Today we will talk about the bicycle effect and how this is related to the dividend policy.
Recently I was chatting with a friend who likes to ride a particular bike route, he has a professional bike and extensive knowledge of the sport, I asked him; How do you get to the top of Las Palmas so fast? (El Alto de Palmas in Medellin, Colombia, is a traditional route frequented by cyclists, it has a category 1 trip between the Country Club and the top of Las Palmas which is a reference in question to speed and resistance). His answer was as follows: Simon that’s like an equation where you have to combine an excellent bike, have an adequate body weight, good nutrition, rest, technique, training and mental self-control.
When we take the equation as an analogy to organizational performance, the success of a company is based on many factors: team work, brands, products, service, competitive advantages, correct administrative and financial management and the economic sector where it operates among others. Also, if we delve into each of these factors we find a world of variables. If we examine For example Financial management, we could talk about capital structure, the cost of capital (WACC), management of working capital that affects cash flow and profit margins among others. This applies to all aspects of the organization.
Now, why are there cyclists who achieve superior performance compared than others? or in the business world: Why do some entrepreneurs have a lot of success generating wealth and others do not? The answer is that the ones with success are focused on refining the equation all the time and those without or limited success simply do not. They don’t because they are comfortable and complacent with their average results, or simply do not know how to work the equation and the benefits that this can represent.
This I see for example when I visit two companies of the same economic sector, which sell more or less the same products and carry a similar time in the market, for example:
-One of the companies has revenues of 20 million dollars per annum, is very successful and has generated a lot of wealth. Their market value is significant and its owners have an excellent lifestyle fruit of the money and dividends that their company has provided them.
–The other company, although it could be in the same position, only has revenues of 2 million dollars per annum, it does not have a good administrative team, it is disorganized, it has few competitive advantages and its market value is very low, which results in difficulties when it comes time for sale as it is unattractive purchase.
The paradox is that both entrepreneurs have more or less the same time in the market and their physical and mental effort together with their dedication can well be similar.
How does this relate to dividend policy? When you ask the company to generate enough cash flows to be able to reinvest and at the same time generate dividends, your mentality changes, you start to think about how to tune the equation, how to make the system more efficient and effective, how I should best finance “buying the right bike, having the right body weight and nutrition”. Simply the change in mindset makes you more demanding as an entrepreneur. To not only pay yourself a salary and live comfortably but to reach a higher level of performance and be one of the most profitable and successful companies in your market segment.
The best thing you can do to start improving your mentality is first to have a board of directors and advisors across several fields that will help you to improve each area of your company. Secondly that you require the company to generate enough cash flows to be able to reinvest and reach new goals whilst paying yourself well for the work and risk you assume.
Now ask yourself the following questions:
– As an employer do you have an adequate salary, does your company pay you dividends that outweigh the investment you have in it and for your level of risk in the investment?
– Do you have a work team that can successfully operate your company in your absence? is this team well prepared, motivated and paid well?
– If you wanted to sell your company today, would you receive an attractive selling price? is your company attractive to be acquired by important players in your industry?
– Financial and accounting; is your company organized? do you have a low financing cost and accounting structure that reflects the reality of the company? does the company generate enough cash flows to meet the needs of the company and its shareholders?
If your company is not having enough success it is time for you to think like the professional cyclist and focus on tuning the equation so you can reach new and more demanding goals.
Simón Restrepo Barth, Investment banker, lecturer of finance and partner of ONEtoONE Corporate Finance.