HEWLETT- PACKARD Management Acceleration Program. BUILDING BUSINESS ACUMEN Terminology

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1 HEWLETT- PACKARD Management Acceleration Program BUILDING BUSINESS ACUMEN Terminology

2 CASH DEFINITIONS: 1. Cash is the total amount of all cash and near-cash on hand at any given point in time, such as the end of a quarter or fiscal year. It includes all bank deposits, bills and coin that might be on hand, plus cash equivalents, which means short-term securities, such as Certificates of Deposit, which can be readily liquidated and converted quickly into actual Cash within 90 days. 2. Cash flow or Cash generation refers to the amount of Cash flowing into the company, less the Cash flowing out of the company, over time, such as during a quarter or fiscal year. Cash Flow from Operations, or Cash Flow from Operating Activities, or Cash generated from Operating Activities all refer to the primary measure of Cash Flow: the actual Cash received from the primary business of the company (Cash in), less the Cash expenditures (Cash out) associated with the primary business. FINANCIAL STATEMENTS Measures of Cash and Cash Flow: Balance Sheet: The total Cash balance is found on the Balance Sheet s first entry under Current Assets. The Income Statement (P&L) does not reflect Cash or Cash Flow. Statement of Cash Flows: The Cash Flow or Cash generated by the company is found on the Statement of Cash Flows. There are three primary categories of activities in which a company can receive or use Cash (generate Cash and disburse Cash), which are reflected on the Statement of Cash Flows: 1. Operating Activities These are the core business activities of the company, what you are in business to do, in contrast to other ways Cash can be generated which are not the primary business. (For instance, the company might buy or sell a building to generate or use Cash, but you are not in the Real Estate business as your core operation.) Cash generated from Operating Activities is by far the most important measure of Cash Flow. 2. Investment Activities These include buying and selling securities (stocks and bonds); acquiring or selling other businesses; or buying and selling real estate or large equipment. 3. Financing Activities These include selling stock to investors, or repurchasing shares from investors; paying dividends; borrowing from and repaying loans to banks or other lenders. TERMS RELATED TO CASH : Cash generation; Cash from operations; Cash generated from operations; Cash flow; Cash generated from investing activities; Cash from financing activates; readily marketable securities; Cash equivalents; Cash management; treasury function; liquidity; liquidity crisis IMPORTANCE OF CASH: Cash is a company s oxygen supply. A company can be profitable and still go out of business because profit relates to the accounting recognition overall revenue and expense, but Cash Flow relates to when you actually collect and disburse Cash. You can t pay bills or salaries with profits only Cash! WAYS I CAN IMPACT CASH or CASH FLOW: 3.

3 Profit DEFINITIONS: Profit is the difference between what a company sells its products for, less what it costs them. It is what is left over from sales revenue after expenses. Margin is usually expressed as a percent of sales price. Thus a 25% net Margin means that the company keeps about 25 cents out of every sales dollar. Profit is usually expressed in the difference in dollars between a company s revenues and its costs. There are different applications of the calculation of Margin: Gross Margin is the difference between the individual sales price of a product or service, less the direct costs associated with producing or acquiring the product or raw materials. Overall company margins mean total sales revenue less all direct costs of buying, fabricating, or selling the products and service company-wide. Net Margin means total sales less all costs of the company equivalent to net profit. FINANCIAL STATEMENTS Measures of Profit Income Statement (Profit & Loss Statement): The Income Statement (P&L) reflects total revenues (sales) less various categories of expenses to calculate Profit. Operating Profit (see below) can be calculated from the P&L. Net earnings, or net profit is shown as the bottom line on the P&L how much the company has left over after all expenses are paid. TERMS RELATED TO MARGIN : Margin is basically the same thing as earnings, profit, net margin, net profit margin, income, and net income. All these terms represent what is left over after certain categories of expense are deducted from certain categories of revenue. Gross Profit and Operating Profit: Alcon uses Gross Profit and Operating Profit as key indicators of company performance. They are the difference between operating revenues (the revenue received from core business activities) less three categories of expenses which are primarily under the control of company employees: Cost of Goods Sold (COGS or Direct expenses) manufacturing labor, raw materials, support expenses for the manufacturing process, etc. (Gross profit can be calculated as: Revenues Cost of Good Sold = Gross Profit; Gross Margin can be calculated as: (Revenues COGS) Revenues = Gross Margin. Sales, general and administrative expense (SG&A, overhead) the costs associated with running the basic business, including salaries, employee benefits, building costs, utilities, marketing, R&D, etc. Operating Profit is what is left over after a company s operating expenses. Thus, Operating Profit is calculated as: Revenues COGS SG&A = Operating Profit. IMPORTANCE OF PROFIT: Profit represents the company s profitability which is why the shareholders invested in the company. There are only two ways to increase Profit: (1) Increase sales (or individual product or plan prices), or (2) reduce expenses (direct expenses of the product or services, and general overhead expenses). Each approach has limitations: reduce expenses too far, and quality suffers. Increase price too much, and you price yourself out of the market. WAYS I CAN IMPACT PROFIT or MARGINS:

4 Assets DEFINITIONS: Assets include property, plant, equipment, Cash, technology, intellectual property, and people. The more you can increase an asset s ability to work to make money, the higher the productivity a company gets in its assets. In general companies measures the efficient use of assets how hard a company s assets work to make money, to produce revenue profitably. A company can increase Return on Assets in two fundamental ways: (1) Decrease the amount of assets used to get results, and (2) increase the results obtained from using the same assets. FINANCIAL STATEMENTS Measures of Assets: Balance Sheet and Income Statement: An important measure of Assets, or the efficient use of assets, is Return on Assets (ROA). It is measured by taking the net income (profit or earnings) from the Income Statement which represents the return generated by the company and dividing this figure by the assets on the Balance Sheet, which represent the investment by the company to generate the return (profit). Companies might also measure Return on Equity (ROE), a similar calculation using shareholder equity instead of assets. Inventory turnover is another important measure of Assets, calculated by dividing a company s total operating revenue on the P&L by the inventory in the asset category on the Balance Sheet. This figure tells how many times per year the inventory turns or sells out to generate the total sales revenue. TERMS RELATED TO Assets : Volume, units sold per period, cycle time, inventory turnover, Return on Assets, Return on Equity, Return on Investment, sales per employee, income per employee, efficiency, productivity, worker productivity, asset utilization, process efficiency, process improvement IMPORTANCE OF ASSETS: Assets directly contribute to profitability. The higher the number of units sold per period, including inventory turnover; or the lower the cycle time in getting a new product to market or in making decisions; or the more efficiently work processes operate; or the more productively assets are utilized; or the more efficiently employees work, the more profitable the company becomes. Business models: Cash generation and profitability are a function of the interaction of Margin and Utilization of Assets. Certain businesses and industries (such as food markets and discount stores such as Wal-Mart) have a large volume of sales and small margins, but are very profitable and generate significant Cash. Other industries (such as aircraft manufacturers or shipbuilders) produce and sell small volumes of product but make large Margins and are profitable. The Apple ipod and iphone, and Starbucks, are examples of products and businesses that have both high volume and large margins to create profitability and Cash Flow. Business with low margins and low product sales volume don t last long! WAYS I CAN IMPACT VELOCITY: 3.

5 GROWTH DEFINITIONS: Growth means increase (or decrease) in a particular business measure from one year to the next. When a business is generally referred to in the financial media as a growth company, the reference is usually to growth in revenues. However, Wall Street and the financial markets focus heavily on growth in EPS or earnings per share. Organic growth internal Growth from the company s initiatives to hire more employees, open additional offices or markets, sell more to existing and new customers, introduce additional product lines, and drive revenues through use of its own resources. Inorganic growth Growth through mergers and acquisitions, and acquiring distribution capabilities; buying market share, customers, and additional product and service lines through alliances. Advantages and disadvantages: Organic Growth can be slower but more controllable. Inorganic growth can be very rapid but can be expensive in terms of the upfront costs to buy or merge with another company. Also, analysis shows that a substantial percentage of mergers and acquisitions are not successful in fulfilling the intended objectives of the parties. FINANCIAL STATEMENTS Measures of Growth Income Statement (Profit & Loss Statement): The Income Statement (P&L) shows two or three years comparative data for the organization. Key Growth measures include (1) top line sales or revenues; (2) bottom line net income (earnings or profit), and (3) earnings per share (EPS) which the financial community watches closely. Important expense categories (such as benefit expense or SG&A for WellPoint) are watched closely by management. Comparing one year against another enables the calculation of the percent increase or decrease year to year in any category. Balance Sheet: Growth can also be measured for total assets and liabilities, for shareholder equity, and for individual asset and liability categories such as Cash and debt. Statement of Cash Flows: Growth in the amount of Cash generated from operating activities can be especially important. TERMS RELATED TO GROWTH : Increase, growth company, sales, revenue, EPS, expansion, acquisitions, development, business development, customer base, number of employees, number of offices, asset growth IMPORTANCE OF GROWTH: A large public company must either grow profitably and sustainably (sales revenue, profits, EPS) or die. If it is not growing revenues and profits through new customers, innovating new products and services, and making use of emerging technologies, its competitors will seize its customers and market share over time. Shareholders purchase stock for the primary purpose of seeing the price increase. It is the primary purpose of the CEO, hired by the Board of Directors, which is elected by the shareholders, to increase the shareholder value (stock price) of the company. WAYS I CAN IMPACT GROWTH: 3.

6 CUSTOMER DEFINITIONS: 1. External customers are those who make decisions concerning the purchase of a company s goods and services. They might also be the end users those who actually consume the products or services sold by a company. Professional service firms have clients and health care organizations have patients, all of whom receive personal services. Customers might be distributors or brokers. 2. Internal customers are fellow employees with whom we work, and specifically to whom we provide services in the normal work processes of our company. We are the internal customers to certain employees who provide us with work product, information, or other requirements to do our jobs and we are internal suppliers to other employees who are our internal customers. FINANCIAL STATEMENTS Measures of Customers There are no direct measures of Customers on standard financial statements. Companies keep track separately of data on external Customers such as numbers of Customers, patients, members, or other consumers and users of products and services; Customer satisfaction levels; turnover rates of Customers; and numbers of new Customers per period. Income Statement The income statement shows sales revenues, which reflects Customer purchases of goods and services from the company during any reporting period. TERMS RELATED TO CUSTOMERS : External Customer = member, consumer, client, end user, purchaser, patron, distributor, reseller, broker Internal Customer = associate, worker, co-worker, laborer, staff, employee, personnel IMPORTANCE OF CUSTOMERS: Everything begins with a sale or service to a Customer, patient or member. The Customer generates Cash, which creates Growth. Employees are responsible for Margin, or the profitability of the company, through cost controls, efficiency, productivity (Velocity), the development, marketing and sale of services and products desired by Customers, and for overall Customer satisfaction. It is 3 to 5 times more expensive to obtain new Customers than to retain existing Customers. As desirable as it is to meet or even exceed Customer needs, it is better yet to anticipate those needs to skate to where the puck will be, not to where it is. As Henry Ford said, If I had listened to my customers, they would have wanted a faster horse. WAYS I CAN IMPACT CUSTOMERS or CUSTOMER SERVICE: 3.

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