Q: I’m a little new to the business realm and just recently hired an accountant. When we talked about how my company made money, I was a little stumped by some of the terms he used. What’s the best way to brush up my “business acumen” so to speak?
A: At the core of every successful business, from a global giant to a corner store, are the same fundamentals of moneymaking: cash flow, margin, velocity, return and growth. Additionally, at the core of every successful business leader is an intuitive understanding of the relationships among them.
When you have business acumen, you realize the importance of every job within the company. A mailroom clerk with business acumen knows that getting checks to the accounts receivable department more quickly will ease the company’s cash flow. Likewise, a sales rep with business acumen knows that higher-margin products will increase the company’s return.
However, when you are starting a business or the complexity of your job increases, it’s easy to lose sight of the fundamentals. So the following are the most basic financial terms/concepts that anyone in the business world should be familiar with:
Cash Flow. No business survives long without it. You should know how much cash your business generates and how much cash it consumes. What are the sources of it? What drains it? What’s the timing of the inflows and outflows and how is it changing? More revenues (sales) often means more cash. But growing a business consumes cash. How fast can the company expand without straining its cash flow?
Margin. When people talk about the bottom line, they generally mean net profit margin – the money the company earns after paying all its expenses, interest, and taxes. But gross margin is important, too. Gross margin is the difference between a product’s selling price and what it costs to make the product (the “costs of goods”), expressed as a percent of the selling price. Changes in it can signal important shifts in a business. When PC makers saw their 32 percent gross margins decline to 20, they knew (or should have known) the competitive landscape had changed.
You have to know how changes inside or outside the business affect gross margin. Are there new entrants in the market who are winning customers? A competitor who’s found a clever way to reduce costs and prices? A change in the pricing power of suppliers?
Velocity. Velocity refers to speed, turnover, or movement. How much revenue do you turn over, or generate, for each dollar of inventory? If you have $1 million in inventory for the year and revenues of $10 million, your inventory velocity is 10. This tells you how fast you’re moving raw materials through the factory, turning them into finished products, and moving those products off the shelf to customer – the faster, the better.
Service businesses can track velocity, too. For banks, velocity of equity – how much revenue is generated per dollar of equity – is a useful measure. The concept applies to every business.
Return. Return is the ratio of money gained or lost on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or net income/loss. The money invested may be referred to as the asset, capital, principal, or the cost basis of the investment. Return is important because it’s one of the “true” indicators of how your business’ assets are performing – which is imperative when comparing one year to the next.
Growth. Growth is just a measure of the increase/decline from one time period to the next. Every business needs to grow revenue, cash and assets to stay in business. How do you grow in a way that keeps the other aspects of money making in balance? There’s no formula – people with business acumen figure it out. Street vendors in villages around the world use business acumen every day. They have to – their next meal often depends on it.
Hopefully the above gets you started in your quest to increase your financial understanding of business. Yet, the best way for you to improve this is to just get out there, study and read as much financial literature possible, learn from what occurs in your business and read the case studies from other businesses.