Really, It’s Just a Ratio: Secrets of Communicating Financials for IROs, CCOs and Business Pros
By Randall Bolten, Founder, Lucidity; Author, “Painting with Numbers: Presenting Financials and Other Numbers So People Will Understand You”
If you’re an investor relations professional, you have a tough job. Great companies often have complex financials and novel business models, and the investors you’re trying to reach have many companies they’re following, too little time, and competing demands for their attention. Communicating the basic points about a hot company to a distracted audience isn’t easy – especially when your target audience can’t remember last quarter’s numbers or don’t want to do complex arithmetic in their heads.
In this environment, there is a dividing line between IR professionals who can do this work and contribute at the corporate leadership level, and those who are merely transmitters of corporate data. And what distinguishes the leaders from the transmitters is sometimes simply a matter of understanding when and how to use the humble ratio.
Ratios – or key indicators (KIs) – add meaning and context to a bewildering pile of raw numbers in a quickly and intuitively understandable form. Here are some KIs related to a company’s operations that should already look familiar, that are standard, garden-variety ratios:
- Gross Margin = Gross profit ÷ Total revenues
- Operating Margin = Operating profit ÷ Total revenues
- Y/Y Revenue Growth = Change in amount ÷ Base period amount
[ “Amount” = revenues, expenses, profits, or any other number routinely presented to investors.]
What these KIs all have in common is that they’re simply a numerator divided by a denominator. They work well as business metrics because (a) they encapsulate results that are critical to the business’s success, and (b) they enable the reader to compare businesses of different sizes.
But KI’s don’t have to be standard, or garden-variety. There are many other KIs that can be useful in explaining your company’s trajectory – to both senior corporate management and investors. Here are some examples:
- New Business % = Revenues from new customers ÷ Total revenues
- Repeat Business % = Revenues from existing customers ÷ Total revenues
- Average Deal Size = Total revenue ÷ Number of transactions
(Note: As with New Business % vs. Repeat Business %, you can look through either end of the telescope. Many companies want to show a large or steadily increasing Average Deal Size, but others may want to show the opposite, to demonstrate success through retail or other high-volume channels.)
- New Product Revenue % = New product revenues ÷ Total revenues
- Employee Productivity = Total revenues ÷ Number of employees
- Market share = Company revenue ÷ Total industry revenues
You may well find that KIs like these are metrics or variants of metrics that company leadership is already tracking internally. To identify the essential KI’s for your business, you’ll need to work closely with management to identify which metrics offer key insights to your business and why. And of course you’ll also need to assess the tradeoff between helping investors understand your business’s strengths and protecting company confidential information.
If you show some imagination as well as a deep understanding of your company’s business model, you may find yourself crafting KIs for your company that no one had thought of previously. That can help you establish yourself as one of your company’s key strategic thinkers. . . and all merely because you know how to divide one number by another!
Before we leave this subject, let me offer a few words of tactical advice:
1. Be transparent. When you present a ratio as a key indicator, the source of both the numerator and the denominator should be should be clear, so that management and investors will understand how the ratio was calculated. You don’t want to waste precious time walking your audience through your calculation methodology, or explaining where the numerator and denominator came from.
You should also make sure that your audience has access to the raw numbers. Deriving your KIs from raw numbers that people don’t have access to can make them suspicious of your practices and your motives. And if and when a KI ceases to be meaningful for the way you’re doing business, be sure let your audience know that you’re no longer presenting the KI, and why.
2. Be consistent. The more effective and meaningful a key indicator is, the more investors and management alike will appreciate it. And the more they appreciate it, the more they will expect it to be part of future results, and the more they will wonder why it’s not there if you stop presenting it. So before you start presenting a KI, make sure that it represents a meaningful way to understand your company, and illuminates what is significant about how your business is operating.
3. Be selective. There’s virtually no limit to the number of ratios you can construct that may seem meaningful to your business, but you should only present a handful to your audience, and stick to them. Keeping the number of KIs down will require thought and planning to select them, but presenting too many KIs runs the risk of confusing your audience (and ultimately working against your goal of quick and efficient comprehension).
Randall Bolten is the author of “Painting with Numbers: Presenting Financials and Other Numbers So People Will Understand You.” He has served as CFO for BroadVision and Phoenix Technologies, as well as startups Arcot Systems, BioCAD, and Teknekron. He also held senior financial management positions at Oracle and Tandem Computers. He now runs Lucidity, a consulting practice focused on short engagements with specific deliverables that include enterprise business models, management and financial reporting packages, and incentive compensation plans that work.
Published: June 10, 2012 By: