Chapter 5 - Test 2 Flashcards
Three traditional frameworks to measure and assess firm performance
- Accounting profitability
- Shareholder value creation
- Economic value creation
Two integrative frameworks, combining
quantitative data with qualitative assessments
- Balanced scorecard
- Triple bottom line
Three Standard Performance Dimensions
- What is the firm’s accounting profitability?
- How much shareholder value does the firm create?
- How much economic value does the firm generate?
Reflected in the firm’s stock price
Accounting profitability and economic value creation
tend to be reflected
Accounting Profitability (Examples & Equation)
Firm performance to competitors / industry average
Ex:
- Standardized accounting metrics (GAAP, FASB)
- Form 10-K statements
- Profitability ratios
- Return on invested capital (ROIC)
- Return on equity (ROE)
- Return on assets (ROA)
- Return on revenue (ROR)
Return on revenue
How much of the firm’s sales is converted into profits
Working capital turnover
How effectively capital is being used to generate revenue
Elements of ROIC
Return on revenue & Working capital turnover
Return on Revenue Elements
- Cost of goods sold (COGS) / Revenue
- Research and development expense / Revenue
- Selling, general, and administrative expense / Revenue
The equation for how efficiently a company can produce a good
Cost of goods sold (COGS) / Revenue
The equation for how much of each dollar earned is invested in R&D
Research and development expense / Revenue
The equation for how much of each dollar earned is invested in SG&A
Selling, general, and administrative expenses /
Revenue
Working Capital Turnover Elements
- Working capital / Revenue
- PPE / Revenue
- Intangibles / Revenue
The equation for how much working capital the firm has tied up in its operations
Working Capital / Revenue
The equation for how much of a firm’s revenues are dedicated to cover plant, property, and equipment
PPE / Revenue
Limitations of Accounting Data
- Historical and backward-looking
- Does not consider off-balance sheet items
- Focuses mainly on tangible assets
Shareholders
Own shares of stock, are legal owners of public companies
Risk Capital
The money provided for an equity share and cannot be recovered if a firm goes bankrupt
Total Return to Shareholders Equation
Stock price appreciation + dividends = Total Return to Shareholders
Market Capitalization Definition & Equation
Dollar value of total shares outstanding
- Number of outstanding shares x share price
Limitations of Shareholder Value Creation
- Stock prices can be volatile
- Macroeconomic factors affect stock prices
- Stock prices can reflect the mood of investors
Economic Value Creation Equation
A buyer’s willingness to pay for a product / service and the firm’s total cost to produce it = Economic Value Creation
Limitations of Economic Value Creation
- We must estimate economic value
- Valuing a consumer good isn’t easy
- The value of a good changes
The Balanced Scorecard
Helps managers achieve their strategic objectives using internal and external performance metrics to balance both financial and strategic goals
