Klas Mellander

Apples & Oranges

Everything you need to understand
Business Finance
 Klas Mellander

Apples & Oranges

Everything you need to understand
Business Finance
Apples & Oranges
Everything you need to understand
business finance
Third edition
The first edition of this booklet was published
in 1992 as part of the launch of the highly ac-
claimed business simulation Celemi Apples &
Oranges™ – to-date experienced by more than
a million participants around the world.

The booklet was updated a few years later and

this is now the third edition. Updates includes
modernized terminology, a stronger focus on
cash flow and a more up-to-date “look and
feel”.

COPYRIGHT
This book is protected by COPYRIGHT LAW and international treaties.
No part of this book may be reproduced, used or distributed in any form or by any means, in whole
or in part, without the prior written consent of Celemiab Systems AB. An unlawful disposal or use
of this material may result in severe CIVIL and CRIMINAL PENALTIES. Celemiab Systems AB will
bring judicial proceedings if this provision is violated.
Please report violations to: violations@[Link]
Copyright © 1992-2017 by Celemiab Systems AB. All rights reserved.

100930-01-02 Version 1.1.1

2
Contents
Make a difference 5

PART I: The big picture 6

It’s all about adding value 6
The simple trick that makes it possible 8
Value going out and coming in 10
The assets – what and where they are 12
Yearly cost of Plant & Equipment 14
Who owns the assets? 16
The complete picture 18
Focus on cash 20
Cash Flow – a broader perspective 22

PART II: How are you doing? 24

Measuring business performance 24
Straight from the financial statements 26
Improving or declining? 28
Operating performance – EBIT or EVA? 30
Today’s value of future earnings 32
Focus on future Cash Flows 34
High-value assets not in the Balance Sheet 36
Balanced Scorecard 38

PART III: Tapping the potentials 40

Looking for levers to pull 40
Five short case stories - small wins, huge impact
In search of opportunities 53
How to identify potential for improvements

Glossary 66

About the terminology

Business Finance language is like any other language: There are different dialects, major local
differences from the official language, the same words meaning different things, different words with
the same meaning, and et cetera. In this publication we have chosen terms that we believe to be
reasonably common and, when appropriate, we have included often-used synonyms. This is true also
for common abbreviations.

3
The Business Finance Model
Money is
exchanged for
material and labor

Products and
services are
exchanged for
money

The Business Finance Model is by far the most widespread of all conceivable
models of a business. Actually, in most countries (if not all) the use of this model
is mandatory by law.

Luca Pacioli, “Father of Accounting,” is credited for laying the foundation.

His message (here slightly modernized) was simple:

“Keep track of your money – how much is coming in,

how much is going out ... and to whom the money that is
left belongs.”
He also said: “A Person should not go to sleep until the
debits equals the credits!”
Luca Pacioli, 1446–1517

4
Foreword

Make a difference
For good reason, there is a lot of talk about how important it is that we all see
and understand the big picture of the business (firm or enterprise) we work for.
The problem is that people tend to use all sorts of more or less complex models
to describe different aspects of their business. The so-called big picture comes
in all shapes and sizes and not all of them are easy to grasp – unless, of course,
you already understand the reality they claim to portray.
Models tend to come and go depending on what’s hot and what’s not ...
There is one model that has stood the test of time for hundreds (some say
thousands) of years: the Business Finance Model.
This model is used to inform stakeholders about the business’s economy, and it
is used within companies serving as the basis for making business decisions.
Unfortunately though, it is not always easy to see the forest for the trees – which
actually happens also to those already in the know. Some even say that they
occasionally feel intimidated by Business Finance jargon.
The purpose of this booklet is to change that.
The idea here is to provide a shortcut to understanding the big picture as well
as a source of inspiration.
Our hope is that perusing this guide will help you discover how you can make a
difference in your day-to-day area of responsibility.
Klas Mellander
Co-founder, Celemi

Apples & Oranges?

It is said that one cannot compare apples and oranges, meaning things that are
intrinsically different, in different forms – such as apples and oranges and cash.
But that is, as you will learn, exactly what accountants are supposed to do.

5
PART I:
The big picture
It’s all about adding value
You buy material or expertise, you add value in several steps by doing some-
thing with it and you deliver the finished product to the customer: It is a chain of
activities, and in each step you add value of some sort; this is a Value chain.
Every industry and every business has its own, more or less complex, Value
chain.
The Value of the finished product is essentially determined by the customers –
by how much they are willing to pay for it (22m in the example at the right).
The Cost of making the product or service is the sum total of what you had to
pay in each step of the Value chain (18m in the example). This is the value of the
product or service seen from an accountant’s point of view. In accounting terms,
it is called the Book value.
And this, as you will see, is the foundation of Business Finance and Reporting.
The goal of any business is to create more value than the total amount
spent for making the finished product – the Book value.

A single way to measure value

Many years ago, at different times in different places, the old way of trading
bread for milk or fixing a roof for half of a wild boar became impractical. The
need for a way of identifying value in order to exchange it freely gave rise to the
concept of a common way of measuring value, a yardstick: Money.
Over time, “money” has taken on many shapes and forms: shells, pearls, copper,
gold, salt (hence the word “salary”!), coins, et cetera. Today money is largely
ones and zeros crisscrossing cyberspace.
Having a single way to measure and represent all different types of values
involved in the Value chain (i.e., numerals with a currency symbol) allows us to
compare things that are as different as apples and oranges. Making such com-
parisons is a requirement for tracking a business’s finances.
Money makes the world go ’round …

---
PART I will introduce you to the simple logic behind the basic financial state-
ments – the Profit & Loss Statement, the Balance Sheet and the Cash Flow
Statement.

6
Value Chain
A very simple example, just to make the point:
You purchase raw materials such as wheat, sugar, yeast, water ... > you
make the dough > leave it to ferment > and put it in an oven to let it bake.
> The finished bread is stored > then packaged > and finally delivered to
the customer.
In each step, value is added; and in each step you need to spend some money
for material and labor – thereby increasing the Book value.

Rule #1
The cost of your goods and
services sold equals what you
spent to make them.

10 + 8 = 18

18 22

Rule #3 Rule #2
The idea is to have more money coming in If the customer is willing to pay
than going out. more, you are in business.

PART I: The big picture

7
The simple trick that makes it possible
Behind accounting principles and Business Finance Reporting there is a very
simple and very clever idea (conceived at least 500 years ago):
The Book value of a product in any stage of the Value chain equals the
total of your expenses for getting it to that stage.

This is how it works:

Let’s take a look at the Value chain depicted at the right:
(In the following, let “m” stand for millions in any currency.)
If you paid 10m for the material and 8m for Labor you would most likely think of
these as costs.
However, from a strict accounting point of view, these are not costs before the
finished product leaves the company to the customer. Until then they are de-
fined as expenses, or investments.
This is how an accountant reasons:
• You pay your supplier 10m for the material; as a result
you have 10m less in cash (–10m).
• On the other hand, you have added the worth of 10m
to your stock of materials (+10m).

The same is true for the labor:

• You pay your people 8m; as a result you have
an additional 8m less in cash (–8m).
• On the other hand, you have added value, booked at 8m,
to make the finished product (+8m).

So, basically the value 18m (your expenses) is still in the company as an asset,
but it has been “transformed” from cash to materials and labor – and eventually
to the finished product.
Next:
• When you transfer ownership of the product to the customer, the value
18m leaves the company – now the 18m are regarded as a cost.
• In return, the customer owes you (and will eventually pay) 22m. This is
regarded as your income (more often called Sales or Revenue).

And then the circulation of capital starts over again: You pay your supplier ...
Let’s conclude:
A business is a merry-go-round of capital – and as you will see later, its
speed matters.

8
 “A step-by-step transformation of resources“

Costs
18m

+10m +8m

Expenses
-18m Sales
22m

To many people an expense is the same thing as a cost. From a strict account-
ing point of view though, there is an important distinction:
When a value (an asset of any sort) leaves the company, and only then, it
is regarded as a cost. *

*The only exception is, for example, when you pay back a loan or pay Dividends (a portion of what
the company has earned over the years) to the shareholder(s).

PART I: The big picture 9

Value going out and coming in
As stated above: In the world of Business Finance all (book) values that leave
the company are referred to as costs. In return you get Revenues, which is then
value coming in to the company. Revenues are often called Sales.

Costs are normally put into three main categories as shown in the picture
at the right:
Blue line: Direct variable costs – attributed to the production of the goods or
services sold. Hence they are often Cost of goods sold or Cost of services
sold (or even Cost of sales). These typically include cost of material and
labor used to make the goods or services, but not indirect expenses.

Green line: In addition, you have costs that are more or less fixed, here
referred to as Overhead. They do not change regardless of the volume you
produce, so some actually call them Fixed costs. Overhead costs include
things like Sales and Administration as well as the (fixed) costs for running
the factories and Research & Development (R&D). Here we have chosen to
enter R&D as a separate item, Development.
The difference between Sales (Revenues) and Cost of goods sold is referred
to as Contribution – implying that it should contribute to cover the Overhead
costs. (Gross profit is another often-used term.)

Yellow line: The cost of the Property (buildings) and machinery and other
equipment is a little trickier even if the principle is quite simple:
If you purchase a machine for 25m and expect it to last five years, you should
regard 5m as a cost each year (1/5 of the purchase price): Each year the
value is reduced by 5m which is regarded as a cost, called Depreciation.
(There will be more discussion of Depreciation later.)

Costs that are not attributed to the production of the goods or services sold are
viewed as Common costs.
All of the above is roughly what you will find in a Profit & Loss Statement –
often abbreviated P&L.

10
Profit & Loss Statement
Costs
Material & labor used for production 50m

Overhead & Development 40m

Expenses & Investments

Property, Machinery & Equipment 5m

Sales
Cash - and what the customers owe you 100m

Outgoing and incoming value (money) over a certain period of time is summa-
rized in the Profit & Loss Statement.

Profit & Loss Statement

(in millions)

Sales + 100
Cost of goods sold – 50
Contribution (Gross profit) = 50
Overhead – 35
Development – 5
Depreciation (25%) – 5
Total common costs = 45
Operating profit (EBIT) = 5

PART I: The big picture 11

The assets
– what and where they are
In this snapshot of a business (right), you can easily see what the company’s
assets are and also what form they have.

Current assets
In the outer region you find what are generally called the Current assets:
• Inventory: the value of stock of material, ongoing production and stock of
finished goods
• Quick assets: cash at hand and what your customers owe you (Accounts
receivable)
These are called “current” as they are constantly moving, coming full circle
several times each year – as opposed to the Fixed assets that move more slowly
and stay in the company for several years.

Fixed assets
These include:
• The value of land and buildings (Property)
• The value of your machinery, furniture and such. (Plant & Equipment)

Total assets
All of these assets combined are the means necessary for the business opera-
tion – they are the company’s Total assets.
They are summarized in the Balance Sheet.

20

The Profit & Loss Statement shows The Balance Sheet shows where the
how values are going out and coming different assets are, and in what form,
in over a certain period of time. at a given point in time.

What we’re talking about here are the monetary assets, the capital. But, of
course, you have many other assets, such as patents, goodwill, copyrights, cul-
ture, brand image, competencies, know-how ... which we will come back to later.

12
The Balance Sheet
The Balance Sheet provides a snapshot of your Total assets and where in the
company they can be found at a given point in time

Inventory

Materials & Work in Finished

components progress goods
Total assets
Current assets 4 6 10
Inventory
+ Quick assets

Fixed assets
40 20
Property Plant & equipment

Accounts
Cash receivable

9 11

Quick assets

Balance Sheet
(in millions)
Assets
Cash and bank 9
Accounts receivable 11
Materials 4
Work in progress 6
Finished goods 10
Total current assets 40
Plant & equipment 20
Real property 40
Total fixed assets 60
100
TOTAL

PART I: The big picture 13

Yearly cost of Plant & Equipment
If you lease (rent) your plant, machinery and other equipment, the yearly cost is
fairly straightforward: your cost is what you pay the leasing company – plus, of
course, the cost for using it. However, if you bought it yourself, what is then the
yearly cost?
The correct answer is:
The yearly cost equals how much of its value you lose each year.
This is called Depreciation.
To depreciate = to lower the value of something.
Say that you invest in a new bike, paying 100.
You may reason like this: The first year, the bike cost me 100, but on the other
hand it cost me nothing all the following years.
In a company this is different: Apart from the fact that it would not reflect reality,
you are actually not allowed to regard the entire investment as a cost the first
year because of tax regulations.
The reasoning: A year after you bought it, due to wear and tear, the value of your
bike is down to, say, 80. The bike has lost 20 of its value – and this is then re-
garded as your cost for the bike that year. And this goes on, year after year, until
the value is down to 0 (or until you sell your bike).

Even if it is as simple as that, it can be difficult for many people to wrap their
mind around the concept of Depreciation. Why is that?
The possible trap:
It is easy to confuse costs with what was paid for them during the year.
That though, is reasonably true for Cost of goods sold and Overhead as they
tend to be close to what you paid for them during the year (approximately 90m
in the example below).
Depreciation, on the other hand,
50m is a cost that you do not pay: the
equipment was already paid for
40m
when the investment was made,
40 25 20 5m maybe some years earlier – just
like your bike.
Plant & Equipment
Value reduced by 5m
Total cost: In this example the total cost
95m
was 95m, but only 90m was
Paid from cash ≈ 90m paid for (from cash).

14
Depreciation
Depreciation is simply the yearly decline in value of your Fixed assets. As such it
is a cost – although a cost that does not affect your cash.

Depreciation: value that

leaves the company

Original
investment

Year 1 Year 2 Year 3 Year 4

How Depreciation is reflected in the Financial Statements:

25 20 5m

Balance Sheet Profit & Loss Statement

The value of Plant & Equipment is Depreciation is a value that leaves
reduced from one year to the next: the company. And so it is regarded
from 25m to 20m. as a cost (5m).

Something to ponder:
As Depreciation is based on some sort of a standard formula, you have good
reason to ask: How well does the Book value (the remaining value after Depre-
ciation, the so-called Residual value) reflect the true value of the assets?

PART I: The big picture 15

Who owns the assets?
Let’s take a closer look at the company’s assets:
Where does this money come from? To whom does it belong?
There are two major sources, the owners and the lenders:
The owners’ money: This includes
not only money that was invested
when the company was formed in
the first place but also money the What the Total To whom
company has earned over the years assets are: 100M they belong:
(Retained profit). This money belongs Liabilities
to the company. It is called Equity. As (lenders)
needed, you can ask the owners for
more money as a way of increasing Fixed assets
the Equity fast. You can also ask other
people or institutions for money and in
return give them a share of the owner- Equity
ship of the company. (owners)
Borrowed money. This money be- Current assets
longs to the bank and other lenders. It
also includes what you may owe your
suppliers – unpaid invoices. All of this
money is called Liabilities.
Some liabilities are short-term (to be paid within a year or less), such as taxes
and invoices from suppliers. Other liabilities are long-term.

The “other side” of the Balance Sheet

The lenders’ and the owners’ stake in the business is reported as a separate
section of the Balance Sheet called Liabilities & Equity – which by definition
add up to the same amount as the Total assets.

More costs
In addition to the costs that we talked about earlier, you also have to pay for the
money you have borrowed: you pay Interest.
Finally, you need to take Taxes into account. What is left is the Net profit – the
famous bottom line.
So we need to add these costs to the Profit & Loss Statement – as illustrated in
the picture at the right.
---
On top of that you (sometimes) pay the owners a portion of what the company
has earned over the years. These are called Dividends. Dividends do not ap-
pear in the Profit & Loss Statement though, as they are not regarded as cost or
an expense even if they reduce the assets as well as the Equity.

16
How this is reported in the P&L and Balance Sheet:

4 6 10

40 20

Assets

9 11

Owners 80 Equity
Interest 2m
Lenders 20 Liabilities
Taxes 1m
Society

Liabilities & Equity = 100m

Added to the A new section in the

Profit & Loss Statement Balance sheet

Operations profit (EBIT) = 5 Equity + 80

Interest expense – 2 Liabilities + 20
Profit before taxes = 3 Total = 100
Taxes (33%) – 1
Net profit/loss = 2

PART I: The big picture 17

 The complete picture
This is the (nearly) complete picture of how business works – the Business
Finance Model.
“Keep track of your money – how much is coming in, how much is going
out ... and to whom the money that is left belongs.”
Suggestion: Take some time to compare the items in the schematic below to
the corresponding elements in the financial statements at the right. Consider
how the stream of capital (Costs and Revenues) flows in and out and how that
may affect the value (the assets) inside the company.

Materials & Work in Finished

components progress goods

Cost of
4 6 10 50m goods sold

Overhead &
40m
Expenses & investments

development

40 20 5m Depreciation

Property Plant & equipment

Accounts
Cash receivable
Sales
9 11 100m

Owners 80 Equity
Interest 2m
Lenders 20 Liabilities
Taxes 1m
Society

“Money makes the business go ’round ...”

18
The financial statements
Profit & Loss Statement:
The flow of incoming and outgoing value over a certain period of time.

Balance Sheet:
What’s inside your company at a specific moment: your assets
and to whom they belong.

Profit & Loss Statement Balance Sheet

(in millions) (in millions)

Sales + 100
Assets
Cash and bank 9
Cost of goods sold – 50
Accounts receivable 11
Contribution (Gross profit) = 50
Materials 4
Overhead – 35
Work in progress 6
Development – 5
Finished goods 10
Depreciation (25%) – 5
Total current assets 40
Total common costs = 45
Plant & equipment 20
Operations profit (EBIT) = 5
Real property 40
Interest expenses – 2
Total fixed assets 60
Profit before taxes = 3
100
Taxes (33%) – 1 TOTAL
Net profit/loss = 2
Liability & Equity
Short-term liabilities 5
Long-term loans 15
Total liabilities 20
Beginning balance 78
Net profit/loss this year 2
Total equity 80
100
TOTAL

PART I: The big picture 19

Focus on cash
You know how it is: you may be “rich” in the sense that you own a lot of things.
But if you do not have cash, you cannot buy anything else – at least you cannot
pay for it.
A company’s capital (assets) is either in the form of Cash (Cash & Bank) or tied
up in things such as Inventory and Accounts receivable as well as in Fixed as-
sets.
If you run low on cash you may need to borrow money – which comes with a
cost that you may want to avoid. This is one among many reasons why compa-
nies keep a sharp eye on their cash balance – or Cash Flow.

This is how it works:

Cash Flow:
+10m

-90m +100m

Outgoing cash Incoming cash

• Incoming cash is when you get paid – the customers pay what they were
invoiced.
• Outgoing cash is when you pay – wages, invoices from your suppliers, et
cetera.
• The difference is ... the Cash Flow.
Obviously: if you increase prices, if you sell more, if you reduce cost et cetera,
your profit will increase and, most likely, so will your Cash Flow.

A commonly used shortcut:

By just looking at the P&L, the Cash Flow is often estimated like this:
Incoming cash: 100m Profit & Loss Statement
Outgoing cash: All costs except (in millions)
Depreciation (50+35+5) = 90m Sales + 100
Cash Flow: 100m – 90m = +10m Cost of goods sold – 50

An even shorter shortcut: Contribution (Gross profit) = 50

Overhead – 35
You may come across people who tell
you that “Cash Flow = Operating profit Development – 5
+ Depreciation: 5m + 5m = +10m.” Depreciation (25%) – 5

Which of course is the same thing, Total common costs = 45

even if it could cause some confusion. Operating profit (EBIT) = 5

But there is more to it – as shown at the right.

20
Free up cash
In this example the company reduced Inventory by streamlining the production
processes – all the way from purchase to delivery.
They also got the customer to pay sooner, thus tying up less capital in Accounts
receivable.
As a result: Cash Flow increased by 6m.

Before After
–2

–1
–1

Materials & Work in Finished Materials & Work in Finished

components progress goods components progress goods
–2

+6

Cash Accounts Cash Accounts

receivable receivable

So, the Cash Flow from Operations in this case was:

• Sales minus all costs but depreciation: + 10m (as shown left)
• Less capital tied up means increase in cash: + 6m (above)
• TOTAL Cash Flow: + 16m

The fundamental difference:

• Profit is the difference between incoming and outgoing assets
– Book values.
• Cash Flow is the difference between incoming and outgoing Cash.
This difference is profound as well, as “Book value” can be defined in many
different ways:
“Profit is an opinion, cash flow is a fact.” (Andrew Black et al)

PART I: The big picture 21

Cash Flow – a broader perspective
Most companies view the Cash Flow Statement as an integral part of the finan-
cial reporting, in addition to the Profit & Loss statement and the Balance Sheet.
A Cash Flow Statement typically covers three different areas:
Cash Flow from Operations
As earlier discussed: Payment from customers minus payment for material, labor
and other expenditures
Cash Flow from Investments
Related to payment for selling and buying property and equipment.
Cash Flow from Financing
Incoming cash: borrowing (from lenders) and issuance of stock (owners).
Outgoing cash: repayment of loans and payment of dividends.
Cash flow from Investments and Financing:

20
Property Plant & equipment
Investments Assets
Cash

Financing
Equity Owners

Liabilities Lenders

Society

The example right shows what a Cash Flow Statement could look like. This
company was expanding its’ business and invested in a new factory.
Here are a few highlights:
• Operations: The news was that the company managed to convince some
customers to pay in advance, adding 30m to the Cash Flow.
• Investments: They sold some older property and equipment (+200m)
and invested in a brand new plant (-600m).
• Financing: They also asked the shareholders and the bank for money:
a loan (+200m) and issuance of stock (+100m).

All in all, the net Cash Flow totalled 100m.

22
Cash Flow Statement, example

Cash Flow Statement

(in millions)

Cash at begining of the year 100

Operations
Cash receipts from Customers
For products delivered + 1 000
Payment in advance of delivery + 30
Cash paid for
Material & components – 400
Wages expenses – 200
Common costs – 200
Interest – 20
Income taxes – 10
Net Cash Flow from Operations = 200

Investing Activities
Cash receipts from
Sale of property + 150
Sale of equipment + 50
Sale of share in other companies + 0
Cash paid for
Purchase of property – 400
Purchase of equipment – 200
Making loans to other companies – 0
Net Cash Flow from Investing Activities = -400

Financing Activities
Cash receipts from
Issuance of stock + 100
Borrowing + 200
Cash paid for
Purchase of shares in other companies 0
Repayment of loans 0
Net Cash Flow from Financing Activities = 300

Net increase/decrease in Cash 100

Cash at end of the year 200

PART I: The big picture 23

PART II:
How are you doing?
Measuring business performance
Are we doing OK? How are sales developing? What about costs? Are the own-
ers happy? Are we using their capital in an acceptable way? How vulnerable are
we? What would happen if we did this or that ...?
As you can imagine, financial data can be tweaked and twisted in an almost
endless number of ways. And they are – for the purpose of getting answers to
questions such as those above.
---
PART II will introduce a cross section of typical questions and how to find the
answers – the relevant indicators.

Key Performance Indicators (KPIs)

A performance indicator is used to measure performance – they are called
“Key” if they are regarded as important.
Some KPIs are calculated based on financial data (financial indicators).
Other KPIs are kinds of indexes – for example, Customer satisfaction, which
might be determined based on customer surveys or number of complaints, et
cetera.
Diagnosing using KPIs is comparable to what a physician might do:
• Examine the health of the patient from different aspects.
• Identify signs and symptoms of possible diseases or risk factors
• Determine the root causes of these signs and symptoms
• Treat the root causes where possible.

Hindsight or Foresight?
Analyzing a business’s performance carries the risk of looking too deep in the
rearview mirror.
Ponder this:
“Hindsight is of little value in the decision-making process. It distorts our
memory for events that occurred at the time of the decision so that the
actual consequence seems to have been a ‘foregone conclusion.’ Thus, it
may be difficult to learn from our mistakes.”
Diane F. Halpern, Thought & Knowledge

24
Diagnosis
KPIs are used to diagnose current performance of the business, mainly to find
ways to make improvements.
The “financial outcome” may provide the necessary indicators, but you need to
dig deeper to find (and treat) the root causes.

Diagnose based
on other KPIs Diagnose based on
Financial KPIs

Financial
Outcome

Influencing factors (direction)

Searching for root causes

PART II: How are you doing? 25

In hindsight

Straight from
the financial statements
Many people find the map at the right a helpful way of organizing the Business
Finance data, as it captures all major items and shows how they are related. The
upper section represents the Profit & Loss Statement, and the lower section
represents the Balance Sheet.
The map also shows the answer to the overarching question about performance:

How profitable is the business?

The success of a business as a whole
A simple and common way of measuring the performance of a business is to
compare the Operating profit to the amount of assets used for making it. If you
include all assets, this is called the Return On Assets (ROA).
More often though, you first deduct the Short-term liabilities from the Total as-
sets. The result is called Capital employed. The key indicator is then Return On
Capital Employed (ROCE), which gives you a more accurate view of how well
the company’s capital investments have been used.

From the owners’ point of view

The owners’ investment in the company is the Equity. The return they get is the
Net profit. The indicator is simply called Return On Equity (ROE).

Profit & Loss Statement Balance Sheet

(in millions) (in millions)

Sales + 60 Assets
Cost of goods sold – 24 Cash & bank 12
Contribution (Gross profit) = 36 Accounts receivables 10
Total common costs = 25 Inventory 20
Operating profit = 11 Total current assets 42
Interest and taxes – 5 Total fixed assets 24
Net profit/loss = 6 66
TOTAL

Liability & Equity

Short term liabilities 8

Long term loans 15
Total liabilities 23
Total equity 43
66
TOTAL liabilities and equity

26
The Business Finance Map™

Sales

60

Profit & Loss

Contribution Interest & Taxes
Minus
Cost of goods sold 36 Operating profit 5
Minus
24 Common costs
11 Net profit

25 6

Return On Assets Return On Equity

Quick Assets
17% 14%

22

Balance Sheet
Current Assets Equity
Plus
Inventory 42 Total assets 43
Plus
20 Fixed Assets 66
Short term Liabilities

24
8
Long term Liabilities

15

Return On Capital Employed (ROCE):

Operating profit (11m) divided by Capital Employed (66m-8m) ≈ 19%

PART II: How are you doing? 27

In hindsight

Improving or declining?
This version of the Business Finance Map (right) includes data from two con-
secutive years, allowing us to gauge the progress of the company’s business
performance and to understand the reasons for the change in performance
level.

Questions you may want to ask

Below are typical questions you may ask to determine if a company’s perfor-
mance, viewed from a few different angles, is improving or declining.
“How about our ability to squeeze profit out of
the capital we’ve been using?”
Answer: Improving – from 17% to 19%
Key 1. Return On Assets: Operating Profit (EBIT) divided by Total Assets (%)

“What would the owners say about our ability

to make the most out of their money?”
Answer: Improving – from 14% to 16%
Key 2: Return On Equity: Net Profit divided by Equity (%)

“How is the profitability of our products as such developing – are we

getting paid enough compared to what it cost to make them?”
Answer: Declining – from 60% to 56%
Key 3: Contribution Margin: Contribution (Gross Profit) divided by Sales (%)

“How good are we at turning sales into profit?”

Answer: Declining – from 18% to 17%
Key 4: Return On Sales (ROS): Operating Profit divided by Sales (%)

“Are we getting more or less dependent on borrowed capital?”

Answer: Improving – from 0.53 to 0.47 (a low number is better)
Key 5: Dept-Equity Ratio: Liabilities divided by Equity

“Is the health of our short-term finances improving or declining

– can we pay what we owe?”
Answer: Quite stable – approximately 19%
Key 6: Working Capital Ratio:
Short-term liabilities divided by Current assets (%)

28
Sales
Year 1 Year 2

60 82

Profit & Loss Statement

Contribution Interest & Taxes
Minus Year 1 Year 2 Year 1 Year 2

Cost of goods sold 36 46 Operating profit 5 6

Year 1 Year 2 Minus Year 1 Year 2

24 36 Common costs 11 14 Net profit

Year 1 Year 2 Year 1 Year 2

25 32 6 8

Return On Assets Return On Equity

1 Year 1 Year 2 Year 1 Year 2 2
17% 19% 14% 16%
Quick Assets
Year 1 Year 2

22 23 Current Assets Equity

Balance Sheet
Plus Year 1 Year 2 Year 1 Year 2

Inventory 42 48 Total assets 43 51

Year 1 Year 2 Plus Year 1 Year 2

20 25 Fixed Assets 66 75
Year 1 Year 2
Short term Liabilities

24 27 Year 1 Year 2

8 9
Long term Liabilities
Year 1 Year 2

15 15

3 4 5 6

PART II: How are you doing? 29

In hindsight

Operating performance
– EBIT or EVA?
In most companies general business performance is evaluated based on Oper-
ating profit (not Net profit). The reason is that the financial side of the business
is of a quite different nature than the “main business” and generally managed by
a totally different set of people.
So: If you are responsible for the operation you will be evaluated based on how
much Operating profit you have been able to generate – Earnings Before Inter-
est and Taxes (EBIT).
The finance department will then be evaluated based on how much of the EBIT
is left on the famous bottom line – Net profit.
However, there are a few problems with this.
For example: Who is responsible for how much capital is tied up in things like
inventory and consequently for the interest on borrowed money? Even if the
finance department can negotiate a low interest rate with the bank, you (as head
of the operation) are responsible for how much the company needs to borrow.
Another example: You launch a massive marketing campaign one year and the
cost appears in the P&L of that year. In reality, the campaign should perhaps
be seen as an investment for the next few years. The same is true for things like
education ... is it a cost one year or an investment for the years to come?
In addition, we want to know when the amount of profit is good enough and
when it is not: Have we created ... or maybe destroyed value?

All in all: As a means of measuring business performance,

the P&L has its limitations.
To compensate for these types of shortcomings, many companies apply a con-
cept called Economic Value Added (EVA)*.
The concept of EVA is based on a few simple questions:
• How much value did you actually generate during the year in terms of
profit?
• How much was the actual Cost of capital for the year?
The difference is Economic Value Added (or Lost) …

* Economic Value Added® and EVA® are registered trademarks of Stern Stewart & Co.

30
The EVA method in short
Step 1: Calculate the true profit.
First you need to adjust some of the values in the Profit & Loss Statement and
the Balance Sheet to better reflect reality.
It is mainly about reconsidering whether a certain expense, registered as a cost,
should be seen as an investment instead … and vice versa.
The Operating profit will change accordingly.
From this you deduct the Taxes and you will get the Net Operating Profit After
Taxes (NOPAT). This is regarded as the true value you have generated.
Let’s say that it was 90m.

Step 2: Calculate the true Cost of capital.

The true Cost of capital should include both the cost of Liabilities and the cost
of Equity. The cost of the Liabilities is simple. It’s the interest you pay for them.
Let’s say 5%.
But what is the cost of Equity? In this method the cost of Equity equals what the
owners expect to get in return for their capital. Let’s say that they expect an 8%
return.
The average Cost of capital can be calculated:
• Liabilities: 200m x 5% = 10m
• Equity: 800m x 8% = 64m

And tallied:
• Total capital was 1000m (200m+800m).
• Total Cost of capital was 74m (10m+64m).
• Equalling an average interest rate of 7.4%.
This is called the Weighted Average Cost of Capital (WACC).

Step 3: Calculate the difference – Economic Value Added.

The Net Operating Profit After
Taxes (NOPAT) was 90m
Economic value added:
and Cost of capital was 74m
16M
(WACC).
This means you’ve generated
16m more than “needed” to Net Operating Profit
cover the Cost of capital. Your After taxes: Cost of capital:
Economic Value Added (EVA) 90M 74M
was 16m.

PART II: How are you doing? 31

In foresight

Today’s value of future earnings

Invest today. Harvest tomorrow.
The question is: How much do you need to harvest tomorrow in order to make it
worthwhile to invest today?
Any investment (in shares, in new plants, in development of new markets, prod-
ucts, et cetera) is, or should be, discussed from this perspective.

What about this offer:

“Invest 100 today and you will get 150 back in five years …”
Well, that depends …
180
Let’s say that you invest the 100
today. The return rate is 12.5% 160
142
(weighted average cost of capital) 127
113
and you let the money stay invested 100
for five years.
The table shows how your 100 will
grow.
Compared to this, the deal you were
offered does not seem to be that
good (150 in return instead of 180). Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Using the table “the other way around”, you could say that today’s value of 180
in five years is 100 – given a certain interest rate (12.5%).
This is called the Net Present Value (NPV) of future earning.

Net Present Value (NPV)

Similarly, the Net Present Value of the 150 you were offered in five years is only
83 (at 12.5%), which is much less than the 100 you were asked to invest.
Here is how you calculate it. (Don’t spend too much time on the formula, your
computer will do the job for you – look for the function NPV.)

Expected cash flow at

the end of the fifth year 150 Net Present
=83 Value (NVP)
100% + 12,5% (Interest 1.1255
rate) = 112,5% = 1.125
Number of years

32
When is an investment worthwhile?
Here’s an example to answer the question.
• You intend to invest 300.
• You expect the earning per year to be 100.
• You believe that this will go on for 5 years.
This means that you pay 300 now, and get 500 back, eventually …
Not bad, or …? Let’s see.
You want your 300 back, but you also want a return, say 12.5%.

So this is the question you will ask:

What is today’s value of the expected 100 per year in return? For example, the
100 you get the first year has a higher value today than the 100 you will get the
fifth year.
As the graph shows, today’s value of the 100 per year in 5 years is 355. And
that seems to be good enough and you will probably be inclined to make the
investment …

355
300

Investment Net Present Value of

expected future earnings

Expected future earnings 100 100 100 100 100

NPV (at 12.5%) 89 79 70 62 55 = 355

PART II: How are you doing? 33

In foresight

Focus on future Cash Flows

A different approach is to set aside the Balance Sheet (Book values) and
concentrate on the Cash Flow.

This is the reasoning:

• You have invested 300 in a new plant, system, product development or
other initiative.
• The requirement is that the investors get their money back with a reason-
able return rate (WACC), in this case 12.5%.
• The investment is expected to last four years – the economic life of the
investment.
With this information you can calculate the average Cash Flow you need to gen-
erate every year in order to meet the level of return demanded – breakeven.

300

Investment So you have to generate a cash flow of 100 per year

over four years in order for the investors to get their 300
back together with the desired return (12,5%)

Net Present Value

Cash flow demands 100 100 100 100

Net Present Value 89 79 70 62 = 300

34
Cash Value Added
If you are able to exceed the expected 100 per year, this is regarded as value
creation. This can be measured as Cash Flow Return On Investment (CFROI)
or Cash Value Added* (CVA®).
Like this:
• Operating Cash Flow: 120
• Capital charge (the demand): minus 100
• Cash Value Added = 20
Expressed as a ratio, the CVA index is 120/100 = 1.2

The main advantage of focusing on Cash Flow is that you do not need to worry
about the way the Operating profit is calculated, whether or not your equipment
is correctly valued, et cetera.
We have said it before:
“Profit is an opinion, Cash Flow is fact.”
This rings true to investors and business managers alike.

Questions to consider
Even if the above describes a simple method, it is not completely free from dif-
ficulties.
Some major issues:
• What should be regarded as an investment? It is easy when it comes to
the purchase of new equipment. But what about replacing old equipment?
• How should you regard the purchase of spare parts?
• Is the development and launch of a new brand or investing in creating a
new brand profile an investment or not?
• What is the economic life of the investment? Will the investment generate
Cash Flow for five years or ten years?
These types of questions are typical of companies who are adopting the meth-
ods of Cash Value Added.

* “CVA®” by Fredrik Weissenrieder and Erik Ottosson

PART II: How are you doing? 35

High-value assets
not in the Balance Sheet
It is fairly obvious that a business has a lot more assets than the ones
that appear in the Balance Sheet.
For example:
A strong business concept; patents,
copyrights and specific know-how;
tools and processes; people and their
skills and loyalty; corporate culture;
customer base; brand image; network
of suppliers and partners; reputation
for environmental and social responsi-
bility and a lot more.
These types of assets are at least as
important, but as they are less tan-
gible, less visible, they are most often
called Intangible assets.
Question:
How do you measure the value of these assets in financial terms?
One possible answer:
You do not need to do that. But you could use other types of measures in order
to monitor how they are developing.
Another answer:
If the (book) value of your company is 100m (Equity) and an investor is willing to
pay 150m for it, almost by definition the 50m extra must reflect how the investor
views the value of the Intangible assets.
Or more accurately: The price the investor is willing to pay reflects how much
future profit he or she believes the company can generate.
Although this conclusion seems reasonable, there are a lot of questions about
the relevance and credibility of quantifying Intangible assets in financial terms.

Managing Intangible assets

Of much greater importance is finding ways to describe, monitor and manage
Intangible assets – sometimes referred to as Managing Intellectual Capital.
The point is that all assets of any importance (regardless of how tangible they
are or aren’t) should be monitored and managed with the same care.
A requirement is that they are made visible in one way or another.

36
The principle of an Intangible Assets Monitor
(Karl-Erik Sveiby)

“Market value”
Tangible Intangible assets
assets
Our equity
Customer Knowledge
according to the
base capital
Balance sheet.
The value of
(Total assets minus Our Our
Liabilities) our customers’
knowledge and organization people
image The value of The value of
our tools and our people’s
processes competencies

Growth

Innovation

Efficiency

Stability

• Growth is simply a measure of increase (or decrease) compared to the

last time the item was measured.
• Innovation is an indication of the degree of renewal brought by the
customers (new ideas), the organization as a whole (new ways of doing
things) and people (their ability to capture and realize new ideas).
• Efficiency is mainly about the ability to make profit out of the asset.
• Stability refers to the risk of loosing (some of) the asset.
For example, customers and experts leaving the company or tools and
processes getting obsolete.

Even if sophisticated figures and formulas are used to calculate these indica-
tors, when communicated it is sometimes enough to indicate the general trends
(as done here).
See also Balanced Scorecard (following pages).

PART II: How are you doing? 37

Balanced Scorecard
Your company has a vision (“what we want to become”) and a strategy for how
to reach the vision. Then it is obviously important to not only communicate the
vision and the strategy, but also what it will take to succeed.
This is the purpose of a Balanced Scorecard* – basically a “balanced” selection
of Key Performance Indicators reflecting critical success factors:
• Long-term goals: These highlight aspects that are key to success from a
strategic point of view. For example: A low-price retail chain has different
priorities than a cutting-edge pharmaceutical laboratory.
• Short-term goals: These highlight aspects that are currently focus areas
for improvement. For example: A company that starts losing important cus-
tomers might choose to focus on KPIs associated with customer satisfac-
tion, such as complaints about quality or service level.

A Balanced Scorecard typically covers four main perspectives:

Finance

Customer Vision & Internal

relations strategy processes

Learning &
development

“What gets measured gets done” or ...?

Using Balanced Scorecards of some kind is quite popular even if they some-
times fail to deliver the desired results. For example: If people feel like they are
drowning in information, they tend to ignore the signals that are supposed to
help them focus and prioritize.
The same is true if the signals are (or are
perceived to be) contradictive. This way

*The concept was introduced by Robert Kaplan and David Norton

38
Example
A Balanced Scorecard allows you to monitor performance along a range of criti-
cal success factors so that, depending on your area of responsibility, you can
take action accordingly.

Finance Internal processes

Profitability per customer Lead time

Average Contribution margin per Average time from order to delivery.
customer in the primary target
group.
Quality
Operations efficiency Total number of errors.
Profit margin (Operating profit,
EBIT) divided by Sales.
Use of resources
Purchasing efficiency Utilized time divided by total time
Cost of material and components available (people or equipment).
compared to industry benchmark.
Time to market
Inventory capital Total time from idea to launch of
Total inventory in relation to Sales. new products or services.

Customer relations Learning & development

Customer satisfaction People satisfaction

Percentage of customers who are Percentage of employees satisfied
satisfied or very satisfied. or very satisfied with their overall
situation.
Service level
Percentage of orders delivered to Knowledge and skills
specification and on time. Percentage of employees fulfilling
their job profile.
Availability
Percentage of articles that are Innovation
available for the customer to buy. Total number of internal ideas
currently under development.
Customer complaints
Number of complaints per 10.000 Diversity
articles Number of different ethnic groups
represented in the company.

In this example the performance is illustrated by a black bar – from red to green,
from low to high performance.

PART II: How are you doing? 39

PART III:
Tapping the potentials
Looking for levers to pull
Knowing what you want to achieve is one thing; knowing what levers to pull is
quite another ...
Every business is made up of myriad more or less intertwined “cause-and-
effect chains,” just as within any living organism. A business organization is truly
organic and not as mechanistic as we sometimes may think.
Although that doesn’t preclude identifying the possible root cause behind a
certain effect, as illustrated by the example right.

---
PART III is intended as a source of inspiration: How do you find potentials for
improvements and what can you do to tap into them?

Many small wins – five case stories

In the following you will find five short and to-the-point case stories demonstrat-
ing how even a few small improvements can make a huge difference – if the
right levers are pulled..

A lever is something
that could turn small efforts
into major achievements

40
 A simple example, just to make the point:
This picture shows a stylized version of how a company has mapped what it is
that drives Cost of goods sold in several tiers.

Product
design Purchase Sales
Quality
Culture Tools
Utilization Cost of
Technology of material
Leadership goods sold
Scrapping
Sense of & rework
belonging Labor Common
Attitude costs
Raw material
Skills size
...

Influencing factors (direction)

Searching for root causes

Presuming that you’re looking for ways to lower the Cost of goods sold, the
diagram offers several possible drivers.
Let’s say that you find that Utilization of material is rather poor and declin-
ing. You consider a range of possible causes and decide that Scrapping and
rework seem to have the greatest potential for improvement. And you ask,
“What can we do about it?”
Then you continue to work backward in the cause-and-effect chain: “What has
the greatest impact on Scrapping and rework?” That could be anything from
flaws in the product design or the production equipment to the quality of the
purchased components.
It could even be that people just do not care.
If it turns out to be the latter you need to ask, “Why are people careless?” You
may find that the employees lack a sense of belonging, that they feel alienated
and cannot see any point in trying to be more responsible.
You may conclude that this in turn is an effect of poor leadership.
You have found the root cause and that is what needs to be fixed – and this is
probably where you will get the strongest leverage of your efforts.
You have pulled the right lever – just as they did in the case stories presented
on the following pages.

PART III: Tapping the potentials 41

Case 1: Manufacturing – focus on EBIT

“We decided to go for the low-hanging fruit …”

A manager explains:

“
We were not happy with the predicted profit for the year and made a decision
to look for short-term, easy-to-grab opportunities – regardless of their size. We
scheduled a series of brainstorming workshops, most of them with people from
different functions, to get fresh ideas ...

Brainstorming on the factory floor

It turned out that people had loads of ideas. When asked why they hadn’t taken
these ideas further a typical answer was, ‘I really didn’t think it would make much
difference.’
But now, while they were at the table, we asked which of these ideas would be
really easy to implement ...
The result was a ‘Let’s do it’ list with some 36 items – including ideas for
reducing scrapping, simple change in assembly order, an innovative, yet simple
new tool to be used in a certain process, et cetera. The list also included a de-
mand for one of the suppliers to secure zero error in their deliveries of compo-
nents.
Put together, these changes added up to a reduction of Cost of goods by 4%.
An interesting side effect was that workers felt more involved as a result of
this initiative. This in turn led to greater responsibility being taken ... which led
to fewer errors ... which led to higher Customer satisfaction ... which led to an
increase in Sales by 2%.
Offer added value instead of discounts
Our market has become more and more price sensitive and it has been increas-
ingly tempting for the sales people to offer discounts as a means of securing the
order.
Not all of the sales people fully realized how
discounts affect profit ... Not until a recently
hired salesperson provided this demonstration: Profit Discount
‘What if instead of a discount we offer more value 5%

(extra services of some kind) with a similar value for 200

the customer ... but at a lower cost for us.
195
For example: A 5% discount means that we lose
two thirds of the planned profit as shown here. 190
Extra
By instead offering the equivalent worth of value 185 Cost

added, we would only lose one third of the planned

180
profit due to the extra cost of the added services.’ Cost
175
By applying this idea to a selection of our key
accounts, the result was that the average price 170
level went up 2%.

42
 All in all
We also needed some extra marketing efforts and some more help from the
support functions. But it paid off ... as you can see, the EBIT almost doubled!
Not too bad!

cus_on_EBIT
What we achieved Effect on EBIT
Sales (volume) +2%
Prices +2%
Cost of good sold -4%
Marketing & sales +2%
Support functions +1%

Marketing & sales

Support functions
Cost of goods

EBIT +98%
Profit & Loss Statement
Before After
Prices
EBIT before

Sales 1 000 1 040

Cost of goods sold 600 588
Volume

Gross profit 400 452

Marketing & sales 110 112
Support functions 180 182
Other 60 60
Total common costs 350 354
EBIT 50 98

How to read the graph

• Far left: EBIT before changes
• Light blue: Increase in EBIT, item by item
• Red: Decrease in EBIT, item by item
• Far right: The total effect on EBIT

PART III: Tapping the potentials 43

Case 2: Manufacturing – focus on Cash Flow

“When good habits have become bad habits …”

The CEO explains:

“
To us, cash is king. So at one point, we asked ourselves: What would it take to
double the Cash Flow?
As we also strived to improve on profitability, we knew that this in itself would
improve Cash Flow – which we actually did by reducing the Cost of goods by
2%. The approach was mainly to ask people in Production to ask themselves,
‘Why do we still do things like this; is there a better way?’
But there was more to do:
We examined the inventory levels – as we had done several times before – and
to start with, we actually did not find any room for improvements worth going for.
Until one day when our purchasing manager happened to see a pile of material
close to one of our machines. She asked the first line manager, ‘Will you use all
of this today?’ and the response was, ‘No, not today, but next week. But I do not
want to risk not having it here when I need it.’
As it turned out, most of the first line managers did the same thing. It had been a
longtime habit to order material from stock way in advance of when it was actu-
ally needed. The reason? In previous times it often happened that production
stopped due to delivery delays. That problem had been solved years before, but
obviously the habit did not change.
A crash course in Cash Flow and Cost of capital for the first line managers was
all that was needed.
And as a result, the inventory level could be reduced by 5%.

Then we asked ourselves, are there more bad habits prevailing from the
time they were good habits?
And there were.
In the old days we did not dare to ask important customers to pay their invoices
on time – ‘they might be upset’ was the thought. We also had (have) a tendency
to offer more generous credit terms than the customers asked for. On average,
the customers pay within 55 days after sales are made. By getting them to pay
only 4 days sooner, we were able to reduce Accounts receivable by 7%.
To encourage this new habit, we played the song “What a Difference a Day
Makes” daily in the cafeteria.

44
Changing bad habits
Another bad habit that we were able to change was to accept the suppliers’
payment terms without really negotiating them. Only a few days longer payment
terms resulted in an increase in Accounts payable by 4%.

All in all
So as you can see, changing habits could double Cash Flow!

”
What we achieved Effect on Cash flow
Cost of good sold -2%
Inventory -5%
Accounts receivable -7%

Cash flow +100%

Accounts payable +4%

Accounts payable
Accounts receivable
Profit & Loss Statement
Before After
Cash flow before

Gross profit Inventory

Cost of goods

Sales 1 000 1 000

Cost of goods sold 600 588
All other expenses* 350 350
Incoming cash, net +50 +62
Canges in ...
Inventory (-) +20
Accounts receivable (-) +12
Account payable (+) +6
Total cash flow ... +50 +100
... from operation, before payment of taxes

*All other costs except depreciation

PART III: Tapping the potentials 45

Case 3: Professional services

“A lost hour is gone forever …”

One of the co-founders explains:

“
It is common knowledge in our industry that ‘a lost hour is gone forever.’
The same is true for airlines, cinemas, restaurants ... you name it. An empty chair
is a lost opportunity to earn money, but you still have to pay the cost for it.
Fortunately, the reverse is also true: Whatever you can charge someone for
occupying that empty chair will more or less fully appear on the bottom line.

What we did ... and why we did it

As a company, we have been growing quite fast over the last years while profit-
ability has shrunk almost at the same pace – mainly due to ‘too many lost hours.’
Only 60% of the specialists’ working hours were billable last year.

We asked ourselves ... Why?

We knew it wasn’t a matter of laziness or lack of responsibility; we knew that
a degree of over-delivery (people putting more hours than planned into a job)
could explain a smaller portion of the problem, but far from all of it.
We looked at the way we are or-
ganized, how resource planning is
conducted and things like that ... but
still no breakthrough solution.
Profit (EBIT)
Then someone suggested a different Fixed costs
way to configure the project teams,
which would allow for greater flex- n)
utio
ibility. t rib
Con
It required the staff to be trained in le s(
Sa
some additional skills on top of their
specialities (multi-skilling) and it
required that we develop a few new
tools to add to our bag of tricks. 60% 66%

This picture shows how an increase in

utilization (billable hours) from 60% to
66% affects the profit.

46
The result was staggering:
• Less overtime was needed which reduced the cost of staff by 2%.
• As we offered a bit more value we could raise prices by an average of 2%.
• As the portion of billable hours went from 60% to 66%, we had more
hours to sell without having to recruit more people or pay any other extra
costs: Sales went up 7% and all of it was pure profit.

All in all
It took some time to get there, but it was worth it, as we eventually tripled the
EBIT – like for like.

”
What we achieved Effect on EBIT

EBIT +200%
No. of hours sold +7%
Price per sold hour +2%

Salaries
Utilization 66% (60) +6%
Salaries (prof. staff) -2%

Utilization

Profit & Loss Statement

Before After
EBIT before
Hours sold

Sales 1 000 1 091

Cost of service sold 600 591
Gross profit 400 500
Sales and marketing 100 100
Product development 130 130
Other exenses 120 120
Operation costs 350 350
EBIT 50 150

PART III: Tapping the potentials 47

Case 4: Retail operations

“All hands on …”
The store manager has this story to tell:

“
Tougher competition, more demanding customers, higher staff costs, market
slow-down ... There were many ways to explain why the store’s performance did
not live up to expectations. However, no one on the management team fell into
the trap of (just) blaming the circumstances. We all knew that it was up to us to
‘fix it,’ as somebody said. After a lengthy discussion about several ‘how-to-fix-it’
ideas, we concluded:
We need to engage every single individual in this store and ask for his or
her contribution.
And so we did … and we had a pretty clear idea about what we should ask for.
These are the questions we asked – and a summary of the answers we got:
Q: How do we increase floor traffic, the number of visitors?
A: By making buying in this store such a good experience that custom-
ers want to come back and also spread the word.
(Effect: 2% more visitors.)
Q: How do we convince more visitors to actually buy something, to
become customers?
A: By seeing to it that they can get what they are looking for.
(Effect: Portion of visitors actually buying went up by 3%).
Q: How do we get customers to buy a bit more?
A: By seeing to it that they not only get what they want, but also what
they did not know they wanted. (Effect: Average purchase up 1%).
Q: How do we get more profit out of the Sales?
A: We need to promote the higher-margin products more effectively
and we need to reduce waste. (Effects: Profit margin increased by 1%
and less waste reduced the Cost of goods sold by 1%.)

And soon a lot of things started to happen:

Workers responsible for replenishment started to ask the salespeople on the
floor how to best prioritize. All workers attended to customers whenever pos-
sible: ’How may I help you?’ … ’Have you also seen this product?’ Workers in
the back office came onto the floor to help out during rush hours. We fixed more
of the damaged products which helped to reduce waste. The most attractive of
the higher-margin products were identified and made more visible, and so on
and so forth.

48
All in all
It did not take long before we could harvest the result. I believe these numbers
(below) say it all! We had doubled the profit and were (almost) back on track.
And yet, we have only just begun …

What we achieved Effect on EBIT

Visitors +2%
Conversion rate 63% (60%) +3%
Avarage purchase +1%

EBIT +100%
Margin +1%

Cost of goods
Cost of goods sold -1%

Avarage purchase
No. of customers

Margin
Profit & Loss Statement EBIT before
Before After

Sales 1 000 1 082

Cost of goods sold 600 632
Gross profit 400 450
Staff 200 200
Marketing 50 50
Operation 100 100
Operation costs 350 350
EBIT 50 100

PART III: Tapping the potentials 49

Case 5: Selling

“The last 5% that that made a 100% difference”

This company has a large sales organization spread around the world. The
recruitment and training procedures are rigorous, and as a result the major-
ity of the sales people are high performers. Within the company’s information
management system is a very ambitious knowledge repository where every
sales process (from the first contact to the won or lost pitch) is supposed to be
documented, allowing for knowledge sharing.
It turned out the system wasn’t being used the way it was intended, so the inter-
est in actually reporting has been declining – “Just a lot of extra work.”
At a point when the system was about to be revised, the question was raised
whether to keep the knowledge repository or not.
One of the most senior salespersons has this confession to share:

“
We agreed that the captured knowledge was poorly utilized and came up with
some suggestions for making better use of it, for example in training new hires.
As the discussion continued we realized that there was one important aspect
missing in these stories and hence possibly in our own minds:
What about all the situations where ‘we do not know what it is we don’t
know?’
It was like a blinding flash of the obvious. When we tell our stories we are very
rational, we have an explanation for every outcome: why we won this order, why
we did not win that order. What if we actually do not know exactly why we won
or lost certain orders? What if we just think we know?
After a while we realized that in spite of (or possibly due to) our vast experience,
we take it for granted that we sold the right things with the right arguments
while the customer might have signed the order based on (slightly) different
criteria.
We picked up some twelve recent cases where we had tough competitors to
pitch against (50/50 won and lost orders). And we discussed them in-depth.
We found that in at least one third of the cases we couldn’t give a credible
explanation of what it was that eventually tipped the balance.
It was then that we realized that ‘we do not know what it is we don’t know,’ and
we decided to change that. We asked a highly regarded sales performance
consultancy for help – and we got it.
We have now become (a little) better at reading and understanding the custom-
ers’ needs, including (and this is important) the needs the customers did not
know they have. And this in turn changed the dialogue with the customers as
well as the precision of our proposals.

50
As a result …
Our hit rate (portion of won orders) soon went from 25% to 27%. We also
increased the number of opportunities by 2% and we got a 1% more ‘requests
for proposals’ from our opportunities.
And that was actually enough to double our profit.

What we achieved Effect on EBIT

Number of opportunities +2%

EBIT +100%
Portion requests 51% (50%) +1%
Hit rate 27% (25%) +2%

Hit rate
Opportunities
EBIT before

Profit & Loss Statement

Before After
RFPs
Sales 1 000 1 124
Cost of service sold 600 674
Gross profit 400 450
Operation costs 350 350
EBIT 50 100

PART III: Tapping the potentials 51

Sample value drivers – and what they drive
Read more about each of these value drivers on the following pages.

Superior products
Innovation
Differentiation Products and
Product range, value-added services services offered
Pricing – customer needs
and demand

Marketing messages
Brand values Customer
Selling awareness
Targeted customers and perception
Competition

Product quality
Delivery excellence Customer Sales
satisfaction,
Customer support
reputation
– repeat business

Purchasing efficiency Cost of purchased

Supplier loyalty material
Supply chain – components and Profit
Raw material prices services
Cost of
goods and
Utilization of services
Waste material sold
Product design
Tools and methods
Waste handling

Utilization of labor
Planning
Multiple skills
Development Common
Responsibility costs
Utilization of
machinery
Planning and equipment
Maintenance
Product design
Hours per day
Cost of marketing
and sales,
development and
Alignment support functions
Focus
Simplicity

52
In search of opportunities
As the previous case stories (pages 42-51) demonstrate, a range of small im-
provements can make a huge difference on the bottom line – providing that you
have found the right levers to pull. If you don’t, you may end up merely address-
ing the symptoms rather than the root cause of a certain problem.
To identify opportunities for improvements and find the right levers, you need to
have some general idea of the “moving parts” of your business: What is driving
what? What is the magnitude of the different drivers’ impact? And et cetera.
As mentioned earlier:
A business is an organic system, and as such quite complex.

Value driver tree

A Value driver tree offers a simplified version of such a system, the idea being
to capture the business’ key drivers and their interdependencies on several tiers.
At the left is a simple example of a Value driver tree (with only a few tiers).
In the following chapters we will explore the value drivers included in this tree a
bit further.

To get the most out of this section, browse through the following eight pages
seeking to identify potentials for improvements in your own company – and,
possibly, to come up with ideas about leversExample
(drivers) worthwhile
of possible drivers pulling.
Which of the statements in each pair is closest to your own reality?
This is what we suggest: Superior products?
We are mainly trying to sell what We are mainly trying to offer
For each pair of statements (bubbles), we have to offer. what we can sell.

determine which one you think best Innovation

reflects your own reality. Mark the We tend to “look in the rearview
mirror” in our product develop-
We are truly innovative in find-
ing new, breakthrough products
corresponding circle. If you think your ment.
“If it is not broken, don’t fix it.”
for the future.
“If it is not broken, break it.”
reality is somewhere between the two Differentiation

statements, mark one of the middle Actually, our offerings are not as
unique as we pretend.
We definitely stand out from
the competition.

circles.
Product range, value-added services
Our product portfolio is far from Our customers keep coming
where our customers expect it back as they know they can get
to be. what they are looking for.

A piece of advice: Pricing

Skip over items you find less relevant, and if–Ouryou miss something,
pricing is based on costs
or the prices offered by the justvalue
add it. – as per-
Our prices are based on the
of the products
competition. ceived by the customers.

We have to offer low prices We can offer low prices as we

even if we do not have low cost have low cost advantages.
advantages.

PART III: Tapping the potentials 53

Sales
Products and services offered
The first question any customer asks is: “Do you have what we want?”
On top of that: Different cus-
tomers have different needs Service scope Innovation
profiles, as in this example.
Environment Reliability

The following addresses how Price Efficiency

well your products meet your
targeted customers’ needs and One point of contact Brand strength
demands, today and tomorrow.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Superior products?
We are mainly trying to sell what We are mainly trying to offer
we have to offer. what we can sell.

Innovation
We tend to “look in the rearview We are truly innovative in find-
mirror” in our product develop- ing new, breakthrough products
ment. for the future.
“If it is not broken, don’t fix it.” “If it is not broken, break it.”

Differentiation
Actually, our offerings are not as We definitely stand out from
unique as we pretend. the competition.

Product range, value-added services

Our product portfolio is far from Our customers keep coming
where our customers expect it back as they know they can get
to be. what they are looking for.

Pricing
Our pricing is based on costs Our prices are based on the
– or the prices offered by the value of the products – as per-
competition. ceived by the customers.

We have to offer low prices We can offer low prices as we

even if we do not have low cost have low cost advantages.
advantages.

54
Sales
Customer awareness and perception
“What is not communicated does not exist,” a marketer said.
It is a matter of sending the right messages to the right customers via the right
channels.

Just to make the point:

If you had these three options (right), which
one would you choose? And more impor-
tantly, why?
8.- 11.- 10.-

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Marketing messages
Our messages are merely Our messages are based on
reflecting how we see ourselves deep customer understanding
– Inside-out. – Outside-in.

Brand values
Our brand values reflect who we We live our brand values in
want to be, not who we are. everything we do.

Selling
In our sales we focus on our In our sales we focus on the
“points of sales” – product customer’s “points of purchase”
features. – customer benefits.

Targeted customers
We tend to be all over the place, We have identified our pre-
trying to be all things to all ferred customers and focus our
customers. sales efforts accordingly.

Competition
We compete against the com- We compete for customers
petition rather than for custom- rather than against the competi-
ers. tion.

PART III: Tapping the potentials 55

Sales
Customer satisfaction
There are at least two reasons why Customer satisfaction is among the top
three key indicators in many companies:
Satisfied customers tend to come
back for more.
Satisfied customers can do a lot of
(free) marketing for you by spreading
the word.
Unfortunately the latter is true even if
the customers are not satisfied:
“Word-of-mouth” is a double-edged sword.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Product quality
It is too costly to secure 100% Our customers say, “We never
quality. have any complaints at all.”

Delivery excellence
We tend to forget that the Our customers say, “Always
delivery is as important as the on time, in the right place and
product itself. to specification.”

Customer support

When the product is delivered, Our customers say, “When

we tend to forget about it – the the product is delivered the
relationship with the customer is relationship with the supplier
basically over. has only just begun.”

56
Cost of goods and services sold
Purchase of material and components
The purchase is far from just getting what you want at a good price.
What you must look at is the total
Landed costs of your purchased
material and components.
Landed costs include all costs of the
purchase when it has “landed” on
your doorstep: the purchase price as
such, transports, handling, temporary
storage, insurances, import fees and
more.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Purchasing efficiency
We tend to wait far too long be- We have top-notch proce-
fore we renegotiate the contract dures for how to look for and
with or replace old suppliers. evaluate suppliers as well
as how to negotiate win-win
contracts.
Supplier loyalty
We tend not to bother too much We are constantly monitoring
as long as we get what we want our suppliers’ performance and
at the price agreed upon. give them a helping hand when
needed.

Supply chain
Our supply chain is far from We have a holistic view of the
streamlined – it looks more like total supply chain – upstream
a patchwork, developed over as well as downstream.
many years.

Raw material prices

Different suppliers/business We thrive on economy of
areas buy raw material indepen- scale advantages as we have
dently – even if it is the same coordinated all purchases of
material. raw material.

We are ill-prepared for surpris- We are well prepared to take

es, such as a sudden increase action if there is a sudden
in prices. increase in prices.

PART III: Tapping the potentials 57

Cost of goods and services sold
Use of material
The question is: How much of the purchased material do you actually use and
how much is more or less thrown in the waste bin?
When you make gingerbread you at
least have the advantage of being able
to reuse the waste – but that is far
from always the case.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Waste
Our coworkers are not aware of Our coworkers are fully aware
the cost of waste – and they act of the cost of waste – and they
accordingly. act accordingly.

Product design
We have a high scrapping We keep scrapping costs at a
cost because the design of the minimum by designing compo-
components is not done with nents with Utilization of material
Utilization of material in mind. in mind.

Tools and methods

The tools and methods we use We have developed tools and
are the main cause of Scrapping methods to minimize Scrapping
and rework. and rework.

Waste handling
Most of the waste is just thrown Most of the waste is recycled
away. in one way or another.

58
Cost of goods and services sold
Use of Labor
The meaning of Use of Labor (or Labor utilization) is twofold:
Productivity: To what extent people’s
working hours are used to create value.
Capability: To what extent the company
makes use of people’s competencies,
desires and capacity to grow.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Planning
Most of the time we are either We have a lean production
understaffed or overstaffed. model that allows us to staff
production in an optimal way.

Multiple skills
Our people cannot handle Our people can handle several
different tasks so they cannot different tasks so they can be
be used where they are most used where they are most
needed at a given time. needed at a given time.

Development
We keep track of our vacancies We keep track of our people’s
and needs and recruit or place competencies and desires and
people accordingly. try to place them accordingly.

Responsibility
Our workers seem to be reluc- We know that if we inform and
tant to take responsibility. engage our people they cannot
avoid taking responsibility.

PART III: Tapping the potentials 59

Common costs
Use of machinery and equipment
We have stated that Cost of machinery is a Common cost. Many companies
view it as a “semi-variable” cost – something between Variable costs (Cost of
goods sold) and Fixed costs. It is a Fixed cost as long as the produced volume
stays within the capacity of the machinery. If that volume is exceeded, you need
to invest in more equipment or try to squeeze more out of the machinery you
have.
It is the latter we address here.
If you have a very expensive piece of machinery, then you want to use it as much
as possible.
Airlines, for example, strive to keep
the “turnaround time” (from arrival
to departure) for the aircrafts at a
minimum to get the most out of the
machines.
In manufacturing, lean production is a concept aiming to (among other things)
reduce, or even eliminate, any bottleneck in order to maximize the use of the
expensive machinery.

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Planning
Productivity suffers from Our production plans are well
unplanned, time-consuming coordinated with sales and
changeovers. delivery plans.

Maintenance
Most stoppages are a conse- Almost all maintenance is
quence of poor maintenance preventive (and done when the
– we tend to prioritize using the machines are idle) and aims
machines before maintaining them. at keeping stoppages at a
minimum.

Product design
The design of our products We design our products with
does not allow us to make the efficient use of machinery in
best use of the machinery. mind.

Hours per day

Our expensive machinery is Our expensive machinery is
used almost eight hours a day. used almost around the clock.

60
Common costs
All other costs
There was a time when the Common costs (such as Sales and Administration)
were a fraction of the total costs. Most of the cost was Cost of goods sold.
Today it’s different. In many industries the Common costs even exceed the Cost
of goods or services sold.
This makes it a bit more difficult to gauge how these costs actually add to the
value the customers pay for. Or, put another way: How profitable are these
costs?
To compensate, companies typically try to attribute as much of these costs as
possible to the relevant product category or business area. (The Contribution
remaining when these costs are deducted is often referred to as “Contribution
margin 2.”)
Whether this is the case or not, there are a few overarching drivers worth con-
sidering:

Example of possible drivers

Which of the statements in each pair is closest to your own reality?

Alignment
Different units seem to have All units are going in the same
different priorities and agendas. direction with a common goal.
We are viewed as many compa- We are seen as ONE company.
nies under one umbrella.

Focus
As we tend to see market We have clear ideas about
potentials all over the place, where our market potentials lie,
we have difficulty focusing our and we concentrate our efforts
efforts. accordingly.

Simplicity
We are far too sophisticated to To us, simplicity is the ultimate
even come close to simplicity in sophistication – and typical of
how we do things around here. how we do things around here.

Do not underestimate the power of alignment.

PART III: Tapping the potentials 61

All in all

What would happen if ...?

How well do you know your business’ potentials?
What would happen if you actually pulled a few of the levers you have identified
in the previous section?

To find out, go to [Link] and look for “Celemi Profit & Cash Flow simu-
lator.”
This is how it works:
Click the + – buttons (top right) and see the effect on Profit or Cash Flow.
You can choose between different types of businesses and you can use pre-set
data or enter your own.
1

iPad

Manufacturing Ð proÞt What would happen if …

Type of
busines
s

Input
data

Reset

Home

Demo

62
63
 Business finance in a nutshell
Terms used in this book and examples of commonly used synonyms and related
terms.

Sales
Revenues (US)
Turnover (UK)
Contribution Interest & Taxes

Income Statement
Profit & Loss Statement
Income
Gross profit Related term:
Minus Sales profit Financial costs
Cost of goods sold Contribution margin 1 Operating profit
Cost of services sold EBIT
Minus Operating income
Direct costs
Variable costs Common costs Contribution margin 2 Net profit
Operating costs Net earnings
General expenditures “Bottom line”

Return On Assets Return On Equity

Indicators
Related term:
Return On Capital
Employed – ROCE
Quick assets
Includes:
Cash & bank
Accounts receivable Current Assets Equity

Balance Sheet
Includes:
Plus Share capital
Inventory TOTAL ASSETS Retained earnings
Includes: Related terms:
Stock Plus Capital employed
Work in progress Fixed Assets Working capital Short term liabilities
Finished goods Includes: Includes:
Real property Loans
Plant and equipment Accounts payable

Long term liabilities

Includes:
Loans

64
Glossary
Here you’ll find the most important terms used in this book. Also included are
common expressions that mean the same thing (=) or approximately the same
thing (≈), as well as some terms not discussed in the book but that are widely
used.
The explanations presented here are brief; if you want to learn more, we recom-
mend visiting
[Link]
Just enter the term you want to learn more about.

Accounts payable Before ...

Unpaid invoices from the company’s sup- Example: “Profit before Taxes” means
pliers of goods and services. that Taxes were not included in the profit
calculation.
Accounts receivable
Invoices that customers have not yet paid. Book value
For example: Plant & Equipment could
After ... have real value (such as market value)
Example: “Profit after financial items” compared to how they are valued in the
means that the financial income and Balance Sheet.
expenses (such as Taxes) were included in
the profit calculation. Bookkeeping
The recording (entry in the books) of all
Amortization events that affect the company’s finances.
The paying off of debt – most often in
regular instalments over a period of time. Borrowed capital
Sometimes the term is used as a synonym Also called Liabilities.
for depreciation of the value of intangible
assets, such as a patent or a copyright. Capital employed
Total assets less cash and/or Accounts
Annual report payable (or other noninterest-bearing li-
A summary companies present to their abilities) and less proposed Dividends.
owners and to the community on their
financial condition during the past year. Capital turnover rate
It includes a report from management, a A measure of how many times the assets
Profit & Loss Statement, a Balance Sheet, have been used during the year – as an
a statement of changes in financial posi- indication of “the speed of the circulation
tion, et cetera. of capital.” It is calculated like this: Sales
divided by working capital.
Apples & Oranges
Refers here to the fact that the financial Cash & Bank
principles of bookkeeping make it possible Cash & Equivalents
to compare values of different kinds – “to Often called Liquid funds. Shows how
compare apples and oranges.” much the company had on the Balance
Sheet on a particular date in the form of
Assets ready cash for paying wages, supplier
The value of everything that is used for the invoices, et cetera.
business operation.
Cash Flow
Balance Sheet The difference between incoming cash
A summary of the company’s assets and and outgoing cash over a certain period
to whom they belong (e.g. shareholders of time.
and lenders).

Part IV: Glossary 65

Cash Flow Statement Deferred revenue
A financial report that includes all cash Advance payments from customers for
inflows and outflows. goods and services that have not been
delivered yet. The company is indebted to
Cash Value Added (CVA®) these customers until delivery is made.
The difference between actual Cash Flow
generated and the demanded Cash Flow Depreciation
(as defined by the investors). A reduction in the value of Fixed assets.
Depreciation affects the Profit margin but
Common costs not the cash balance, because the cor-
“Common” means that the costs are con- responding payment was made earlier.
sidered as common to the entire operation
and do not vary directly with the produced Depreciation according to plan
volume. Here we define Common costs as This is Depreciation based on the esti-
the sum of Overhead and Depreciation. mated service life of the equipment. Tax
regulations normally permit a higher rate of
Contribution Depreciation.
The difference between Sales and Cost of
goods/services sold. Dividends
Compensation to shareholders for the
Cost of goods sold capital they have invested.
Cost of services sold
Cost of sales DSO
Equal to the amount the company had to See Days Sales Outstanding.
spend in order to produce goods and/or EBIT
services. Also called Direct costs or Vari- Earnings Before Interest and Taxes. See
able costs. Operating profit.
Costs EBITDA
Different (finance) people assign differ- Means “Earnings Before Interest, Taxes,
ent meanings to terms such as costs, Depreciation and Amortization.” A useful
expenses and expenditures. In this book figure when it comes to calculating Cash
we use the term “cost” to indicate a value Flow.
that leaves the company, thus reducing
the assets. Economic Value Added (EVA®)
A concept used to get a more accurate
Cost of capital view of the actual performance of the
Includes the cost of Liabilities and the cost business.
of Equity.
Equity
Current assets Owners’ (shareholders’) money.
Assets expected to convert to cash within
one year from the Balance Sheet date. Expenditure
Sometimes divided into quick assets Cost.
(liquid funds + Accounts receivable) and
inventory capital. See also Fixed assets. Expense
A business cost (direct or indirect)
Current liabilities included in the Income Statement as a
Short-term liabilities. Debts to be paid deduction from sales in the calculation of
within one year, such as Taxes due, Ac- profit.
counts payable, et cetera.
Financial costs/expenses
Days Sales Outstanding (DSO) Expenses related to financing, such as
How many days, on average, it takes interest on loans.
before the customers actually pay after
the sale has been made. A simple way of Financial income
calculating DSO: If total Net sales was Income not related to the company’s
100M and the Accounts receivable (what operations, such as Dividends paid on
the customers owe you) was 20M, then shares that the company owns and inter-
one fifth of the sales is Accounts receiv- est on money deposited in a bank.
able. So DSO is: one fifth of 365 days (a
year) or 73 days. Financing
The acquisition of capital for the compa-
ny’s operations. This term can also mean
“where the capital comes from.”

66
Finished goods Lenders
The value of finished goods in stock. Primarily banks and other credit institutes,
but suppliers and customers can also
Fixed assets act as lenders (the former by providing
The part of the company’s assets that is supplier credits and the latter by paying in
tangible Property and is not expected to advance).
be converted into cash for some years.
They are fixed as opposed to current. See Liabilities
Current assets. Money borrowed from a bank or other
lenders.
Fixed costs
The costs that a company always has, Liquid funds
regardless of whether production is taking Means roughly the same as Cash (be-
place, such as wages and rental costs. cause money deposited in a bank is also
considered cash). Called “Cash and
General expenses equivalents” or “Cash and bank” in the
Overhead. Balance Sheet.
Gross profit Long-term liabilities
Contribution. Loans for which the company has negoti-
ated a pay-back term of several years.
Income
Defined here as an incoming value that Net profit
increases the company’s assets (e.g. sales The famous “bottom line” of the Profit &
income, financial income). Loss Statement.
Income Statement NOPAT
Same as Profit & Loss Statement. Net operating profit after taxes.
Incoming payment Operating profit
Money that enters the company (cash and Sales less Cost of goods/services sold
cash equivalents). and Common costs. Also called EBIT
(Earnings Before Interest and Taxes).
Indirect cost
A cost which cannot be directly attributed Outgoing payment
to a specific product. May be allocated to Money that leaves the company (from
specific products or departments through Cash and equivalents).
various cost accounting methods.
Overhead
Intangible assets The Cost of sales and support, et cetera.
Assets that are not tangible, e.g. the value Included under Common costs.
of the company’s methods and processes
or people’s competencies. Owners
The people who own the company or,
Intellectual property more precisely, who own the company’s
For example: copyrights and patents. Equity.
Inventories Prepaid expenses
= inventory capital. See below. Advance payments to suppliers for goods
and services that have not yet been
Inventory capital delivered. The supplier is indebted to the
The sum of the values of materials in company until delivery is made.
stock, work in progress and unsold fin-
ished products, i.e. the portion of Current Profit
assets which does not consist of Quick See Net profit and Operating profit.
assets.
Profit & Loss Statement (P&L)
Landed cost A summary of sales, costs and expenses
The total cost of a product, including during a certain period.
purchase price, freight, insurance, and all
other costs up to the port of destination. Property
In some instances, it may also include the The value (Book value) of the real estate
customs duties and other taxes levied on (land and buildings) that the company
the shipment. owns.
Quick assets
Liquid funds + Accounts receivable.

Part IV: Glossary 67

Resources Share capital
Refers here to values (capital) in different The portion of the company’s Equity that
forms. corresponds to the owners’ investment.
Retained earnings Stocks of finished goods
Each year, the company’s Net profit is The Book value of finished products that
added to its Equity. Retained earnings are have not yet been sold.
thus the portion of Equity which does not
consist of Share capital. The Net profit for Stocks of materials & components
the year is often presented separately. The value of input goods – raw materials
and components which have not yet been
Return processed.
Means what you “get back.” Often ex-
pressed as a percentage. Tax due
The estimated payments owed to govern-
Return On Assets (ROA) ment entities. It is recorded in the ac-
Operating profit as a percentage of Total counts as a current liability until paid.
assets. Shows how well the assets have
been used. Taxes
Compensation to the community. The
Return On Capital Employed (ROCE) amount depends on the company’s earn-
Operating profit (EBIT) divided by Capital ings.
Employed (Total assets minus Shortterm
liabilities). Total assets/Total capital
The total Book value of all assets.
Return On Equity (ROE)
Net profit as a percentage of Equity. WACC
Shows how much Equity has grown. Can Weighted Average Cost Of Capital.
be calculated in three different ways:
Based on Equity last year; based on Work In progress (WIP)
average Equity during the year; based on The sum of the values of the materials
Equity at the end of the year. and effort (labor, energy) being applied to
items (goods and services) that are still in
Return on investment (ROI) production.
In essence the same as Return on assets.
Working capital
Sales The capital that is used for getting the
Total amount sold/invoiced during a pe- business running. Most commonly calcu-
riod. Often called Revenues. lated: The total of the company’s cash,
Accounts receivable and Inventory less
Sales and administration Short-term liabilities such as Taxes and
Overhead. A term used to designate a Accounts payable.
company’s general or indirect costs.

68
 All you need to understand Business Finance
The contents in a nutshell:

Part I: The big picture

Will introduce you to the simple logic behind the basic financial
statements – the Profit & Loss Statement, the Balance Sheet
and the Cash Flow Statement.

Part II: How are you doing?

Will introduce a cross section of typical questions about the
performance of a business and how to find the answers – the
relevant key performance indicators, KPIs.

Part III: Tapping the potentials

Is intended as a source of inspiration: How do you find potentials
for improvements in your own organisation – and what can you
do to tap into them? Learn from five compelling case stories.

Serious fun
People engaged in an Celemi Apples &
Oranges™ business simulation seminar –
to-date experienced by more than a million
participants around the world

Learn more about how Celemi can help

you engage people at [Link]

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