The Basics of Making Money
HERE’S a question to test your prospects as a business leader: How does your company make money? If you can’t answer it, you’re hardly alone. Many MBAs can’t answer it. Many CFOs and vice presidents can’t answer it. Experienced CEOs sometimes struggle to answer it. What I’m testing with this question is your business acumen.
The Universals of Business
At the core of every successful business, from a global giant to a corner store, are the same fundamentals of moneymaking: cash, margin, velocity, return, and growth. And at the core of every successful business leader is an intuitive understanding of the relationships among them. It’s easy to think the basics of business are for beginners. Everyone knows what cash is, and that companies must make a profit. But business acumen isn’t about knowing definitions. It’s about keeping the basics of moneymaking in sharp focus and balancing them in a way that’s healthy for the business. When you have business acumen, you realize the importance of every job at every stage of your career. A mailroom clerk with business acumen knows that getting checks to the accounts receivable department more quickly will ease the company’s cash flow. And a sales rep with business acumen knows that higher-margin products will increase the company’s return.
As the complexity of your job increases, it’s easy to lose sight of the fundamentals. If your business acumen doesn’t develop, you can stumble — focus too much on revenue growth and overlook cash, or focus too much on cash and overlook growth. That’s why you should never consider it beneath you to revisit the moneymaking basics. They should be front and centre in your diagnosis and decision making in every job you have. Here are the basics:
No business survives long without it. You should know how much cash your business generates and how much cash it consumes. What are the sources of it? What drains it? What’s the timing of the inflows and outflows and how is it changing? More revenues (sales) often mean more cash. But growing a business consumes cash. How fast can the company expand without straining its cash flow?
When people talk about the bottom line, they generally mean net profit margin — the money the company earns after paying all its expenses, interest, and taxes. But gross margin is important, too. Gross margin – the difference between a product’s selling price and what it costs to make the product (the “costs of goods”), expressed as a percent of the selling price can signal important shifts in a business.
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