Financial performance measurement
Financial Performance Measurement also called financial statement analysis uses all the techniques available to show how important items in a company's financial statements relate to the company's financial objectives. Persons with a strong interest in measuring a company's financial performance fall into two groups:
Management's Objectives All the strategic and operating plans that management formulates to achieve a company's goals must eventually be stated in terms of financial objectives. A primary objective is to increase the wealth of the company's stockholders, but this objective must be divided into categories. Management's main responsibility is to carry out its plan to achieve the company's financial objectives. This requires constant monitoring of key financial performance measures for each objective listed above, determining the cause of any deviations from the measures, and proposing ways of correcting the deviations. Management compares actual performance with the key performance measures in monthly, quarterly, and annual reports. The information in management's annual reports provides data for long-term trend analyses.
Creditors' and Investors' Objectives Creditors and investors use financial performance evaluation to judge a company's past performance and present position. They also use it to assess a company's future potential and the risk connected with acting on that potential. An investor focuses on a company's potential earnings ability because that ability will affect the market price of the company's stock and the amount of dividends the company will pay. A creditor focuses on the company's potential debt-paying ability. Past performance is often a good indicator of future performance. To evaluate a company's past performance, creditors and investors look at trends in past sales, expenses, net income, cash flow, and return on investment.
To evaluate its current position, they look at its assets, liabilities, cash position, debt in relation to equity, and levels of inventories and receivables. Knowing a company's past performance and current position can be important in judging its future potential and the related risk. The risk involved in making an investment or loan depends on how easy it is to predict future profitability or liquidity. If an investor can predict with confidence that a company's earnings per share will be between $2.50 and $2.60 in the next year, the investment is less risky than if the earnings per share are expected to fall between $2.00 and $3.00. For example, the potential of an investment in an established electric utility company is relatively easy to predict on the basis of the company's past performance and current position. In contrast, the potential of an investment in a new Internet firm that has not yet established a record of earnings is very hard to predict. Investing in the Internet firm is therefore riskier than investing in the electric utility company.
- A company's top managers, who set and strive to achieve financial performance objectives; middle-level managers of business processes; and lower-level employees who own stock in the company.
- Creditors and investors, as well as customers who have cooperative agreements with the company.
Management's Objectives All the strategic and operating plans that management formulates to achieve a company's goals must eventually be stated in terms of financial objectives. A primary objective is to increase the wealth of the company's stockholders, but this objective must be divided into categories. Management's main responsibility is to carry out its plan to achieve the company's financial objectives. This requires constant monitoring of key financial performance measures for each objective listed above, determining the cause of any deviations from the measures, and proposing ways of correcting the deviations. Management compares actual performance with the key performance measures in monthly, quarterly, and annual reports. The information in management's annual reports provides data for long-term trend analyses.
Creditors' and Investors' Objectives Creditors and investors use financial performance evaluation to judge a company's past performance and present position. They also use it to assess a company's future potential and the risk connected with acting on that potential. An investor focuses on a company's potential earnings ability because that ability will affect the market price of the company's stock and the amount of dividends the company will pay. A creditor focuses on the company's potential debt-paying ability. Past performance is often a good indicator of future performance. To evaluate a company's past performance, creditors and investors look at trends in past sales, expenses, net income, cash flow, and return on investment.
To evaluate its current position, they look at its assets, liabilities, cash position, debt in relation to equity, and levels of inventories and receivables. Knowing a company's past performance and current position can be important in judging its future potential and the related risk. The risk involved in making an investment or loan depends on how easy it is to predict future profitability or liquidity. If an investor can predict with confidence that a company's earnings per share will be between $2.50 and $2.60 in the next year, the investment is less risky than if the earnings per share are expected to fall between $2.00 and $3.00. For example, the potential of an investment in an established electric utility company is relatively easy to predict on the basis of the company's past performance and current position. In contrast, the potential of an investment in a new Internet firm that has not yet established a record of earnings is very hard to predict. Investing in the Internet firm is therefore riskier than investing in the electric utility company.
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