At Advantexe, we believe that leadership is equal to the execution of your business strategy and a good business strategy has metrics of financial performance such as revenue growth and profitability. Last week I wrote a blog about the concept of EBITDA – defined as earnings before interest, taxes, depreciation, and amortization – and how it remains an important and valuable metric of business performance. It turns out that this blog was one of our most popular ever and I received several emails asking me for more information. I received this email from one of our former participants of a Business Acumen learning journey:
Great blog on EBITDA. I am sharing it with my team as EBITDA is something they are evaluated on but not everyone understands very well. Question for you. How would you recommend me sharing with my team a couple of ways to increase our EBITDA? One of my Prioritized Goals this year is to increase our department’s EBITDA by 50 basis points. Any help will be greatly appreciated”
As I started thinking about this email, I realized this question is the basis for a nice follow-up blog.
For those of you unfamiliar with the concept of the “basis points,” I will start there. In financial management, basis points (BPS) refer to a common unit of measure for percentages. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to represent the percentage change in a financial metric such as margin or return on assets. The relationship between percentage changes and basis points can be defined as follows: 1% change = 100 basis points, and 0.01% = 1 basis point. An example of a departmental goal would be:
- In 2017, increase EBITDA by 50 basis points
A 50 point basis point increase in EBITDA would be a .50% increase. That may not sound like a big thing, but consider if your business unit EBITDA is $50,000,000, then a 50 basis point increase is worth $250,000. That $250,000 can be used to re-invest in the business in the form of more sales people, more marketing, or even more equipment. It can also be returned to shareholders which will make the value of the stock go up.
So how can leaders impact and increase EBITDA Basis Points? Here are three common and direct ways which can be applied to your business immediately:
When you discount prices, you are in effect reducing your EBITDA. The easiest and most effective way of increasing your EBITDA is to maintain your prices and sell your customers on the value of your products or services. While you are able to maintain your prices, you can then look for other areas to reduce costs and increase your earnings.
Increase your Working Capital by Effectively Managing Inventories
Many leaders and business professionals don’t realize that poor inventory management practices negatively impact working capital and EBITDA. Think about it this way. For every product that you produce and sits in inventory is a product that has cost you money but you haven’t collected revenue on yet. Those two factors impact your EBITDA twice by not having the revenue and by incurring the cost. To be an effective leader, you need to ask questions about production, the need for too much inventory, and finding the right balances between sales and manufacturing.
Focus on Optimizing Management of Travel & Entertainment Budgets
Your travel and entertainment budget should be viewed as an investment. Taking a client out to dinner or sending a direct report to a training program should have a return in either increased revenues or decreased costs. However, from an accounting perspective the T&E budget is viewed as a pure cost that reduces profit. The job of a leader is to optimize the budget to yield the most return on investment. Is that visit to that customer necessary? Is it critical for everyone to fly to a team meeting, or can it be done in a virtual meeting space? Optimizing the T&E budget in a more effective way can significantly increase EBITDA.