Knowing your business is about understanding how your organization
makes money, which includes understanding the key elements of
revenue, expenses, and profit. It is also about understanding your
business partners' key financial metrics and why these are
important to them. This knowledge allows you to identify strategic
opportunities for learning to add the most impact to your business.
And it also enables you to speak the language of your key
stakeholders and helps you build the business case for your
learning solutions.
Mention business financials and the discomfort begins for many
people as balance sheets, income statements, and financial ratios
immediately come to mind. Rather than being an expert at
calculating financial ratios or creating income statements, you
need to interpret the basics of this financial data to spot issues
and identify how business strategy external trends, and the
marketplace affect these numbers. No one, including your business
partners, expects learning professionals to be financial experts.
However, you do need to understand your organization's basic
business model and business drivers. The good news is that only a
basic understanding of business and financial data is required for
learning professionals.
To use an old adage, you don't need to know all the specifics of
how your watch is made, you just need to know how to read the time.
For many years, business leaders viewed learning professionals
solely as functional specialists or "trainers." As learning
professionals, we have perpetuated this viewpoint by not readily
identifying ourselves as businesspeople, not speaking the
"language" of business, and not understanding or using the tools of
business. However, where do we work? We work in business! We are
both functional specialists and businesspeople. In the book
Finance Intelligence for HR Professionals (Berman and
Knight 2008, 21), John Hofmeister, the president of Shell Oil, sums
this up aptly when he says that "anyone working in a business is a
businessperson - so human resources people, for example, are
businesspeople with a specialty in human resources."
A study by the U.S. Securities and Exchange Commission found that
only half of all American adults could pass a basic financial
literacy test. How many professionals sit in business meetings
every day and don't understand a business concept or financial
term? Not wanting to look stupid in front of others, they just keep
quiet rather than ask for clarification. Learning professionals
cannot afford to be in this silent group.
Learning professionals need to know business acumen in three
sections:
- How does your business make money?
- What is your company's business model?
- How does your business track its money flow and ultimate net
profit?
After we consider this business acumen primer, I've also included a
section on strategies and tools for applying your business
knowledge so that you can better understand your stakeholders'
needs. In addition, we'll look at strategies and tools for managing
your relationships with these stakeholders. You will find that the
knowledge you gain can be used in preparing business cases and
communications for learning.
How Does Your Business Make Money?
Virtually every business involves revenue, expense, and profit.
Typically, a business is selling a product or service to a buyer
for more than what it costs the business to make, sell, and
deliver. The cash proceeds of the sale are referred to as revenue.
However, this does not equal net profit (profit minus expenses) for
the business. It costs money to make and sell the product or to
deliver the service. Some of these costs are more directly linked
to the making, selling, and/or delivery of the product or service.
A few examples of these direct costs are materials, manufacturing
labor, equipment, advertising, sales salaries, and commissions.
There are also more indirect costs that go to support the overall
business's efforts in making, selling, or delivering the product or
service. Indirect costs are support or "administration," including
such services as human resources, legal, training, and finance. The
direct and indirect costs are subtracted from the revenue the
seller received. Business leaders view indirect or administrative
costs as "overhead" and not directly related to generating profit.
This underscores the importance of aligning your learning with the
business to ensure that you are clearly contributing to achieving
net profit. At the end of the day, this is what interests business
leaders.
So, now that direct and indirect costs have been subtracted, does
the business get its profit from the revenue it has collected? Not
quite yet. There are still other expenses, such as interest on
loans and taxes, that must be deducted. Then the business can
collect its profit, which is referred to as its net profit. Viewed
as a formula, this would be
Profit - (Direct costs + Indirect costs) = Net profit
These same basic building blocks of business exist whether the
business is a company or a multinational Fortune 100 business. All
these steps in the business process offer opportunities for you, as
a learning professional, to affect the business's net profit.
Understanding the basics of how your business makes its net profit
is required for you to add value back to the business. A host of
other tools to build your business acumen can be found on the
Business Literacy Institute's website (www.business-literacy.com).
Different levels of stakeholders in your business will focus on
different aspects of revenue, expenses, and profit. Senior leaders
will focus on the entire "highway system" of profitability.
What Is Your Company's Business Model?
From the general components of any business (revenue, expenses,
profit) we now move to the way a particular company makes money.
This is called the company's business model. Think of a business
model as a blueprint for how a company implements its strategy. It
gives you a big-picture snapshot of your company's strategic
priorities and how your company is designed to make money.
Understanding how your company makes money is important for you as
a learning professional. This knowledge can help you understand the
key levers that drive the entire business, helping you to align
your strategic learning solutions with these levers. In
Business Model Generation, Alexander Osterwalder and Yves
Pigneur (2009) identify nine building blocks of a business model:
- customer segments - customers grouped by common needs,
behaviors, and attributes
- value propositions - how a product or service solves a
customer's problem or satisfies a need
- channels - how a company communicates and reaches its customers
- customer relationships - the level of relationship, ranging
from highly personalized to automated services
- revenue streams - cash generated from customer segments
- key resources - the physical, financial, and human resources
required to implement the business model
- key activities - the most important actions for the company to
operate successfully
- key partnerships - the company's network of suppliers and
partners
- cost structure - the most important costs incurred for the
company to operate successfully.
A familiar business model is that of Wal-Mart, the discount
department store and chain of warehouses. In 2010, the Forbes
Global 2000 (based on revenue size) named Wal-Mart the world's
largest public corporation. Wal-Mart's business model is a
low-price strategy, "everyday low prices." It accomplishes this
through economies of scales in purchasing, advanced inventory and
shelf management, and leveraging "float" or interest-free loans by
paying its suppliers in 90 days while selling its products within
seven days. Learning solutions for Wal-Mart will thus emphasize
supply chain management to ensure that its purchasing and inventory
capabilities are strong.
In Business Model Generation, Osterwalder and Pigneur
incorporate their nine business model building blocks into a visual
Business Model Canvas, which is shown in figure 2-2. The business
strategy and how the business is designed to make money are
captured in a one-page snapshot. Figure 2-3 depicts a Business
Model Canvas for a personal products company. The company's
business model emphasizes recurring revenue streams through
disposable products. For the consumer, the initial razor handle
purchase is inexpensive or even free. The ongoing, recurring
purchase is the blades. The blades are disposable and are sold at a
high margin or profit. Its key resources include a patent strategy
that blocks other consumer product companies from gaining market
share from this personal products company.
How Does Your Business Track Its Money Flow and Ultimate
Net Profit?
Although the business model maps the way a business makes money,
financial statements show you how the company is performing. Think
of these financial statements as a scoreboard for business
performance showing how money flows through a business, where it
comes from, where it goes, and what ends up being net profit to the
business. So to understand how your business tracks its money flow
and ultimate net profit, you need to have a basic understanding of
three main financial statements:
- the income statement
- the balance sheet
- the statement of cash flows.
Understanding the basics of these financial statements will help
you answer these questions about your business:
- Is your business profitable?
- Are your revenues growing or decreasing? * How effectively is
your business using its assets?
- How efficient is your business in collecting the money it is
owed by customers?
- How effective is your business in clearing out inventory?
- How effective is your business at controlling costs? Does your
company have a low, moderate, or high rate of debt?
- How well is your business positioned to withstand an economic
downturn?
- How does your business compare with other industry competitors?
It's not necessary that you memorize or practice calculating
financial formulas; you just need to understand why a few of these
data points are important to your business leaders. Don't sweat the
formulas - just follow the money!
Financial statements are used to report these numbers to assess
business performance. To ensure alignment, learning professionals
must understand the numerical performance metrics with which their
business leaders are measured. By understanding the key financial
indicators, a learning professional can track business trends and
identify critical performance opportunities for the business. This
enables the learning to support the business with strong alignment
and a proactive approach to adding value.
The Income Statement: Is Your Business Profitable?
It is important for learning professionals to understand how
profitable their company is at any given time. Imagine requesting a
large learning investment from senior executives without knowing
the state of the business. If profits are down, your investment
request will only serve to highlight your disconnection from the
business. So instead, how can you, as a learning professional,
proactively offer learning solutions to improve your company's
levels of profitability?
One tool for determining a company's profitability is its income
statement. The income statement is sometimes referred to as a
profit-and-loss statement, or P&L, or earnings statement. This
statement shows revenues (sales), expenses, and profit for a
defined period of time. Ultimately, it measures your company's
profitability. Important components include the metrics of the
gross margin and the operating margin. Figure 2-4 depicts an income
statement. The gross margin measures your company's manufacturing
and distribution efficiency during production. Higher margins show
better performance.
If your company has high gross margins, it will have more money
left over to spend on other business operations, such as research
and development or marketing. Here are the basic aspects of the
gross margin, organized as barebones formulas and sample
calculations (note that Q1 = the first quarter of a four-quarter
fiscal year, and that all revenues and cost of goods sold are in
millions of dollars):
- Formula: (Revenue - Cost of goods sold) / Revenue.
- Purpose: Measures the percentage of sales retained after
production costs are incurred.
- Q1 2010: (2,953.4 - 2,173.3) / 2,953.4 = 26.4%.
- Q2 2010: (3,703.4 - 2,655.8) / 3,703.4 = 28.3%.
- Q3 2010: (3,730.3 - 2,651.4) / 3,730.3 = 28.9%.
- Q2 2010 average among Company X's peer companies: 31.2%.
The Operating Margin
Operating margins measure your company's pricing strategy and
operating efficiency. Again, higher margins are better. Your
business leaders look closely at the operating margin to determine
if their pricing management is effective. They also look at the
operating margin to determine if the operating expenses of the
company are too high. These expenses include selling, general, and
administrative costs, referred to as SG&A. The learning
function is typically considered part of SG&A, or "overhead."
Here are the basic aspects of the operating margin, again organized
as bare-bones formulas and sample calculations (note that Q1 = the
first quarter of a four-quarter fiscal year, and that all revenues
and cost of goods sold are in millions of dollars):
Formula: Operating income / Revenue
- Purpose: Measures the profitability of a company before
interest and tax expenses.
- Q1 2010: 133.5 / 2,953.4 = 4.5%.
- Q2 2010: 383.0 / 3,703.4 = 10.3%.
- Q3 2010: 408.2 / 3,730.3 = 10.9%.
- Q2 2010 average among Company X's peer companies: 11.8 percent.
Earnings per Share From Continuing Operations
Most income statements include a calculation of earnings per share,
or EPS. This calculation tells you how much money shareholders
would receive for each share of stock they own if the company
distributed all its net income for the period. Here are the basic
aspects of earnings per share (note that Q1 = the first quarter of
a four-quarter fiscal year, and that all revenues and cost of goods
sold are in millions of dollars):
- Formula: Net earnings attributable to company
shareholders/Weighted-average diluted shares outstanding.
- Purpose: Measures the profitability of a company.
- Q1 2010: 11.8 / 336.6 = $0.04.
- Q2 2010: 256.7 / 339.1 = $0.76.
- Q3 2010: 271.7 / 339 = $0.80.
Summing Up
Why are an income statement and its key metrics useful to a
learning professional? Understanding the components of
profitability enables a learning professional to identify learning
solutions that will drive increased profit. For example, if
operating margins are lower than forecast, a number of potential
learning solutions could be applicable. Perhaps the sales force is
discounting products at a high rate, causing decrease margins.
Possible learning solutions on negotiation skills and pricing
management could be useful here. If the G&A (general and
administrative costs) are higher than target, there is an
opportunity to reduce the expenses incurred by your learning
function. Perhaps you could increase your use of virtual delivery
to decrease overall company travel expenses. Or minimally, you may
delay your request for additional headcount resources for your
learning function.
The Balance Sheet: What Is Your Company Worth?
As a learning professional, you need to understand what your
company owns and what it owes at a given point in time. Learning
professionals should also be aware of how much debt and other
liabilities it takes to create that profit. Through understanding a
company's debt and other liabilities, a learning professional can
provide learning solutions resulting in improved time to payment
from customers or in increased movement of inventory into cash. The
company balance sheet provides this information for the learning
professional. There are three major parts to the balance sheet:
assets, liabilities, and shareholder's equity. By design, the
balance sheet must balance. The balance sheet goes beyond the
income statement, which shows only profit. The balance sheet shows
your company's amount of debt. Your company could be making a
profit, but it could also have high debt to fund the business
operations.
The Debt-to-Equity Ratio
Your company's assets (items of economic value) should be greater
than its liabilities (debt). This allows your company to withstand
periods of financial problems, such as a recession. When your
company seeks loans, the prospective lenders look to see if your
company's balance sheet has manageable levels of debt compared with
its assets. This signals your company's ability to repay its debt.
Here are the basic aspects of the debt-to-equity ratio (note that
Q1 = the first quarter of a four-quarter fiscal year, and that all
revenues and cost of goods sold are in millions of dollars):
- Formula: Total liabilities / Shareholders' equity.
- Purpose: Measures the amount of debt and equity financing a
company is using.
- Q1 2010: 12,565.7 / 7,124.3 = 1.8.
- Q2 2010: 13,177.7 / 7,156.2 = 1.8.
- Q3 2010: 12,541.8 / 7,673.5 = 1.6.
Anything your company owns that can potentially generate cash is
considered an asset. Assets are listed on the balance sheet in
order of how easily they can be converted to cash. Assets include
the money owed your company by customers who purchased products or
services on credit, known as accounts receivable. If customers do
not pay on time, your company cannot pay other debts, because it
has money tied up in the customers' products or services. You want
to see a high turnover, or shorter time elapsing between the
customers' receipt of products or services and payment of the
invoice or bill.
Here are the basic aspects of days sales outstanding, presented in
a simple formula and with sample calculations (note that Q1 = the
first quarter of a four-quarter fiscal year, and that all revenues
and cost of goods sold are in millions of dollars):
Another measurement of good asset management is how quickly your
company sells its inventory of products. The faster your company
turns over (sells) inventory (sells), the less money your company
has tied up in its inventory. The longer inventory sits on your
shelves, the longer the money invested in this inventory is
unavailable to your company. Here are the basic aspects of
inventory turns, organized as a barebones formula with sample
calculations (note that Q1 = the first quarter of a four-quarter
fiscal year, and that all revenues and cost of goods sold are in
millions of dollars):
- Formula: Current quarter cost of goods sold annualized/Period
ending inventory balance.
- Purpose: Measures the number of times inventory is used in a
period of time.
- Q1 2010: (2,173.3 * 4) / 1,364.0 = 6.4 turns.
- Q2 2010: (2,655.8 * 4) / 1,429.5 = 7.4 turns.
- Q3 2010: (2,651.4 * 4) / 1,539.0 = 6.9 turns.
- Q2 2010 average among peer companies: 6.8 turns.
Why are a balance sheet statement and its key metrics useful to a
learning professional? Understanding how your company's assets
(items of economic value) compare with its liabilities (debt) helps
you target learning that increases assets and decreases reliance on
debt. For example, you might provide learning to the employees in
the Accounts Receivable Department on how to negotiate payment from
a customer. In another example, you could provide learning on
integrated planning targeted to managers in sales, inventory, and
operations. This could be an optimal time to demonstrate your
learning function's effectiveness at streamlining key processes,
resulting in financial savings for the company.
The Cash Flow Statement
Understanding how cash flows in and out of the company helps the
learning professional understand the health of a business and the
strategic priorities of the business leaders. Is the company
generating cash from its operations, signaling an efficiently run
workplace? To what extent is the company investing its cash in
research and development, signaling growth? Does the company have a
high level of debt to pay down, signaling high interest expenses
and limiting other investments? The cash flow
statement provides answers to these questions.
The cash flow statement tells you where money comes from and where
it is spent by organizing and reporting the cash generated and used
in these three categories:
- Operating cash flow - often referred to as working capital - is
the cash flow generated from internal operations. It includes the
cash used to run the business; cash coming in from sales of the
product or service; and cash going out to pay for salaries,
vendors, raw materials, and the like.
- Investing cash flow is generated internally from nonoperating
activities. It includes capital investments in plant and equipment
or other fixed assets, or investment in research and development.
- Financing cash flow is the cash going to and coming from
external sources, such as lenders, investors, and shareholders.
A company with a more positive cash flow is effective at turning
its profits into cash. Having more cash available internally
reduces the need for a company to borrow money and pay high
interest rates.
The Return on Invested Capital
The return on invested capital (ROIC) is a commonly used financial
measure that quantifies how well a company generates cash flow
relative to the capital it has invested in its business. ROIC, in
basic terms, is the amount of profit that a company earns for every
$1.00 of capital invested in the business. Here is the formula to
calculate ROIC, accompanied by sample calculations (note that Q1,
Q2, and Q3 indicate the particular quarter of the four-quarter
fiscal year, and that the figures in the formula are in millions of
dollars):
- Formula: Trailing quarter operating income (after tax)
annualized / Period ending invested capital.
- Invested capital = Net receivables + Net inventory + Prepaid
expenses and other current assets + Total noncurrent assets -
Accounts payable - Accrued compensation and benefits - Other
accrued expenses.
- Purpose: Measures the return management is generating on
company-funded investments.
- Q1 2010: (133.5 * 0.80)*4) / (2,172.9 + 1,364.0 + 684.0 +
14,896.7 - 1,193.9 - 438.2 - 1,566.7) = 2.7%.
- Q2 2010: (383.0 * 0.80)* 4) / (2,821.5 + 1,429.5 + 678.0 +
14,575.6 - 1,421.9 - 482.1 - 1,969.2) = 7.8%.
- Q3 2010: (408.2 * 0.80)* 4) / (2,466.5 + 1,539.0 + 666.5 +
14,720.4 - 1,401.3 - 536.1 - 1,632.7) = 8.2%.
- Q2 2010 average among peer companies: 8%.
Determining whether your company has a healthy cash flow can help
you target high value learning solutions to increase positive cash
flow.
This is a excerpt from Chapter 2 of Strategic Learning
Alignment: Making Training a Powerful Business Partner, an
ASTD Press publication that can be purchased here.
-------------------------------------------------------------------------------------------------------------------------------------------------------------
Rita Mehegan Smith is vice president of
enterprise learning for Ingersoll Rand - a $14 billion global,
diversified industrial company - and dean of Ingersoll Rand
University, which is responsible for developing strategic
organizational competencies, providing leadership education, and
driving the company's culture around the globe.