An executive’s “financial signature” is the key to how he or she evaluates risk and reward to build company value.
CEOs and other top executives have certain financial preferences that are ultimately expressed in their management decisions. Some, for instance, are comfortable investing in potentially lucrative but risky ventures while others much prefer pursuing a market with razor-thin margins and low entry costs. Still other executives are adept at exploiting businesses with high margins but minimal indirect expenses. Are any of these approaches inherently superior — or inferior — for building value?
Answering that question first requires a way to measure the different fiscal behaviors of executives. “Financial signatures” can capture such information by measuring particular approaches by executives for building value and for using resources to achieve such goals. Standard models for measuring leadership capabilities tend to focus on certain attributes such as strategic vision and the ability to execute, but they do not directly take into account leaders’ financial approaches. They might, for instance, focus on a person’s ability to cut costs within a given vision but fail to look at the specific ways in which the individual tackles such issues. Financial signatures provide that missing view.
What Is a “Financial Signature”?
Business leaders have two basic drives: to add value to products or services and to deploy resources with a certain amount of efficiency. The first drive can be inferred from a business’ gross margin, defined as gross profits (that is, revenues minus the cost of goods sold, or COGS) divided by revenues. Gross margin is generally accepted by financial analysts as a way to measure the amount of value added to a product or service. It is a far more accurate measure in that respect than profits, which can sometimes be high when value-added is low and vice versa. The second drive can be inferred from a business’s relative indirect expenses, defined as expenses not included in COGS divided by revenues. This number might not be the best measure of resource utilization, but it does provide a good indication of that quantity, and information on expenses is readily obtainable from a profit and loss statement.
The financial signature incorporates both numbers — gross margin and relative indirect expenses — to determine an executive’s particular fiscal approach to business. To ensure the comparison of apples with apples, it specifically looks at those two quantities with respect to the average values for a particular industry or market.