In working with so many private companies, accounting firms get to see it all — different companies, industries, sizes and definitely different performance. Through that experience, some commonalities can be found that directly impact performance, for better and for worse.
Smart Business spoke with Mario O. Vicari, CPA, director at Kreischer Miller, about the differences between top-performing and underperforming companies.
What are the factors that give the best indication of a company’s fitness?
Although there are many metrics one could consider in evaluating a company, there are two that really matter and they are related. The first is net margin, which is the percentage of net profit per dollar of sales. Think of it as how many pennies you keep for yourself for each dollar you sell from operating the business. This is a simple yet powerful concept. The second is the company’s return on invested capital, which expresses how the net margin relates to the amount of total capital deployed to generate the net profit.
Looking across many companies’ performance, most companies are somewhat better or worse than average in different degrees. However, there are very few private companies that have exceptional returns. These are the outliers — the top 5 percent of private companies.
While many factors affect performance, the common denominators among higher performing companies are:
- They have absolute clarity about the customers, markets and opportunities that fit their business model, and have clear rules around customer acceptance, including the economics that are acceptable to them.
- Having established rules around customer acceptance, they have the discipline to follow through on their strategy, which means that they will say no to opportunities that are not a fit.
What are the commonalities of underperforming companies?
Companies that are struggling and in need of a turnaround often have poor gross and net margins and low returns on invested capital. Looking into the details of their customer and product mix, often what is found is a hodgepodge of customer and product sales that are widely dispersed and unfocused. These bad results come from a lack of strategy and associated rules around customer acceptance. To these companies every sale is a good sale because they have no established business rules about their target customers and products, or in some cases they have rules but don’t follow them for the sake of getting the sale. This lack of focus and discipline results in low margins and returns. These decisions are often misguided by the belief that growing sales is the goal, whereas it ought to be growing profits.
What are the characteristics of companies that perform well?
In the better-run companies, it can be said that:
- Everyone in the company knows the company’s focus and what customers they choose to serve.
- They establish business rules for their sales and customer service people, including pricing, margin requirements, etc.
- They have mechanisms in place for exceptions and approval, and clear guidance for when the company may vary from its norm. Exceptions have to be approved and are not the norm.
- The leaders of the company don’t override and break the rules. They lead by example.
- The company’s incentive programs are designed to reward behavior that is consistent with the company’s rules.
These companies have a point of view about new opportunities that most businesses don’t have, which is why they perform at such high levels. They know that the customer acceptance decision is a two way street and is not only up to the customer. They know that they have a choice about which customers and opportunities to pursue, and which ones to avoid. They know that they don’t have to work with everyone to be successful and have the discipline to say no when the opportunity is not a fit for their business model.
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