Rick’s Theory of Relativity

Everything in business is relative. I’m not talking about aunts and uncles, but about comparing your business to others and accelerating your profitability and growth beyond the competition. Customers, suppliers, bankers, employees and owners are always comparing your performance, and the most important comparison is the overall rapid growth in the value of your business.

Value is usually defined as EBITDA (earnings before interest, taxes, depreciation and amortization) multiplied by a factor for your industry. For most manufacturers, for example, that’s a factor of 4 to 6. Dramatic increases in profitability and growth accelerate valuation.

Albert Einstein developed his theory of relativity, E = MC2, which says that various measurements of quantity are relative to the observers’ velocity. In Rick’s Theory of Relativity, if you want to generate rocket fuel for growth and profit, you need to increase the speed of the engine.

Rick’s Theory of Relativity:

  • E = Engine for Profitable Growth
  • M = Margin
  • C1 = Cash Flow
  • C2 = Capacity Utilization

Margin

Whether you’re a manufacturer, distributor, service organization or other type of company, the margins you earn should be considered on a part (or service) category basis. The ability to move margins up or down to improve sales and profits has a big impact on growth and profitability. My consulting associate Phil Symchych says that if a part, service or activity doesn’t produce profit, it consumes profit. Do most of your activities produce or consume?

Cash Flow

It’s critical to understand your cash-to-cash cycle to determine the time it takes from the point when you spend a dollar – typically on wages and inventory – to the point when you get it back from your customers. Not only does this keep the company healthy, but strong cash management can also boost profitability.

In recent engagements, I’ve seen cash to cash cycles that vary from 35 days to over 300 days. Anything over 55 or 60 is not very good and costs you money. While this varies according to industry, long cash-to-cash cycles are a bad omen. Bankers get really nervous when they see cycles over 90 days. Long cycles also consume profits. Do you know your cash-to-cash cycle?

Reducing your inventory not only frees up cash, but drops a significant amount to the bottom line as well. Over my 15 years of consulting with mid-market companies, I’ve measured the cost of holding inventory and it typically runs in the 2.5% to 3% per month range. That means that $2 million in inventory will cost almost $170,000 to hold for 90 days, and over $700K to hold more than a year.

Capacity Utilization

The ability to increase capacity without capital investment can fuel profitability and growth. Leveraging your fixed costs can dramatically impact your business value. Many people think the primary result of efforts like lean, six sigma, continuous improvement and others is cost reduction and efficiency, but in fact, the real goal is improved flow and expanded capacity.

When Henry Ford created the Model T it initially took 12.5 hours to finish a chassis assembly. Implementing the mass production approach reduced that to a mere 93 minutes. Eventually a completed car came off the line every 10 seconds. This meant that Ford could cut the car’s price and realize his vision: to make an affordable car for the masses.

Ford’s profitability and growth were astronomical. Constant improvement led to the business models later used by Toyota and others, which many companies try to copy today.

Is your engine tuned for profitability and growth? Do you have the rocket fuel you need to power exponential improvement? When your sales and marketing people are calling for more power, can your engine respond? Use Rick’s Theory of Relativity to accelerate your profit and growth, and the stars will be the limit.

© 2014 – Rick Pay – All Rights Reserved