Utilization of Key Performance Indicators As a Measure of Success

From our CPAAI (CPA Associates International) Colleagues, Rosenswig Mcrae Thorpe in Canada

Utilization of Key Performance Indicators As a Measure of Success

There are many challenges to managing a business in an ever-changing and competitive marketplace.  Monitoring the company’s performance and progress is a key aspect of management.  Many businesses use key performance indicators to measure and understand the success of their operations and to compare results against historical/industry data in order to make sound financial decisions and ensuring organizational goals are being achieved.  Following are some KPIs:

·       Profitability: to assess a business’s ability to generate earnings compared to its expenes and other relevant costs.  Some metrics are:

·     Return on Equity (ROE) = net income divided by shareholder’s capital.  This metric measures the corporation’s profitability relative to the money shareholders have invested.  Higher ROE represents an increase in the company’s ability to generate profit without the need of additional capital

·     Earnings before interest, tax, depreciation and amortization (EBITDA).  This metric is used to analyze and compare profitability between companies and industries

·     Other metrics include gross profit, return of investment, return on sales, etc.

·       Cash Flow: evaluate the ability to fund operations and meet financial obligations.  Example of this is:

·     Operating cash flow = earning before interest and taxes (EBIT) + depreciation – taxes +/- change in working capital.  Working capital is current assets over current liabilities.  This ratio measure the number of times a company can pay off current debts with cash generated from ongoing, regular (core) business activities in the same time period.

·       Liquidity: measures the ability of the company to meet its short term obligations.  Most common metrics include:

·     Current Ratio = current assets over current liabilities.  The higher the ratio, the more capable the company is in paying its obligation.

·     Quick Ratio = (cash + marketable securities + accounts receivable) over current liabilities.  The higher the ratio, the better the company’s liquidity position

·       Solvency: measures the ability of the company to meet its long term debts.  Some metrics include:

·     Equity Ratio = shareholders’ equity over total assets.  This measures how much shareholders would receive in the event of liquidation.  Higher ratio represents the shareholders are more likely to receive some assets during the liquidation.

·     Debt to Equity Ratio = total liabilities over shareholders’ equity.  This ratio measures the company’s financial leverage.  Lower ratio signifies less risk to the lender and more ability to repay the loan.

·       Efficiency: analyze how well a company uses its assets and liabilities internally.  It includes:

·     Asset Turnover Ratio = sales over average total assets.  This measures the efficiency of a company’s use of its assets in generating sales revenue.  Company with low profit margin will tend to have high asset turnover.  The higher the ratio, the better the company is performing.

At the initial stage, it is important for businesses to establish their KPI targets and goals and choosing the proper KPIs to evaluate performance.  These targets will be utilized as a benchmark to compare against actuals and to identify potential problems and opportunities.