measuring success - why profit and cash are not enough andrew likierman 12.11.08

MEASURING SUCCESS - WHY PROFIT AND CASH ARE NOT ENOUGH

Andrew Likierman

12.11.08

Andrew Likierman 12.11.08

MEASURING SUCCESS IS CRUCIAL TO ANSWER KEY QUESTIONS

“How do we know we’ve succeeded?”

So …“What are our priorities?”

“How well are we doing?”

So .. “What do we do now?

“What are the implications for the longer-term?”

“What do we tell people outside?”


WHY PERFORMANCE MEASUREMENT IS NOT WHAT MANY ASSUME

Most people assume

- there is an established framework

- it is quantitative

- there is an answer to every question (or if there isn’t, hard work will give an answer)

In practice

- there is no established framework or the answer

THE MENU

How much choice on measures?

Cash and profit

Measures for different stages

Non-financial measures

Comparisons

Risk

Tomorrow morning


HOW MUCH CHOICE ON MEASURES?

With no outside requirements, lots

But these usually mean there isn’t a choice

Companies need to distinguish between objectives, means to objective and constraint

eg - profit or cash may be any of the 3

- in a recession, cash constraints usually dominate


SO WHAT ARE THE CHOICES FOR OVERALL MEASURES?

4 TYPES

Company financial

Cash

Profit

Company non financial

Market

Share price

and for non-quoted companies, personal objectives

Satisfaction

Vanity

Not covered


CASH

The ultimate objective (usually) is an ability to generate

It’s also the ultimate constraint

But only one measure of success

Because it gives only part of the story


WHY NOT THE ONLY MEASURE?

Mainly

- hopeless on fixed capital

- doesn’t register working capital

- serious timing issues


PROFIT

An essential measure

But only one

Because it gives only part of the picture

And it’s based on so many judgements

So can’t be “right”


WHY ONLY ONE PART OF THE PICTURE?

Inherent problems

eg: annuality, inflation, cost of capital, international dimensions

Prediction problemseg: depreciation, contracts, pensions

Problems of definition

eg: “normal” trading, profits/capital gains, extraordinary/ exceptional items, stock options

The cost basis of accountseg: asset definition (brands), opportunity costs


FINANCIAL MEASURES - POINTS TO BEAR IN MIND

1. All organisations need them

2. Financial success is a characteristic of a “good” company

3. There is no universally accepted financial measure

4. The main measure does not have to be financial

5. All measures are subject to manipulation. A financial measure will also be subject to financial manipulation

6. A financial measure may be a constraint, not a target


NON-FINANCIAL MEASURES

Clear and useful

But can’t be the bottom line

And can only be overall measure with “protection”

Since they need to be financed


DIFFERENCES TO LARGER COMPANIES

Owner/key shareholder dominance

Reconciling objectives of owners/managers

Fewer constraints on objectives

Greater propensity to confuse constraints with objectives

(Sometimes) more non-financial objectives

Greater degree of ambiguity


Profit

CashCash

DIFFERENT STAGES – DIFFERENT PRIMARY INTERMEDIATE MEASURES

MaturityRecovery

Crisis

Expansion

Startup

Non-financial

Pre-startup

Resumedgrowth

Profit


DIFFERENT STAGES, DIFFERENT MEASURES (1)

Pre start up

Progress against plan (gathering information and support from potential stakeholders (including finance, suppliers, customers and key staff)

- non-financial measures dominant

Early phase

Progress against plan (including basic assumptions, start-up expenditure, growth of revenue, cash burn)

Progress against milestones (including break-even)

- cash dominant


DIFFERENT STAGES, DIFFERENT MEASURES (2)

Expansion from proven base

Performance against others

Performance against plan (including budget and longer-term plan)

- profit-based measures dominant

Maturity

Performance against opportunity cost of activities

- cash dominant


MEASURES NEED TO CHANGE

To reflect changing phases and stages of growth

They usually change too late


PRE CRUNCH - Profits growth

EARLY - Proportion of assets on vulnerable (ie sub-prime) categoriesProportion of funding from wholesale sources

LATER - Basel and regulatory ratiosLiquidity

AND CIRCUMSTANCES CHANGE

http://images.google.co.uk/imgres?imgurl=http://www.theyeshivaworld.com/wp-content/uploads/2008/03/BearStearns_logo.standard.jpg&imgrefurl=http://www.theyeshivaworld.com/news/Business+News/15700/Bear+Stearns+Stock+Now+Worthless,+Fed+Takes+New+Steps+to+Ease+Crisis.html&h=224&w=298&sz=8&hl=en&start=18&tbnid=ehRcDXIUxOqR5M:&tbnh=87&tbnw=116&prev=/images?q=bear+stearns&gbv=2&hl=en&sa=G

http://images.google.co.uk/imgres?imgurl=http://news.hotproperty.co.uk/Images/18282767/Call_for_calm_over_Northern_Rock_large.jpg&imgrefurl=http://news.hotproperty.co.uk/Call_for_calm_over_Northern_Rock_18282767.html&h=300&w=294&sz=7&hl=en&start=7&tbnid=BCeIUGdTw_Mp1M:&tbnh=116&tbnw=114&prev=/images?q=northern+rock&gbv=2&hl=en&sa=G

http://images.google.co.uk/imgres?imgurl=http://www.hurleypalmerflatt.com/images/UBS.jpg&imgrefurl=http://www.hurleypalmerflatt.com/2.7.clients+credentials.html&h=583&w=1559&sz=233&hl=en&start=3&tbnid=mKBQ5_ubPowMUM:&tbnh=56&tbnw=150&prev=/images?q=ubs&gbv=2&hl=en&sa=G


NON-FINANCIAL MEASURES

Underpin financial measures

…help to• Focus on key strategic aspects• Provide useful signals • Get behind basis of financial decision-making• Benchmark internally and externally


NON-FINANCIAL MEASURES- SOME EXAMPLES

Markets repeat purchases sales datareputation survey

Capacity hotel occupancy rate room data oil replacement rate (geological) survey

People turnover people datacommitment survey

Product/reject rate production dataService appreciation survey

(complaints)

Yes, but…

How good is the measure?

What’s the link to profitability?


FOR EXAMPLE –SPENDING ON BRANDS

Spend onbrands

FormulaMore salesBlack

Box


LEADING AND LAGGING INDICATORS

Lagging

Focus historically and basis for decisionseg Market share, sales, employee satisfaction

Normally easier to identify and captureBut may lack future relevance

Leading

Measures that drive performance, often intermediateeg: proposals written, customers visited

Help the organisation to plan and decideBut difficult to identify and may lack credibility


SOME LEADING INDICATOR EXAMPLES

“If it’s raining in Brazil, buy Starbucks”

10-year/2-year US Treasury yields

R-word

Burger King

Insurance mis-selling claims

Humana

Net-Jets

Case-Schiller index


CONSIDER BETTER MEASURES ....

Profitable customer/regretted staff losses

Not just new customers acquired

And employee turnover

Committed/embedded employees

Not just satisfied

Net promoter score (customers and employees)

Not customer dissatisfaction (complaints)

Or employee satisfaction (turnover)


THERE ARE 4 WAYS TO COMPARE PERFORMANCE…

Last yearOthers

Objective/plan

This year

Opportunity


OPPORTUNITY

Whatwe’redoing

Whatwe could be doing

Opportunity


MEASURING OPPORTUNITY

Personal“Sliding Doors”House maintenance

At workWhen the successor to someone doing a job for many years shows what a great/lousy job he/she has been done

Having property lying idle (and possibly in the books at the wrong price) and which could be sold

Real examplesGEC – opportunities lost then thrown away


COMPARISON BASES - PROBLEMS

Last year Others

Objective/plan

This year

Opportunity

SAME BASIS? DISTORTED?

LEVEL?

RELEVANT?

BASIS?


Others

COMPARISON BASES – INTERNAL USES

Last year

Objective/plan

This year

Opportunity

Minimum Most powerful

If possible

So what?


COMPARISON BASES - DEVELOPMENT

Last yearOthers

Objective/plan

This year

Opportunity


PERCEPTIONS MAY ALSO BE DIFFERENT

Insiders may not be aware, may not understand or may have a different view of what outsiders want

- eg measures of, timescales for, performance

Outsiders may not be aware, may not understand or may have a different view of what insiders are doing

- eg providers and users of capital or on strategic direction


COMPARISON BASES – POTENTIAL DISCONNECTS

Last yearOthers

Objective/plan

This year

Opportunity

You Them


RISK “HEAT CHART”

IMPACTLow High

High

LIKELIHOOD

Low


…WITH NUMBERS

24 64

30

16

1 6

IMPACTLow High

High

LIKELIHOOD

Low


MAJOR IT PROJECT

◘

IMPACTLow High

High

LIKELIHOOD

Low

Primaryrisk


MAJOR IT PROJECT

◘

IMPACTLow High

High

LIKELIHOOD

Low

Primaryrisk

Mitigating action


MAJOR IT PROJECT

◘

IMPACTLow High

High

LIKELIHOOD

Low

Residualrisk


SO… SOME SUGGESTIONS (1)

Understand fully how you are being measured- by those who analyse what you do- by those who provide your finance

Be aware of realities of freedom of manoeuvre

Performance measurement- shouldn’t be taken for granted - is not an optional add-on


Recognise definition as- a crucial management task- involving politics and communication- as well as economics

Externally- look coolly at misperceptions- use all your weapons

Internally, measures must be- clearly understood- linked to overall measures

SO… SOME SUGGESTIONS (2)

A FINAL TIP

Numbers

Commentary

People

Important

Essential

Critical


IN THE OFFICE TOMORROW

Do I/colleagues understand how the organisation measures success?

Do I agree with colleagues on how success is measured?

Do we understand the implications of the choices?Gettin

g it right gives comparative advantage


[email protected]

measuring success - why profit and cash are not enough andrew likierman 12.11.08

Documents

andrew likierman

answer slide

financial success

financial measures points

financial manipulation

target slide

right slide

story slide