Numbers are the language of business

I read this phrase in a document somebody shared with me recently and I love it.

I am not a trained accountant but early on in my career both as an entrepreneur and investor I learnt the importance of numbers, understanding financial statements and my wife even describes that she watches me reading spreadsheets and financial reports and says that I am reading the story behind the business – numbers really are the language of business!

I have written previously that for me the most important number on the P&L is Gross Profit.  Revenue is often the one people focus on but this is a vanity metric and as I often say it is gross profit that pays the payroll and bills.

I spoke with a leader recently where he had come into a business as CEO and improved the gross margin from 15% to 41% which is fantastic.  They had done this through a combination of focus on both cost of goods, pricing and routes to market.

I think one thing to look out for when analysing company numbers is gross margin per customer and the average selling price compared to list i.e which customers are getting discounted pricing. 

When I have given training sessions to sales teams I talk about the impact of discounting and give a simplistic but powerful case study example regarding a customer buying a product with a 30% gross margin asking for a 10% discount.

Most sales people automatically say no pronblem but without understanding the gross margin if you give a 10% discount this reduces the gross margin to 20%, but most importantly the business will now have to sell 50% more to that customer in order to maintain the original gross profit contribution (which pays the Opex bills) to the business it had previously. I have found it certainly makes sales people think about discounting differently.

One company that has become well known for this focus is American company Transdigm.  They have a 3 P Philosophy that focuses on Price, Productivity and Profit.  On pricing rather than an across the board price increase which most companies introduce on an annual basis they focus on a line by line basis increasing (and sometimes decreasing) pricing per customer to drive profitability.  How many companies have this discipline?  Not many in my experience.

The importance of gross profit is also supported by research at the McKinsey Global Institute who identified it as a primary driver of shareholder value creation across multiple industries.  Their research went one step further to look at relative market gross margins and concluded that if companies were in the top 30% compared to their sector peers they were more likely to succeed and maximise shareholder value. 

How many boards track gross margin improvements and benchmark it against sector market peers – I would guess not many.