In part 1-4 of this business leadership series you’ve investigated the business structure, identified the gaps and communicated a clear and vivid vision. Now, it’s time to start thinking about how you can improve the financial results of your business. In part 5, you will analyze and identify what you can (and should) focus on in your business to make it profitable. In other words, you have to find the key levers that drive results and that you have control over.
Back to the Basics
Bringing financials back to basics, income is made up of two components: revenue and expenses. It’s as simple as that – if you have $100 in revenue and $80 in expenses, you made $20. That’s how every business operates: revenue and expenses. Where it starts to get tricky is that each of those is made up of several sub-components.
I’ll use an insurance company example:
Income = premiums, Fee income, investment income
Expenses = claims, operating expenses, reserve changes, commissions, taxes
As the business leader, you need to figure out what you can impact – and what is most impactful. In the picture below, known as a net income drill-down tree, you’ll see how I’ve gone through the various components of revenue and expenses to identify what the key levers are and, importantly, what we have a lot of influence over. We know that if we focus on improving the key levers, we can have a meaningful impact on our financial results.
Continuing with the life insurance example, this is what the analysis looks like in action:
The green example on the left side of the chart shows that revenue has several components, but the biggest driver is premiums. Premiums, in turn, are driven by new sales, persistency (those who stay and keep paying), and rates (the more competitive, the more business, but the lower the premiums). In this example, we determined that the ability to sell (generate new sales) is our biggest driver of premiums.
From there, we can look at the drivers of sales: rates, effectiveness of sales, and pipeline. Then, we focus on what salesforce effectiveness is driven by: pre-sale activity and ability to close business. This type of drill-down analysis requires the right combination of expert resources to ensure all voices are heard, such as finance, sales, underwriting, actuarial, etc.
Now follow the green path in the example back up chart: if pre-sale activity is the biggest driver of salesforce effectiveness, and salesforce effectiveness is the biggest driver of sales, and sales are the biggest driver of premiums, and premiums are the biggest driver of revenue, then you’ll want to focus your attention on improving, monitoring and measuring pre-sale activity.
Take the same approach for the expense side of the chart (the red path). Understand what the biggest drivers of expenses are and then hone in on the ones you can have most impact on.
Where Can You Make A Difference?
Business leaders need to focus on what they can influence and control (the levers/drivers described above), determine how to improve upon those levers, then continually measure and monitor them to observe the impact your actions are having on the overall results of on the business. You can’t pay attention, control, or do everything. Instead of worrying about everything, you need to spend time on the things you can control and what’s most impactful.
The sample chart above will be somewhat different for each organization and every type of business. However, all companies can start at the top with revenue and expenses.
Try the process for yourself – did you discover a new focus area or rearrange your strategy afterwards? Or perhaps you gained more confidence in the direction you’re already taking? Learn about the next steps in business leadership – running the business.