Running any business is a complex puzzle. In order to look at the big picture in your business, you need to know the answers to some basic financial questions. It is not enough for your CFO or some other “bean counter” to know this information. Business acumen requires every manager to be aware of these answers so that you will be able to guide your company to success. Managers also should be able to answer each of the following questions for their employees as well:
How Your Company Makes Money
The purpose of every business is to make a profit. You need to make money in order to survive, but in order to do this; you must identify what makes your company money. You need to examine your products and services to determine which ones are actually making money for the company. For example, a bakery makes croissants, cookies, and cakes. The croissants account for 80% of the sales, and the cakes make up 15% of the sales. Cookies make up 5%, and some days most of them are thrown out. Knowing what makes your company money will help guide your strategy and enable you to make smarter, better-informed decisions.
Know Your Sales
Companies need to grow to stay competitive. You are able to identify growth only when you see an increase in sales over time. Knowing last year’s sales and current sales is essential to understanding the current status of your company.
The Profit Margin
Every business needs to make a profit. The profit margin indicates how well the company is running. A large, successful company typically has a 13% net profit margin. The higher the profit margin, the more efficient the business is run. There are two types of profit margin: gross profit margin and net profit margin. Both are found when the profit is divided by the total revenue. The difference between the two is that the net profit margin is profit after tax and operating costs.
- Revenue = $150,000
- Gross profit = $50,000/150,000 = 33% gross profit margin
- Net profit = $10,000/150,000 = 10% net profit margin
A company’s costs affect other financial aspects such as profits. This is why it is so important to control costs. Many companies choose to increase profits by cutting costs. However, this can backfire when the costs you cut directly affect quality, employee satisfaction, or customer satisfaction. There are two basic kinds of costs:
- COGS: Cost of goods sold is also called direct cost. This includes costs associated with production, materials, labor, inventory, distribution and other expenses. The individual COGS must stay below the sale price to make a profit.
- Operating expenses: Overhead expenses are included in operating expenses, which is any expense necessary to keep the company running that is not COGS. Examples include support function salaries, rent, marketing, R&D, utilities, equipment, travel, etc.
If you don’t know the answers to each of these questions, then do some digging to find out! Talk to your Finance expert, most are happy to share their knowledge. Take Finance and Accounting for the Non-financial Manager course at your local business school. Most offer some version of this kind of management training. Read your company’s annual report.
When you can answer these 3 essential business acumen questions, you’ll be able to provide direction, prioritize and make better decisions.