Financial and non-
financial categories
Any company that publishes a financial report
will be required to set out key figures on the
revenue generated and the expenses incurred
during the course of its activities. These figures
can be compared using mathematical
calculations called financial ratios.
However, financial ratios alone may
not give an accurate vision of the
company’s future prospects.
Non-financial ratios, or key
performance indicators,
do not measure financial
performance, but they do
reveal other important
characteristics of a company
that will ultimately affect its
profitability, such as customer
loyalty and research and
development (R and D)
productivity.
Measuring
performance
There are two main ways of measuring a company’s performance: financial
and non-financial. To assess financial performance, a company calculates
financial ratios. To assess other areas of the business, a company examines its
key performance indicators (KPIs), which help management and staff evaluate
performance and how it can improve. KPIs also enable interested outsiders, such
as investors, lenders, or analysts, to decide whether to invest in the business.
Company
Tracking and forecasting
Financial and non-financial measures can be
used to forecast company performance and
track fraud. See pp.152–153.
US_144-145_Measuring_performance_review.indd 144 21/11/2014 16:23
144 145
how finance works
Measuring performance
TREND ANALYSIS USING PERFORMANCE MEASUREMENTS
69%
of multinationals
link performance
measures to
future financial
results
A comparison of
either financial
ratios or KPIs
between companies
in the same industry
and across time
is often used to
track a company’s
performance.
Current ratios
are calculated by
dividing current
assets by current
liabilities: the
higher the ratio,
the more liquidity
a company has.
Financial ratios
Used by investors and
lenders to gauge financial
health of an organization: if
it’s likely to survive economic
slump, and what prospects
it has for future growth
Standard set of ratios used
by the financial industry
Calculated based on figures
provided in financial reports
See pp.148–149.
Key performance
indicators
Used internally and by
investors, as they appear
in financial statement
May be calculated daily or
even more frequently for
internal use
Companies can set diverse
KPIs to reflect future goals
Unique to each company
See pp.146–147.
1 2 3 4 5 6 7
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
FAST FOOD CHAIN A
CURRENT RATIO COMPARISON OVER TIME
Fast-food chain A is shown to be a consistently better performer over
time, and so has the most solid financial standing of the three companies.
Some professional services
companies, such as multinational
PwC, undertake quarterly surveys,
interviewing senior executives to
find out how optimistic they are
about their sector and the wider
economy. Such surveys help
companies measure their own
performance objectively.
THE BIGGER PICTURE
FAST FOOD CHAIN B
FAST FOOD CHAIN C
CURRENT
RATIO
YEAR
Financial
measures
$
Non-
financial
measures
$
US_144-145_Measuring_performance_review.indd 145 15/12/2014 12:57
144 145
how finance works
Measuring performance
TREND ANALYSIS USING PERFORMANCE MEASUREMENTS
69%
of multinationals
link performance
measures to
future financial
results
A comparison of
either financial
ratios or KPIs
between companies
in the same industry
and across time
is often used to
track a company’s
performance.
Current ratios
are calculated by
dividing current
assets by current
liabilities: the
higher the ratio,
the more liquidity
a company has.
Financial ratios
Used by investors and
lenders to gauge financial
health of an organization: if
it’s likely to survive economic
slump, and what prospects
it has for future growth
Standard set of ratios used
by the financial industry
Calculated based on figures
provided in financial reports
See pp.148–149.
Key performance
indicators
Used internally and by
investors, as they appear
in financial statement
May be calculated daily or
even more frequently for
internal use
Companies can set diverse
KPIs to reflect future goals
Unique to each company
See pp.146–147.
1 2 3 4 5 6 7
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
FAST FOOD CHAIN A
CURRENT RATIO COMPARISON OVER TIME
Fast-food chain A is shown to be a consistently better performer over
time, and so has the most solid financial standing of the three companies.
Some professional services
companies, such as multinational
PwC, undertake quarterly surveys,
interviewing senior executives to
find out how optimistic they are
about their sector and the wider
economy. Such surveys help
companies measure their own
performance objectively.
THE BIGGER PICTURE
FAST FOOD CHAIN B
FAST FOOD CHAIN C
CURRENT
RATIO
YEAR
Financial
measures
$
Non-
financial
measures
$
US_144-145_Measuring_performance_review.indd 145 15/12/2014 12:57
How it works
KPIs are the non-financial measures of a company’s
performance—they do not have a monetary value
but they do contribute to the company’s profitability.
Any company department can adopt KPIs to gauge its
performance. A KPI for an accounts department might
be the percentage of overdue invoices, as this will help
determine the department’s efficiency. This is an
example of a lagging indicator—it is an outcome and
therefore easy to measure, but not straightforward to
influence. Companies also look for leading indicators,
which are focused on inputs and easier to change. A
leading KPI for the accounts department might be the
percentage of purchase orders raised in advance.
Key performance
indicators (KPIs)
Key performance indicators (KPIs), or key success indicators (KSIs),
are based on a company’s goals and vary depending on the company
and industry. KPIs are usually stated in a company’s annual report.
A
c
c
o
u
n
t
s
S
a
l
e
s
a
n
d
m
a
r
k
e
t
i
n
g
C
u
s
t
o
m
e
r
s
e
r
v
i
c
e
H
u
m
a
n
r
e
s
o
u
r
c
e
s
Number of retrospectively raised
purchase orders; finance report
error rate (measures the quality
of report); average cycle time
of workflow; number of
duplicate payments
Net promoter score (NPS—how many
customers would recommend company);
customer retention rate; customer
lifetime value (total amount of
money generated by
one customer)
Number of customer complaints;
customer satisfaction (measured over
time); average email response
time; number of products
sold compared to total
sales calls made
$
Corporate KPIs
KPIs can be set up as dashboards on computers
so that they can be checked frequently. These
dashboards show examples of KPIs specific
to departments in a company. Having
set their KPIs, the departments are
subject to managerial review,
which could result in
action if KPIs are
sub-standard.
US_146-147_Key_performance_indicators.indd 146 15/12/2014 12:57
146 147
HOW FINANCE WORKS
Measuring performance
C
u
s
t
o
m
e
r
s
e
r
v
i
c
e
E
n
v
i
r
o
n
m
e
n
t
a
n
d
s
u
s
t
a
i
n
a
b
i
l
i
t
y
31%
of companies
use a computer
dashboard
to monitor KPI
measurements
BALANCED SCORECARD SYSTEM
This strategic system offers a different
way of monitoring a company’s
performance. It was proposed by
Robert Kaplan and David Norton at
the Harvard Business School in the
1990s, and Harvard Business Review has
cited it as one of the most influential
business ideas of the last 75 years; it
is estimated that over 50 percent of
large companies in the US, Europe, and
Asia use the approach. The Balanced
Scorecard consists of four ways to view
an organization’s performance:
Learning and growth
Employee training and
corporate culture
Business
processes
Includes specific
measurements for
monitoring daily performance
Customer perspective
Customer satisfaction
Financial perspective
Traditional financial data
O
p
e
r
a
t
i
o
n
s
H
u
m
a
n
r
e
s
o
u
r
c
e
s
Economic value of an employee’s
skill set; employee satisfaction levels;
revenue per employee; rate of
employee turnover
Waste recycling rate; size of carbon
footprint; size of water footprint
(amount of water usage);
energy consumption
Cost variance (difference between
budgeted cost and actual cost of work);
time taken to get a product to market;
optimally running operations
US_146-147_Key_performance_indicators.indd 147 09/11/2016 11:01
146 147
HOW FINANCE WORKS
Measuring performance
C
u
s
t
o
m
e
r
s
e
r
v
i
c
e
E
n
v
i
r
o
n
m
e
n
t
a
n
d
s
u
s
t
a
i
n
a
b
i
l
i
t
y
31%
of companies
use a computer
dashboard
to monitor KPI
measurements
BALANCED SCORECARD SYSTEM
This strategic system offers a different
way of monitoring a company’s
performance. It was proposed by
Robert Kaplan and David Norton at
the Harvard Business School in the
1990s, and Harvard Business Review has
cited it as one of the most influential
business ideas of the last 75 years; it
is estimated that over 50 percent of
large companies in the US, Europe, and
Asia use the approach. The Balanced
Scorecard consists of four ways to view
an organization’s performance:
Learning and growth
Employee training and
corporate culture
Business
processes
Includes specific
measurements for
monitoring daily performance
Customer perspective
Customer satisfaction
Financial perspective
Traditional financial data
O
p
e
r
a
t
i
o
n
s
H
u
m
a
n
r
e
s
o
u
r
c
e
s
Economic value of an employee’s
skill set; employee satisfaction levels;
revenue per employee; rate of
employee turnover
Waste recycling rate; size of carbon
footprint; size of water footprint
(amount of water usage);
energy consumption
Cost variance (difference between
budgeted cost and actual cost of work);
time taken to get a product to market;
optimally running operations
US_146-147_Key_performance_indicators.indd 147 09/11/2016 11:01
Profitability ratios
These are used to see how
effective a company is at
generating profit. Profitability ratios
may mirror investment valuation
ratios. One example is the operating
profit margin ratio. A high ratio is good,
as it indicates that a high proportion of
revenue (gross income) converted into
operating income (profit minus costs).
Efficiency ratios
These show how efficiently
the company uses its assets
and resources to maximize profits. An
example is the sales revenue to capital
employed ratio, which indicates a
company’s ability to generate sales
revenue by utilizing its assets. Similar
ratios can examine how quickly the
company settles its bills and invoices.
How it works
Financial ratios are used to assess the financial
standing of a business and identify any problem areas
that might affect its future prospects. The process
involves comparing two related items in the financial
statement, such as net sales to net worth or net income
to net sales, and using those ratios to measure the
relative performance of the company. There are many
different ratios to choose from, depending on the
purpose—for example, whether the purpose is to
measure the company’s ability to provide a good
return to shareholders, its capacity to handle debt,
or the efficiency with which it operates. The ratios
can also be used to compare a business with its
competitors or in comparison to specific benchmarks
within the company to determine how consistent its
financial results are.
Top financial ratios
These are some of the ratios most
commonly used by people involved
with assessing businesses. They are
best considered comparatively and
in the context of the economic
climate. The ratios are for analyzing
established companies, usually public
ones with shares traded on the stock
exchange—start-ups and small-to-
medium enterprises generally do not
have a full enough range of figures to
provide any kind of reliable guide.
Lenders, investors, analysts, internal management, and other
interested parties calculate financial ratios to decipher what
financial statements are really saying about the state of a business.
Financial ratios
SALES
REVENUE TO
CAPITAL
EMPLOYED
RATIO
OPERATING
PROFIT
MARGIN
==
NET SALES
CAPITAL
EMPLOYED
OPERATING
INCOME
REVENUE
Other profitability ratios
Return on equity (ROE) is measured
as net income after tax / shareholders’
equity. The higher the ratio, the greater
the profitability, but not if a company
is relying too heavily on borrowing.
EBITDA to sales ratio is measured
as EBITDA (earnings before interest,
taxes, depreciation, and amortization) /
revenue. It gauges the profitability of
core business operations. The higher
the margin, the greater the profits.
Other efficiency ratios
Accounts receivable turnover ratio
is measured as net credit sales /
average accounts receivable. It shows
how efficiently a company turns sales
into cash. The higher the ratio, the
more frequently money is collected.
Inventory turnover ratio is measured
as the cost of goods sold / average
inventory. It shows how efficiently a
company manages its inventory level. A
low ratio usually equates to poor sales.
$$$
6
321
0 .
=
–
+
x
US_148-149_Financial_ratios.indd 148 15/12/2014 12:57
148 149
Liquidity ratios
This group of ratios reveals
whether or not a company
has enough cash or equivalent assets
to meet its debt repayments. An
example is the working capital ratio
(also a measure of efficiency), which
indicates whether a company has
enough short-term assets to cover
its short-term debt.
Solvency ratios
While liquidity ratios look at a
company’s short-term ability
to meet loan repayments, solvency
ratios indicate the likelihood of a
company being able to continue
indefinitely with enough cash or
current assets to pay its debts in the
long run. An example is the debt to
equity ratio.
Investment
valuation ratios
Thes ratios are typically used
by investors to gauge the returns they
are likely to get if they buy shares in a
company. An example is the dividend
payout ratio. It indicates how well
earnings support the dividend
payments—more mature companies
tend to have a higher payout ratio.
10–14%
the minimum return on
investment (ROI) needed
to fund a company’s future
HOW FINANCE WORKS
Measuring performance
DIVIDEND
PAYOUT
RATIO
DEBT TO
EQUITY
RATIO
WORKING
CAPITAL
==
=
YEARLY
DIVIDEND
PER SHARE
EARNINGS
PER SHARE
TOTAL
SHAREHOLDERS’
EQUITY
TOTAL
ASSETS
CURRENT
ASSETS
CURRENT
LIABILITIES
Other liquidity ratios
Cash ratio is measured as total cash
(and equivalents) / current liabilities.
It shows whether a company’s short-
term assets could repay its debts. A
high ratio is seen as favorable.
Quick ratio (acid-test ratio) is
measured as current assets minus
inventories / current liabilities. It shows
how easily a company can repay short-
term debt from cash. The higher the
ratio, the more easily it can pay.
Other solvency ratios
Interest coverage ratio is measured
as EBIT (earnings before interest and
tax) / interest expense. It indicates
how easily a company can pay the
interest on its debts. The higher the
ratio, the more easily they can pay.
Debt ratio is measured as total
liabilities / total assets. It indicates
the percentage of the company’s
assets that are financed by debt. A
low ratio is considered favorable.
Other investment valuation ratios
Net profit margin ratio is measured
as profit after tax / revenue. Another
measure of a company’s profitability, it
is also useful for comparing a company
with competitors. The higher the ratio,
the more profitable the company.
Price to earnings ratio is measured
as market value per share / earnings
per share. It indicates the value of the
company’s shares. A high ratio
demonstrates good growth potential.
Investors beware
Ratio analysis must be used over
time—at least four years—to
understand how a company
has reached its current position,
not just what the position is. For
instance, if debt has suddenly
gone up, it could be because the
company is branching out into new
areas of potential profit, or to limit
the damage of a poor past decision.
WARNING
US_148-149_Financial_ratios.indd 149 09/11/2016 11:02
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