Insight into how to utilize this key Business Acumen metric as a critical measure of business performance
In Advantexe’s simulation-centric Business Acumen learning journeys we teach new hires, experienced managers, high potential leaders, and executives how to measure the success of their strategies through financial metrics of performance.
The core metrics of performance we use and train on include foundational tools such as Return on Sales (ROS), Return on Assets (ROA), and Return on Equity (ROE). These “big three” financial metrics are the heart of financial acumen. They provide insights into the relationships between profitability driven from revenue, profitability driven from the assets that are invested in the business, and the profitability of the equity provided to the business by owners and investors.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is another excellent financial metric that many business professionals find useful because it provides a strong analysis of the controllables a business manager has at his/her disposal.
For a time during the late 1990s and early 2000’s some businesses started to evaluate performance in terms of “Economic Value Added” (EVA) which is also known as Economic Profit. Most recently, I have discovered that organizations have been using Total Shareholder Return (TSR) as a key metric.
About two years ago I became exposed to an interesting situation at a client who was dealing with an activist investor who has a unique perspective on how to measure the success and value of a firm. As part of my work, I helped prepare leaders for working with the activist investor by training them to speak a different language of business. Many of the ideas and insight of the activist investor are prudent and thought provoking and one of the more useful tools we learned about – and built into our award-winning AGES simulation platform was a concept called Cash Operating Return on Assets (COROA) which was first introduced by Jack Ciesielski, author of The Analyst's Accounting Observer.
Simply defined, COROA is the ratio of all of the cash an organization generates in a time period (usually a year) plus adding back in taxes and interest and then dividing that number by the cumulative investment in assets during the history of the business. COROA provides one of the purest measures of how well a business is being run because it assesses the cash being generated by the business from the assets invested in the business. If the COROA is low, then the leaders are creating positive long-term cash flow and aren’t investing wisely in the right assets.
In a Business Acumen training session I ran this week, I decided to track the COROA of 4 competitive organizations playing against each other in our highly competitive healthcare industry simulation. Each of the organizations had a unique strategies; two were executing a Product Leadership strategy, one was executing a Customer Intimacy strategy, and the fourth was executing an Operational Excellence strategy.
All four organizations utilized cash efficiently; the product leaders investing in R&D, the Customer Intimate investing in service infrastructure, and the Operationally Efficient company investing in capacity and manufacturing. After three simulated years, the team producing the best COROA was the Operationally Efficient company that found the perfect balance between quality products sold to cost conscious customers. The OE company was able to grow revenue by at least 5% per year and after an initial investment in capacity they were able to maintain their plants at 85% utilization and through maintenance and process improvement increase their yield every year.
The combination of revenue growth plus asset utilization provided a significantly better COROA (23.45%) then the next best competitor (14.66%). The second-place competitor had high revenues, but their costs of goods sold kept increasing and as a result of poor sales forecasting produced more product than they were able to sell. That inventory further reduced the overall COROA.
In summary, there are many excellent metrics of performance and most of them provide great insights into the challenges and opportunities of leading a business. COROA is a unique metric that is worth paying attention to and focusing on as part of a truly balanced scorecard.