Recently, I was listening to a CEO give a fantastic explanation of his job (described as “how to be a CEO in about 10 minutes – some free of charge advice”). Of course, it’s a massive over-simplification* but, fundamentally, this is what business is about. I’ve left out all of the juicy metrics – they were confidential – and I’m not naming the CEO either but I thought it would be interesting to share the basics, particularly if, like me, you have no formal business qualifications…
If you run a company – it’s a good idea to have a strategy. Often, that strategy boils down to three things:
- Run the company properly
- Grow the company
- Prepare for the future
Whilst all three principles need to be applied, 1. needs to be in place before you can focus on 2. and 3., so let’s look at “running the company properly”.
There are three important metrics to consider:
- Gross margin
- Operating expenditure
- Operating profit
We’re all in business to make money (or generate value in another form – which generally involves raising funds along the way). Gross margin is about customers allowing companies to charge more for a product or a service than it actually costs to create because the company adds value. The amount of margin that customers will allow depends on the types of products or services that are sold – and some products rely on high volume sales with low margins, whilst others are highly profitable in themselves because they attract a premium price (e.g. if they are in short supply). Even if you don’t know what the margins are, it’s pretty easy to see which companies are charging a premium and which are not.
So that’s gross margin. The next thing to consider is operating expenditure (OpEx). This is the overhead of running a company: premises, people, etc. Reducing OpEx is about reducing overheads – and if you want to know if you are an overhead, consider whether your presence in the workplace has a direct impact on customers. If it doesn’t, then you’re an overhead…
You can’t run a company with zero OpEx, but it needs to be appropriate and under control.
Gross Margin minus OpEx equals operating profit – and I said earlier that, generally, we are in business to make a profit.
Now, profit is all well and good, but companies need cash in order to function – and a company’s cashflow is vital in order to be able to buy materials (to create products and services) and to allocate money for capital expenditure (CapEx) like new equipment and other investments in growing the company (e.g. acquisitions). Just like a current account, negative cashflow is not necessarily a problem, as long as the company can be recapitalised (e.g. by its shareholders), or borrow money from a financial services institution (e.g. an overdraft, or a loan). At some point the intention is such that the incoming revenues are sufficient and the margin/OpEx healthy enough that profits grow and cashflow turns positive. At that point, a company can return value to its shareholders, or invest for the future.
So that’s how to run a company, with a little bit of growth in the mix too (principles like the service-profit chain can help too, linking profitability, customer loyalty, employee satisfaction and loyalty and productivity). With the basics in place and a good team on board, planning for the future is about vision – recognising upcoming challenges and finding new opportunities (maybe even some disruptive innovation).
* At least, I imagine it is – I’ve never been a CEO and don’t expect I will be in the near future either!