Planning and Execution – Ground Rule #2 – Know What Makes Your Business Tick

This is the next in a series of posts that will describe what the CEO of the Reliance Electric Company thought about basic commitments, how the organization was going to operate and ground rules for managers. Once again, all the content of this article is based on the work of B. Charles Ames as outlined in his management manifesto titled Basic Management Concepts dated January 14, 1974.

To Chuck Ames, it was clear that a good business planning process was not possible if managers didn’t understand the economics of the business. He challenged managers to know the answers to the following “fundamental questions.”

  1. How much does each product or service contribute to profit? Both in terms of profit   contribution and absolute profit (after allocations).
  2. How does volume effect costs and profit structure?
  3. How and where are significant costs added to products and services? How and where is value added to the product or service? Define “value added” as something for which the customer is willing to pay.
  4. How many dollars of assets are committed where? What return is being earned in each identified area?
  5. How sensitive is profitability to changes in key variables? Examples of key variables include price, product mix, and costs.

Ames suggested traditional accounting systems were unable to automatically generate data to answer the five fundamental questions. It takes thorough analysis of the numbers to understand the answers for a particular business. Anyone who has had a serious business discussion about overhead allocation will understand the problem.

Ames said blaming the accounting system for not knowing the answers is just an excuse for sloppy thinking and an unwillingness to understand and, perhaps, run the numbers in a different order. He said the data, to help understand what makes the business tick, were actually available almost all the time. It just takes some digging.

Chuck Ames and his wife Jay currently manage the Ames Family Foundation. They divide their time between a home in Vero Beach, Florida and a second home in a suburb of Cleveland.