CEO JOURNAL Thinking Like a P&L Statement DAN MARCUS, TDC CONSULTING INC., AMHERST, WISCONSIN F
ew would argue that the goal of business is other than to earn superior profitability over time.
Tat being the case, why do so many businesses fail to accomplish this goal? Why, in fact, do so many languish in a persistent state of chronic low profit- ability? Te answers lie mainly in our fundamental assumptions about how businesses make money. CEOs naturally bring to the job their
own experiences and predilections that color their perceptions of how profit is made. For many of our industry’s CEOs, whose careers have been spent manufac- turing castings, the answer to the ques- tion of how to generate more profitabil- ity is invariably to produce more castings. Tis is a fallacy, of course. And the fallacy is reinforced and compounded when those CEOs, who admittedly come to the job unfamiliar with “all that financial stuff,” turn to their finance departments for guidance. When profitmaking according to operations thus meets prof- itmaking according to accounting, the combination all too often proves toxic to the bottom line. But how can this be? Accountants
know all about money and stuff, right? Sort of. While it’s true that accountants know all about counting money, none that I have met know much about man- aging, much less managing for profit. Likewise, while all accountants know about analyzing past financial perfor- mance, none that I have met knows much about thinking ahead like a P&L statement. As it turns out, accountants and accounting concepts are part of the profit problem, not part of the cure. Te lethal combination of operations
and accounting has long influenced top management thinking in our industry, and the most pervasive and pernicious result has been the settled belief that the cure for less profitability is more volume. Tis fallacy and its attendant breakeven and fixed-cost absorption rationaliza- tions are at the root of our industry’s history of chronic low profitability and have caused untold damage to bottom lines and investment returns alike. Te truth is this: the cure for less
48 | MODERN CASTING April 2011
profitability is better volume, not more volume. In fact, every metalcaster already has more than enough volume to consis- tently earn superior profitability. So why don’t they? Because their CEOs are not thinking like a P&L statement. If they were, they would act on the simple fact that bottom line profit is earned through a favorable combination of P&L revenues and P&L expenses. Instead, CEOs too often think in terms of standard costs, job costs and breakeven analyses, which goad them to pursue volume above almost all else. But instead of improv- ing the bottom line, this approach ends up bloating both P&L revenues and expenses and most often does so unevenly and unfavor- ably in a cascading se- ries of negative events that batters the bottom line and weakens the business. Tese cycles begin as the CEO tasks the sales staff with bring- ing in more volume as soon as possible, and in their zeal to comply, they gener- ate an influx of work at aggressive prices. Moreover, too much of what they sell will turn out not to fit, and this means increased scrap, more waste and higher costs. Combined with those low prices, all this new volume actually causes profits to weaken. Te second cycle arises out of the
operations-oriented CEO’s conclusion that still more volume is required in order to build a better bottom line and that more capacity, along with more ef- ficient capacity, must be created to make that happen. Of course, the decision to upgrade and/or expand is verified by payback or net present value analyses, which are rooted in the accounting department’s unreal and assumption- laden system of standard costs. What
is now a profit emergency occurs when the new equipment is in, the deprecia- tion and interest expense is larded onto the already weakened P&L, and neither actual revenue nor actual cost behaves as anticipated by accounting’s standard cost system and pro forma financials. Te third cycle in this volume-induced
When
profitmaking according to
operations meets profitmaking according to
accounting, the combination all too often proves toxic to the bottom line.
profit emergency melodrama lies at the job cost level and in another deadly ac- counting driven concept—cost-plus pric- ing. As to job costs, and in stark contrast to objective P&L real- ity, the standard cost system now believes the newly upgraded and expanded op- eration to be more cost efficient. Tis news, in the hands of an already too aggressive sales team and filtered through the lens of cost-plus pricing, drives prices for new work ever lower in what has become an intensifying race to the bottom. Tis is precisely the situation most turnaround managers inherit—the plant full to bursting, the opera- tion and costs out of control, prices too low and margins all but non-existent. Worse yet, they typically find
the chief financial officer scratching his or her head, looking back at last month’s results, trying to figure out what hap- pened by drilling down into the vari- ances, and still secretly convinced that the real culprit is too little cost absorp- tion and not enough volume. Earning superior profits is about
CEOs freeing themselves from the inclinations of operations and the dictates of accountancy; it is about managing the bottom line by thinking like a P&L statement.
Keep the conversation going. Reach the author at
tdcmetal@wi-net.com to comment on this or any CEO Journal column or to suggest topics for future columns.
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68