Finance Acumen for Operations Manager
– Dr. V. Bharathi
In the changing business scenario, the primary concern of any business is to enable the organization to constantly deliver good financial results leading to sustained growth of the business in the changing times while making best use of the opportunities and steering challenges. Operational and Financial performance are the two sides of the same coin as companies need to optimize operational performance to support financial performance. Accordingly a certain degree of financial acumen is vital for all the business stakeholders to appreciate the link between operational performance and financial health of the Company.
This article examines the link between operational performance and financial health of the company in a multi project scenario. Interwoven aspects in the business are raising funds, investment in capital and working capital, revenue generation and wealth creation. These aspects are recorded in two important financial statements, Profit & Loss Statement and Balance Sheet.
The ‘Profit and Loss Account’ or the ‘Income Statement’ summarizes the various components of revenues and expenditures. The net difference between the two constitutes the ‘Income’ or ‘(Loss)’, as the case may be. The Balance Sheet is a statement of assets and liabilities at the end of the accounting period (a “snapshot”) of the business. The balance sheet shows at a particular point in time what resources are owned by a business (“assets”) and what it owes to other parties (“liabilities”). It also shows how much has been invested in the business and what were the sources of that investment finance.
The operational performance begins from the phase of raising required funds from the appropriate sources at a reasonable cost. There begins the journey of creation of Liabilities and Assets for the organization. Investment decisions are very critical as it measures the company’s ability to utilize its assets to generate revenue. Operational performance at every stage impacts the profit and wealth maximization objectives. The operational performance has direct impact on the liquidity, solvency, asset utilization and profitability of the company. The flow chart above shows the bird’s eye view of financial management in Business Organization.
A. Liquidity Position
The liquidity position of the company can be ascertained by establishing a relationship between current assets and current liabilities. In other words, understanding how much current assets are maintained for every one rupee of current liability. It is appropriate to maintain 1.5 to 2 times current assets to current liability. A ratio of less than one is often a cause for concern, particularly if it persists for a considerable length of time. Too high current ratio is also not good as excessive money blocked in the current assets reduces profitability.
The liquidity position of the company can be improved by optimizing the Operating cycle time. The time required for a business to make an initial outlay of cash to produce goods and receive cash from the customers in exchange for the goods or services is known as Operating Cycle(OC) or Cash Conversion Cycle (CCC). The figure below shows the Operating cycle elements.
A few important operational aspects that optimizes the duration of the Operating cycle are :
I) Supply Chain Management
• Identification and development of competent suppliers
• Proper estimation of procurement lead time
• Execution of contracts
• Sustenance of Suppliers
II) Production Management
• Suitable manufacturing facilities
• Proper planning and scheduling
• Process capability
• Competent workforce
III) Receivables Management
• Assessing customer’s credibility
• Credit policies
• Follow-up and monitoring mechanisms
B. Solvency Position
The term solvency implies the ability of the enterprise to meet its long term obligations on the due date. Long-term lenders are primarily interested in two things. The safety of principal which is to be given by way of loan, and regular servicing of the loan, in the form of payment of interest commitments and repayment of installment of loan.
Employment of short term and long term funds appropriately is very significant in magnifying the shareholders return/wealth. A few Operational parameters which impact the solvency position of the company are deployment of short term and long term funds, execution of sale orders, realization of money from customers etc.
C. Asset utilization
Company creates assets to generate sales. The utilization of assets is ascertained to review the decisions of asset acquisitions. This measurement triggers various questions such as “Are we blocking too much money in fixed and current assets?”, “How much revenue is being generated by each rupee’s worth of assets invested in the business?” etc. A few factors that influences the companies to block their money in fixed and current assets are:
Every business aims to earn profit as it is required for the survival and growth. The need for reasonable profit in a business is to contribute to the net worth of the organization. Company’s overall efficiency and performance gets reflected in various profit levels. It is very important to assess the profit earned or returns relative to the various elements of business like Cost of goods sold, Sales, Capital Employed, Equity etc.
A good sense of financial awareness would help Operations Manager to take appropriate decisions in every stage of the business leading to improved liquidity, solvency, asset utilization and profitability positions.