(This post was first published here on October 26, 2015.)
In my last post I shared that we now open our teaching on business acumen with the simple belief that value wins the day. I wrote that it is critical that business leaders understand the basics of business even if their area is highly focused on something that doesn’t require a direct involvement with the money side of things.
Business acumen is a bit out of character from the rest of the year of LEAD 365. Most of the year we focus around three main areas—can you name them? If not, I’ll give you a reminder in a bit.
The business acumen day is meant to be like an MBA-in-a-day. Sort of like Father Guido Sarducci’s comedy bit on his Five-Minute University.
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You will recall that in this session we covered the basics from the book What the CEO Wants You to Know and then spent some time touring a business to see how the concepts are applied in real life. The key concepts to remember are these:
- Profit: the difference between the selling price of a product (or service) and the cost needed to produce it.
- Margin: the profit divided by the cost.
- Velocity: the number of times you can make that profit over a period of time.
Let me pause here for a moment. I think most of us are familiar with the concepts of profit and margin. It still might be good to teach it to all who go through LEAD 365, but almost every one of our participants understand these basics. But velocity, that might be a different deal.
I remember reading about velocity in What the CEO Wants You to Know back when the book came out, and it definitely added to my business acumen. I’m not normally a fast person—I’m what we gently call a “processor.” Finding the best, right answer is my natural desire, whether it takes five seconds, five minutes, or five months. I was never so aware of the cost of the luxury of taking my sweet time until I learned about velocity. In short, the time I take to process things slows down my team’s ability to make a profit more often.
Slow down the design of a new product by two months and it robs the business of two months of profit. Slow down the production line by 10 percent and it robs the business of its velocity by 10 percent. Slow down the time it takes to finish a job for a customer and you slow down when you can start the next project for a customer. All of this slows down the gathering of profits.
Do you remember the equation from the book that uses velocity? Seems like it had something to do with margin and the total payback. Okay, enough teasing, here it is: Velocity x Margin = Return
In the book, the fruit-stand lady told the MBA students that you can make a lot of money by turning a slight profit very quickly over and over. Sell lots of apples at a 2 percent profit and you can make a nice return. What did she mean by “return”?
It seems that a good measure to assess how well a product is doing is to look at its total return (velocity x margin). That will tell you the full story. Margin alone won’t. Velocity alone won’t. Multiply the two and you know if you have a successful product. Well, almost.
You still need to see how much it cost you to produce that return. If I invest a million dollars to get a return of ten thousand dollars over a year, it might be a good return but not for the investment of a million dollars. So the final bottom-line measure that most companies use is return on some kind of cost. This can be return on investment (the million dollars) or return on assets (the million dollars plus other assets that were tied up in creating that return) or return on equity. It turns out you can choose any “return on” number you like as long as it helps you know if you are doing well.
You might ask if the return on investment you’re getting is better than you could get at the bank. Is it better than you can get in real estate? Is your return on the use of your building (return on assets) better than you could get than if you leased it to someone else? Is your return on equity better than if you invested your money with a financial manager? You can look at any return measure you like—return on sales, return on people, return on time—whatever you think will be a good comparison to other options that will be helpful as you assess how you’re doing. These are the measures that help a business leader know if she is doing well or not.
The basics really are quite simple. What the CEO Wants You to Know—and our LEAD 365 team—believe it’s critical that you understand these basics if you’re going to be a good business leader, regardless of the area you are leading.
Of course, like many simple concepts, they get quite complicated once you dive into all the details and different ways they can be applied. If you are a finance or accounting leader you dive a lot deeper than we did, and you use many more key measures that help you understand how the business is doing. If you’re not a finance or accounting leader, these basics are enough.
And that is enough review on business acumen.
There is one more thing I promised in the second paragraph. If you don’t recall what the three main topics were for our year of study in order to be a great West Michigan leader, here they are:
- Be a person worth following
- Build a great team
- Create clarity around purpose, vision, and values
As always, we would love to have you share your thoughts on this topic or any of the others we write about.
Thanks for being a leader worth following! I hope your week is a great one!
Rodg
Image by Colby Stopa. Used under CC by 2.0 license.
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