Critical Equations

Critical Equation #1
"Breaking the Mystery about Pricing"

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% Δ V = - % Δ P / (CM % + % Δ P)


How many times have you heard people say, “If we cut price, we can sell a lot more product”, or “let’s heavily discount this deal to win it…. make our money on future sales.” Pricing is the moment of truth in product planning and business negotiations. Pricing decisions have an enormous impact on the bottom line and, as a result, a company’s ability to create shareholder value over the long run. Yet, nothing is harder to get right (market valuation and market price being equal). Depending on the product/service offering, pricing decisions often are made without full knowledge of their financial impact and often are left to too late in negotiations. Not understanding price-volume trade-offs only exacerbates the situation and results in the sub-optimization of profit.

The Most Important Equation in Business

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Critical Equation #2
"Understanding and Analyzing Variances"

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Variance = OM I - OM J


All business leaders need to be able to create and manage a budget. This can be a relatively simple process of making sure expenditures do not exceed agreed upon limits or, when one has responsibility for an operating profit and loss statement, quite complicated and require considerable expertise. Careers have been made or lost because of the ability or inability to understand, communicate and take effective action on how a business is doing relative to its plan. The difference between a budgeted amount and the actual amount over a specified period of time, in either absolute dollars or percentages, is commonly known as a variance. The heart and soul of managing a small department or a global enterprise is in understanding the drivers of your business in the form of variances. Knowledge of operational finance, the language of business, is essential to successful applications of variance analysis.

Understanding Critical Equation #2 can:
  • Enhance your company’s competitive advantage
  • Demonstrate effective risk management, and
  • Increase the probability of meeting your commitments.

Variances come in three fundamental types: Planning, Execution and Growth. Effective business leaders need a working proficiency of all three. The difference between good and great companies often is a function of how capable their leaders are at understanding each of these variances. Success will be measured in incremental shareholder value.

Variance Analysis

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Critical Equation #3
"Key Financial Metrics - The DuPont Model"

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NI/S x S/A = NI/A x A/E = NI/E


A prerequisite for business leaders at all levels of an organization is the ability to make comparisons of financial data. These comparisons are typically made to time (trend analysis), to competitors (competitive analysis), or to a plan (variance analysis). Being able to draw insight from comparative data is essential to making decisions under uncertain conditions such as limited information, time pressure, divergent opinions, and limited resources. Drawing insight from financial data requires understanding the drivers of return on equity found in our equation #3. Understanding how we can impact these drivers from an operational perspective is central to creating short- and long-term shareholder value. The primary accounting tool, applicable across all industries, is the DuPont Model. Most importantly, the DuPont Model requires business leaders to be responsible for both the income statement and balance sheet (we will recognize the criticality of cash flow in due course). The DuPont Model, of course, is not without criticism, and we do not argue for its being the sole driver of business decisions. Its application must be balanced with the potential negatives we will discuss along with an understanding that no model can capture in its entirety the economic reality of every business. While numerous authors argue that use of the DuPont Model has eroded, we have seen no evidence of this across our many clients. In fact, we will demonstrate that a modified version of the standard DuPont Model that incorporates financial leverage can help explain the significant deterioration of many businesses during the recent global recession, in particular financial services.