Will your automation business survive, thrive?
Do NOT take on too many J curves at once, because a company can stall with too many, no matter how brilliant the next idea is. Will the next J curve add value, AND is it the timing right? Questioning the logic of a J curve today with today’s logic doesn’t mean you are questioning the original decision.
For example, closing a gold mine at $400 an ounce might have made perfect sense, but the decision can require reconsidering after gold prices exceeded $1000 per ounce. At the time Rolls-Royce went bankrupt in 1972, Setchell said, it was developing 35 jet engines, spending 40% of its resources working on projects that were not returning profit.
Albert Einstein is attributed with saying, “Everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted.” Numbers are the language of business. Leaders need to equip themselves with numbers that provide key metrics. A balance sheet is difficult to understand and doesn’t provide an easy snapshot of a business’s health.
For each $1 of investment how many dollars of revenue can be generated and for each $1 of revenue, how much profit is there? With the given risk of an activity, is the return sufficient? Is enough cash flow generated to continue being an entrepreneur? These are important numbers that accountants don’t provide.
Traditional generally accepted accounting principles (GAAP), using traditional income statements and balance sheets can hide what’s really going on in a company. Setchell said company leaders need to focus on return and cash flow by looking at:
- Percentage return on operations (ROO, a measure Setchell made up, is a simpler measure than return on capital employed, used by many large public companies.)
- Percentage of operational cash
- Revenue leverage rating
- Revenue profitability rating.
Those have eight “fiscal focus levers,” according to Setchell, that practical actions can target. Four have to do with the ability to create revenue or input leverage: revenue collection, inventory management, supply chain management (the accounts payable relationship to suppliers), and fixed asset utilization. Four have to do with reasons for creating revenue or output leverage: price strategy, direct cost control, indirect cost control, and volume strategy.
Avoid self-delusion. Numbers must include the actual costs of company leaders or founders, even if they’re not taking full salary and benefits. Cash flow is the lifeblood of a business. If profit is like food to a business, then cash flow is oxygen. You can live for a little while without food, but not very long without oxygen. Anyone ever place call to customers on Thursday to make payroll on Friday? That’s too close for comfort and why cash flow is important.
Each action relating to the eight levers impacts cash flow. The cash-flow calculation is money in and money out, like rainwater in a tank. If you can buy supply chain items on credit, that creates good flow. Selling on credit, creates more pressure on flow. Operational cash flow statement is best tracked over a 12-month period. Total money in is revenue.
Operational cash flow, if negative, can be an early warning liquidity problem, showing that a company could be profitable but going broke. Looking at only revenue and profit means that the company could go broke without anyone noticing. “This reporting format creates through-the-roof performance,” Setchell said.
Think of ROO percentage of an interest rate of return for dollars invested in a business, perhaps the “most powerful single number to measure business success,” Setchell said. Looking at business with these tools provides a roadmap to strengths and weaknesses and a decision validation tool, with numbers entrepreneurs can understand. Seeing input versus output shows how input is the investment and real operating profit (ROO) is the output after calculating for expensing with owner salaries and the like. Revenue/investment x real profit/revenue = ROO.
“Using this formula makes any business more valuable. I’ve done this more than a thousand times. It works.” Decision validation helps people understand what to validate and what to ignore. Are we able to fund this decision without jeopardizing our future? Should we and can we? You need a “yes” on both before saying “yes” to a decision.
An example looks at what a business can do with money rather than what money costs the business. Don’t get talked into a logical decision if it’s wrong, Setchell said. It may be advantageous to offer to pay your supply chain instantly if they will discount by 2.2%-5%. Do the math within your supply chain in both directions, he recommends.
Cash flow testimony
Adrian Fahey, CEO, Sage Automation, who has worked with Setchell to improve business decisions in his 300-person company, noted that cash is king. With most engineering businesses, Fahey said, 90-120 days for receivables is usual; moving that to the high 50s or low 60s performs very positive results.
Knowing the cost of decisions helps to more effectively position a company for downturns and accelerate more quickly during economic expansion. “When the rest of market headed for the hills, we pumped money into our business, contrary to conventional wisdom. Now we’re enjoying stronger returns than competitors,” Fahey said.
Parting advice from Setchell: For CEOs to succeed in today’s market, they must:
- Develop a balance of experience and desire to learn and broaden skills.
- Have healthy thirst to learn new stuff. Understand quadrants of business drivers to target personal development in company leaders.
- Define and harness the foundation of the business
- Challenge and influence market (across the organization)
- Understand and challenge management of people
- Make and follow procedures for operations
- Implement core management principles to maximize value
- Hold teams accountable with 3W action management
- Understand measurements focused on creating value
- Make more effective decisions (should we/can we)
- Hold strategic investments accountable by managing the J curves
- Learn from the past to influence the future.
About the conference, CSIA
More than 500 attended the 2013 CSIA Executive Conference, CSIA said, exceeding the 2012 record of 470. Founded in 1994, the Control System Integrators Association (CSIA) is a not-for-profit, global professional association that seeks to advance the industry of control system integration. Control system integrators use engineering, technical, and business skills to help manufacturers and others automate industrial equipment and systems. CSIA members provide services for dozens of industries. Headquartered in Madison, Wis., CSIA helps members improve their business skills, provides a forum to share industry expertise, and promotes the benefits of hiring a certified control system integrator. CSIA has more than 400 member firms in 27 countries.
- Mark T. Hoske, content manager, CFE Media, Control Engineering, Plant Engineering, and Consulting-Specifying Engineer, with information from CSIA, email@example.com.
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