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Ram Charan What Every Company Should Know

Ram Charan, What Every Company Should Know

The Basics of Moneymaking

by Ram Charan

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Posted on Wednesday, June 6, 2007, 12:00AM

Here's a question to test your prospects as a business leader: How does your company make money?

If you can't answer it, you're hardly alone. Many MBAs can't answer it. Many CFOs and vice presidents can't answer it. Experienced CEOs sometimes struggle to answer it.

What I'm testing with this question is your business acumen.

The Universals of Business

At the core of every successful business, from a global giant to a corner store, are the same fundamentals of moneymaking: cash, margin, velocity, return, and growth. And at the core of every successful business leader is an intuitive understanding of the relationships among them.

It's easy to think the basics of business are for beginners. Everyone knows what cash is, and that companies must make a profit.

But business acumen isn't about knowing definitions. It's about keeping the basics of moneymaking in sharp focus and balancing them in a way that's healthy for the business.

When you have business acumen, you realize the importance of every job at every stage of your career. A mailroom clerk with business acumen knows that getting checks to the accounts receivable department more quickly will ease the company's cash flow. And a sales rep with business acumen knows that higher-margin products will increase the company's return.

Moneymaking Basics

As the complexity of your job increases, it's easy to lose sight of the fundamentals. If your business acumen doesn't develop, you can stumble -- focus too much on revenue growth and overlook cash, or focus too much on cash and overlook growth.

That's why you should never consider it beneath you to revisit the moneymaking basics. They should be front and center in your diagnosis and decision making in every job you have.

Here are the basics:

• Cash

No business survives long without it. You should know how much cash your business generates and how much cash it consumes.

What are the sources of it? What drains it? What's the timing of the inflows and outflows and how is it changing? More revenues (sales) often means more cash. But growing a business consumes cash. How fast can the company expand without straining its cash flow?

• Margin

When people talk about the bottom line, they generally mean net profit margin -- the money the company earns after paying all its expenses, interest, and taxes. But gross margin is important, too.

Gross margin -- the difference between a product's selling price and what it costs to make the product (the "costs of goods"), expressed as a percent of the selling price -- can signal important shifts in a business. When PC makers saw their 32 percent gross margins decline to 20, they knew (or should have known) the competitive landscape had changed.

You have to know how changes inside or outside the business affect gross margin. Are there new entrants in the market who are winning customers? A competitor who's found a clever way to reduce costs and prices? A change in the pricing power of suppliers?

• Velocity

Velocity refers to speed, turnover, or movement.

How much revenue do you turn over, or generate, for each dollar of inventory? If you have $1 million in inventory for the year and revenues of $10 million, your inventory velocity is 10. This tells you how fast you're moving raw materials through the factory, turning them into finished products, and moving those products off the shelf to customers. The faster, the better.

Service businesses can track velocity, too. For banks, velocity of equity -- how much revenue is generated per dollar of equity -- is a useful measure. The concept applies to every business.

• Return

Margin multiplied by velocity equals return. If your return is lower than your cost of capital, your business is likely to be in trouble. That's when shareholders get concerned.

How do you boost your return? See if you can boost your margin or increase your velocity -- or, better yet, both.

• Growth

Every business needs to grow to stay in business. How do you grow in a way that keeps the other aspects of moneymaking in balance? There's no formula -- people with business acumen figure it out.

Where Business Acumen Counts Most

Street vendors in villages around the world use business acumen every day. They have to -- their next meal often depends on it.

In companies, business acumen is crucial when the external world changes and there's a need to reposition the business.

Like when Hollywood studios started selling videocassettes directly to the public at the same time it sold them to video rental companies. That's when Blockbuster's rental business started to slide.

People wanted to buy movies, not just rent them, so Blockbuster started selling them. But the moneymaking was completely different.

Blockbuster was used to buying videocassettes on credit and making payments with the cash from renting them. Returns were high.

Selling videocassettes meant laying out the cash up front, holding lots of inventory, and waiting for the cash to come in when the videocassettes were sold. Cash flow, velocity, and return were all adversely affected.

Where Do You Want to Go?

You don't need business acumen to make a meaningful contribution to a business. But you'll need it to rise through the leadership ranks.

You can't acquire it at a seminar or in a quick read. You learn it by using it in real business situations.

Start now by applying it to your company. Ask for the numbers or pull them from the annual report. Precision isn't necessary -- knowing what to focus on is.

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153 Comments

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  • EG - Tuesday, March 10, 2009, 12:05AM ET  Report Abuse

    • Overall: 2/5

    CFO that don't know this?!!! CEO that struggle to get this? Come on, this is so basic; you don't need an MBA to understand this; you need smarts...not too much value added here...maybe for someone who is way too green

  • vm - Friday, March 6, 2009, 4:16PM ET  Report Abuse

    • Overall: 5/5

    An excellent piece. You have covered all aspects of a business. This has given me an opportunity to look into those companies who may be basically strong.

  • Mack - Monday, March 2, 2009, 3:35PM ET  Report Abuse

    • Overall: 3/5

    This article was good information for those who haven't studied business concepts. However, there is no new information for those of us who have been keeping pace all along. The important point that is overlooked is that promotional decisions are made mostly on the basis of likeability, social connections and intangible issues such as nepotism. That's why the business people who have MBAs from elite schools don't generally perform any better than those who went to average schools or no school at all. The Wall Street elitists are the ones who precipitated this economic decline. I am not impressed with the people who rose through the leadership ranks of this nation's banks, insurance companies, auto companies and financial institutions. If business acumen is required and possessed to rise, how do you explain this mess? I'll tell you that most of the people who rose were not qualified based on objective measures. They were chosen for the intangible reasons that I mentioned.

  • Yahoo! Finance User - Saturday, February 28, 2009, 1:58AM ET  Report Abuse

    • Overall: 1/5

    I noticed that the work environment of America, changed when Sam Walton died. "Lets save American consumers money", the new owners said. Slowly from every business took to their reformed stance of making and buying products. And what happened was owners of business did not look in their communities, cities and towns, and closed all the workplaces, pulled the rug under from working Americans and ship them overseas. Now we can buy almost anything dirt cheap, but the only problems is no one is going to be able to afford even the most inexpensive item on the shelf, because the value of their dollar dropped significantly. My word to all and any business owners in America. Look around and get out of the office. Americans need jobs, that creates other opportunities for everyone in your town, state and country, don't flood the market trying to make a quick killing. Don't look for outstanding profits margins, think in the long term. Buy don't rent. If you can produce your own electricity for your stores, do it, greener is better anyway. Make a constant effort to re-examine your product to make sure its affordable, reliable, and needed. The one thing that does bother me, is this, Shareholders and their constant need for dividends and profits puts a big strain on the people below them to push hard, they loose track of what was important. Steady growth and the public's perception of goodwill, honest business practices and it willing to be fair to their employees, as their are part of the communities we live in.This will make a strong company for you and your family(s) to live better. Our fathers did not sell stocks or shares but they built the stores in which they sold them. Ask your self this question?, when did any foreign people walk into any American store and purchase any amount equaling the products you purchased from other countries? I would like to see a serious reply.

  • Island Girl - Tuesday, February 24, 2009, 1:23PM ET  Report Abuse

    • Overall: 5/5

    This article is an MBA in two minutes. BRAVO!!! Ileana M.Bryan-Ballesteros MBA

  • Jerry - Friday, February 20, 2009, 3:53AM ET  Report Abuse

    • Overall: 5/5

    the basic of money making ha? i'm interested in how we are making the poor richer or shall i say a fair prosper society. why beacuse i'm a bussiness man and i like the people to have money so that they can buy my products! that's why you idiot superrich who what u can think of is collecting money to your ubs bank accounts!

  • Yahoo! Finance User - Friday, January 23, 2009, 12:02AM ET  Report Abuse

    • Overall: 4/5

    Great article. Especially the concepts of margin and velocity which also have relevance to personal finance and could really help most Americans. One of the best ways to utilize velocity in personal finance is a Mortgage Savings Account. MSA's have been used by Aussies for 20 years and were so successful at saving mortgage interest that Richard Branson introduced them to the UK in 1997. www.maxhouse.com offers information on how to open an MSA in the U.S. or just google "Mortgage Savings Accounts".

  • Jerry - Monday, January 12, 2009, 12:25PM ET  Report Abuse

    • Overall: 5/5

    Too bad many business leaders get to their position by cronyism, nepotism, or politics and not business knowledge. As more of our economy becomes linked to politics, and less to knowledge and science, we will become a weaker country.

  • Julian - Friday, December 12, 2008, 3:02PM ET  Report Abuse

    • Overall: 5/5

    Need a bit more on velocity, though the Blockbuster example works....

  • Hilbert - Wednesday, October 29, 2008, 10:05PM ET  Report Abuse

    • Overall: 3/5

    must give example , company/ies. And elaborate more.

  • Bill - Tuesday, October 28, 2008, 12:37AM ET  Report Abuse

    • Overall: 1/5

    Ram must have been born with a trust fund or perhaps to a wealthy family. He's clearly a guy that's been reading a lot of text books rather than building business from the ground up and running them. Not a word about trust, work ethic, integrity, product quality, fairness, a firm handshake and looking somebody in the eye which are the cornerstones of every successful business of any size. C,M,V,R and G are irrelevent absent a high quality product or service and a firm handshake and good will between a willing buyer and willing seller that trust each other. C,M,V,R and G are simply labels made up by members of academia to describe in simplistic terms a small part of how we business owners do what we do. Good business men understand C,M,V,R and G but they are not the basics of moneymaking. The basics of money making are honesty, integrity and selling a high quality product or service at a compelling price.

  • albertino5175 - Saturday, October 11, 2008, 11:54AM ET  Report Abuse

    • Overall: 3/5

    The content reminds me of business 101 in college. Reality is a totally different arena, there is no room for error nowadays. I trust the market will be stronger than ever, recession is here but not for long. The only advice I can give for today's businesses is WATCH YOUR EXPENSES (DON'T FIRE PEOPLE, SPEND LESS ON LUXURIES) and MONITOR YOUR INVENTORY.

  • Mohammad - Thursday, October 2, 2008, 3:28PM ET  Report Abuse

    • Overall: 4/5

    it is clear that you have a sublime perspective on busines issues. after reading your article, i can conclude that business decision is a mixture of art and science.

  • Bernard - Wednesday, October 1, 2008, 12:41PM ET  Report Abuse

    • Overall: 3/5

    It's well written, simple and accurate but nowadays you need much more to succeed. Look out to the recession we will have very soon, in fact we are already in, but they don't say it loud. Good luck guys.

  • Yahoo! Finance User - Saturday, September 20, 2008, 9:00PM ET  Report Abuse

    • Overall: 4/5

    it is simple,lucid,familiar to everyday bussiness,easily digestable&instantly assimilateable for commen reader.thanks

  • joe - Friday, September 19, 2008, 6:22PM ET  Report Abuse

    • Overall: 5/5

    testing emer push

  • Prasanna V - Friday, September 12, 2008, 12:59AM ET  Report Abuse

    • Overall: 5/5

    Great writing!

  • Yahoo! Finance User - Friday, August 22, 2008, 10:09PM ET  Report Abuse

    • Overall: 5/5

    Return as you explain it here is the key. I seriously doubt many people understand and fewer know how to speak of it to others.

  • Yahoo! Finance User - Thursday, August 21, 2008, 2:56PM ET  Report Abuse

    • Overall: 3/5

    I like money. Can I have some money. What is a margin. Is that Like butter or something. And Gross Profits. If you think profits and money are gross I'll take it. Anw where I want to go? Uh the beach?

  • Slugabug - Thursday, August 7, 2008, 5:04PM ET  Report Abuse

    • Overall: 2/5

    Hey! Here's an idea. Just make money the way our Government does. Print it!

  • graciela - Thursday, July 17, 2008, 1:13PM ET  Report Abuse

    • Overall: 4/5

    The basics-- always a good place to begin.

  • Yahoo! Finance User - Thursday, July 17, 2008, 12:52PM ET  Report Abuse

    • Overall: 3/5

    Good article, but real world senarios are hard to generalize, NO "universal" rule exists. Factors vary from business to business arena.

  • Doreen - Friday, July 11, 2008, 7:05PM ET  Report Abuse

    • Overall: 5/5

    I MISS RAM CHARAN!

  • jyjy - Saturday, July 5, 2008, 11:15AM ET  Report Abuse

    • Overall: 5/5

    it wes good to find out more about business this is the right way to make more money is to focus on what you buy and what you sale and for sure is to focus on work

  • Yahoo! Finance User - Friday, June 27, 2008, 2:28PM ET  Report Abuse

    • Overall: 1/5

    more useless info

  • Yahoo! Finance User - Tuesday, June 24, 2008, 7:19PM ET  Report Abuse

    • Overall: 4/5

    Good article. These are principals used by three adolescent millionaires. They wrote a book that covers many of these ideas and more. They put expert advice to the test to see if it worked and what do you know they succeeded. Pulling Weeds to Picking Stocks is written by these boys. Amazing.

  • Yahoo! Finance User - Sunday, June 15, 2008, 8:12AM ET  Report Abuse

    • Overall: 5/5

    Great article, but why is Ram still on here if he hasn't posted new content in over a year?

  • Yahoo! Finance User - Tuesday, June 10, 2008, 9:13PM ET  Report Abuse

    • Overall: 4/5

    All successful people and teams never lose sight of the basics. If they do lose sight, they find themselves in big trouble. Also, for those who say money cannot be created/earned, look up the multiplier effect. It is an important concept in economics that everyone should know. Thank you Mr. Charan for this article.

  • InvestTime - Saturday, June 7, 2008, 4:12PM ET  Report Abuse

    • Overall: 3/5

    Setting aside big business (100 EEP's or more), the small companies on the majority seem to suffer due to the consequences from inadequate information about the fundamental structure of supply and demand. Although precision isn't quite necessary, it's rather important when crunching numbers. Maybe instead of learning the basics of making money, we need to learn the basics of how to budget our checkbooks.

  • Yahoo! Finance User - Monday, June 2, 2008, 12:29PM ET  Report Abuse

    • Overall: 3/5

    not enough about service sector

Showing comments 6-35 of 153<< PreviousNext >>
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More From Ram Charan

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