“…….Chesshire Cat, could you tell me, please, which way should I go?
"This largely depends on where you want to go," said the Cat.
"I don't care much about the place…" said Alicia.
"Then the path you take doesn't matter much either," said the Cat.
-… That takes me somewhere - added Alice to try to explain…
"Oh, you'll always get somewhere," said the Cat, "if you walk long enough!"
Carrol Lewis, Alice in Wonderland.
Many times, one of the most difficult questions to answer, to an entrepreneur, is usually related to Am I doing it right? Should I be satisfied with the results I get?
In this article we try to play with these concepts, which we would try to summarize in:
- Business profitability, how do I measure it? It is more interesting to have the money invested in my company. Or should I compare myself with the market? What is more important,…. ROE, ROA, or economic profitability? What is the risk premium that I should charge for having business and not having my money so "safe"? What is the risk premium that the Bank charges me, when do you finance me ?.
In the example case, which, if you have time, you could recommend to the firm what it should do, regarding the aspects that we have commented or others that you can think of.
Example case: Martínez SL
Do I dare to tell Martinez the path he has to follow? Would you know how to do it?…
Analysis of your results (Example)
Martínez SL, sells 2 MM euros a year, and has obtained a BAI (Profit Before Taxes) of 26.5 thousand euros.
Your questions:
- Is the profit fair, or at least desirable in current market conditions? Where should we improve?
Our analysis process:
- The BAI obtained hides a higher remuneration (with respect to the market) that the owner makes to his wife, to whom he is discharged. Likewise, he personally receives a lower remuneration for what we estimate, his qualification and his functions. You do not receive or pay, rents or other similar concepts (below or above).
And from here and from the base data, we obtain some conclusions that can guide Martínez SL
ROA and leverage
It seems that the bank, according to our calculations, charges an average interest rate of 11.29%, which implies, together with the dividend that the main shareholder wants, a total cost of liabilities of 4.86%. However, the ROA (Return on Assets) is 4.04%, which would mean that it is in negative leverage.
In other words, if the money you get costs you more than what you make, you are impoverishing the company every year! For example:
Economic profitability
This is the return on sales. In our case, 1.76% of the total, a percentage that we must compare with the sector, and with Martínez's own evolution in the previous 3 years at least.
The sector has an economic return of 2.13% and the data from previous years of Martínez are:
ROE (Return on equity)
This ratio indicates that it is 4.89%. If we assume that the market currently pays 2.80%, for money without risk (which would give us a “safe” bank for the amount we have invested in the company), we have that the business risk premium we charge is 2.09%…. Is it sufficient according to our market criteria ?.
Risk premium charged by banks
On the other hand, taking into account the current Euribor rate plus the differential usually applied by banks, and their commissions, we calculate 4.59% as the risk premium charged by banks. This risk premium will have to be compared year-on-year and then decided.
Some conclusions:
• Its Economic Profitability is deteriorating (1.76% the latest data).
• Your ROE (Return on Equity) is low, given that the risk premium, which you receive is low depending on the sector and the times. Your ROA has to be fixed as soon as possible because it is in negative leverage.
• The risk premium charged by the Bank is high, and you should study how to negotiate a reduction in its costs or its financing, or its balance sheet structure.
Decisions are useless.
Story:
There were five birds, in a tree, and thinking…..thinking…. And three of them decided to go flying…
How many birds were left on the tree?
!!!!!!! Five… !!!!!
Because it is one thing to decide and quite another to take action.
And sometimes… quite a few times…
We do not remember the difference…
I, personally, have entered many business and strategic meetings to decide things, but some of them have been of no use, because no action has been taken…
!!! To action !!!
It is one thing to decide, and another to take action, and sometimes we in our usual lives do this too…. true?.
In fact, as we said at the beginning of this work, we walk the road, and we DO NOT know where we are going to stop, but the question is to walk and walk, even if we are devoured by day to day, even if we do not have time to see and make decisions and action on the important. (If you like stories, ask me for the story about the lumberjack, go to the hair.)
Let's hope Martínez listens to us. Let's hope. Let's put a candle.
