The Need to Know

Twenty-four hours a day, seven days a week, 365 days a year – I exchange a lot of email messages with my clients. I don’t mind in the least. It keeps me in the loop. And occasionally I get one that’s unique…

Early this week, I received the following from one of the partners in a client company:

“Hey Brad – I have been having developmental discussions with Dave [my client’s tech support guy], and one of the critical knowledge areas he would like to be more proficient in is finance… He seems to have a reasonable understanding of his particular area of [budget and] expenditures but he really needs to (a.) have an understanding of how [we] make money… what factors really drive the profitability of the Company, and (b) be able to easily communicate with Finance in their terminology… If he understands that, he will have more effective conversations with the consulting staff on where technology can help… to impact the business.”

Dave is not a new employee. He’s been on board for several years, keeping his head down and responding to the daily technical problems of a busy office. His priority is “up time,” and his management of technical outsourcing demonstrates a real concern for the budget and for continuing cost reduction. He’s loyal, dedicated, and seeking to grow – an employee to build on.

Every month, Dave and all of the other employees receive an email summary of the Company’s financial performance – Revenues, Direct Costs, Overhead, and Profit – together with a projection of expectations for the next two months. In best open book management fashion, the intention is to engage “the team,” so that everyone pulls together to achieve maximum profit.

In reality, however, it turns out that neither Dave nor most of his non-managerial fellow employees (and maybe a few of the managers, too) have any real sense of what’s involved in pricing, in identifying and assigning direct costs to jobs, in determining overhead, or in assessing whether the firm’s profit level is good, bad, or indifferent (although most of them at least know that it’s not a good sign when a negative number shows up on the bottom line!). Like Dave, most of the staff members are bright, early in their careers, eager to learn, but relatively clueless financially.

A day after the email, I sat with the Managing Director, the Controller, and the Human Resource Manager of this firm. We all acknowledged that in the rush of each day’s activity to the judgment of the market (internal as well as external), perspective gets lost. We also agreed to initiate “The Brown Bag Lunch Seminar Series” to provide the staff with things that every employee should understand when reading the open books:

  1. The top line is not the bottom line: Sales may be strong, but it doesn’t mean that we’re making money. You need to appreciate what else drives profit.
  2. A single data point does not describe a trend: Monthly results need the context of last year and the year to date. What longer-term trends are important?
  3. Cash is not profit: We can lose money and still have a healthy cash balance. Even more common in growing companies, we can be making money and be out of cash. You need to understand why.
  4. Profit is not cash: It usually doesn’t get divvied up by the partners/investors at the end of the year. In fact, often it doesn’t get distributed at all. But it invariably gets used. You ought to know how.
  5. Our people get paid market rates: That’s part of the reason that we make money. When we overpay, we compromise our competitive advantage. How does the market tell us this?
  6. The Company’s net worth is probably not its market value, in part because your individual value is not represented on the balance sheet. Could this make a difference to you?
  7. Our bank is not our investor: So why do they keep lending to us if we’re almost always out of cash? Can they cut us off?

And, perhaps, the ultimate need to know –

  1. What are the early warning signs that we’re going down the chute? How do you know when to get off the bus?

Alligator Bites

Speaking of figuring out what it takes to make money in a business…

Fourteen round-trip charter flights to Europe, two to LA, one each to San Francisco and Chicago. Total capacity about 2100 seats. My job as manager: to fill them all. The time line: my senior year in college. The incentive: making enough money to pay my college term bills.

Flying on an aircraft chartered from the likes of British Airways, SwissAir, and United not only meant traveling on a plane full of University-affiliated people (let’s have a party!), it got you a great fare – less than half the going commercial rate. If you were heading home to the West Coast for Christmas, or planning the Grand Tour of Europe during the summer, you couldn’t pass it up.

But in those days of regulated fares, you couldn’t mark it up, either – at least, not very much. Thirty-five bucks. That was what the International Air Transport Authority felt was appropriate on top of the $210 average per-seat cost that we paid the airlines for each Europe round-trip.

Thus, the basic equation: 2100 seats @ $35 yields $73,500 to work with as a contribution to overhead IF we filled every seat. For every empty seat, the contribution dropped by $245. Clearly, we couldn’t afford many empty seats. In fact, we couldn’t afford any – profit, after paying a staff of six (mostly fellow students), plus rent, marketing, legal and accounting, etc. was a function of sending off every flight at 100% capacity. [For perspective, tuition, room, and board fees were less than a tenth of the current cost – it was a while ago.]

I quickly determined that my bottom line was maximized by having a warm bottom in every seat. This in turn required not only a great marketing program to fill each flight, but a well-communicated and tightly-administered cancellation policy predicated on there being no refunds until both the flight and your cancelled seat were filled. So saying “No” was the key, even to senior faculty members with a last-minute change of plans. Not an entirely popular outcome, but that was the economic model, and I made sure that my whole staff understood it. After all, they had to administer it.

Draining the Swamp

My 273-unit high-rise condo complex has 1,340 common-area lights, each of which is in use 24 hours a day. The property committee last week calculated the savings to be realized by replacing the 75-watt incandescent bulbs with 15-watt CFLs:

Wattage saved per bulb 60
Hours per year 8,760
No. of bulbs 1,340
Total kwh saved (a. * b. * c)/1000 704,304
Savings on electricity @ $.11/kwh $ 77,473
Bulbs per year @1000 kwh/bulb* 11,738
Bulb expense @ $3 $35,215
Bulbs per year @ 8000 kwh/bulb** 1,467
Bulb expense @ $6 $ 8,804
Savings on bulb expense (g. – i.) $ 26,411
Total savings (e. + j.) $103,885



Source: Marty Silverman