If you’re a manager of managers, you probably wish they had a clear understanding of how your company makes money. Otherwise, their decisions are likely to be myopic (in their silo) and disconnected from your company’s financial Big Picture.
So, how does your company actually make money? To answer that question, let’s explore a simpler example: How does an apple farm make money?
The obvious answer – by selling apples to customers in exchange for Revenue.
But if we peel back the onion, or the apple in this case, we discover the steps have to happen before Revenue is earned:
- The farm needs to pay employees to pick the apples and to tend to the trees by pruning, watering, and fertilizing. These activities require supplies, such as water and fertilizer, and other overhead such as power and insurance. These Expenses are necessary to produce the apples that earn Revenue.
- But these Expenses themselves are not enough. To produce apples, the farm also needs land, machinery, money in the bank, and expertise in apple farming. We’ll call these components Assets. These physical, financial and intellectual Assets are the farm’s infrastructure. Without Investment in Assets, the Expenses could not produce apples and earn Revenue.
- But where did the funding for these Investments come from? How did the farmer pay for the Assets? Typically, some of the funds came from a lender who extended a loan, called a Liability, to the farmer.
- But the lender typically won’t approve a loan unless the farmer has some “skin in the game,” by funding some of the Investment with their own money, called Equity. Qualifying for a loan based on Equity is called leveraging equity.
- But where did the Equity come from? Well, it had to come from the farmer’s personal funds or from the farm’s Income, that is, the amount that Revenue exceeds Expenses.
Now we have closed the “virtuous circle” of how an apple farm makes money. I call it the Universal Business System™ (UBS). The UBS in one sentence is:
Equity is leveraged with Liabilities to fund Investment in Assets that together with Expenses generate Revenue that results in Income that adds to Equity.
The UBS is how your company makes money (and survives and thrives). Try tracing through the analogy of the apple farm to identify the components of your company’s Universal Business System™.
When your managers have a clear understanding of how your company makes money, they will to be less myopic (in their silo) and their decisions will be more connected to your company’s financial Big Picture.