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Financial Performance Indicators in business

Updated on June 5, 2013

Business managers, in managing the business, must make appropriate and timely decisions. They must make proper plans. In order to do that, it is imperative to monitor a range of performance indicators in the business. Business managers have traditionally focused on financial measures of performance to monitor the progress of their business organizations. However organizations in both the private sector and public sectors are increasingly using non-financial indicators to assess success.

Knowing where you are financially is more important with growth of the business. Lack of knowledge of the financial position of the organization can lead to even business failure and as a result, owners and directors of the organizations may face various other consequences.

For any business, minimum financial information means a profit and loss statement and a balance sheet. In addition to this basic information, there are other financial information required by the business managers to make appropriate and timely decisions. For example, a monthly age analysis of debtors is a must for a business which provides credit facilities to customers. Regular reports on debtors and inventory help the management to avoid unnecessary working capital.

It is important to prepare key performance indicators regularly based on the financial statements and compare with the same for prior periods and also concentrate on trend analysis reports prepared based on successive monthly reports.

Some key financial performance indicators are given below:

  • Return to investors

This is the capital gain on investment plus dividends received during the period.

  • Cash generation

Poor liquidity is a greater threat to the survival of an organization than poor profitability. Cash generation is vital to ensure investment in future profitable ventures. The alternative to cash via retained earnings is borrowing.

  • Value added

This is usually explained as revenue less the cost of bought out materials and services. It represents the value added to an organization’s products by its own efforts. A problem with this indicator is that it may not be possible compare the figures with other industries or even with other companies in the same industry.

  • Profitability

Profitability is the rate at which profits are generated and is often expressed as profit per unit of input. However, profitability limits an organization’s focus to one output measure which is profit. It overlooks quality and does not provide enough insight into the dynamics and balance of an organization’s individual business units and the balance between them. It fails to explain as to why one business sector has more favourable prospects than another. Profitability is remote from the actions that create value. Also the inputs used to calculate profitability may vary between organizations. However, it is a well known and accepted measure which is readily understood.

  • Return on Assets

This is calculated by dividing annual profit by the average net book value of assets. Therefore, it is subject to the distortions inevitable when profit is used to determine performance. Distorting factors for interpretation and comparison include depreciation policy, inventory revaluations, write off of intangibles such as goodwill etc. Also RoA ignores the time value of money.

Non-financial performance indicators are frequently used for performance evaluation.

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