Beginning the Chain: Financial Imperatives

Because Senior-level managers drive the measures of everyone else in the organization, it is important to start by understanding the three financial imperatives, or yardsticks, by which Senior managers are ultimately measured. These imperatives are profit, position, and cash.

Maintaining a daily balance of profit, position, and cash is the role of every Senior-level manager. Figure 3-1 draws a picture of these imperatives and the balance among them.

Figure 3-1: The financial imperatives and their measures.

Profit

The starting point in this analysis of value is the organization ‚ s profit performance. Profit is measured by adding incoming revenue and subtracting outgoing expenses within a specified period of time. Profit is shown on a report known as the income statement or the profit and loss statement.

Many people believe that if an organization is making a profit, it must be doing well. Not necessarily ! An organization may be making a profit, but how it does so defines the stability of its business position. The dot.com bubble taught many people the value of managing position.

Position

Position is the mix of the assets and liabilities of an organization. An organization that is too heavily in debt, versus other methods of funding to make a profit, is at a high risk of being unable to withstand adverse business conditions. Such an organization is said to be highly leveraged, that is, to be carrying far too much debt versus the amount of assets on hand available to pay back that debt if it should suddenly need to do so, given a greatly reduced revenue stream.

Individuals know that if they have reached the limit on their credit cards and then lose their job, they could be forced into bankruptcy to resolve money problems. Such individuals have borrowed a great deal, assuming that future income would cover their debt. Unfortunately, because of the loss of a job, they are unable to pay the debt back or to get more debt to cover expenses.

Organizations can get into the same situation. Managing position means maintaining the appropriate mix of the assets, liabilities, and owner ‚ s equity of the organization. Assets are items such as cash or things that can be converted to cash in the short or long term . Liabilities are short- and long-term debts . Owner ‚ s equity, also known as shareholder ‚ s equity, is the ownership claims to the value of the assets in an organization. An organization ‚ s position is shown on its balance sheet.

Cash

Profit and position define the third imperative: cash. Every manager and every WLP professional who wants a seat at the table must understand that profit does not equal cash. An organization may be making a profit, but the actual cash from that profit may be tied up in forms that are not easy to spend . The cash may be tied up in what is known as accounts receivable, or the payments owed to the organization by its customers for what they have purchased. Or, the cash may be tied up in the form of inventory, the stock on hand that ‚ s ready to deliver as soon as a sale is made.

Senior managers must always ensure that the organization has enough real cash on hand at all times to cover its payroll, expenses, and loan payments. The sources and uses of cash come from continuous changes in the net income, assets, and liabilities. These changes are documented in the cash flow statement.

A Balancing Act

Managing profit, position, and cash is a constant balancing act. The final part of knowing what keeps Senior-level managers (and, therefore, everybody else) awake at night requires that you understand how the organization maintains an optimal balance among these three imperatives. Senior managers monitor balance by using ratios. Ratios are a comparison of how large one type of profit, position, or cash measure is in relation to another. Examples of common ratios are inventory turnover ratio, return-on-assets (ROA), and contribution profit margin ratio.

Ratios consist of two types: operating ratios and financial ratios. Operating ratios tell a Senior manager if the organization ‚ s day-to-day activities are staying within acceptable boundaries. Financial ratios tell a Senior manager if the organization is maintaining the appropriate returns for its efforts.

Important ‚  

Creating value chains that reach from the language of performance to the language of finance requires a connection to profit, position, cash, as well as the balance that must be maintained among these three imperatives.

Making the connection between what WLP professionals do and what those who manage the financial side of organization do during the week is sometimes not easy to see. To help you see the connection, this book uses a fictitious medical manufacturing and services company: ABC MediCompany. ABC manufactures a line of products, offers some services related to its products, and has an established customer base. In the next three chapters, you will see sample financial statements and ratios for ABC. You will learn how to use measures from these statements to communicate your value to ABC ‚ s Senior managers, Mid managers, 1st/Ops managers and Individual contributors.