This week, during the CFA class, (corporate financial accounting), we discussed about Evaluating a Firms Performance.
We could see that performance measurement has a great significance in effective management of an organization and in the enhancement of processes since the only measurable thing is manageable.
Different measures have been used by researchers and practitioners to measure business performance.
There are various financial analysis tools that are being used.
- Graphics analysis
- Regression analysis
- Common sized analysis
- Financial ratio Analysis
Graphics analysis: This uses pictograms, pie-charts, bar-charts et al to analyze and interpret a firm’s performance.
Regression Analysis: This helps to predict the effect of the dependent variable on the independent variable.
Common sized Analysis: this includes financial data, entire financial statement , in relation to a single financial statement item or base. There are 2 types of common sized analysis
- Vertical common sized analysis.
The balance sheet can be analyzed using the vertical common sized. Each item Is expressed as a percentage of total asset.
For the income statement, each item can be expressed as a percent of the total net revenues.
For the cash flow statement, each line can be expressed as a percent of sale, assets, or total in and out.
The vertical common sized highlights composition and identifies what is important.
- Horizontal common size:
This measures percentage increase of each item from the prior year or showing each year relative to a base year. This further highlights items that have changes unexpectedly or remains unchanged.
With this, we can compare growth from the prior year to the base year as well as the growth comparison between two companies over a given period.We can now ask series of question as to why, how, when, where and what.
Financial Ratios:
Ratios expresses one number in relation to another. This gives a standardized data in terms of mathematical relationships expressed as percentages, times, or days. The ratio method, facilitates comparisons and trends across companies. Ratio in itself in reality is not the answer it is only an indicator of relative activity, profitability, liquidity and solvency.
Analysis solves the problem of Why.
When using financial analysis tool, it is important to note that computation is not the same thing as analysis.
Analysis goes beyond computing data and numbers. It encompasses computation and interpretation.
When analyzing a company’s past performance, here are some of the questions to be answered.
- What aspects of the performance are critical to successfully competing in the industry?
- How well did the company perform (relative to its own history and competitors).
- Why and What caused the performance?
- Does the performance reflect the company’s strategy?
Financial ratio is an indicator of the following categories;
Activity ratio: how efficient are the firms and management of its assets.
Liquidity: how efficiently can the firm meet its short-term goals.
Solvency: How well is the firm positioned to meet it long term goals.
Profitability: How well and how much are the firm achieving return on its investment.
Valuation Ratios: How does the firms’ performance and financial position relate to its market value.
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