Managing By the Numbers Book Review

Managing By the Numbers written by Chuck Kremer, Ron Rizzuto, and John Case provide a great framework for how to manage your company using the Holy Trinity of financial statements, the Balance Sheet, Income Statements, and Cash-Flow Statement. The authors argue key metrics from each statement should be used to understand the health of a business.?

Many make the mistake of looking at one in isolation. If business leaders only examine net profit or return on assets, they will fail to understand how much cash they have to run the business on a daily basis. If they only pay attention to operating cash-flow, they will not understand how profitable the business is as a whole including all other expenses. The authors argue, these three metrics in combination do a great job of assessing the performance of a business, net profit, operating cash-flow (OCF), and return on assets (ROA).?

#1 Track Net Profit on the Income Statement

Net Profit = Total Revenue - Total Expenses

This metric is provided on a company’s income statement. It is a measure of a company’s profitability. It takes into account all expenses, including, cost of goods sold, depreciation, marketing & selling expenses, general admin expenses, and income taxes. No expense is spared in this metric. Different accounting practices allow for manipulation of expenses like depreciation and goodwill amortization. Therefore, net profit tells a good story but not the full story.?

Additionally, from net profit alone, business leaders won’t know:

• How much cash is going into the bank account
• If the company is spending too much on inventory
• If account receivables is increasing or decreasing

#2 Track OCF on the Cash Flow Statement

Direct Method OCF = Cash Revenue - Operating Expenses Paid in Cash

Indirect Method OCF = Net Profit + Depreciation & Amortization - Net Working Capital

There are three types of cash flows, operating, financing, and investing.?

“Operating cash flows measure the inflows and outflows related to a company's main business activities, such as selling and purchasing inventory, providing services, and paying salaries.” - Investopedia

For most small to medium size businesses, the direct method is recommended. OCF gives an account of how much cash remains after paying all operating expenses with cash the business has collected. The indirect method is useful for businesses with large changes in non-cash accounts (depreciation, accounts payable, and accounts receivable). The cash flow is adjusted to reflect the delta in working capital.?

#3 Track Return on Assets on the Balance Sheet

Return on Assets = Net Profit / Average Total Assets

Finally, the balance sheet provides an account of a company’s assets and liabilities. Businesses own assets and take on liabilities to generate a profit by effectively using it to serve customers. A company’s return on assets is an indicator of how efficiently business leaders are using the assets they have under management.?

#4 Use a Financial Scorecard

The authors developed this very useful scorecard to quickly determine how a business is performing and to help forecast the balance sheet at the end of the year.?Managers can perform calculations horizontally across columns to ensure the ending balance sheet meets their expectations. They can also perform calculations vertically across rows as a sanity check to ensure everything balances.

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Yours Truly,

Omar Waller