You should FIRE the Star Players

It is a given fact nowadays that people do not stay in one place quite unlike the Japanese Culture where people stay with a single employer for their lives and employers taking care of employees for their lives. Nowadays companies also ensure that their HR strategies are strong enough to absorb alarming attrition rates. 

A company can never run on star players it is always the average people that ensures the achievement of corporate goals and objectives. He went on explaining how demanding star players are and their increased bargaining powers due to attraction by competition.

What is the correct formula or the correct balance a company should keep between star players and average? 

The categorization of employees as star players and average is mainly done through a performance appraisal system. Performance appraisal systems have matured with significant evolution in the area where a new science exists to accurately measure performance of employees. This cumbersome process filters a percentage of people who are identified as key players/star players in achieving corporate goals. The rest are in a common category called average.

Companies nowadays have the hygiene benefits associated with the performance appraisal outcomes and these benefits ensures lower level of dissatisfaction among employees. I always had the question why companies are not matured enough to understand the difference between motivation and reducing dissatisfaction. Their could be different motivational desires for star players like recognition,  challenge. Instead companies tend to overload the star players with good perks, where they could anyway get from any other company.

But the average, they get less paid, get less attention and further demotivated. This average accounts to about 90% of the company. A company can't achieve anything without the significant contribution from this less concerned group of employees. Even the so called star players perform well with the contribution from the average. 

If the money invested on retaining the star players are utilized on the average it will give a better ROI. 

I am of the view point that if companies cannot identify the difference between motivation and reducing dissatisfaction companies should fire the star players. 

 

A different perspective to performance management

A different perspective to performance management

Numerous researches have been conducted by numerous people in developing a science to define a framework for accurate performance management. Performance management is seen as a key tactical tool in identifying gaps in a tactical plan which ultimately drives organizations to a successful strategy.

Recently I was asked a question at an interview as to what advantage a good performance management framework, would give to a Chief Operating Officer. Theoretically it provides a clear view of deviations from the desired position.  The wise gentleman replied a good performance management framework would give a competitive advantage to the CEO.

Giving a second thought on this response, a performance management framework is actually the first step in the cognitive decision making process of humans, which is the information search process. A performance management system will actually enable managers to make informed decisions.

Thus the question I am now facing is why should a performance management system be aligned with the tactical plan? The initial test in a sound performance management framework is to identify the strategy, have a tactical plan in line with the strategy, and to make the tactics measurable. These measurable KPIs are the key building blocks for an effective performance management system.

But in reality if it is a tool to take informed effective decision, why shouldn’t we start from what are the decisions that we should make. I think the modern trend in performance management leads to an information over load, whether it is dash board concept or a simple employee performance report.

What are your views on this? Should it be a reverse engineering approach where we should start from what decision needs to be made?

The Value Proposition

In delivering superior value to customers, as an organization, the organization needs have a well positioned value proposition. In my research on what this value proposition really contemplates on, I came across this interesting definition put forward by Aaker & McLaughlin (2007).

A customer Value proposition is the perceived functional, emotional, social or self expressive benefit that is provided by the organization offering. And the most important attribute of a good value proposition is that the proposition should be sustainable overtime to differentiate the offering from its competition to support the organizations long term strategy.

This definition signifies the importance on customer perception, which is molded external, internal factors which has a unique moral definition for each person. A company should be very careful in mingling with the psychological transaction between the customer and the seller since once perceived as distrustful will lead to cascaded social perception.

For instance, Volvo positioning the brand as the worlds safest car brand could tarnished if proven otherwise. Most of the companies find it difficult to understand the level of match between the presented value proposition VS the perceived value proposition.

Hence it is always vital that as a company conscious efforts are put to understand this gap. And also critical aspect would be to benchmark against the competition which targets the same consumer segments and focus on the tangible KPIs like money spent on the transaction.

2012 - Whats it Going to Be

I am so excited as it is the first day of 2012, and looking back at 2011. What an year it has been, plenty of opportunities, plenty of pit falls, plenty of tears, hard work and overall I am happy about 2011 personally. 2012 what do you have in store for us.

It is very interesting what trends would invade the society in 2012. Will it be another i-revolution, will it be another magnum opus improvement by facebook, Will it be another record breaking twitting year. Since recent past change is inevitable everywhere and it is at a pace that we cannot even cope up with rapid changing trends. For any company to be successful they need to understand the change and the pace of change.

Future is so unpredictable, that not a single company can have documented operational plans but to be successful adaptability would be a key. Mamoths, dianosores are extinct as they never adapted to the changes in the environment. Similar concept will be applicable to any company, if a company is not willing to change, if the company is not willing to take advantage of the changing conditions.

Carbon Emissions is the most critical environmental problem that every human being on this planet is facing. While everyone of us worries about carbon emissions as a problem. A persons sees opportunity in this and introduces the concept of carbon trading. Change will come, wise man will see opportunity in change while others worry about facing it.

Do You Know Your ROTI?

The first time I encountered with a marketing professional was where I attended a seminar organized by one of the leading Marketing Business Schools in the country. The presenter first asked the audience what they wanted to hear as he was willing to take up any challenging topic that came out from the audience. Being a marketer he would have predicted that based on the Sri Lankan student behavior, no one would throw him a topic to talk about. And then he said, I am very much concerned with my ROTI and urged to respond quickly.

ROTI = Return on Time Invested, That is one of the most amazing ratios I have ever heard and is directly in line in our lives. I have been observing this ratio applying it to each circumstance I face in my life, and I was fascinated by how a simple Ratio could put a core science in how the humans behave.

Simple example would be going out on a trip with friends, if you observe our behavioral pattern we always try to enjoy at the maximum on the little time that we spend on trips. Unconsciously the mind is preprogrammed to calculate this ratio and to maximize the return on the time we invest. Return is not always in monitory terms it could be love that we expect as a return, a reciprocal favor that we expect. Whether we like it or not human evolution has embedded selfishness in the man kind.

ROTI would be such an important ratio if we correctly use it, in everyday life. It could be a key in making decisions in life and could consciously maximize the return the ultimate goal of any human.

Liquidity as a Key Indicator

1. Current Ratio

This ratio can be calculated as follows,

Current Ratio = Current Assets/Current Liabilities

This ratio contemplates on identifying the organizations ability to meet shot term liabilities. Generally a ratio between 2 to 3 is considered good. The lower the ration it means that the company has difficulties in meeting the short term obligations.

In the case of lower ratio these variables can be further expanded. Liabilities within 3 months time, 6 months time, 9 months time, 12 months time and whether the current assets can be managed to meet the liabilities in a timely manner.

2. Cash to current Asset Ratio

This ratio can be simply calculated as follows,

Cash to CA = Cash/ Current Assets

This ratio will highlight the management of cash which the most liquid asset. Higher ratio could indicate that the company is holding on to cash without thinking of investment opportunities.

3. Quick Asset Ratio

Quick assets ratio only takes into account the most liquid assets and gives a better measurement of the company's liquidity.

Quick ratio = Liquid current assets (Cash, securities, accounts receivables)/ Current liabilities

In this ratio the inventory and other low liquid assets are removed thus gives a good indication of the company's ability to meet the current liabilities.

4. Cash Ratio

Cash ratio can be calculated as follows,

Cash Ratio = Cash and cash equivalents/ Current liabilities

In this ratio the account receivables are also removed and thus give an indication of the availability of immediate assets to cover up the current liabilities.

5. Receivable turnover Ratio

This ratio can be calculated as follows,

Receivable turnover ratio = Sales Revenue / average Receivables

Average receivables can be calculated as follows,

Average receivables = (Previous account receivables + current account receivables)/2

This provides an indicator of the company's credit policy mainly. Higher ratio implies that the company is collects dues from its customers quickly. A high ratio compared to competition might indicate that the company's credit policy somewhat risk averse where the company does not provide enough credit facility and might be loosing on sales opportunity.

6. Average Number of days receivable outstanding

This ratio can be calculated as follows,

Avg No: of days = 365 / Receivable Turn over

Thus this gives the number days the receivables are out standing. If the ratio is expanded we can arrive at the following ratio,

Avg No: of days = (Average Receivables * 365)/Sales Revenue

This ratio gives an insight to the credit management policy of the company.

To arrive at better insight you would analyze deep into,

a) Who are the company's suppliers? What is the breakdown supplier by supplier based on credit performance?

b) Is the company dependent on few suppliers or does it have a large number of supplier bases?

7. Inventory Turn over Ratio

This ratio can be calculated as follows,

Inventory Turnover = Cost of goods sold/average inventory

This ratio signifies the effectiveness of inventory management. A high ratio would indicate that the company is managing its inventory well which enables the company to manage the working capital more effectively.

A very high ratio also may indicate that the company does not maintain sufficient levels of inventory thus leading to loss of potential customers.

A company which is practicing concepts like just in time would have a very high inventory ratio.

a) How effective is the re-order level? How effective is warehousing?

b) What is the average lead time of a supplier?

8. Payable Turnover Ratio

This can be calculated as follows,

Payable turnover = Annual purchases / average parables

This ratio can be further broken down into,

Annual Purchases = Cost of goods sold + Closing inventory - Beginning inventory

Average payables = (Current payables + Current Payables in the previous year)/2

This ratio explains how much of credit the company uses from its suppliers. This ratio is calculated when checking the credit ratings and a low ration could indicate that the company does not get much credit from its suppliers.

This may be because,

a) The company does not have a good credit history with suppliers

b) If the suppliers have a very high bargaining power they might negotiate a very low credit period

9. Average Number of Days Parables Outstanding

This ratio can be calculates as follows,

Average number of days parables outstanding = 365/payable turnover

This ratio is quite similar to the ration discussed in the above section. This ratio tries to express the credit period using days.

This ratio is also defined as the average age of payables.

10. Cash Conversion Cycle

This ratio can be calculated as follows,

Cash conversion cycle = average collection period + average number of days in stock - average age of payables

This ratio highlights the speed of conversion of collections into cash. A high amount ratio could imply that the company has invested on sales in the pipeline maintaining higher number of days in stock and with high collection period.

11. Defensive Interval

This ratio can be calculated as follows,

Defensive interval = 365 * (cash + marketable securities + accounts receivable)/ operational expenses

This ratio is used to identify the worst case scenario to identify how long the company can survive incurring its normal operational expenses without generating sales.

Operational expenses are funded with the current assets and this gives the number of days the company can survive without generating sales.

A higher ratio will imply that the company is maintaining a lot of current assets. To conclude on the utilization of current assets ratios like current ratio, quick asset ratio should be considered.

Health check of a company
This document contemplates on presenting an analysis ratios and how to use these ratios to analyze a company. Ratios are derived from the three main financial statements which are profit and loss statement, balance sheet and cash flow statement. And this is the most scientific way to understand a company’s performance.
The following is an extract of a profit and loss statement.

Sales Revenue	2000
Cost of Sales	(1200)
Gross profit	800
Distribution Costs	(400)
Administrative Expenses	(240)
Other Income	40
Profit before Tax	200
Income Tax Expenses	(50)
Profit for the year	150

1. Gross Profit Margin
Gross Profit (GP) Margin can be calculated as follows,

GP Margin = (Gross Profit/Sales Revenue) %

In this Scenario the gross profit margin of the company is 40%.

What does this ratio mean? Does this mean the company is doing well? Is the company performing exceptional? The main objective of this document is to develop the ability to analyze a company based on the financial performances.
When analyzing a ratio the most important thing is to break down the ratio into to atomic units to understand the insight of the ratio.

Gross profit (Sales Revenue – Cost of sales)
Sales Revenue (selling price per unit * No: of units)
Cost of Sales (Opening inventory + Purchases – Closing Inventory)

Gross profit margin could increase mainly because sales revenue increasing or the cost of sales is being reduced.
For the sales revenue to increase either the selling price of a unit should increase or the number of units should increase.
You would like to know the answers for the following questions to conclude.
Questions
a) Has the company increased the selling price to earn higher revenue but has it decreased on the number of units sold.

b) If the number of units being sold is decreasing is there high competition in the market, what is the market share of the company?

c) Has the sales revenue increased/ decreased compared with the previous years? What is the percentage increase in sales Revenue?

d) How are competitors doing?

When analyzing ratios it should be critically appraised and should always question the atomic principles of the ratios.

For the gross profit to increase the other things possible is that the cost of sales has increased. Cost of sales gives insight to the effectiveness of the supply chain management of the company.
With reference to the breakdown of the cost of sales you should try to look for answers on,
a) Has the opening stock increased or decreased?

b) Has the closing stock increased or decreased?
*Company which has implemented Supply chain management concepts like Just in Time would not have an impact on closing and opening stock on the Cost of goods sold

c) Has the cost of purchases increased/Decreased compared to previous years. Has the inflation levels impacted the cost of purchases.

2. Percentage change in Revenue
This Ratio is important to benchmark the sales revenue against the performance of the previous years.
% Change = [(Sales in base year – Sales in previous year) /Sales in Previous year] %

This will give insight to the company’s performance on sales on a year on year basis. In the example since the company has increased the percentage of growth in the year 2010 it could be concluded that the company is well.

Yet this could have happened due to other reasons such as ill performance of competition where its customers coming to our company.
A better analysis would dig deep into the sales revenue trying to understand the variations of selling price and the units.

3 Percentage change in selling price
% Change = [(Selling price in base year – Selling price in previous year) /Selling price in Previous year] %

4 Percentage change in number of units sold
% Change = [(No: of units in base year – No: of units price in previous year) /No: of units in Previous year] %

Let’s apply these two ratios to the given scenario.

Deeper analysis shows that the prices of the product have increased but the number of units has decreased.
a) Has the sales price increased due to inflation or is the company focusing on a premium pricing strategy?

b) How are the competitors doing on pricing?

c) The number of units are decreasing drastically are these customers switching to competitors? How to get the lapsed customers back to the company? Are the competitors reducing prices to attract customers?

Building this analytical thinking would enable to master in ratios and better analyze a company’s portfolio.

5. Compound Annual growth Rate (CAGR)

This ratio contemplates on arriving at an average figure to for the year on year growth rate.
You can use the following ratio to calculate it
Future Value (FV) = Present value (PV) (1 + Rate(R)) ^ Number of years
In applying to the above scenario,
FV = 2000, PV = 1800, R=?, Years = 2
After applying the values to the formula you get a CAGR of 8.475%, this presents an average value for the year on year revenue growth, and this can be used as a bench mark to compare the growth rates for each year. For instance in compared with the CAGR year 2010 the company has done well in terms of sales. This ratio could be used to compare with competitors.

6. Percentage Change in Cost of sales
% Change = [(COGS in base year – COGS in previous year) /COGs in Previous year] %
This Ratio gives insight to the direct cost structure direct costs related to the company.
Increase in this ratio could be due to many reasons,
a) Increase in the inflation of the country

b) Weak supply chain management, change in suppliers.

c) Weak management in the inventory levels

This ratio could decrease,
a) Better management in supply chain, Change in suppliers
Companies may select low cost suppliers to reduce cost of sales, but it is important that suppliers are selected not purely based on the price variable. As lower quality inputs could lead to low quality outputs (Garbage IN – Garbage OUT)
b) Decrease in Inflation, Taxes which affects in decreasing the cost of inputs.
Trying to analyze the ratios from a critical perspective enables to get into more insight.

7. Distribution cost as a percentage of Sales
This Ratio is important to understand how well the company is using the channels. This could be calculated as,

Distribution cost as a percentage of sales =
Distribution costs/Sales Revenue%

This revenue explains the effectiveness of managing distribution channels which is normally the responsibility of the procurement department. In this explain this ratio 20%. Decreasing in the revenue highlights better management of distribution channels.
a) This ratio could change based on the number of units sold as to distribute more products distribution cost would increase but maintaining a stable portfolio is important.

b) Based on the target geographical area, this ratio might change since distribution costs increases based on the geographical span covered.

To arrive at a better conclusion it is better to compare the ratio with previous year’s figures.

8. Profit before Interest and Tax (PBIT) Margin
PBIT Margin = PBIT/Sales Revenue%

Let’s consider a break down of the PBIT.
PBIT = Gross Profit – Operational Expenses
Thus for the PBIT margin to increase either the gross profit should increase or the operational expenses should decrease. How to increase the gross profit was discussed in the earlier sections of this document and thus see how we can reduce the operational expenses.

The operational expenses consist of the administration expenses, depreciation, distribution costs. An improvement in the PBIT margin signifies that the company is better managing the above mentioned operational expenses. Thus this ratio clearly highlights the managerial capability and thus this can be used as a performance measurement of the management of the company.

9. Interest Cover
Interest cover can be calculated as follows,
Interest Cover = PBIT/Interest Expenses

This ratio will give an indication of the company’s burden in debt expenses. The lower the interest cover the company is ridden by debt.
To understand this lets see how interest expense is calculated.
Interest Expense = Debt * Annual Debt Rate


Higher the interest expense is higher the company’s debts. For the company to afford the finance cost or the interest cost it is important that PBIT covers the expenses. If the Ratio is below 1.5 company’s ability to meet interest expenses is questionable.
For a better analysis answers to following issues might need to be looked into.
a) The company might not been looking to optimize its capital structure

b) The company might be charged high interest rates and the company might not be effective in finding lower cost financing means.

c) The countries economic policy and due to high inflation interest rates might have gone up.

10. EBITDA

EBITDA is the earnings before interest, tax, depreciation and amortization.
EBITDA = Revenue – Expenses (Excluding Tax, Interest, Depreciation, Amortization)

This ratio is very important to compare profitability among competition because it eliminates the accounting and financing decisions. For instance a company adopting a reducing balanced depreciation policy may have higher depreciation costs in the initial year after the purchase of assets in compared with a company which is adopting a straight line method to calculate depreciation.
And also different companies adopt different strategies to finance operations. For instance a listed company can use a rights issue to finance which is lower cost of finance in compared to borrowing.

11. EBITDA to Interest Cover
This ratio can be calculated as follows,
EBITDA to Interest Cover = EBITDA/ Interest Payments

This Ratio assesses a company’s profitability at least to pay the interest expenses. A ratio greater than 1 indicates that the company has coverage to pay off its interest expenses.
EBITDA eliminates the cost of depreciation and amortization thus would give a better indication of the financial durability of the company.

12. Profit after tax Margin
Profit after tax is also known as the earnings attributable to share holders. Since only after arriving at the profit after tax the company decides on the dividends and the amount of retained earnings. This ratio can be calculated as follows,

PAT Margin = Profit after Tax / Sales Revenue %

PAT margin in the above example is 7.5%. In other words for each $100 sold the company generates a net profit of $7.5.
To arrive at a conclusion on profitability, a year on year basis profit variance should be calculated, and also compared with the competition.
An increase on sales does not necessary mean that the profit margins would improve. If the cost structure increases at a higher rate the profit margin will be affected. This ratio will give a good indication about the cost management.

13. Pre tax Margin
Pre tax margin can be calculated as follows,
Pre Tax Marin = Profit before tax/ Sales Revenue%

In the above example the pre tax margin accounts to 10%. Comparison of the pre tax margin with after tax margin will show the tax margin.

14 Contribution Margin
In understanding the contribution margin, it is important to define contribution,

Contribution = Sales – Variable Costs

The difference between contribution and profit is that contribution does not take into account the fixed costs. This ratio is important for product profitability analysis.

The contribution margin can be calculated as follows,
Contribution Margin = Contribution / Sales Revenue%

Variable costs are mainly the direct costs in line with the product or service, thus contribution margin will highlight the effectiveness in managing the direct costs with relate to production. Better analysis would try to find answers to the following
a) Comparison of the contribution revenue with the net profit margin. This will highlight the fixed asset portion

b) What is the method company used to absorb overhead costs? Can we propose Activity based costing to improve profit calculations?