Coaching, Cooperation and Confidence

October 30, 2014

One of the finest moments in the life of a parent, and one of the most decisive moments in the life of a child is when he is better at something than his father or mother. For fathers is often a sport, and when it comes to football that moment is near for me. Sometimes we bring that moment closer by letting our kids win a game, but they don’t really believe. It does make them happy for a moment, but for their confidence it does not do much.

 

In companies it is often the other way around: the managers are usually afraid that their staff, or others in the company, will become better at something than they are. Sometimes they already are. They keep their team on a short leash and take a position of seniority by instructing their staff which method to use, and thereby create a dependency, because they are the experts. This serves no other purpose than boosting the ego and amplifying the senior position of the expert manager to confirm the power-relation. These people emphasize their own interest in an organization by claiming successes that should be attributed to others.

 

Leaders who hire people who are better than they are quite rare. Perhaps out of fear of being irrelevant.

 

This is a pity of course, because the organization will be weaker rather than stronger, and the full potential of the organization is not utilized. Moreover it is quite frustrating and demotivating when someone hijacks your successes to secure his own position. It will lead to conflicts. And: “Internal conflict is like an autoimmune disease: the technical cause of death may be pneumonia, but the real cause remains and hidden from plain view.” Negative circle …

 

We have a tendency to instruct. People working with me might recognize that. We think we know how things should be done; we give the order and request an update on the results a week later. In an environment with a lot of educated content experts this is not surprising: since our schooldays this is how we acquired knowledge: the teacher instructed us, we did our homework, and then she tested whether we had done well.

 

It may work, but this may not be the most motivating method.

 

There is also much talk about the “Master-Apprentice” principle. The Master passes his knowledge and experience on to the Apprentice, who goes to work right away, is continuously instructed and corrected and sometimes gets assignments to figure something out for himself. I would call this mentoring.

Mentoring comes from Greek mythology, where Odysseus, when he left for Troy, entrusted his home and the education of his son Telemachus to his friend Mentor, with the command: “Teach him everything you know.”

 

mentor

 

 

 

 

 

Still a lot like the schooldays.

For those who have no insecurities about their own position and relevance, and who dare to look at the potential of people rather than just their current performance, there is a third way: coaching.

If we create a coaching culture and use a management style that focuses a bit more on coaching instead of directly diving into the facts and methods, we could cooperate in such a way that our coworkers become aware of the possibilities for working smarter, and for removing obstacles to success, without handing over the responsibility for their work and their own accomplishments. Then everyone can claim his or her own success.

Success builds confidence, confident people to take personal responsibility, and so on. Positive circle!

 

Let’s help each other so, instead of trying to outsmart one another.

Not that this is exactly easy. John Whitmore, of whom more later, said: “It maybe harder to give up instructing than it is to learn to coach”.

 

My own first experience with coaching was not entirely voluntary. I will explain why. With one of my best friends I have a deal to learn something new together every year. We do this mainly because we’re both busy and otherwise we might spend too little time with each other, but also because new things are interesting. It was not easy to agree on what is interesting enough to learn, though. We looked at twenty weeks of furniture making, at ten days cooking course at Le Gordon Blue in Paris, at a curriculum at Harvard, and at some other things, but consensus was not reached. Therefore, the deal was adjusted: one year he decides, the next year I will. My choice for example was to follow a curriculum of Art History at The Hermitage. Ten weeks, one evening per week. For me a nice and safe option, with a classical education, and a history as a gallery owner in Amsterdam. Maybe I wanted to start my learning experience as an expert, and not feel inadequate or look like a schoolboy. When his turn came up last year he got back at me and opted for a course in Professional Coaching” I guess because he knew that I would otherwise never do that. I’ve already written about this before, and I am very glad we did it. Incidentally, as my revenge, next year we will follow a training course in Skydiving. This was my choice, because a long time ago he was selected to train as an F16 fighter pilot. He had to parachute jump, too. For some reason, after two jumps, he did not dare to jump out of a plane anymore. Dream gone, and replaced by a career in e-commerce, which turned out rather well. But still, this fear has always bothered him, and now he has to get over it.

 

jump

 

 

 

 

 

 

 

 

 

Sometimes we need a bit of external help and pressure to make you us aware of what we do not know or what we can do but are not doing. In the end, it remains our own responsibility what we do with it.


Paradoxes and Dilemma’s

July 2, 2014

Last Sunday, for the first time in five years, Qhuba had a Beach Party: we had Beach Volleyball, a Sand sculpture-artist, barbecue, Soccer Championship on a big screen, and… partners and kids.

It was great. Why didn’t we do that before? Company – Family – Party,

Indeed, why did we not? Work life and personal life are interconnected nowadays, we work from home sometimes, they hear the stories, and how much fun is it when your kids and your spouse get to meet the people you work with and talk about? Great Fun! And probably I am the reason it never happened before, because work and home were different worlds me, and I kept them separate. This seemed like a good idea, and now it does not sound like such a good idea anymore. Or maybe for some people it still is, since not every attends these kinds of Parties, and not everyone who does attend brings his family. Not everyone has a family, for that matter.

Trying to think this through it becomes obvious that companies and people are constantly faced with Paradoxes.

This was an example; there are many more, bigger and smaller:

 

  • Work and Private mixed or separated
  • Command & Control, or Self Steering?
  • Customer Focus, or People First?
  • Collective growth or personal development
  • Lean, or Agile?
  • Exploitation or Exploration?
  • Management or Leadership?
  • Focus or differentiation?
  • Short term or long term
  • Cash or Value?
  • Product focus or Market orientation?
  • Network company or traditional Hierarchy?

 

The list goes on as long as you want, but first this: are these Dilemma’s or Paradoxes. I believe the difference is crucial. As far as I am concerned they are Paradoxes. In my definition a Dilemma is an “either-or” contradiction, usually the result of, or the solution to a problem. Good stuff for tough Leaders, because they need to make a choice between two alternatives that appear to be equally attractive or unattractive.

A Paradox on the other hand is an “and-and” challenge, seemingly contradictory and exclusive at first glance.

 

 

But what if the juxtaposition of alternatives is only perceived, and we do not think the challenge through, or we are not open to new possibilities as a result of our background or our worldview? Our opinions are often shaped by assumptions about what is right, and we act in accordance with those assumptions, without questioning where they came from.

If we do this, we turn Paradoxes into Dilemma’s, which we will then solve by making choices that have only losers, leading to polarization, negativism and missed opportunities.

 

Bob de Wit and Ron Meyer wrote about this in their book “Strategy Synthesis – Resolving Strategy Paradoxes to create Competitive Advantage”:

Most people are used to solving puzzles, resolving dilemmas and making trade-offs. These ways of understanding and solving problems are common in daily life. They are based on the assumption that, by analysis, one or a number of logical solutions can be identified. It might require a sharp mind and considerable effort, but the answers can be found.

However, most people are not used to, or inclined to, think of a problem as a paradox. A paradox has no answer or set of answers – it can only be coped with as best as possible. Faced with a paradox, one can try to find novel ways of combining opposites, but one will know that none of these creative reconciliations will ever be the answer. Paradoxes will always remain surrounded by uncertainty and disagreements on how best to cope.

 

So Paradoxes require effort, and learning how to deal with them, rather than killing them by making simple choices. A few simple steps might help, but it is a journey into uncharted waters.

The first step: Acknowledgement: make clear and agree on the fact that you are dealing with a paradox and not with a Dilemma that requires a “yes” or “no”, or a “left” or “right”.

Then: Accommodate a conversation, a discussion or a process. This might be the hardest part; talk about the paradox without all your preconceived notions of “how we do it”, or what is best, but instead look at the alternatives from all sides, seriously considering both their positive aspects as well as their negative aspects.

After that: Acceptance: we need to accept that for most paradoxes there are not simple solutions, and that the outcome is uncertain, as it the future. A change mindset helps. Let’s have that Family–thing and see what happens.

And finally: Creativity: look for workable ways to deal with complex concepts, systems, structures and solutions. Experiment and be prepared to turn the whole thing upside down.

 

And complexity…? If we can give each other the leeway to organize a Beach Party, to attend or not to attend, and to bring spouse and kids are not bring them, and if our kids can build sandcastles together, and decide to destroy them again, or finish them, or to play volleyball or watch soccer then we should be able to deal with the business paradoxes, too. Especially if we are able to admit that we will be wrong sometimes, or even that we want to be wrong.

 

For all who want: another Beach Event next year. With kids, Or without, Or both. I will be there.


Why we all (should) hate “How”

March 25, 2014

So much can be read from the way people talk. The choice of words is something worth paying attention to. Are they constantly talking about I rather than about We? No need to explain what it means. Although: here context plays a role, too. Are you having a discussion about Strategy and choices? Than the I-sayers might have more focus on their own agenda and personal feelings than on the collective ambition and the team. Are they we-sayers when talking about Execution, Objectives and responsibilities? Make sure people take responsibility for what they promise to accomplish, for the effort they put into it, and for the results.

I have similar experiences with the word „How”. Usually How refers to the process, and as soon as people, for instance in a Management Team, start diverting attention from the content to the process, you can conclude that they either lack the content, and have no opinion about the subject at hand, or they are stalling. Both pose serious problems for decision-making. The question Why a decision should or should not be taken is the crucial one.

When executing, it is the other way around. When someone has taken responsibility for implementing a decision, focus from his Peers or his Manager on How he should do this will most likely not lead to better results, but reduces the responsible person to someone who does not feel trusted with the task.
Not letting your employees figure out how to go about their business is an excellent way to make them stupid. Treat them like kids and you will have a Kindergarten on your hands instead of a company. or an Army – which in some circumstances (like War) has it use too.
Slide1Talking about Words, War and Companies: don’t we all love the idea of People, Planet, Profits, as sketched by Peter Frisk? Or for the realists, like Ben Horowitz: People Product Profits? And don’t we usually see the exact opposite? More along the lines of Politics, Paranoia and Pay-for-Preceived-Performance? Now that is something we want to do something about. An excellent Why (we want to do it differently).

And what about “How”? Does it have any use? Sure it does. In: „How can I help?”


How to build a business – Strategy Execution Cycle

August 3, 2013

Building a Business starts with an idea, which is then converted into action.

Simple and straightforward, but not always enough to be successful. Libraries can be filled with books about how this conversion is done, and usually the terms Strategy and Management are introduced on the first page. It is not always clear what is meant by the terms, and the explaining usually involves many more terms, like mission, vision, leadership. Once you are sufficiently confused you are lucky if you can understand where the author is taking you. Bullshit Bingo is never far away.

What is a Strategy really: is it a statement, or a plan, or just a hypothesis about value creation?

And what about Management? Sometimes you are introduced to the world of let it all run it’s course, your people will know what to do, the collective will manage itself (as Ricardo Semmler does), and sometimes to give every single employee a specific responsibility and task, and constantly measure how the task is performed, with Key Performance Indicators (Robert Kaplan).

Unless you want to turn into a one-man show, it is important is to be able to share your idea with others: Why do you want to do it, what do you want to do and for whom. And how will you be successful: Can you identify what the success-factors are, decide which of the underlying activities are vital and are you able to measure if they are performed up to the standard you have set for yourself and your business?

There is no single truth of course: are we talking about a bar in Berlin, a multi-national enterprise run from the United States, or a Production Plant in China? Hardly the same thing. Where you do it matters a lot: Context is crucial.

Equally important is who you have around you. Can you inspire them and share your vision and some of your responsibilities with them, delegate some of the vital activities to them? Time to get organized.

This requires planning and probably money. Decisions are needed on what initiatives have priority are and how they are funded.

Once you are in business the execution of your idea needs constant evaluation and adjustment, just like a hypothesis needs testing and change.

We believe these are five steps that not only reflect common sense but are also universally crucial to bring a business idea to fruition. We have called this approach SCOPE. An acronym where each letter represents a stage in the process of Strategy Execution:

Strategy – Context – Organisation – Planning – Execution

For Qhuba and its clients we have taken the “buffet approach”. You will pass all the five stations, but what you use from the process and the templates depends on your needs and appetite. The full cycle looks like this:

Slide2

In the middle the basic templates for communication:

  1. The Business Blueprint, which describes the building blocks behind the idea: the values, and the vision, the words you want to own and the x-factor you think you have. In short: the success-factors
  2. The Strategy Map, which describes the value creating activities through series of cause and effect linkages, clustered per success-factor
  3. The Scorecard, which describe the objectives per activity per success-factor.

Nothing is new here, nothing is revolutionary. The Plane, the Crew with the Flight Plan and the Cockpit, if you like analogies.

The only aim is to make a clearly defined approach with unequivocal terms and definitions and some practical tools available for all.

In five short articles we will describe the five steps, as well as the three tools, and then we will go through the whole sequence for our own company.

If you like the approach you might want to do the same for yours.


How to build a business – the American Dream

October 29, 2012

The American Dream: it does not exist.

From rags to riches on the basis of an excess of ambition and talent is a nice story, but in practice there is more to it. Malcolm Gladwell, who previously wrote books like The Tipping Point and Blink published an entertaining book about why some people are much more likely to succeed than others. Outliers.

The summary: origins, environment, and coincidence are just as important as intelligence, talent, ambition and perseverance. It would like to add (Gladwell does not): the ability to recognize opportunities and to grab them with both hands. I have written a blog about this ability – Effectuation – earlier.

Therefore, contrary to the stories that usually circulate about highly successful people – a story that focuses on intelligence and ambition, Outliers argues that if we want to understand how some people succeed, we must study in detail things like their background, their generation, their family, their place of birth, and even their birth date. These usually drive the coincidences that make them who they are. There is also such a thing as “making enough hours”. This is the “10,000 hours theory”, developed and popularized by Dr. Anders Ericsson, who basically found out that spending massive amounts of practice hours on a specific subject will lead to expert mastery in that field, more than talent will. Or the other way around: virtually no one who did not spent ten thousand hours of something, became really good at it. Whether a person has the opportunity to make those hours depends on… coincidences and perseverance.

The story of success is much more complex and interesting than it appears to be at first.

The logic that Gladwell uses to explain the success of the Beatles, Bill Gates, Asians in Mathematics, Jewish takeover lawyers and others is peculiar and interesting. It is all about coincidences. For Gates: the availability of sufficient computer time at exactly the right time, for the lawyers: they were all born from garment makers around 1930, they do not have to fight in the war, were not eligible for the WASP Wall Street firms, and had, around 1970, sufficient experience with acquisitions, which until then were not fancy. Before 1970 Yankee law firms refused to do this inferior work, which after the ‘70s was considered to most prestigious legal work.

So it boils down to: talent, ambition, and ten thousand hours of experience. Character and competence. We should start asking our candidates whether they have ten thousand flying hours. For those who join us as Professional (sometimes call the “professor” role) this will not be a problem. For entrepreneurs (the pilots in the plain), the headhunters, the networkers and sales-people that might be a challenge.

 

Thousands of hours experience with a specific task, seems contradictory to what Ricardo Semler propagates in his book The Seven Day Weekend.

The title is misleading. Weekend does not mean doing nothing but: do things that you like and make you happy. Semler, then CEO of Semco, a company with roots in Sao Paolo,  introduced a style of leadership that took liberalism and democracy as a starting point. Why do most people in most countries agree that democracy is the best way of governing, but why are most businesses organized along dictatorial line? Companies and the Roman army have many similarities. Companies and kindergartens have many similarities. What are the similarities between armies and kindergartens? 1. Decisions are made for you. 2. Personal initiative is not really appreciated and 3. Hardly anyone really enjoys it.

Semler turns it around: If employees care first and foremost about their self-interest, if Management refuses to impose (or even take) decisions, if there is a culture of transparency and trust, intrinsic motivation and peer pressure will do the rest. This involves making employees responsible for a lot more than putting in the hours.

It has taken decades to turn his business around to a democratic, innovative and successful enterprise, where employees determine their own working hours, their own salary, their location and decide who will be their bosses and their colleagues.

How nice is that: A company where people may attend the meetings they want to attend and all business information is available for everyone.

Employees are no longer just a means of production, but adult people with talents and ambitions who are asking, as many times as possible, the question “why?”.

It would be quite something if this could work, and I am convinced that it can work. I am not so sure if we have the patience and time to make all the mistakes, and to accept everyone making all the mistakes that are part and parcel to such a process.

 

But then, why not? If we are able to select and interest only the most talented people, with the highest integrity, and if we can all be fully transparent about our intentions, we will get there. First we will be looking for people with 10,000 hours on the clock.


How to build a business – Ten Questions

October 16, 2012

We have been in business for several years, we have more than sixty world-class people working with us, worked for eighty-eight world-class clients, held one hundred and fifty-three management meetings and published numerous internal and external documents. At some point it seemed to make sense to bring it all back to ten basic questions. The answer to those questions should describe all the major aspects of our business. Answers that all of our people should be able to give, when the questions are asked.

 

Here are the questions:

1. Where do we come from?

2. Why do we exist?

3. What do we look for in our resources ?

4. How do we behave?

5. What do we do?

6. How will we succeed?

7. What is the one most important thing right now?

8. Who must do what?

9. How are we organized?

10. How we make decisions and deliver on them?

 

And here are the answers

 

1. Where do we come from?

Qhuba, founded in 2007, is a fast-growing network organisation with more than sixty Partners, Staff and Associates (‘Qhubans’). Qhuba means drive, the drive to work together, to learn, to grow and to succeed.

 

2. Why do we exist?

We exist because we believe running companies can be fun and strategies can be implemented successfully when people of character and competence work together.

Qhuba believes that strategies are best executed by a multi-disciplinary leadership team that takes collective responsibility.

 

 

3. What do we look for in Qhubans ?

Regardless of whether they are Clients, Candidates, Network Partners, Prospects, Associates, Staff, Associate Partners, Partners, Managing Partners, Equity Partners, Practice Directors, Shareholders, or Friends, we expect:

  • Character (Integrity and Intentions)
  • Competencies (Hard and soft skills)
  • Network
  • Track record
  • A drive for Autonomy, Mastery, Contribution and working with Peers.

 

4. How do we behave?

We are Independent, Reliable, Uncompromising, Connected

 

5. What do we do?

When organizations look for support in the successful execution of their strategies, we provide (introductions to) people with the right character and competence. We can do this based on Client Value Pricing, on temporary assignments, on the client’s payroll, for a success fee or without a fee.

 

6. How will we succeed?

Together Qhubans use conversations to build a network of world-class professionals to make clients successful by providing capable people and by arranging introductions, opportunities and exposure, meanwhile building a highly recognised organisation as a platform for professional and personal growth.

 

7. What is most important right now?

Increasing Reputation in our network

  • Increase NPS with clients by delivering results
  • Increase credibility with prospective clients through content-marketing, sales and references
  • Increase Trust within Qhubans through growth and success
  • Increase Reputation with candidates through marketing

 

 

8. Who must do what?

Strategy, Structure and Reputation:   Wouter Hasekamp

Network:                                              Tjibbe van der Zeeuw (Liesbeth Hans)

Knowledge and Research                   Liesbeth Hans

Publications:                                      Hotze Zijlstra

Marketing:                                           Wouter Hasekamp, Rachelle Nall

Enablement and Support:                  Dennis van Alphen (Tom Kisters, RikJan Kruithof)

Portfolio:                                             Partners and Practice Directors (Peter Rappange, Mohammed Chaaibi, Gerard Kok, Evert-Jan Tazelaar)

Sales:                                                 Mario School (Susanne van Kleef, Gerard Kok, Evert-Jan Tazelaar)

Delivery:                                             Tjibbe van der Zeeuw (Beatrice Friebel)

 

 

 

9. How are we organized?

Qhuba is organised in Practices that address specific areas of expertise, without losing sight of the collective goal: strategy implementation across disciplines. Practices in the portfolio of Qhuba are:

  • Interim Management
  • Recruitment & Executive Search
  • Programme and Portfolio Management
  • Lean and Transformation
  • Finance and Benefits Management
  • Sourcing Support
  • Lean IT
  • Cloud Consulting
  • The Qloud Company

 

 

10. How we make decisions and deliver on them?

We believe in Collective Leadership: given our values and despite different intentions and goals we want to be able to operate as a tribe of peers, each contributing as a person and as a professional, without giving up our autonomy. Starting points for this ‘Tribal Democracy’ are:

  • Freedom of Thought
  • Freedom of Speech
  • Freedom of Choice
  • Freedom of Dissent
  • Radical Transparency

 

 

Conditions for participation in decision-making are:

  • Trust, which consists of Character (Integrity & Intentions) and Competence (Capabilities & Results)
  • Transparency of Information and Opinion. Silence equals disagreement. This is our first rule of engagement.
  • Commitment, both active commitment and formal commitment. This is the second rule of engagement
  • Accountability; there is zero-tolerance for lack of Trust, lack of Integrity, lack of Transparency, lack of Commitment, but also for Passivity, broken promises, non-performance
  • A shared definition of success made measurable and a focus on results. One team, one goal.

 

Success is measured by:

  • Client Benefits Realized and Nett Promoter Score
  • Staff retention en recruitment
  • Revenue – Margin – Profit

How to build a business – Finance and Ratios

January 2, 2012

Happy New Year. The calendar year has just finished. Lots of companies will be busy closing the books, and preparing Annual Reports. Do they really understand what their accountants are going to produce?

When building a company, when executing your strategy… Two things are certainties: (1) you want to be able to steer your company financially. So you need, at any given time, to be able to answer questions like: Does revenue grow as planned? Are costs within budget? Do we make net profit? Is the cashflow sufficient? Are debtors paying in time? Do we have an acceptable return on capital invested?

(2) at some point you will need financing, if things go well. We recently refinanced our company, to get access to working capital for growth. We managed to borrow 80% of our monthly turnover, secured by our invoices (Accounts Receivables). Of course there were discussions with banks about performance, solvency and other ratios. For non-financials, which most entrepreneurs are, it might be interesting to have all the relevant information based on an example balance sheet and profit- and loss statement (also called income statement). I will give it a go.

In the attached Excel file I have created an example. Early next year I will put in the definitive Qhuba numbers.

Balance sheet and ratio’s

Balans en ratio’s

The theory:

A balance sheet, also known as a “statement of financial position”, reveals a company’s assets, liabilities and owners’ equity (net worth). The balance sheet, together with the income statement and cash flow statement, make up the cornerstone of any company’s financial statements. If you are a shareholder of a company, it is important that you understand how the balance sheet is structured, how to analyze it and how to read it.

The balance sheet is divided into two parts that, based on the following equation, must equal each other, or balance each other out. The main formula behind balance sheets is:
Assets = Liabilities + Shareholders’ Equity

It might seems confusing that Equity is on the same side of the Balance sheet as Debts or Liabilities. That is because Assets (“what you have”) is paid for by Equity (“your money”) and Debt (“money you borrowed”): Assets – Liabilities = Equity

This means that assets, or the means used to operate the company, are balanced by a company’s financial obligations along with the equity investment brought into the company and its retained earnings.

Assets are what a company uses to operate its business, while its liabilities and equity represent how you paid for these assets. Owners’ equity (or shareholders’ equity) is the amount of money initially invested into the company plus any retained earnings, and it represents a source of funding for the business.

Types of Assets

  • Current Assets

Current assets have a life span of one year or less, meaning they can be converted easily into cash. Such assets include cash, accounts receivable and inventory. Accounts receivables consist of the short-term obligations owed to the company by its clients. Lastly, inventory represents the raw materials, work-in-progress goods and the company’s finished goods.

  • Non-Current Assets

Non-current assets are assets that are not turned into cash easily, or have a life-span of more than a year. They can refer to tangible assets such as machinery, equipment, buildings and land. Non-current assets also can be intangible assets, such as goodwill, patents or copyright.

Liabilities

On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside parties. Like assets, they can be both current and long-term. Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet. Current liabilities are the company’s liabilities which will come due, or must be paid, within one year. This includes both shorter term borrowings, such as accounts payables, along with the current portion of longer term borrowing, such as the latest interest payment on a 10-year loan or mortgage.

Shareholders’ Equity

Shareholders’ equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet into the shareholder’s equity account. This account represents a company’s total net worth. This is purely the Net worth from an Accounting point of view, and has no relation to the value of the company in terms of its earning capacity. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders’ equity on the other.

As you can see from the balance sheet above, it is broken into two sides. Assets are on the left side and the right side contains the company’s liabilities and shareholders’ equity. It is also clear that this balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders’ equity.

Analyze the Balance Sheet With Ratios

With a greater understanding of the balance sheet and how it is constructed, we can look now at some techniques used to analyze the information contained within the balance sheet. The main way this is done is through financial ratio analysis.

Financial ratio analysis uses formulas to gain insight into the company and its operations. For the balance sheet, using financial ratios (like the debt-to-equity ratio) can show you a better idea of the company’s financial condition along with its operational efficiency. It is important to note that some ratios will need information from more than one financial statement, such as from the balance sheet and the income statement.

The main types of ratios that use information from the balance sheet are financial strength ratios and activity ratios. Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how they are leveraged. This can give investors an idea of how financially stable the company is and how the company finances itself. Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle (which include receivables, inventory and payables). These ratios can provide insight into the company’s operational efficiency.

There are a wide range of individual financial ratios that investors use to learn more about a company.

 

1. Liquidity Ratios

1.1 Current Ratio (CR)

The current ratio is a financial ratio used to test a company’s liquidity (also referred to as its working capital position) by calculating the proportion of current assets available to cover current liabilities. Or: are there enough assets to pay for short-term debt.

Formula: Current Ratio = Currents Assets/Current Liabilities

In our example: 320.000 / 160.000 = 2

1.2 Quick Ratio

The quick ratio is a liquidity indicator that further refines the current ratio by measuring the amount of the most liquid current assets there are to cover current liabilities. The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which are more difficult to turn into cash. Therefore, a higher ratio means a more liquid current position.

In our example: 220.000 / 160.000 = 1,375

1.3 Cash Ratio

The cash ratio is a further refinement, where only cash is taken into account, compared to current liabilities.

The above ratios are not widely used in practice (except by the Dutch Chamber of Commerce). The development of working capital is more interesting. Let’s have a look at what Working Capital is.

Working capital

Working capital (abbreviated WC) is a financial metric that represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.

A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash.

‪Net Working Capital = Current Assets − Current Liabilities

‪Net Operating Working Capital = Current Assets − Non Interest-bearing Current Liabilities

Usually CFO’s like Koos Boot,  former CFO at Wegener , look at the total current assets (excluding cash) less the total non-interest bearing current liabilities. So, cash and bank debt are excluded. They are part of the financing of such working capital and is not part of the capital itself.

1.4 Debtors
 – Days Sales Outstanding (DSO):

Days Sales Outstanding is a company’s average collection period. How many days does it take your customers to pay you, in relation to your sales. Days Sales Outstanding is calculated as total outstanding receivables at the end of the period analyzed divided by total sales for the period analyzed (typically 90 or 365 days), times the number of days in the period analyzed.

Formula: DSO = Accounts Receivable/(Total Revenue/365)

Of course here you have to take the AR of a certain period (three months, or a year) and compare it to the revenu in the same period, divide by the number of days in that period

Sometimes it needs adjustment for VAT, which are included in the Accounts Receivable, but not in the Revenue and for last batch of invoices, which might not be due.


2. Profitability Indicator Ratios

A general statement: this requires comparing P&L (a number that comes from a certain period) to numbers of the Balance Sheet (at a specific moment), so it might be correct to use Balance Sheet averages, for instance: Balance Sheet at the begin and end of the period.

2.1 Return On Assets  

The return on assets (ROA) percentage shows how profitable a company’s assets are in generating revenue.

This number tells you what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets.

ROA can be computed as: Net Income/Total Assets

This number doesn’t say everything. A thriving business can still get into trouble, i.e. in a situation of extensive growth, in which the ability to secure external funding comes up short.

Example:

Net profit:                             €   44.700

Interest paid:                       €   15.000 +

Operating income:             €   59.700

Total assets                        € 560.000

Return on Assets:              € 59.700 / € 560.00 * 100% =10,66%

 

2.2 Return On Equity       

Return on equity (ROE) measures the rate of return on the ownership interest of the common stock owners. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth.

Formula: ROE = Net Income (after tax)/Shareholder Equity

A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company’s return on equity compared to its industry, the better.

Example:
 ROE= € 44.700 / € 200.000 * 100% = 22,35%

2.3 Return on capital employed (ROCE)

Return on capital employed ratio, expressed as a percentage, complements the return on equity (ROE) ratio by adding a company’s debt liabilities, or funded debt, to equity to reflect a company’s total “capital employed”. This measure narrows the focus to gain a better understanding of a company’s ability to generate returns from its available capital base.

By comparing net income to the sum of a company’s debt and equity capital, investors can get a clear picture of how the use of leverage impacts a company’s profitability. Financial analysts consider the ROCE measurement to be a more comprehensive profitability indicator because it gauges management’s ability to generate earnings from a company’s total pool of capital.

Formula: ROCE = NOPAT/Capital Employed

As Koos Boot pointed out to me: it might be more useful to look at Economic Value Added of Economic Profit to determine if the company creates value.

He wrote to me: “In that case you compare how much the company earns with its investments (ie total assets minus non-interest bearing debt) compared to what the company must pay on its funding. The latter is both interest and a (fictitious) compensation for equity providers. The latter charge is always higher than the interest for the banks because there is more risk involved. Both items (earnings on assets and capital costs) have to be adjusted for tax effects.

The analysis is used to separate the effects of investment versus funding.

Your understanding NOPAT (net operating profit after taxes) is here also (rightly) called, but not explained.

My experience is that in practice there is little use of ROA, RONA and similar concepts, but more often ROCE is used and then usually together with EVA.

In my experience ROE is rarely used. It is more common among shareholders than companies (and is therefore in itself  relevant)

3. Cash Flow Indicator Ratios

3. 1 Operating cash flow

While EBITDA is sometimes called “cash flow”, it is really earnings before the effects of financing and capital investment decisions. It does not capture the changes in working capital (inventories, receivables, etc.). The real operating cash flow is the number derived in the statement of cash flows.

Overview of the Statement of Cash Flows

The statement of cash flows for non-financial companies consists of three main parts:

  • Operating flows – The net cash generated from operations (net income and change in working capital).
  • Investing flows – The net result of capital expenditures, investments, acquisitions, etc.
  • Financing flows – The net result of raising cash to fund the other flows or repaying debt and dividends.

By taking net income and making adjustments to reflect changes in the working capital accounts on the balance sheet (receivables, payables, inventories) and other current accounts, the operating cash flow section shows how cash was generated during the period. It is this translation process from accrual accounting to cash accounting that makes the operating cash flow statement so important.

3.2 Free cash flow can also be calculated by taking operating cash flow and subtracting capital expenditures.

Formula: FCF = Operating Cash Flow – Capital Expenditures

3.3 The free cash flow/operating cash flow

The free cash flow/operating cash flow ratio measures the relationship between free cash flow and operating cash flow.

Free cash flow is most often defined as operating cash flow minus capital expenditures, which, in analytical terms, are considered to be an essential outflow of funds to maintain a company’s competitiveness and efficiency.

The cash flow remaining after this deduction is considered “free” cash flow, which becomes available to a company to use for further expansion, acquisitions, and/or financial stability to weather difficult market conditions. The higher the percentage of free cash flow embedded in a company’s operating cash flow, the greater the financial strength of the company.

Formula: Free Cash Flow (Operating Cash Flow – Capital Expenditure)/Operating Cash Flow

 

3.4  Working capital ratio

This ratio indicates whether a company has enough short-term assets to cover its short-term debt. Anything below 10 indicates negative W/C (working capital). While anything over 20 means that the company is not investing excess assets. Most believe that a ratio between 12 and 20 is sufficient,

If you have calculated how much capital you have, you do not know whether that amount is high enough. To determine to some extent, working capital is often related to the annual revenue or total assets. 
The working capital ratio is calculated by dividing working capital by total assets or annual revenue and the result multiplied by 100 percent.

Example:

Inventory:               € 100.000,=

Debtors:                   € 100.000,=

Cash:                        €   20.000.= +

Current assets        € 220.000,=

Current account:    €   80.000,=

Creditors:                 €   80.000,= +

Short term debt:      € 160.000,=

Working capital:    €   60.000,= (+)

Turnover:                            € 500.000,=

Working capital ratio:     € 60.000,= / € 500.000,=  12%

4. Ratios related to debt

Solvency ratios if one of many ratios used to measure a company’s ability to meet long-term obligations. The solvency ratio measures the size of a company’s after-tax income, excluding non-cash depreciation expenses, as compared to the firm’s total debt obligations. It provides a measurement of how likely a company will be to continue meeting its debt obligations.

In practice you will almost always find: Net debt / EBITDA. This is often a covenantratio for bank financing. Net debt is usually all interest-bearing debt minus cash.
In fact it indicates how many times your income your debt can be. This will sound familiar if you consider  your personal situation. The bank provides mortgage that will not exceed three times your annual salary.

4.1 Debt-Equity Ratio 

To a large degree, the debt-equity ratio provides another vantage point on a company’s leverage position, in this case, comparing total liabilities to shareholders’ equity, as opposed to total assets in the debt ratio. Similar to the debt ratio, a lower the percentage means that a company is using less leverage and has a stronger equity position.

Formula: debt-equity ration = Total Liabilities/Shareholders’ Equity  

Often you will see the old solvency ratio Shareholders’ Equity / Total assets. Total assets are often adjusted for non-interest bearing liabilities. These are deducted from the assets (ie a net assets balance).

4.2 Interest Coverage Ratio

To what extent are expenses covered by your operating interest? In short, you can easily pay off interest on your financiers from the realized profit.

Banks establish different standards for different industries.  The assumption is that the RF (ICR) must be at least 4. After all, interest rates may vary over time, and you must be able to cover a higher interest rate.

The higher the number, the more security to foreign capital providers can be given.  As a result, the interest obligations of the company are met.

Example (based on a dutch BV structure):

Turnover:                    € 500.000

Cost of sales               € 100.000

Salaries                       € 150.000

Depreciation              €   60.000

Other costs                 € 115.000 –

Operating result        €   75.000

Interest costs              €   15.300 –

Profit before tax         €   59.700

Tax                                €   15.300 –

Profit after tax            €   44.700

Interest coverage ratio   € 75.000 / € 15.300 = 5

4.3 Tangible Net Worth

A measure of the physical worth of a company, which does not include any value derived from intangible assets such as copyrights, patents and intellectual property. Tangible net worth is calculated by taking a firm’s total assets and subtracting the value of all liabilities and intangible assets.

Formula: Tangible Net Worth = Total Assets – Liabilities  – Intangible Assets

Again, this says nothing about the future earning capacity and is is therefore not widely used. Sometimes banks like to have an old-fashioned view at equity and deduct all intangible assets just to be sure. The outcome is then divided by total assets. If you score above 30% is, one feels (rightly or wrongly) comfortable.

4.4 Capital Base

Since Solvency II banks are looking intently at their clients’ Capital Base (in Dutch: Garantie Vermogen). In our dealings with Deutsche Bank, they used the following definition for Capital Base:

The Capital base comprises share capital, retained earnings, subordinated debts (debts that are only repaid after the bank loans have been repaid) and reinvestment reserves arising from revaluation. Minority interests and Intangible Assets like goodwill are deducted.

Capital Base Ratio: Capital Base/Balance Total

So:

share capital plus

retained earnings plus

subordinated debts  plus

passive tax latencies (like reinvestment reserves) minus

Intangible Assets (such as goodwill)

Minority interests minus

Active tax latencies (like Deferred Taxes)

As a percentage of the balance sheet total

 

The balance sheet, along with the income and cash flow statements, gives an insight into a company and its operations. There are probably many differences per country, per industry and per bank you are dealing with on what is important, and what is not.

Investors have a different view of the world than banks, and both of them have different views than the entrepreneur or executive who is implementing his strategy. In all cases: you have to understand what you are looking at, and you have to make your own choices based on the facts that are important to you. In the end, financial figures might distort the reality as you know it, but if you understand their language, they do not lie.