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The Management
Part 2: The Compensation Models Provide Insights
The simple profit sharing is too tempting: The term “profit sharing” initially sounds unspectacular. In principle, however, it would be better if the incentives were based on cash flow and not on profit. What does “cash flow” actually mean?
Imagine: You are the owner of a retail store. To acquire customers, you send out mailings. This generates revenue, but in the worst case, after a short time, you may lack the money to purchase goods, pay your employees, and settle bills. It is also uncertain whether the outstanding amounts can be collected. Your profit and loss statement will look brilliant. It’s only the cash flow statement, i.e., the actual payment flows, that reveals the dilemma.
Cash flow vs. profit and loss statement:
The profit and loss statement is distorted by numerous expenses and revenues that are not cash-effective. Only the cash flow indicates which funds have actually flowed into the company.
Incentives for management in the wrong direction:
The balance sheet policy of a company has no impact on cash flow and provides a suitable basis for bonuses that relate to short-term successes. If it’s just about increasing earnings per share, for example, a share buyback program (very modern) is sufficient, even if it is financed by debt – same profit, fewer shares, higher earnings per share. Such practices are not in the interest of other shareholders.
The Facts:
- In general, profit sharing may not sound wrong. However, the devil is in the details.
- Not every dollar of sales ultimately results in profit.
- Through the cash flow statement, the actual payment flows are much better recognizable.
- The cash flow remains unaffected by a company’s balance sheet policy.
Our Conclusion:
Due to bonuses and other performance-oriented compensation models, CEOs in the USA currently earn about 360 times as much as an average paid employee. This is neither appropriate nor comprehensible, but simply a blatant self-service mentality. Especially since the hurdle seems to be set relatively low. Please bear in mind, salaries come before profit. What is being paid here, you won’t get back.
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