Do you think of your business as a financial investment?
Do you make time to review your strategic progress? Do you have clear measures by which to measure your strategic progress? Are you clear about the short-term, medium-term, and long-term objectives of your strategic plan? Do you see your strategic plan as a series of strategic projects, or do you see it in terms of the overall growth and wealth creation objectives?
Ultimately, your business is a financial investment, and the objective of financial investments is to achieve a financial return. Taking an investment management approach to your business means focusing on achieving a return commensurate with the size of the investment, the cost of capital, and the risk profile of the business.
Creating wealth will be achieved when businesses achieve higher returns than those merely commensurate with their investment return profile. If businesses are achieving higher returns, wealth creation will be leveraged by reinvesting a higher proportion of the retained profits back into the business.
What we observe in small to medium sized businesses
The saying “you can’t see the forest for the trees” comes to mind when I think of this issue. Experience demonstrates that most strategic decision makers in business are dealing with a lot of detail. Often, this detail can be around some of the key focus areas of the business, as you would expect it to be. However, this often results in strategic objectives fading into the background and, after some time, becoming dislocated from the strategic goals of the business.
These businesses need to establish those clear short-term, medium-term, and long-term wealth creation objectives. These objectives will relate to return on investment and should consider the level of reinvestment and the power of compounding as it applies to investment returns.
Your business is a wealth engine
Wealth is created by investing at high returns, and the more you invest at those high returns, the more wealth will be generated. So, the ultimate goals of wealth creation are:
- What level of returns can you achieve each year?
- What level of funds can you invest into your business each year?
- How can these funds be invested in a way that maintains the high returns?
Now, not every business has genuine growth opportunities. Some businesses have become non-competitive due to changes in economic, technological, or legislative environments. But most small to medium sized businesses do have significant investment opportunities. Their challenge is often managing the resources required to assess and implement the investment opportunities well enough to achieve the wealth creation goals.
The Virtual CFO Group Australia works with clients to establish the multi-term goals for wealth creation. It also helps to establish the framework in which performance can be reviewed from the perspective of strategic goals and not simply profitability. This will often highlight those modifications to strategic plans that are required to better achieve the wealth creation performance levels.
What are the key settings of a wealth engine?
Essentially the key measure of return is “return on equity”. The measure of return is net profit after tax (NPAT). This is the measure of return that is available to shareholders. This is measured as a percentage of net assets. In theory, net assets equates to the investment that shareholders have made in the business. Of course, a range of accounting and other valuation issues can influence this measure. For some business founders, they have invested many years of sacrifice of remuneration, which can rightly be added to the book value of net assets.
The reinvestment ratio is the other critical wealth creation measure. This is the amount of NPAT that is reinvested into the business (i.e., not taken out as dividend/distributions). The basic logic is, if you can reinvest those funds in projects that provide a 20% return on investment, or thereabouts; why would you want to take it out of the business to invest at a much lower rate?
The Virtual CFO Group Australia has extensive experience in working with businesses to help establish the strategic frameworks for creating real wealth.