John Jorgensen possessed one of the greatest manufacturing minds that I have ever encountered. He was a long-time president of Orscheln Company and Ortech, both Missouri-based businesses.
One of John’s favorite business measures was ROAM, short for return on assets managed. He felt it was a holistic measure that best described the financial performance of a company because it was not a one-dimensional key result indicator.
While John served mid-sized businesses, I believe his opinion is applicable to small businesses.
Most Small Business Owners Only Focus on the Income Statement
Before meeting and working with John Jorgensen, I met Dave Potter on the campus of Truman State University (formerly Northeast Missouri State University) who possessed similar views on financial performance.
Dave, a partner for KPMG Peat Marwick, recruited me to join their St. Louis office in the late 80s. I recall Dave stating that good CEOs know how to manage a P&L. But he followed by saying great CEOs manage a balance sheet. I learned the true meaning of his wisdom years later.
As a CFO serving small businesses, both John’s and Dave’s insights have influenced me to focus holistically on the financial health of small business, not just on sales, gross margins, or earnings. Even free cash flow is only part of the picture while still very important.
Instead, I take a hard look at return on assets managed, primarily for retailers, distributors, job shops, and specialty contractors (a large part of my client base).
And this mindset has been beneficial to my clients who otherwise would only be focusing on their income statements. These are the clients who are seeking and obtaining efficiencies with the asset investments they are managing. The end result has been better and healthier cash flow.
ROAM – A Tale of Two Companies
Let’s pick on Avery Dennison, a manufacturer with more than $4 billion in total assets. Their return on invested assets over a recent four-year period ranged from 7.1% to 9.0%. The trend is good.
Normally, I don’t benchmark small business ROAM results with peer companies (I’ll explain why later). But, in this case, I wanted to see how Avery Dennison compares to one of it’s peers, Bemis. Here’s the comparison:
Bemis is clearly outperforming Avery, but the gap has been narrowing the past few years. We’ll see why in a minute.
That’s because return on assets managed is the product of two other measures–pre-tax earnings as a percentage to sales and asset turnover.
Below, we can see that Bemis has a more attractive bottom line than Avery. But in the second chart, we see that the Avery asset turnover is moving in a positive direction and outpacing Bemis.
That’s why Avery started closing the ROAM gap per the chart above. Avery is now generating $1.01 in sales for every dollar invested in assets. While Bemis was once at $1.00, it’s now down to $.86 or every dollar in assets employed.
Is that a bad thing? Is Bemis management losing it’s touch? Not necessarily. Asset turnover generally drops as a company starts to either 1) purposely increase its asset base as it primes itself for new growth, or 2) upgrading its current infrastructure through additional capital expenditures that may have been deferred in prior years.
But that’s not why asset turnover dropped in the most recent year. Instead, Bemis saw it’s cash conversion days increase by nearly 5 days with increases to both days sales in receivables and days in inventory. True, CapEx spending jumped from $140 to $185 million. In short, the lower performance is the result of all of these assets increasing on the Bemis balance sheet.
ROAM in the Small Business World
I really like return on assets managed as a proxy for overall business health in a business. But here is some food for thought regarding this all-important key result indicator:
- Most small businesses do not have a fixed asset system. Accordingly, I’ll find fully-depreciated fixed assets that still remain on the balance sheet. Accordingly, make sure you have a clean set of general ledger accounts in fixed assets before you start using this number. (Note: I exclude depreciation in the numerator and accumulated depreciation in the denominator; that’s why fully-depreciated assets still on the books will falsely drag ROAM downward. I mention this below).
- Personally (my opinion only), I don’t use this number for benchmarking. The best benchmarking is always against ourselves shooting for targets that are realistic and attainable. While I prefer consistency on this measurement, I’m looking at the recent trend. Are we going upward or downward? And what’s driving the results?
- Regarding the math, we’re focusing on the return on assets managed at historical cost. Therefore, I remove accumulated depreciation from the denominator, and I exclude depreciation expense from the numerator.
- ROAM is not as meaningful in professional services as the asset base is low. The largest assets are typically cash and receivables. Investments in hard assets are generally minimal. And that’s especially true as many professional services firms are outsourcing their server technologies to the cloud.
ROAM – Just Do It
ROAM says it all as a holistic, all-encompassing financial measure for any sized business. Gross margins, net operating margins, revenue per FTE, days in inventory, and days in accounts receivable. Keep watching those numbers.
Start getting comfortable with the numbers baked into ROAM like the measures just mentioned. Once ROAM becomes a household measure in your business, you’ll begin growing from a good CEO to a great CEO according to Dave Potter.
Thank You John Jorgensen
While your friends and family will say your life was way too short, it was all in God’s timing.
Thank you for everything you did, the wonderful family you raised, and the way you served so many men and women in special ways around the world.
Not only were you an inspiration for all of us to give more than 100% when on the job, you also showed us how to live outside the workplace.
You will always be missed.