Gap 6: Financial Constellations | Beyond the Blazer
Directors misunderstanding what is important in financial reports may limit growth and result in decision-making errors.
In Gap 4, I wrote about the gap of not allowing yourself to learn. I, too, am not an accountant and had to give myself the opportunity to decode all those numbers, percentages and ratios.
Let me share with you a different view on learning financial literacy.
Look up into a clear, night sky and you will see stars. A few at first. As your eyes adjust, you start to see more stars… and more, until falling stars burst into view. Keep looking, and your eyes adjust to the depth of the stars; some appear closer than others. You can determine the sizes, and the fog of the Milky Way.
Throughout the centuries, people have looked to the stars to help them navigate across open oceans or featureless deserts, know when to plant and harvest, and preserve their folklore. To make it easier to read interpret the celestial calendar, they grouped the brighter stars into readily recognisable shapes; the constellations.
This is the same as learning to read financial statements.
At first, learn to read a few elements well; the first stars. Then other elements will come into focus. You will start to determine what is important - the closer stars - and what isn’t - the distant stars.
Good financial executive summaries will draw the financial constellations together. Financial patterns will show how operational trade is performing, how well your assets are working and your overall position compared to similar industries.
Another approach is to create your own financial constellation. We all recognise the Crux, or the Southern Cross, which has help many navigate south.
What is your Southern Cross in financial terms? What are the key group of financial numbers that inform you of how the business is travelling and to help you navigate?
Here is an example of my Southern Cross financial constellation. Because of the diversity of financial statements as well as your needs and priorities, how you name the stars in your financial constellation may be different.
Cash at the end of financial year in the cash flow statement tells me how quickly the organisation will be able to solve unexpected problems or take advantage of opportunities. Generally, the benchmark is to have enough to cover at least three months of annual expenses.
You may be bringing in the cash, but are you making any money? You may be achieving your GP% but still not be profitable.
Profitability ratios measure your organisational performance and ultimately indicate the level of success of your operations. It is, at its most basic level – for every dollar a customer pays you, how much are you keeping?
My go-to calculation is revenue divided by net cash provided by operating activities. I like to see around 15%. I’m concerned when I see this under 9% with no trend in improvement.
At a granular level, I like to look at the difference between receipts from customers and payments to suppliers and employees. I like to keep minimum 12c from every dollar. Again, I’m concerned when it is under 10c with no trend in improvement.
Debt and liquidity
Debt to Assets – or in plain English Owe to Own - indicates the extent to which you are able to meet the all debt obligations from sources other than cash flow and hence remain solvent and able to continue to operate. Generally speaking, it should be less than 1.
I also like to use interest coverage to see how many times your net profit covers your interest expense obligations.
Liquidity ratios tell me if you can pay the bills when they fall due. The easiest to calculate in the current ratio; total current assets divided by total current liabilities. In general, the higher the liquidity ratios, the sounder are the club’s activities and its ability to withstand tight cash flow periods.
Labour | employee benefits expense and wages
Labour can be a big money drain on operations. It’s a fine balance between getting the right level of service, productivity and maintaining profitability.
Unfortunately for clubs, without the right amount of staff you can’t sell product and have the entertainment experience customers are expecting.
Overall, the suggested benchmark is 18-30% of revenue (or sales) for that department and overall, and it is dependent on size. The larger the venue, the easier it is to capture economies of scale and lower your wages percent. If wages are over consistently over 40%, your club’s growth and profitability will be tested.
Return on Assets
Return on Assets, and its sister ratio, Return on Investment, indicate how efficiently your business is using assets and equity to make a profit. Clubs are often asset-rich. RoA indicates how efficiently profits are being generated from your buildings and facilities compared to similar businesses. It is usually described as a percentage by dividing net profit before tax over total assets. The benchmark I use is minimum 3%.
EBITDARD is Earnings Before Interest, Tax, Depreciation, Amortisation, Rent and Donations. Unfortunately, I have seen some boards misunderstand the ‘donations’ part and mistakenly factor in their core sporting operations (like bowls). This produces a healthier EBITDARD but doesn’t remove the reality that they are going broke by ignoring other ratios!
I treat this ratio with caution. Depending which accountant has prepared financial statements, it can be difficult to calculate this ratio with ease.
EBITDARD can be used to compare profitability between clubs but there are serious limits to what the metric can tell us about overall performance. Its proponents argue that EBITDARD offers a clearer reflection of operations by stripping out expenses that can obscure how the company is really performing – such as interest, tax, different levels of donations and so forth.
A club can make its financial picture more attractive by touting its EBITDARD performance, shifting attention away from high debt levels and poor profitability.
Growth is a historical view of financial performance illustrating revenue and bottom line increases and decreases over time. It can show how fast your club is expanding, or contracting. If there is no discernible difference year on year, then your business is treading water. Add in inflation and net present value, and treading water means you will eventually run out of steam!
So there you have my financial constellation that directs me to understanding the health, wealth and general well-being of a club. There are so many other stars out there, too! Like I said, your financial constellation may be different. Start building your financial constellation by allowing yourself time to learn where the stars are directing you.
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