Performance measures

• Gross Profit % (net sales minus the cost of goods and services sold)
• Net profit % (the bottom line after all expenses paid)

Profit is one of the key measures of business performance. It measures how many cents of profit the business is generating from every dollar of sales. The higher the ratio the better the business is performing .You should track your performance carefully against industry competitors. 

Tips

Profitability in your business can be maximised by improving price, cost of goods sold and operating expenses. An increase in price will have a more favourable impact on profit than an increase in volume. This is because a 1% increase in price will not impact direct costs, operating costs or inventory as volume does.

Efficiency measures

• Day’s receivable % Day’s payable  %
• Days inventory % Working capital cycle

Day’s receivable measures the average length of time between credit sales and payment receipts. Management should regularly pull accounts receivable reports and take action where necessary. You should view delinquent account the same way as excessive expenses.

Day’s payable shows the average number of days that lapse between the purchase of goods and the payment of them. It is a rough measure of how timely a business is meeting its payment obligations

Inventory days measures how much inventory (days) is on hand. The goal of every business is to get out the finished goods as soon as possible. Manufactures focus on elements of inventory: raw materials, WIP & finishes goods. Retailers focus on converting slow moving stock items to cash, and service industries focus on billing work in progress as early as possible

Working capital cycle is measured by days in inventory plus days receivable less accounts payable. The higher the working capital cycle the more costly it is to fund.

Tips

To minimize working capital cycle, the business should ensure that invoices are provided with delivery or bill as soon as the work is performed. Another way of reducing the working capital cycle is the use of trade credit. Trade credit is the financing that the business receives from suppliers. This should be used as much as possible. In fact suppliers should be paid according to their credit terms but not before.

Efficiency and liquidity maintenance should always be a top priority even in the most well run business.

Return measures

Return on equity %

This measure shows how much profit is being returned on the shareholders equity each year. It is a vital statistic from the perspective of equity holders in a business.

Leverage measures

Debt to equity %

This is the balance between assets owed verses assets owned. Generally creditors prefer a lower ratio to decrease financial risk.

Coverage measures

Debt service cover

It shows the ability of the business to fund its commitments to the bank ( the current portion of the long-term debt and interest payable )If this ratio is under1, it indicates that the business does not have sufficient cash after tax to meets its commitment to the bank.

Tips

Businesses have very little control over interest and ability to retire debts. Instead management should focus on managing profits via drivers such as price improvement, operating expense management, day’s receivable and inventory management etc.