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A look into financial ratios

financial ratios

Reviewing and understanding financial statements can be difficult, even for trained financial analysts. Financial documents can be long and confusing. Sometimes they are confusing on purpose because the analysts who created them may want to hide information.

That’s where the power of ratios comes into play. Ratios show the relationship of one number to another. Financial ratios measure a company’s financials to provide clear insight of performance.

I like to relate ratios to pivot tables or graphs used to display clarity for data. If you have a spreadsheet filled with data, it would be difficult to see a clear picture of what the numbers mean. If that same data goes into a pivot table or graph, you will have a much better understanding of what the data is telling you.

Below is some insight into commonly used financial ratios:

Profitability Ratios

Profitability ratios are the most commonly used ratios and they display whether a company can generate profits. This is, how well a company is able to take in more money than it spends. There are a lot of different profitably ratios, below are just a couple:

Gross Profit Margin Percentage – The gross profit margin percentage is the gross profit divided by revenue. The result is then shown as a percentage like below”

Gross Margin = gross profit/Revenue

Return on Assets – ROA will show what was returned to the business as a profit from every dollar invested. The formula is net profit divided by total assets.

ROA = Net Profit/Total Assets

Leverage Ratios

Leverage refers to debt and leverage ratios are used to show if the company is making or losing money used by its debt. Below are two commonly used financial leverage ratios:

Debt-to-Equity – The debt to equity ratio shows how much debt the company has for each dollar of shareholder equity. The formula is total liabilities divided by share holder equity.

Debt to Equity =     Total Liabilities/Share Holder Equity

Interest Covered – This ratio shows how much interest a company has to pay related to how much the company is making. The formula is operating profit divided by annual interest charges.

Interest Covered =   Operating Profit/Annual interest charges

Liquidity Ratios

Liquidity ratios are important, particularly to small businesses. They show whether a company has enough money available to pay for its bills and “keep the lights on”. Below are two commonly used liquidity ratios

Current Ratio – This ratio measures the current assets against the current liabilities. The formula is current assets divided by current liabilities:

Current Ratio =     Current Assets/Current Liabilities

Quick Ratio – The quick ratio shows how fast a company would be able to pay off its short term debt by measuring its current assets, minus inventory, against its current liabilities. The formula is current assets minus current inventory divided by current liabilities.

Quick Ratio =     Current Assets – Current Inventory/Current Liabilities

Efficiency Ratios

Efficiency ratios can show how well a company manages its balance sheet assets and liabilities. The bottom line of these ratios is how long it takes to turn expenses into cash. Below is a couple of the key efficiency ratios used:

Days in inventory (DII) – This ratio measures how many days inventory will stay in a company’s system. The formula is average inventory divided by Cost of goods sold divided by day, see below:

DII =    Average Inventory divided by (COGS/day)

Days Sales Outstanding (DSO) – this ratio shows how fast customers pay their bills or how fast it takes to collect cash for the sales. The formula is accounts receivable (from the end of the pay period) divided by revenue per day:

DSO  =     ending A/R  / (Revenue/day)

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Knowing yourself and finding your sweet spot

sweet spot

Getting to know yourself is a difficult journey. A lot of people go through life, never discovering their true talents and passion. They may experience it from time to time, but they don’t know what their sweet spot is. Living life like this feels like a constant uphill battle.

Your sweet spot is the intersection of your talent and passion. Once you’ve tapped into your sweet spot, the sky is the limit. A good way to identify people who are living in their sweet spot, is their attitude towards life. These people don’t look at their job as something they dread or just as a means for a paycheck. No, these people don’t even consider their jobs work. They love what they do. They get excited each morning to go to the office.

For those of us who feel like we are not living in our sweet spot, there is good news. Tools like StrengthFinders, CPI Assessment, and others can help.  These tools help us to understand where our natural talents lay. We also have the opportunity to continue our education at any point. Granted, we have to be willing to put in work.

Serving others will also help you get to know yourself. As leaders we need to help others develop and succeed, and by doing so, we grow. The feedback we receive from others will give us a better picture of who we are.

In my personal journey, it wasn’t until I went back to school in my 30s that I started to get in touch with my strengths. Bethel University provided me with the tools I needed to hone in on my sweet spot. My mission is to help organizations and people succeed, and provide leadership based on Christian values.

Do you know what your sweet spot is? If not, you should consider putting in the work to find it. As the saying goes, it may not be easy, but it’s worth it.

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Quality and the consumer – The 3 corners of quality

quality

Defining what quality means is difficult. On this subject, the great statistician Walter Stewart stated: “The difficulty in defining quality is to translate future needs of the user into measurable characteriscts, so that a product can be designed and turned out to give satisfaction at a price that the suer will pay” (Shewhart, 1931).

In software development, we tend to focus on a series of defined tests. If all our tests pass, we have developed a quality product ready to be shipped. If the product is shipped and the result is a high volume of production defects, the product was not of good quality.

The challenge with the old way of Waterfall software delivery, and only relying on our tests,  is that the consumer of the product is involved too late in the product development process. The consumer is perhaps the most important aspect of developing quality software.

For this reason, we need to involve the consumer all throughout the development process. This way, we build quality up front.

The below figure shows the three corners of quality model put forth by Edwards Deming.

drawit-diagram-4

What we have learned with the application of Agile, is the importance of learning from the customer. Deming talked about this back in the 1970s, but it wasn’t until the early 1990s that it was applied for software development.

On learning from the consumer, Deming writes: “The main use of consumer research should be to feed consumer reactions back into the design of the product, so that management can anticipate changing demands and requirements and set economical production levels. Consumer research takes the pulse of the consumer’s reactions and demands, and seeks explanations for the findings” (Deming, 1982).

What Deming describes is exactly what takes place during the Scrum sprint reviews. During the sprint review, we show production ready software to the consumer. The consumer can then give immediate feedback. This allows us to make changes to the design of the product.

The old way of delivering software looked like this:

drawit-diagram-5

The new way of delivering software using Agile ensures we build quality into the product up front. We build production ready software in short iterations, then review it with the customer. The new way of delivering software looks like this:

drawit-diagram-6

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Don’t let your subordinates problems become your problems

manager03rb1

In my last post, I talked about the importance of proposing solutions when you raise an issue.

The essential message was, don’t look to others to solve your problems. The flip side to that is not letting others dump their problems onto you. Managers tend to let this happen, especially by their subordinates.

In management, we are always dealing with problems. If everything always went smooth and there were no problems, we wouldn’t have jobs. It’s what we do, we manage.

Just because we’re in the business of solving problems, doesn’t mean we take on everything.  Time is our most precious resource, and often we waste it by taking on problems we shouldn’t.

If a subordinate comes to you with a problem, be careful not to take ownership.

This tends to happen more with junior level employees. Often they are afraid to make decisions and take action. The tendency as managers is to jump in and help the team member. Be careful, by jumping in to help, you may be doing more harm than good.

Empower your subordinates to make decisions and solve problems. If they continue to look to you for help, they aren’t learning and growing. We help our employees by not taking on their problems. We help them learn how to resolve issues on their own.

Build trust with your team members by letting them know it’s okay to make mistakes. Show empathy and offer advice, but let them know you expect they will resolve their issues. By not taking on their issues, you free up time to work on your management responsibilities.

For a great resource on this topic, see William Onken’s and Donald Wass’s HBR article here.

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50% of your meetings are a waste of time!

boringmeeting

Clutter! It shows up in all areas of our lives. At home, it’s easy to recognize clutter. When I arrive home at night, I can see when clutter starts building up in the kitchen and living room. I blame it on my 3 year old. At work, a different type of clutter happens and it’s harder to recognize.

I’m referring to meetings. We love to fill our calendars with meetings. The problem is that most meetings we attend don’t add value. Yes, when we first scheduled them, they seemed like a good idea. We then discover, after 1 or 2 meetings, they are unnecessary. Yet, we continue to attend them, knowing we are wasting our time.

Think about it. How many meetings do you attend where you provide the same updates, to the same people?

Observe people’s behavior when you are in meetings. Are they engaged and having a dialogue? Or is everyone looking down and frustrated? If the latter is true, there’s a good chance the meeting needs to go.

Time is our most precious resource and we can’t afford wasting it in meetings that don’t add value. Take a good look at your calendar and sit down with your colleagues to review the meetings. Decide what meetings are unnecessary, then get rid of them!

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