches the button first wins.
What metric should we choose to determine a business winner? All of the following are defendable choices: Market Share, Return on Invested Capital, Total Shareholder Return, Year Over Year Earnings Growth or Same Store Sales, Leadership Development. And the fact is that all of them are important.

More Than One Can Win
In the Olympics, there is only one spot on the podium for a gold medal winner.
Given the variability in metrics that can be employed, we can have a situation where Company A is the winner in ROIC, while Company B is the winner in year over year Sales Growth. Who gets the gold?
The fact is that each company operates in accordance with its strategy, and the success of their efforts need to be compared to that more than to any other firm. Consider the soft drink industry – Coke wins on market share, yet Pepsi operates a successful diversified portfolio that includes the dominant Frito-Lay snack line, so they might win on comprehensiveness. And while they would not medal on sales or market share, Jones Soda is still considered a successful company by many. They are all winners in their own way.
Business is as much about partnership and relationships as it is about competitiveness. It is not just being the first to cross the finish line. Sure we want to sell more products and services than our rivals, yet that may not prevent us from operating a joint-venture with them to exploit opportunities in a new market or industry segment.
In fact, we often attempt to pursue strategies that create win-win outcomes. The customer gets value and the company gets value. Talented employees enjoy working at our firm and our firm is happy to have the talent they’ve got. The M&A deal is structured in a way that both buyer and seller derive something extra from creating a larger pie. In many industries the players exhibit a large amount of cooperative behavior (e.g. airline pricing, cereals).

Nobody Has All “A” Players
The composition of an Olympic team is the culmination of an elaborate screening process. There are local competitions, regionals, and nationals that an athlete must clear to make it on the team. The folks going to London are the crème de la crème.
Yet, back here at the office, we are faced with the fact that our teams are composed of A players, B players, and C players. How best to organize and lead a team in this environment is going to be very different than an Olympic team.
Talent management is a hot topic these days, and it seems everybody wants to populate their ranks with A-players who can be developed into great leaders so our business will live long and prosper. Yet, it is a myth to think we are ever going to have a company full of them.
The fact is we need some of the other types as well. We need B-players who will perform adequately in any number of tasks and be happy to do so, and be willing to stick around even if they didn't get that last promotion. We need specialists with deep expertise in relevant domains, even if they never aspire to leadership roles.
Jeffery Immelt became CEO of GE after a 3-way succession race. The other two folks went on to become CEO’s somewhere else. A-player talent has a tendency to disperse.

There is No Ending
After several weeks, the Olympic games will be completed. We can tally up the medal count and see which country got the most golds, silvers, and bronzes. We will recount the exciting finishes, and begin to think about the next round of games (which should have been in Chicago!).
In business, life goes on. We do not have the luxury of operating for a few weeks every 4 years and spend the rest of the time doing something else while training. Day in and day out the “beer needs to get delivered” and the “sausage has to get made”.
A manager faces a dilemma that the Olympic athlete does not – the trade-off between short-term and long-term. Manager A may direct his efforts towards increasing the current year’s sales for a number of good reasons, and all their resources are directed towards this objective. Manager B, on the other hand, carves out 20% of their team’s time for development activities, projects, and other items that will pay-off in the future, at the cost of lowering this year’s numbers. Both may be correct decisions in their different contexts.
So while Olympians can expend all their effort during August, a business does not have that luxury, because we hope to be around in September as well, and we need to manage with respect to that eventuality.

It’s All About the Future
In the Olympics, the medals are the prize of the competition. The athlete gets the gold, and keeps that medal above the fireplace, locked away in a box, gives it to their parents, etc. and can have it forever. The books are updated to reflect the winners, and these will live in infamy. There will only be 1 marathon winner in 2012, and that fact will not change when it is 2112.
In the business world successes are not so permanent. The fact is, by the time we have determined that we were successful and won our gold-medal (however we chose to measure this feat), it doesn’t really matter because we are already focused on operating in the next year, where success needs to come again…and again….and again.
General Motors had the highest revenues in 1990. Does that mean investors are flocking to them because they “medaled” in their race? No? Why not? Because we do not care how they did, we care about what they are going to do.
Wal-Mart had the highest revenues in 2011, surely this is still relevant? Not really…we want to know what 2012 and beyond is looking like.
It is a “what have you done for me lately” world, and a business always has its eye on that. The goal today is to remain relevant tomorrow - by the time the results for the current race are announced, they really are irrelevant.

Key Takeaways
The Olympic games are fun to watch, and to witness top performers operating at their peak is a pleasure, yet if we are not careful we can infer more than we should as it applies to our daily lives. Make sure you take home the right lessons.
Questions
·         What lessons can you think of that might be unproductive to learn from the Olympic games?

Add to the discussion with your thoughts, comments, questions and feedback! Please share Treasury Café with others. Thank you!

Saturday, July 21, 2012

Triangulating Mission and Vision Using Mindmaps

An organization’s mission and vision requires periodic review for a number of reasons:
·         First, things change. Business does not occur in a vacuum. Your customers are not doing things exactly the same way they were last year and their needs will have evolved. The same can be said for your competitors, your employees, and you!
·         Second, we tend to get wrapped up in the day to day. The process of “getting the beer out the door” or “making the sausage” takes priority in an operating entity, and time for reflection, introspection, and “assessing the view from the top of the mountain” is hard to find.
·         Third, you have spent additional time “simmering”. You have come up with relevant thoughts and ideas about your mission and vision that occurred to you upon awaking from sleep, or in the shower, or en route to work, or in conversations with peers, colleagues, etc.  
This week marks the 1 year anniversary of Treasury Café, and as our first post dealt with the vision of the finance function, this seems like a great time to revisit.
What are some steps we can take to help us determine what this vision is?

Determine What Finance is Responsible For
A vision needs to reinforce the mission of the organization, where we can define “mission” as a statement that answers the question “why do we exist?”
One way to develop insights about this is to think about what the finance group does within an organization, as the success of any vision will depend on its ability to “further the cause” of the mission. Assuming that what our finance group does in some way fulfills its mission, examining these responsibilities can help us glean insights into what needs to be incorporated into our vision.
While this activity will be somewhat unique to our own particular situation, we can supplement this with the vast wealth of books, articles, blog posts, whitepapers, etc. about the roles and responsibilities of finance in the organization.   

Triangulate for the Essential Activity
With this treasure trove of information, we can analyze it for common themes and topics. The advantage to this approach is we focus in on what is generally agreed versus the particularities of one information source. This process is called “triangulation”.
The following tables shows a listing of CFO roles and responsibilities from 7 separate sources.
Maintain Records
Trusting the Numbers – ensuring business decisions are grounded in sound financial criteria
Budgeting and Strategic Planning

Financial Strategy
Auditing/Controlling
Providing Insight – analysis to support CEO and other senior managers
Compliance: Tax, Regulatory, Legal

Investment Management
Functional Services
Getting Your house in Order – Leading key initiatives in finance that support overall strategic goals
Risk Management

Funding
Functional Systems & Practices
Funding Organizational Strategy – enabling and executing strategy set
Communications: Board, Investors Creditors, Ratings Agencies

Cost Planning and Budgeting
Strategic Planning
Development of Business Strategy – defining the overall strategy for the organization
Performance Evaluation

Financial Operations
Strategic Change
Communication to External marketplace – Representing the organization’s progress on strategic goals to external stakeholders
LT and ST Investments

Performance Management


Cap Structure / Cost of Capital




Financial Reporting




Cost Accounting / Cost Management



Creating Value

Custodian
Catalyst – stimulate behaviors to achieve strategic and financial objectives - Execution
Supporting Value Decisions

Commentator
Strategist – provide leadership in determining strategic business direction and align financial strategies; Performance
Protecting Value

Counselor
Operator – Fulfill the finance organization’s responsibilities; Efficient


Steward – protect and preserve the assets of the corporation; Control

It can be somewhat confusing to examine this list as it is shown. Some common items might be on separate lines (such as “Custodian” under Ghosh and “Steward” under Deloitte), or some items might be subsets of others (such as “Communication to External Marketplace” under Ernst & Young and the broader “Communications”, which includes internal constituents such as the Board, under Fabiozzi).
One way to manage this process is to use the technique of mind-mapping. Figure A shows the items in the tables in “mind-map” form.

Figure A
Pick an Organizing Theme and Rearrange
Our objective in triangulation is to tease out the common themes. Ideally, we want this listing to be as small as possible so that it’s easy to remember. For instance, Ghosh breaks things down into three activities that all start with the letter “C” – Custodian, Comment and Counsel. This makes things easy to remember and recall.
So using his framework as the initial starting point, we rearrange the tiles in the mind map and examine what we’ve got. This is shown in Figure B.
When we observe this figure, we can note that there are 14 items that remain uncategorized. Several of these are “groupable” amongst themselves, such as financing and operations.
Figure B

Iterate
Using the mind-map is an iterative process that can follow many paths. From Figure B, one path we could follow is to re-create the activities using a different construct. If we followed this path, the next one I would try would be Deloitte, as that has only 4 categories, so the “small as possible” objective would be obtained.
Another approach could be to just see how many categories we can fit the unassigned variables into and add to these topics to the Ghosh ones.
Following the rearrange by Deloitte path we arrive at Figure C.
Figure C

The “Aha” Moment
In reviewing this, I was not very satisfied with the “Catalyst” category. What do I do with this? And what do I do about the remaining “Unassigned” categories?
Reviewing the Catalyst definition, which involved “stimulate behaviors”, I started looking at the other categories to see whether things might be moved over, or whether I could subsume this category into one of them.
One of the facets that the Catalyst and Strategist roles have with each other is that they both involve collaboration and interpersonal exchange with others in the business. We do not create strategy in a vacuum.  We do it through discussions, in meetings, on retreats, etc. with others. When acting as a catalyst, we are impacting others through our interactions. They both are things we do with others.
The Steward and Operator categories, on the other hand, involve handling information and creating reports out of it. The custodian aspects are things we undertake for the good of the company but do not generally involve others within the firm. In other words, these are things we do for others.
And this was my “aha”, that essentially we can classify our role into two very broad categories:
·         things we do with people, and
·         things we do for people.
Comparing this to the vision from the first Treasury Café post:
·         To serve as an approachable and dependable partner
·         To inspire in others confidence in our abilities, knowledge, and expertise
The first bullet is a “with people” objective. You cannot partner in a vacuum. The second bullet is applicable to both the “with people” and “for people” functions.
While this “aha” moment may not be earth shattering or of a change the world variety, the process we have gone through has served the purpose of enriching the original perspective, adding a layer of understanding to it.

Figure D shows the final mindmap (link is to final map):
Figure D

Key Takeaways
Even if a revisit of your vision and mission does not result in dramatic change, it can enhance and deepen your understanding of the current one.
Questions
·         How would you characterize the mission of the finance organization?

Add to the discussion with your thoughts, comments, questions and feedback! Please share Treasury Café with others. Thank you!

Friday, July 13, 2012

How to Get Actionable Intelligence Out of Your ROIC Calculation

Return on Invested Capital (ROIC), the topic of our last post “Your Step by Step Guide to Calculating ROIC”, is a fundamental metric for any financial analysis, due to five reasons:
·       The ROIC metric is free from the distortion (and crafty earnings manipulation by CFO’s) of financing activities, such as levering up the balance sheet, hiding debt in operating leases, etc.
·       The ROIC metric standardizes (to the extent possible) performance across firms allowing for an “apples to apples” comparison between companies or business units within a company
·       The ROIC metric can be subsequently decomposed into several value drivers, allowing for insight into future management decisions and granular evaluation of contribution by different organizational functions
·       The ROIC metric is directly tied to the firm’s valuation, which is based on discounted cash flows
·       The ROIC metric can be used to compare performance to the company’s cost of capital

The Magic of Math
In algebra, we are often given equations which require us to “perform operations” (meaning we can change it) that will make it appear different yet not change the original result.
For example, when given the equation z = x /y, we can modify this using the following lines of thought:
·         A variable x is equal to that variable divided by 1, or x = x/1
·         A fraction is equal to the multiplication of the numerator and 1 divided by the denominator, or 1/x.
·         Any number divided by itself equals 1
Therefore, our ROIC equation, which is ROIC = NOPAT / Capital, can be re-written as (NOPAT / 1) * (1/ Capital). With a 1 in the numerator and denominator, we can use any number in both spots and keep ROIC the same.
Figure A
Therefore, by adding sales in both spots, we can adjust ROIC to that shown in Figure A.

From One Ratio to Three
The modified ROIC equation in Figure A thus becomes the product of two ratios, each of which are encountered in the field of finance.
The first term, NOPAT / Sales, is the Net Profit Margin, which answers the question “how much of each sales dollar (or other currency unit) goes to the bottom line?” This is a common question and something helpful to know as we operate our business.
The second term, Sales/Capital, is known as Asset Turnover. This is a measure of how many sales per period are generated by our asset base. A turnover of ²1 means that for each ²1 of assets we generate ²1 in sales (the symbol ² represents Treasury Café Monetary Units, or TCMU’s, freely exchangeable into any currency at a rate of your choosing). A turnover of ²0.5 means that for each ²1 of assets, we generate ²0.5 of sales. A turnover of ²2 means for each ²1 of assets, we generate ²2 of sales.
Figure B
So by virtue of the algebra, we now have ROIC, Net Profit Margin and Asset Turnover…3 ratios rather than 1.
We can use concepts from calculus to translate changes in these ratios to how that impacted ROIC itself. In other words, these equations answer the question “if the ratio changed by this, then how much did this change ROIC?” These equations are shown in Figure B. This type of analysis is called an “Attribution of Change Analysis”.

Sanfilippo Redux
In our last post we calculated the Return on Invested Capital for JB Sanfilippo & Son, a Chicago based food manufacturer specializing in nuts by following the traditional method of calculating the ratio by dividing NOPAT by Capital.
Using our ratio approach, we can now break down Sanfilippo’s ROIC into two components, Net profit margin and Total Asset Turnover, and calculate ROIC by multiplying the two.
Finally, we can use the change attribution equations to determine exactly how much ROIC changed due to each of the factors changing.
A good analyst will always seek out ways to verify that what they are producing is accurate and correct. In this case, we can compare the results of our ROIC calculation to that of our prior post in order to see whether there is any difference. And indeed there is not.
Figure C
We can also compare our attribution of change calculation with the total change in ROIC and determine whether similar results have occurred.
These calculations are shown in Figure C. For both the ROIC and attribution calculations, the results are the same as the alternative methods, which should give us great comfort that our algebra has worked as intended!

How This Helps
This methodology of breaking down the ratio into separate components has a number of advantages:
It Provides Explanation – performing the ROIC calculation and reporting that it went from 6.1% last year to 4.1% this year tells us something, but not much. Why did it go down? The basic calculation is silent. But through our ratio and attribution analysis, we know that ROIC went down due to lower net profit margins, and would have declined by 2.4% (Figure C, Item J) had it not been for improvements in asset turnover (Figure C, Item K), which partially offset the impacts.
It Can Answer Follow-Up Questions – given the above assessment, we might be tempted to ask “how much does total asset turnover need to improve to offset the net profit margin decline?” Because we have ratios with several variables and only one unknown, we can use algebra to rearrange the equations in order to arrive at the answer that asset turnover would need to be about 3.1 to have maintained ROIC at last year’s level.
Figure D
It Allows You to Select Alternatives – in order for asset turnover to improve to 3.1 from 1.9, we would essentially have been required to increase sales by about 50% over last year’s levels. Our Net Profit Margin, on the other hand, would have needed to improve by almost 1%, or $6 million, in order to keep ROIC at last year’s level. We can ask “Is it more likely we can improve margin by $6 million (through cost cuts or revenue increases) or to grow our sales at current prices and current assets by 50%?” These are operational questions that can be answered by operational folks, and therefore we have transformed a metric that is not actionable into one that is.
It Allows You to Compare Against Competitors – Figure D shows the ratio and attribution analysis for Diamond Foods, a competitor. Evaluating this, we see that their margins in 2011 were almost 9% compared to Sanfilippo’s 2%. Offsetting this, Sanfilippo’s asset turnover is over twice as good as Diamonds. This can suggest strategy differences, as well as benchmark improvements. If others in the industry are turning assets a lot less often, how much room for improvement is there? Conversely, if margins at our firm is almost 4 times less, how much room might be available by focusing on those items? For Diamond, a strategy on improving turnover, such as a Lean or Six Sigma effort that can lead to reducing the asset base, might yield higher opportunities.

Key Takeaways
By using a value driver ratio approach combined with a change attribution analysis, we can place better information into the hands of our strategy and operating units which allow them to make better decisions. This places finance in the role of adding value to the enterprise through partnering.
Questions
Have you performed a value driver analysis at your firm? How did it turn out?

Add to the discussion with your thoughts, comments, questions and feedback! Please share Treasury Café with others. Thank you!