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Business is very simple. To succeed, an entrepreneur needs to follow the universal laws of business. Whether the business is a one-person shop or a billion-dollar conglomerate, they are governed by the same business principles. This is the premise of Ram Charan’s primer on how companies work in his book “What the CEO Wants You to Know : How Your Company Really Works
Table of Contents
“What the CEO Wants You to Know : How Your Company Really Works
Many people spend more than a hundred thousand dollars on an MBA without learning to pull the pieces of the business puzzle together. Using simple language and real-life illustrations, this book describes the various elements of a business and the relationship between these variables.
The most important thing to remember is that business laws are universal. While it may appear that running a one-person business is simpler, it requires the same kind of decision-making a CEO of a billion-dollar company makes. In fact, according to Charan, the “best CEOs and the man or woman running the one-person shop think the same way.”
A solo home-based entrepreneur and a CEO both think of every aspect of their businesses – product, sales, customers, profit margin and return on assets. They both know which of the items in their product line are profitable and which are not. Both understand the value of customers and the importance of keeping their products moving off the shelf. Of course, a home-based entrepreneur may not use the fancy management terminology preferred by big corporations.
If a person understands that certain business principles are universal, then that person has what Charan calls “business acumen.” Business acumen is focusing on the basics and making money for the company.
According to Charan, every business conforms to the three basic parts of moneymaking – cash generation, return on assets (combination of margin and velocity), and growth. Whether running an online or traditional business, a business owner must understand these parts individually and the relationship between them. These three basic parts, plus customers, form the nucleus of any business.
Business Principle 1: Cash
Cash generation is the difference between all the cash that flows in the business and the cash that flows out. Cash is the lifeblood of any business, or as Charan describes it, “the company’s oxygen supply.”
An astute entrepreneur must always ask whether the business generates enough cash. What are the sources of cash generation? How is the cash being used? Failing to ask these questions often spell the end of the business. Without cash, a business can be in trouble even if other aspects of moneymaking – profit margin and asset velocity – look good.
If the business generates sufficient cash, the entrepreneur is better positioned to grow the business. An entrepreneur can make better investing decisions, not to mention be more in control, if it has its own cash rather than borrowing money from investors.
Business Principle 2: Return on assets (combination of margin and velocity)
An entrepreneur uses either his own money or someone else’s money to invest in the business. The things invested – be it products, stores, or websites – are the business assets.
An entrepreneur possessing acute business acumen will ask the following questions:
- How much money will be made with these assets?
- What kind of money is being returned through their use?
In short, a smart entrepreneur must always ask, “What is the return on assets?” An entrepreneur must follow the rule: the return on assets has to be greater than the cost of using their own money and other people’s.
Earning a good return on assets has two components – profit margin and velocity. Return on assets is simply nothing more than profit margin multiplied by velocity. In simple arithmetic, return on asset is
Return = Margin x Velocity
A grocery owner will earn more if she can clear her shelves and replace the goods every day. Walmart, for example, has a 360 inventory of toilet tissue. This implies that the entire toilet tissue inventory is sold almost daily. Therefore, Wal-Mart recoups its investment in toilet tissue daily, plus some profit.
Even if the profit margin is small, a business can thrive if it has a fast turnover of its inventory. A faster velocity leads to a higher return. The faster the inventory reaches the customer, the better it is for the business. According to Charan, the best companies have a return on assets greater than 10 percent after tax.
Business Principle 3: Growth
Growth is vital to every business. It energizes the business and creates new opportunities. However, growth for growth’s sake does not do any good. According to Charan, the growth of a business “must be accompanied by improved margin and velocity, and the cash generation must be able to keep pace.”
A smart entrepreneur does not only push for sales. Instead, he or she must know how and why the business is growing and whether the growth can be sustained. Sales may be growing, but if the cash situation worsens, the entrepreneur must take a prudent approach and step back. When growing a business, the businessperson must determine if the company is generating or consuming cash and whether the profit margin is improving or worsening.
Another characteristic of a person possessing business acumen is his or her ability to find opportunities for profitable growth when others can’t. Charan gives the case of Walmart and Sears and the difference in the two giants’ approaches to growth. In the mid-70s, Sears considered the retail sector as a mature business with no room for growth. Hence, Sears diversified into new markets and opened its financial services division. On the other hand, Walmart continued to open new stores while maintaining a higher-than-average return on assets. Walmart’s bold move when others considered the industry flat paid off: in 2000, Walmart had sales of $165 billion compared to Sears’ sales of about $40 billion.
Business Principle 4: Customers
A universal law of business is that no business can thrive without customers. Hence, a smart entrepreneur instinctively understands his or her customers. Charan explains that entrepreneurs with business acumen closely connect with their customers and are strongly convinced that the business cannot thrive without satisfying them.
Entrepreneurs must always know the pulse of their customers. A savvy entrepreneur knows that the best way to get to know the customer is to make the special effort to observe and talk directly to people who use their products and services. Find out what the customers need – directly from them. Direct contact provides insight that even expensive market research cannot.
In thinking about customers, Charan advises to keep it simple. A business owner must clearly know what the customer is buying. It may not be the physical product or service alone but intangible qualities such as reliability, convenience, or trustworthiness.
The secret of the great CEOs of our time, such as Jack Welch of General Electric, is their “intense focus on the fundamentals of business.” The best CEOs have a knack for bringing the most complex business down to the fundamentals — the same fundamentals that govern a small family shoe shop or an online store. Like these CEOs, entrepreneurs should never lose sight of the basics if they want to succeed.
Business is all about common sense. Alas, it is surprising to find how often this common sense of business is lacking. This book will help anyone understand in plain and simple language the basic building blocks of a business and use them to figure out how a company makes money and operates as a total business.
Recommended Books on Basic Business Principles:
- Why CEO’s Fail: The 11 Behaviors That Can Derail Your Climb to the Top and How to Manage Them
- How to Become CEO: The Rules for Rising to the Top of Any Organization
- World Class Communication: How great CEO’s win with the public, shareholders, employees, and the media
- The New CEO Corporate Leadership Manual: Strategic and Analytical Tools for Growth
- Warren Buffett on Business: Principles from the Sage of Omaha
- Business Principles and Management
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