It should be noted that finance can be scary and intimidating but with basic skill in financial accounting, we don’t have to be alarmed any longer on some financial accounting terms should. We need to watch the various metrics by which the organization uses to track, measure, and analyse the financial health of a company. These metrics are so important for the organisation, and they fall into various categories like profitability, liquidity, solvency, efficiency, and valuation.
It would be nice to understand these metrics which in turn will help us know how a business is performing from the financial perspective. This knowledge gained from understanding the financial perspective of the firm’s strategic decision-making process is of great advantage for goal setting as a manager in the organization for the department or the team we manage.
As managers, it is important to let the team know its performance either monthly, quarterly, or semi-annually through reports or dashboards which are monitored regularly, and the metrics are easily seen.
The use of the financial analysis to measure the financial KPIs of managers are very necessary; hence the common among them are:
Gross Profit Margin: It measures the profitability of the organization through the percentage of revenue to cost of sales. The revenue is subtracted from the cost of goods sold. On the cost of goods sold, these are goods directly related to the production of the goods or services. It is not inclusive of operating expenses, interest, or taxes. The gross profit margin is specifically a measure of the profitability of a product line without accounting for overhead.
Gross Profit Margin = (Revenue – Cost of Sales) / Revenue * 100
Net Profit Margin: This is the measure of the revenue and other income that is left after subtracting all the other operating costs for the business, including costs of goods sold, interest, and taxes. It is different from the gross profit margin which measures the profitability of the business in general, considering not only the cost of goods sold, but all other related expenses.
Net Profit Margin = Net Profit / Revenue * 100
Working Capital: It measures the business’s available operating liquidity, which can be used to fund day-to-day operations.
Working Capital = Current Assets – Current Liabilities
Current ratio: It is the liquidity ratio which helps one to understand whether the business can pay its short-term obligations—that is, obligations due within one year— with its current assets and liabilities.
Current Ratio = Current Assets / Current Liabilities
The quick ratio or acid test ratio: This is like the liquidity ratio which measures a business’s ability to handle short-term obligations. It uses only highly liquid current assets, such as cash, marketable securities, and accounts receivables, in its numerator. As is well known, certain current assets, like inventory, are not easily able to turn into cash within a short period.
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
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CORRELATION ANALYSIS.