In Doug Tatum’s book, No Man's Land: Where Growing Companies Fail, he describes a set of symptoms that indicate that a company is in No Man’s Land. Some of these include; working in, instead of on the business; working harder and longer hours but not getting the desired results; managers showing signs of “being over their heads”, with cash tight even if the company is basically profitable. Concerns about meeting payroll and other obligations; losing touch with your customers; quality problems with the products and services you sell; deteriorating service levels and lead times getting longer - all these combine to make you and the organization feel that you are in a state of chaos. These are tell-tale signs that your company is in No Man’s Land.
Indicator Tracks Key Trend
There is another kind of indicator you can use to assess when you are entering or exiting No Man’s Land. Operating Leverage is a simple diagnostic measure that shows a clear trend as to whether your business is eroding or improving.
Definition of Operating Leverage
Operating leverage is the change in operating income (i.e. earnings before interest, taxes, depreciation and amortization – EBITDA) over a period of time, divided by the change in revenue or net sales over the same period of time. For an emerging growth manufacturing company this calculation should be done and analyzed each quarter and tracked over a period of sequential quarters to establish a pattern or trend.
Change in EBITDA divided by change in sales
(EBITDA new – EBITDA old / Sales new – Sales old)
When the Operating Leverage calculation trends downward towards 0% your enterprise is entering or is in No Man’s Land. Hopefully you will not fall below 0%. When the Operating Leverage calculation trends upward from 0% and reaches 40% you are exiting No Man’s Land - and operating at a high performance level. You have addressed the problems related to No Man’s Land described above and now have the time to work on, not in, the business.
Growth in Costs Versus Growth in Revenue
What is Operating Leverage telling you? Fundamentally it addresses the growth in your operating costs relative to the growth in your revenue. At Operating Leverage of 25%, for every additional dollar of incremental revenue sold, $0.25 is dropping to the bottom line. At Operating Leverage of 0%, incremental revenue is getting eaten up by costs that are rising faster than your top line. And if Operating Leverage is consistently less than 0%, you are in trouble.
The next part of this article will explore how to make sense of changes in your Operating Leverage - and what to do about them.
About the Author
Mike is an experienced CEO who has a record of achieving sustainable sales and earnings growth with domestic, international, public and private companies, both large and small. Learn more or contact Mike directly here.
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