If your CFO spent the last several weeks pushing out year end financials and calculating so many numbers that they have all become “insignificant ratios”, pause for a moment to make sure that all of the executives in your company know one MAGIC number that will guide their decisions in 2015.
As many readers of this blog know, my tagline is Achieving Accelerated Growth with Sustained Profitability®. And you may also recall that the secret lies in reversing that phrase. It is essential for the leaders of any enterprise to know what truly drives their profitability. Like quality assurance versus quality control, it’s not just about examining the end result (net profit). It’s about using key indicators much earlier in the process that create and predict the end result.
Let’s use two companies within the same industry as an example. One time share enterprise has a magic number of “2.5″. That number results from a formula that involves the factors that drive their success and profitability. Debt/Equity divided by (Occupancy plus Customer Satisfaction). They closely monitor these indicators and pick up or slow down capital investment based on their magic number.
Say their Debt/Equity ratio has been running at 4.0. Whether that is considered aggressive or conservative depends on the economic season. In their case, if their capacity has been running .90 and their customer satisfaction rating has been holding strong at .95, they would be comfortable speeding up their investment in property acquisition and improvements. 4.0/1.85 = 2.16 which is well below their MAGIC NUMBER of 2.5.
A competitor with a more aggressive land approach utilizes the same components but has concluded that 4.0 is their MAGIC NUMBER. The addition of occupancy and customer satisfaction can’t exceed 2.0, so there is always a firm 8/1 cap on their debt/equity ratio. The CFO is happy about that, by the way. This company tends to focus much more on acquiring assets and less on customer service and occupancy, but when the sum of those two numbers slides below 1.5 they can only afford a 6/1 debt/equity ratio. You can probably imagine the fascinating discussions they have when that happens.
Use of a tailored MAGIC NUMBER captures strategy in a tangible way, involves multiple departments, applies short term results, guides decisions and helps to create a more resilient longer term result for the entire enterprise.
What drives your profitability? What components could comprise a MAGIC NUMBER for you in 2015?