What is Business Acumen?
by Josh Lowry
Whether you are the CEO of a Fortune 500 company or a street vendor, there are core fundamentals of business. Both know if more cash is coming in or going out. Both know keeping costs low increases margins. Both know if they move product faster they make more money. Both know by growing responsibly, both in market share and size, they can serve more customers with better care. Both know what customers want and when. Net: Both know how to consistently make money. From the core fundamentals, all other business activities are derived.
While the best executives are leaders and managers, they are business people first. They have business acumen and apply it to help their companies make money. Business acumen is the relationship between the core fundamentals of cash, margin, velocity, growth and customers. The best executives answer the following questions in the affirmative: 1) How does the company make money? 2) How does the organization or team contribute to how the company makes money? 3) Would everyone in the organization or on the team know the answers to the first two questions?
Why is business acumen important? When employees do not have business acumen, they have a difficult time understanding vision and strategy and how to implement and execute them. In most companies, employees advance vertically within functions versus horizontally across functions and units. Business acumen requires having a broad view. It requires understanding the independences between functions and units, including long- and short-term tradeoffs. It requires understanding the core fundamentals and their impact on the company’s ability to make money.
1 – Cash. Cash is the lifeblood of business. Cash generation is the difference between money coming in from sales and money going out from expenses. Money owed to the company by others is accounts receivable. Money owned by the company to others is accounts payable. The timing of each impacts cash generation. In fact, everyone inside the company impacts cash generation; e.g., the company gets paid faster when a salesperson closes a deal with net 30 versus net 90 payment terms. Unless more money is coming in than going out, the business will ultimately fail.
2 – Margin. Gross Margin is revenue less cost of goods sold (COGS). COGS include the direct costs of producing products, including labor and materials. Gross Margin conveys how profitable the business is before subtracting SGA, R&D and ITDA expenses. Note COGS for service businesses include the “cost of revenue;” e.g., direct labor, sales commissions, etc. To determine what is included in the cost of revenue ask, would the company incur the expense if a sale was not involved? Net Margin is the company’s profit after all of its expenses have been paid.
3 – Velocity. Velocity measures speed and turnover. Velocity conveys how many times products or services turnover during a specific period of time – the faster, the better. For example, if the company generates $10,000 in net profit from each product sale, the more products it sells (turns), the more profit it generates. Companies also use margin and velocity to determine return. For example, ROA is (net) margin multiplied by asset velocity (sales/assets). ROE is margin multiplied by equity velocity (sales/equity). ROI is margin multiplied by investment velocity (sales/investment).
4 – Growth. Companies must grow profitably to sustain success. Profitable growth means both the company’s top line and bottom line are increasing; i.e., margins and velocity are increasing at a rate for cash generation to keep pace. Growth attracts people and releases energy. It creates opportunities for investment in new acquisitions, expansion and products. When companies do not grow or do not grow profitably, management is often forced to reduce costs and people. Poor performance can also transform companies into acquisition targets.
5 – Customers. Customers pay the bills. Successful business people have direct relationships with customers and are committed to satisfying them. Customers provide valuable feedback and help identify changes and opportunities in the market. Companies must give customers what they want when they want it. Satisfaction improves margin (customers are willing to pay more) and velocity (company sells products faster). It is always more profitable to sell to existing customers than it is to acquire new ones. Customer satisfaction accelerates both sales and earnings growth.
The best executives and employees have business acumen and they use that knowledge to positively impact the company’s bottom line. Smart companies and leaders know that a culture of business acumen helps them to consistently achieve their financial objectives. Companies often spend training dollars on everything from communication to sales, but their leaders do not understand if or how their efforts impact profitability. Business acumen provides clarity and empowers employees to strengthen the company’s competitive and financial position.
All contents copyright © 2014, Josh Lowry. All rights reserved.