Enhancing Business Acumen

Business Acumen, sometimes called being “Strategic” or displaying “Executive-Level Thinking,” is a phrase found in many job descriptions for managers and leaders.

Business Acumen: The under-appreciated skill in business that can be learned (over time).

Companies want to hire and promote employees with Business Acumen. Yet, in my experience, most organizations do not actually teach this skill, even to those they identify as high potential.

Undergraduate degrees in various aspects of business – accounting, finance, marketing etc. – tend to focus on skills to succeed in the single functional area. Few can afford the $200K cost (plus additional opportunity cost) of a premium business school education which could teach business acumen.

It would be arrogant to suggest a single article can help you develop business acumen. What follows is my simplified recipe on how to enhance your strategic thinking.

Those who join the CxO Community will be exposed to a short interactive course, taught in a Cohort format, that dives into this topic.

THE FOUR PARTS OF BUSINESS ACUMEN

1. How Does a Company Make Money? Or Analyzing Financial Statements.

Understanding how a company makes money requires being able to “read” financial statements.  Making money requires collecting more cash (on a consistent basis) than a business spends.

There are three core financial statements that a business leader needs to navigate.

The Income Statement – Sometimes called the Profit & Loss Statement, the I/S records the revenues and expenses of the business, which can result in net income or a net loss.  GAAP accounting rules govern how revenue is recorded. Expenses are recorded as they incurred and pro-rated over the period in when the services in question are delivered. Depreciation expense shows the period equivalent cost of a fixed asset based on the estimated useful life (e.g., shorter for computers, longer for furniture, longest for factories.)

The Income Statement shows the performance of a business over a period – it can be a month, a quarter, or a year.

The Balance Sheet – This records the Assets and Liabilities of a business. They need to be equal – hence the name “balance sheet.”

Assets are the value of all items that “belong” to the business. Assets include cash (in the business bank accounts), property/equipment (purchased by the business), receivables (owed by customers), security deposits (paid to landlords) etc.

Liabilities are the total value owed by the business to third parties – to vendors (payables), customers (deferred revenue), employees (payroll liabilities), the government (tax liabilities), and lenders (debt).

The difference between all the total assets and total liabilities is Owner’s Equity. Owner’s equity increases when new shares are issued, options are exercised, or the company makes a net profit. Owner’s equity is reduced from the payment of dividends, repurchase of shares, or when the business makes a net income loss. The statement of changes in equity (fourth statement above) is reported typically only with audited financials.

The Balance Sheet shows the state of a business at a specific point in time (typically the last day of a month, quarter, or year.) In the diagram above it is called the Statement of Financial Position.

The Cash Flow Statement – This is the most important statement in a business. It reconciles the “net income” shown on the Income Statement to the period ending “cash and cash equivalents” balance recorded on the Balance Sheet.

There are four big buckets of reconciling items. First, non-cash items such as depreciation and stock compensation expenses. Second, working capital changes such as invoices issued in advance of collections or expenses recorded prior to payments to vendors. Third is capital expenditures – investments in assets that have long lives such as computers, factories, furniture etc. These capital investments are typically lumpy. Fourth, are all the financing activities such as issuances or repayment of debt, issuance of equity, and payments of dividends.

The Cash Flow Statement shows how cash is generated or used by a business over a period – a month, quarter, or year.

2. How Does My Company Make Money? Or Understanding Unit Economics.

• Unit economics refers to a financial representation of how a “single unit” in the business functions. It includes:
  the costs to create a “single unit” in a business (upfront investment)
• The revenues (cash collections) from a unit over its lifetime
• The direct costs to provide all the necessary services to a single unit (expenses) necessary to collect the revenue

What is the Unit? The unit differs from business to business. Getting this metric right is critical. It is most often a single customer but can be a single physical location (e.g., gym, restaurant, hotel, clinic) or a product being utilized (e.g., rental e-scooter, leased industrial robot etc.)

Costs to Create a Unit. There are two primary categories of costs. First is the capital cost to build the unit, if relevant (as in the case of a physical location or a product being rented). Second, is the total sales and marketing cost to acquire the customer(s) who either are the unit, fill up the unit, or use the unit.

Revenue from a Unit.  This can be calculated over a single period for a subscription business (e.g., a month) or a longer period for a marketplace or e-commerce business (where customers may not transact each month but typically do more than 1x in a year.) In no case should the revenue be calculated over a period longer than the effective lifetime of the unit. The lifetime of the unit is the period after which the customer churns (needs to be “re-acquired”) or the physical unit needs to be replaced (due to damage) or substantially upgraded (due to obsolescence.)

Direct Expense of serving a Unit. These are all the expenses to serve the customer such that the contract they have entered with a business has been fulfilled. For an e-commerce business, these expenses would include product costs, packaging, shipping, returns, warehouse expenses, credit card processing cost etc. For a SaaS business, it would include hosting and customer care costs.

Contribution per Unit. This is the difference between the revenue and direct expenses of serving a unit over a period. For subscription businesses, the period is typically a month. For an e-commerce or marketplace business, the period is often a year.

Payback Period. This is the number of months (or years) it takes for the contribution per unit to pay back the total cost to create the unit. Naturally shorter is more attractive to investors. Once the cost to create the unit has been “paid back” future contributions from this unit can be used to pay back the fixed costs of the business – typically the R&D team, the G&A team and other overhead (rent, corporate insurance etc.)

3. What makes my Customer feel Successful and Satisfied? Or Empathizing with the Customer.

Without customers, there is no business. It is essential to have loyal customers (those who spend on a repeated basis with the business.) Ideally, customers become evangelists for the product or service, recommending it to their friends and peers, thus reducing the cost to create the incremental new “unit.”

Empathizing with the customer means understanding in detail the customer needs or job-to-be-done.  All employees in a business should spend time understanding their customer and his/her challenges – whether by directly shadowing them, interviewing them, or simply learning about their life/work process (as regards the need your product addresses).

In B2B, the job-to-be-done can often be quantified numerically – more revenue or less cost coupled one or more of the following benefits, compared with the status quo method:

• is easier to execute;
• is completed faster;
• requires less human oversight; and,
• happens with fewer errors.

In B2C, the practical things including price, quality, features, and functionality matter. However, they are rarely enough to create a sale, particularly for the first-time customer who is being asked to trust a “new” experience.

Consumers tend to choose products or services based on how they believe it will make them feel or what emotional need it would satisfy, in addition to the basics of attractive price and high quality.

Sometimes the need is simply to not take a risk or look foolish. The largest competitor to your product or service is often the customer doing nothing or using their current solution, even if it is imperfect and they know that.

Business acumen is enhanced by remaining curious about your customer, even if your job involves little or no customer interaction.

4. How to Pick a Path Forward when faced by choice and complexity? Or Decision Making under Uncertainty.

On the one hand, we all know that no one can predict the future. On the other hand, we have been taught that financial models, probabilities, decision trees and other mathematical tools aid in making good decisions.

Both are true.

So, what should you do when faced with uncertainty? After all, making decisions is part of the job of an executive and a leader. If you continually defer complex decisions to your boss (particularly without a recommendation), you are going to limit your career progress.

My (oversimplified) advice on approaching the decision-making challenge.

• How Much does the Decision Matter? Jeff Bezos is known for advising that decisions be split into two categories – (i) high cost, consequential ones (he calls these ‘one-way doors’), and (ii) low cost, reversible ones (he calls these ‘two-way doors’.) Is this decision a ‘One-Way Door’? If so, he recommends asking a lot of questions, including why the decision might be wrong or what would need to happen for the outcome to be negative. If the decision is low-cost, where failure or a sub-optimal outcome would be painful but not terrible, I recommend deciding quickly, allowing the organization to execute or focus on a more important priority.

• What are the Key Variables or Assumptions? Those with strong business acumen can figure out quickly what variables really matter. Typically, there are at most two or three variables responsible for 80% of the change in the outcome. Identify those and spend your time thinking through them.

• Adopt the “Outside View”. We find it much harder to make decisions that impact us directly than we do giving advice to others about their decisions. Depersonalize your challenge, whether actually personal or a business challenge. Imagine how others would have approached this challenge. Ask friends or acquaintances in your business network.

• Divide Large Decisions into Stages (if possible). This is not always possible, but if it is, move forward with just the first stage. And, then make the next decision once there is enough proof of success from the first decision. Ensure you have agreed on a metric for success for each stage prior to starting.

• Buy Options. When decisions involve large costs and the fear of a negative outcome is high, investigate whether options are available. You will pay extra for an option, but it will often be a valuable insurance policy. Examples would be signing up for a more expensive, shorter-term lease or hiring someone as a consultant prior to making a full-time offer. In effect, pay extra for the ability to try something and cancel it if it is not meeting your hopes or expectations.

• After Analysis and Diligence, Trust Your Gut. We live in an era where data-driven decision-making is exalted almost to cult-like status. Don’t get me wrong, data certainly helps and should be gathered. However, at some point, almost every decision (especially if people are involved) requires paying attention to emotional signals. Your gut is surprisingly good once you have done the basic diligence. Trust it.

• Don’t Be Afraid to Be Wrong. Everyone makes mistakes. Personal growth and great achievements in business are not possible without some experiences with failure. You only control the decision-making process and not the outcome. Follow a good process and be willing to accept both favorable and unfavorable outcomes.

Pattern Matching

If I had to summarize business acumen in a few words, I would choose pattern matching. Pattern matching is something honed over time. Experience gained by the passage of time (in a career) coupled with curiosity around the decision-making process build business acumen. Those who exhibit above-average acumen almost seem effortless in making decisions (usually the right ones.) That’s because the process of decision-making inherent in strong business acumen can become intuitive. I like Seth Godin’s quote on this subject.