My objectives for today

1. Discuss non-financial and financial drivers

2. Help you understand the link between
these drivers and your businesss financial
health
3. Provide a framework to quantify and
measure these drivers

Not my objectives for today

1. Tell you what you should measure
2. Make you believe that measuring is all that
it takes to be successful

What is a driver?
A value driver is an action that affects business
performance in the short and long term
improving the financial health of your business.
(it adds to the business value)
Example of a traditional value driver:
Introduction of cost controls to manage short-term earnings
and cash flow.
Example of an action that does not add value:
Introduce cost controls that cut short-term costs at the
expense of product development or maintenance of the
companys physical assets.

Are value drivers basically the same?

The answer depends on your business
fundamentals.
Value driver - Improving customer loyalty
If brand makes a differenceyes
If cost is what matters.no

The answer also depends on your business

strategy.
Value driver Low Prices
Wal-Mart.yes
7-Eleven.no

Non-financial drivers
On-time delivery
Process cycle time
Cash cycle time
Number of unqualified leads
Number of qualified leads
Win rate
Proposal rate
Process improvements
Customer satisfaction
Employee turnover

Market share
Share of customer wallet
Number of new products
Number of new services
Customer attrition
Service calls per customer
Number of defects
Labor efficiency
Machine utilization

Financial drivers
Sales growth by customer
Sales from new products
Sales from new services
Customer profitability
Product/Service profitability
Cost per unit
Cost per customer
Break even point
Revenue per employee
Indirect cost as a percent to sales

Working capital efficiency

Asset efficiency
Return on assets
Cash flow ratios
Risk ratios
Liquidity ratios
Return on equity
Increase in business value

How to develop value drivers:

5 Steps
1. Understand the link between operational actions and business
value
Value Driver Tree (Manufacturing or Construction)
New Products
Market Share
New
Customers
Share of
Sales Force

Customer

Revenue per
Unit/Product
Line

Growth

Revenue per
Customer

Value

Effectivenes

Direct Cost

Customer

Days Sales

Retention

Outstanding

per Unit
Unabsorbed

Inventory
Turnover or

Overhead

Year Supply

Cost per Unit

Overhead as a

Average Cash

% to sales

Cycle

Cash
Flow

How to develop value drivers

Value Driver Tree (Service)
Service cost
per customer

Share of
Customer

Staff per
Customer

Customer
Acquisition
Cost

Cash profit
per
Customer

Value

New
Customers
Retention
Rate

Number of
Customers

New Services

How to develop value drivers

2. Identify the value drivers with the highest priorities
How material is the driver: biggest bang for your buck
Example: Reducing customer acquisition cost

3. Can you impact the driver?

Does your organization have the skill set or capabilities?
Do you have room for improvement?
If you are already running very efficiently, can you really improve?

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How to develop value drivers?

4. Consider all of the consequences
Value Driver: Sales volume
Consequence: Reduce costs; increase product availability; increase the
investment in long-term equipment, space, inventory, and the resulting
impact on cash; risk (debt) in the future
Value Driver: Increase the number of customers
Consequence: Reduced ability to service current customer base

5. Sustainable
One time value versus consistently increasing value
Example: Cost reductions as a result of a re-organization or acquisition

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Example of a Value Driver in action:

Continental Airlines

1994, lost $619 million, which was an improvement

considering it had lost an average of $960 million the
previous four years.
Ranked dead last in almost every Department of
Transportation performance measure
Multiple bankruptcies
Gordon Bethune named CEO
Calculated that late and cancelled flights cost Continental
$6 million per month

12

Example of a Value Driver in action:

Continental Airlines

Hes quoted as saying, Customers want to get safely from

point A to Point B on-time with their underwear
He set a goal, Rank among the top three airlines for ontime performance in any month. If met, he would split half
the $6 million with all non-executive employees (about $65
per employee)
The very next month they were ranked fourth, the next two
months they were ranked first
1995,1996, 1997: Continental earned $215 million, $319
million, and $383 million respectively
Share price in 1994: $5.00, in 1995: $65.00

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Continental Airlines
1. Understood the Link between operations and financial
performance
2. Developed a strategy
Fly to Win - Shut down unprofitable routes, develop hubs to win
back business travel
Fund the Future selling off non-strategic assets
Make Reliability a Reality on-time performance, less lost luggage
Working Together remove mistrust between management and
workers

3. Measured performance

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How to measure success in dollar terms

Determine the increase in the value of your business
Dependent on the following:

Cash Flow

Cash Flow Growth

Cash Flow Risk

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Business Value 101

Cash Flow
Free Cash Flow
(Profit after tax +/- Change in working capital CAPEX)

Cash Flow Growth

Increase in free cash flow from year to year
Historical and prospective
Back 3 years
Forward 5 years

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Business Value 101

Cash Flow Risk

Past performance
Management depth
Customer concentration
Vendor concentration
Industry
Geography
Debt

17

Business Value 101

Example
Assumptions
Annual Free Cash Flow: $150,000
Cash Flow Growth: 1% above inflation
Discount rate: 16%

Value Calculation
$150,000/(16%-1%) = $1,000,000

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Business Value 101

Example
New Assumptions
Annual Free Cash Flow: increase 10% or $165,000
Growth: 2% above inflation
Discount rate: 15%

Value Calculation
$165,000/(15%-2%) = $1,269,000
27% increase in business value

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Cash is the lifeblood of your business

In the past we could lean on the money tree
Eager bankers
Understanding families
Hungry equity partners
Home Equity
Air Ball

20

Cash is the lifeblood of your business

Today, and probably in the future, we cant

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Seven Cash Drivers

1.
2.
3.
4.

Sales
Gross Margin
Sales, General and Administrative
Working Capital
Accounts Receivable
Accounts Payable
Inventory

5.
6.
7.

Capital Expenditures
Shareholder Distributions
Taxes

As separate items these are pretty obvious, the key is managing

all of the drivers together (Cash Cycle)

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Cash Drivers and the Cash Cycle

Typical Cash Flow Cycle
Collect Sale
Purchase Material
Direct Labor
Vendor
Overhead
Total Disbursements
Net Cash Flow
Accumulated
Accounting
Sale
Cost of Goods Sold
Gross Profit
Overhead
Operating Profit

Jan

Feb

(10)
(7)
(17)
(17)
(17)

Mar

(25)
(10)
(10)
(7)
(52)
(52)
(69)

(7)
(7)

(7)
(7)

(7)
(7)
(7)
(76)

100
(55)
45
(7)
38

Apr

May
100

(7)
(7)
(7)
(83)

(7)
(7)
93
10

(7)
(7)

(7)
(7)

Total
100
(25)
(20)
(10)
(35)
(90)
10

100
(55)
45
(35)
10

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Cash Drivers and the Cash Cycle

Cashflowability versus Profitability
$120
$100
$80
$60
$40

Cash Flows

$20
$0
-$20
-$40

Accounting
Jan

Feb

Mar

Apr

May

-$60

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Cash Drivers and the Cash Cycle

Cost of the Cash Cycle
Presented in a way your organization might understand if cycle is
repeated 12 times in a year
Interest Cost
Profit on Sales

$8
10%

How to make up the interest cost

Additional Sales
$80 (approx 1 month sales)
Reduction in Overhead
85%

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Create a Cash-Flow Culture

Business owners often understand the need for cash flow
at the gut level, but sometimes arent very good
tracking it and living it.
Focus on Cashflowability versus Profitability
1.

Organization Development
Teach management and employees the link between what they
do and how their actions impact cash flow

Limit it to the items that are really important

Value tree
Ask What are the things that you do that influence cash flow?

Use Incentives
Not always necessary to make them monetary incentives..but it
helps

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Create a Cash-Flow Culture

2. Measure What Matters
Non-financial

Determine what non-financial measures will drive your value

Measure quickly and often
Communicate company wide

Financial

Understand what happened in the past, but spend more time on

what you see in the future
Institute a 12 week rolling cash flow forecast
Introduce a 12 month rolling Sales, Gross Profits, Expenses, Working
Capital, Capital Expenditures Forecast

Benchmark your actual performance to your forecast

Calculate annually the change in business value
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My objectives for today

1. Discuss non-financial and financial drivers
2. Help you understand the link between
these drivers and the your businesss
financial health
3. Provide a framework to quantify and
measure these drivers

28

Not my objectives for today:

1. Tell you what you should measure
2. Tell you that measuring is all that it
takes

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Questions?

jeff@jsmcpa.com

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