Getting to the bottom of the bottom line

GUEST COLUMN

A few weeks ago, I was travelling to conduct one of those ubiquitous "Finance for non-finance managers" training courses for a corporate client. I used the opportunity to meet some of my ex-students.

The ex-student I met was one of those rare breeds: an MBA who had chosen to become an entrepreneur in the manufacturing sector. He took me on a tour of his facilities spread over three sites.

Here was a person who had struggled for over seven years before reaching where he is today. Today, although he still sounds and looks like a man whose mission remains incomplete, he breathes easy.

Throughout our "walk-around-the-factories" talk, his conversation revolved around the need to conserve cash, the motive behind using only rented premises, the need to minimise owned-assets.

There was hardly any talk about his sales turnover or his profits. Could this have been because of the discomfort, and hence the hesitancy, of talking "profits" with his old professor? I doubt it.

The focus for him was clearly on assets. Having burnt himself earlier, he seemed to know that you could quite literally lose your shirt, along with all your other assets, if you are not careful while chasing sales and profits.

In stark contrast were the managers of my client-corporation. They knew the latest turnover figures and profit figures of their company. However, for most of them, the balance sheet was a black hole.

They had, at best, a vague idea about the structure of the balance sheet of their company. And hardly a clue as to the value of balance sheet asset items such as fixed assets, inventories and receivables.

Let me hasten to add that this characterisation is not unique to the managers of this particular company. Time and again, while conducting training programmes for a variety of organisations across the country, I have had similar experiences.

Nor is my student-entrepreneur very different from other entrepreneurs: either in an up-front, conscious manner, or somewhere at the back of their minds, entrepreneurs are typically concerned about funds that are "blocked up" (balance sheet values in our terminology).

It is only that the purely coincidental occurrence of these interactions "" one with an owner-manager and the other with a group of non-owner salaried managers "" made me alive to the stark differences in focus between these groups.

It is widely recognised, in practice and in finance literature, that non-owner, salaried-managers typically tend to be more focused on the profit-and-loss statement figures (sales, net profit) than on the balance sheet. Check out the dictionary meaning of "bottom-line".

The Chambers 21st Dictionary defines the word thus: noun 1. colloq. the essential or most important factor of truth in a situation 2. The last line of a financial statement, showing profit or loss.

"The essential or most important factor of truth in a situation"! Honestly, I do not know whether the origin of this usage lies in finance, but for many non-owner managers the bottom-line figure on the profit-and-loss statement is indeed the essential or most important factor of truth.

Does it mean that owner-managers/entrepreneurs are unconcerned about sales and profits? Not at all. Or does it mean that non-owner managers are absolutely ignorant of the amount of assets employed to generate sales and profits? Again, no. It is only a question of a relative difference in focus.

An owner-manager/entrepreneur who has committed his own capital to the enterprise is obviously concerned about profits. But for him any level of profits will not suffice; the profits should be adequate to compensate him for all that he has committed to the enterprise: the capital, the time, and his whole self.

Therefore, an owner-manager, while keeping an eye on profits, is also closely watching the amount of resources that he is being asked to commit to the enterprise in order to generate those profits.

In the case of non-owner managers, on the other hand, as David Young and O'Byrne put it (in EVA and Value-Based Management): "Corporate bureaucracies can insulate managers, leading them to believe that capital comes from budgets and not from the capital markets."

Basically, as enterprises outgrow a one-man, single-owner scale, they are forced to organise themselves for growth. They have to raise more capital, employ more people. Since all these mean a reduction in control, they are forced to create hierarchical levels of managers to oversee these huge enterprises.

In the process the "distance" between the capital employed and the user-mangers employing it increases: for these managers "capital" becomes a distant, notional figure. For an entrepreneur, capital is a real figure: it is what he has sacrificed.

This, then, has been the challenge for large, organised enterprises: to make managers think like entrepreneurs, to put managers into the shoes of an owner.

When organisations start young, their managers may actually behave more like owners. But as organisations grow and as they succeed, capital becomes a distant concept.

The first attempts to bring about a change in focus were discernible, when companies increasingly started shifting their focus from top-line (or sales) growth to the bottom-line (or profits).

Cost cutting and re-engineering of processes were the buzzwords. Across the world, companies were successful in getting their managers to focus on profits, not sales.

In the process, however, many believe that quite a few companies may have overdone it. They believe that an excessive focus on profits and cost-cutting may have actually destroyed a few companies.

As McGrath, Kroeger, Traem and Rockenhaeuser (a team of consultants from A T Kearney) argue in The Value Growers: "What is more important and what decides the long-term well-being of a company is the strong internal impetus to grow....After years of bottom-line orientation, it is high time for companies to reconsider top-line growth as an option."

Having got managers to shift their focus from the top-line of the profit-and-loss statement to the bottom-line of the profit-and-loss statement, the next logical step was to get them to shift their focus from the profit-and-loss statement to the balance sheets.

EVA and other approaches were pitched exactly to achieve this. Assisted by enterprise resource planning software and a new recognition of the importance of the balance sheet, non-owner business managers in many progressive organisations have a fairly clear idea of the capital employed a their business unit levels, the return on investments made by them, and so on.

But from my experience I still get a feeling that non-owner managers think and behave differently from owner-managers. Today, at the business unit level, non-owner managers in some organisations may be aware of the profits generated by them and even the capital employed by them.

Non-owner managers are also aware of the top-line and the bottom-line of the aggregated profit-and-loss statement at the overall firm. However, at the overall firm level, even today, they are not aware of the aggregate levels of capital employed by the firm.

I do not know whether my observations can be generalised. So the first question is this: do these differences actually exist or are they imagined?

At a different level is the second question: even if these differences exist, do they really matter? Can managers with a good idea about the complete picture at their operational level, but an incomplete picture at the aggregate level, deliver as good performance as owner-managers would?

Then, the third question is this: if it does matter, whatever you do, can you make non-owner managers ever think and behave like owner-managers?

Finally, should the bottom-line be the top-line, or should it be the bottom-line or should it be the level of capital on which these profits are earned? Questions for which I do not have an answer!

The author is a faculty member, Indian Institute of Management, Kozhikode. His email is ud@iimk.ac.in