Evaluation Of Business Performance Flashcards
Profitability
The ability of a business to earn profit, compared against a base.
Efficiency
The ability of a business to manage its assets and liabilities.
Stability
The ability of a business to meet its debts and continue operation in the long term.
Liquidity
The ability of a business to meet its short term debts as they fall due.
Benchmarking
A standard by which something can be measured or judged
Past performance - trends
Budgeted performance
Performance of similar businesses
Industry averages
Profit vs profitability
Profit is the figure determined by revenue less expenses whereas profitability is used to assess the firms capacity or ability to earn a profit by comparing profit against a base like sales, assets or owners equity.
IMPROVING ROA WITHOUT CHANGING AT
Buy in bulk Change suppliers for lower cost price Examine and change rosters to use wage expense more productively Change or reduce advertising Reduce rent expense by changing location
Gross profit margin
For each dollar of sales, indicates how much remains as gross profit. Gross profit/sales * 100. Percentage. A GPM of 32% means for every $1 of sales, 32c is being kept as gross profit and 69c consumed by cogs. It is used to determine the profit made from just buying and selling.
Return on assets
Measures how effectively a business uses its assets to generate profit. Net profit/avg total assets * 100 expressed as percentage. A ROA of 25% would mean that for every $1 invested in assets, the business has generated 25c in profit.
Effects of a higher debt Ratio
Greater risks to the firms long term stability because of greater reliance on borrowed funds and thus a greater risk that the business will be unable to repay both its assets and its interest charges.
However higher debt Ratio means a higher ROI and an increase in profitability as the business is using borrowed funds to finance its operations but owner still receives any profit.
Asset turnover
An efficiency indicator that assesses how productively a business has used its assets to earn revenue. Asset turnover=sales/avg total assets. Expressed in number of times per period. An asset turnover of 1.6 times a year would mean that the sales for the year were 1.6 times the average value of assets used in the period.
Net profit margin
For each dollar of sales, indicates how much % of sales remains as net profit. Net profit/sales * 100. Expressed as %. A NPM of 15% would mean that for every $1 of sales, 15c is being kept as net profit or 85c is being consumed by expenses.
Increased NPM, decreased ROA, same sales.
The ROA has decreased because of a decrease in AT, the business is not using its assets as efficiently to generate sales. They possibly purchased assets they do not need. The NPM may still increase however as the new assets may still be contributing to an increase in net profit as the sales dollars are still kept as profit. The business may have improved expense control from a decrease in wages or other expenses without effecting sales.
ATO AND RTA
Asset turnover shows how well the business assets are being used to generate revenue. Return on assets shows how well the business assets are being used to generate profit. The difference between these ratios is between revenue and profit, the difference is expenses.
Stock turnover
Indicates how quickly a business is selling its stock. Avg sales/cogs * 365. Expressed as number of days. A stock turnover of 36 days means it takes the business an average of 36 days to sell its stock. The lower the STO indicates improved efficiency and will help increase liquidity as stock will be converted to cash.
Debtors turnover
Indicates how quickly a business collects its debts from debtors. Avg debtors/credit sales *365. Expressed as number of days. A debtors turnover of 41 days would mean that it takes the business an average of 41 days to collect amounts owing from debtors. A lower day’s debtor turnover indicates improved efficiency and will help improve liquidity. Debtors turnover should be compared to credit terms offered to customers as a benchmark of performance.
Creditors turnover
Indicates how quickly a business is paying its creditors. Avg creditors/credit purchases * 365 expressed as number of days. A creditors turnover of 14 days would mean it takes the business an average of 14 days to pay its creditors. If CT is significantly over terms, this may help with liquidity but can cause problems with relationships with creditors and may lead to a loss of credit facilities and problems with supply of stock in the future. If CT is significantly under terms, this may mean the business is benefitting from discounts for early payments but may cause liquidity problems as cash is leaving the business earlier then it needs to be.
Working capital Ratio
Shows the ability of a business to meet its debts in the next 12 months. Current assets/current liabilities expressed as current assets:1.
A working capital Ratio of 1.75:1 would mean that the business has $1.75 of current assets for every $1 of current liabilities.
The higher the wcr, indicates improved liquidity. However it is possible that a high wcr eg 5:1 could indicate excess current assets e.g excess cash at bank which will give no return.
Quick asset Ratio
Shows the ability of a business to pay its debts immediately.
Current assets - (stock + prepayments)/
Current liabilities - overdraft
Expressed as quick assets: 1.
Compares quick assets to quick liabilities which are current assets that can be turned into cash quickly and current liabilities that must be paid in a very short term. A quick asset Ratio of 1.2:1 would mean that the business has $1.2 quick assets for every $1 of quick liabilities.
Cash flow cover
Shows the number of times cash flows from operating activities covers current liabilities.
Net cash flows from operating/ avg current liabilities
Expressed as times per period.
A cfc of 1.9 times would mean that the operating cash flows is 1.9 times the average current liabilities. A high cfc indicates improved liquidity. A cfc of less than 1 would indicate that operating cash flows may be insufficient to meet the expected debts of the business.
Debt Ratio
Shows the percentage of th business’s assets that are financed by liabilities.
Total liabilities/ total assets * 100 expressed as percentage
A dr of 55% would mean that the business has 55c of debt for $1 of assets, and 45c of capital. The lower the dr is, indicates improved stability. Less debt means less risk for the business as they are not locked into repayments and are therefore not expressed to changes in interest costs.
Return on owner’s investment
Measures how effectively a business has used the owner’s capital to earn net proift.
Net profit/avg capital * 100 expressed as percentage.
A roi of 12% would indicate for ever $1 invested by the owner, the business has generated 12c in net profit.
Debt Ratio and ROI
A business that relies heavily on borrowed funds will have a higher debt Ratio (high gearing) which is generally considered to be a danger to stability however it will mean a higher ROI as the owner still receives the profit but the business is using someone’s else’s funds to buy the assets to earn that profit. The owner must judge carefully so that the debt Ratio is high enough to maximise ROI without sending the business in difficulties relating to its debt burden.
