Every business has a code that underpins the way they operate from a financial viewpoint. Not knowing your code is like walking through a maze blindfolded. The code of any business consists of the four drivers of profit and three drivers of the balance sheet.
The four drivers of profit are:
- Direct costs/Cost of Goods
The three drivers of the balance sheet are:
- Accounts Receivable days
- Inventory days
- Accounts Payable days
These seven drivers are the principal levers of a business. They are the drivers that management should have some control over. Business improvement is driven by changes to these drivers.
As a Business Advisor your role should be to ensure that every one of your business clients understand how the seven drivers impacts on their profit their cash flow and value of their business. The most effective way to do this is through a simple concept called the Power of One. The Power of One shows the impact of a 1% improvement in the four drivers of profit and a one day improvement in the three balance sheet drivers.
Stated so simply that anyone can understand, the ‘bang for bucks’ of a 1% change really focuses attention on what needs to be done to improve the business. For example take a look at the following table:
Note the huge impact that a 1% price increase has on profit, cash flow and value, compare that to the impact that selling 1% more has. Also we can see the impact that an improvement of just one day has on cash flow and value.
Now that you and your client understand the drivers, the next step would be to discuss the strategies that can be identified to improve the business. In the following example 3 relatively small changes have had a very significant impact on improving profit and cash flow and a massive improvement in the value of the business.
Once the goals have been agreed, they should be monitored regularly with new goals set each meeting. This then becomes the consistent interface for your client and you to run and monitor Board of Advice meetings quarterly or even monthly and drive them to greater profitability, stronger cash flow and to make their business worth more!
The Power of One is a dynamic way to demonstrate the financial impact of key business decisions before they are made. Knowing how far to adjust these levers and the impact of doing so is a crucial way to engage your clients and launch your firm’s business advisory services.
See the Power of One in action at the Smithink Business Advisory Conference on Hamilton Island, 30 – 31 May 2016. Click here for details.
The Power of One is a strategic feature of Cash Flow Story. www.cashflowstory.com.au.