To provide a coherent structure for the many ratios and measures involved, the discussion will be built around three major viewpoints of financial performance analysis. While there are many different individuals and groups interested in the success or failure of a given business, the most important are:
- Owners (investors).
- Lenders and creditors
Closest to the business on a day-to-day basis, but also responsible for its long-range performance, is the management of the organization, whether its members are professional managers or owner/managers. Managers are responsible and accountable for operating efficiency, the effective deployment of capital, useful human effort, appropriate use of other resources, and current and long-term results — all within the context of sound business strategies.
Next are the various owners of the business, who are especially interested in the current and long-term returns on their equity investment. They usually expect growing earnings, cash flows, and dividends, which in combination will bring about growth in the economic value of their “stake.” They are affected by the way a company’s earnings are used and distributed, and by the relative value of their shares within the general movement of the security markets.
Finally, there are the providers of “other people’s money”, lenders and creditors, who extend funds to the business for various lengths of time. They are mainly concerned about the company’s liquidity and cash flows that affect its ability to make the interest payments due them and eventually to repay the principal. They’ll also be concerned about the degree of financial leverage employed, and the availability of specific residual asset values that will give them a margin of protection against their risk.
Other groups such as employees, government, and society have, of course, specific objectives of their own — the business’ ability to pay wages, the stability of employment, the reliability of tax payments, and the financial wherewithal to meet various social and environmental obligations. Financial performance indicators are useful to these groups in combination with a variety of other data.
The principal financial performance areas of interest to management, owners, and lenders are shown in Figure below, along with the most common ratios and measures relevant to these areas.
|Operational Analysis||Investment Return||Liquidity|
|Gross margin||Return on total net worth||Current ratio|
|Profit margin||Return on common equity||Acid test|
|Operating expense analysis||Earnings per share||Quick sale value|
|Contribution analysis||Cash flow per share|
|Operating leverage||Share price appreciation|
|Resource Management||Disposition of Earnings||Financial Leverage|
|Asset turnover||Dividends per share||Debt to assets|
|Working capital management||Dividend yield||Debt to capitalization|
|Inventory turnover||Payout/retention of earnings||Debt to equity|
|Accounts receivable patterns||Dividend coverage|
|Accounts payable patterns||Dividends to assets|
|Human resource effectiveness|
|Profitability||Market Performance||Debt Service|
|Return on assets||Price/earnings ratio||Interest coverage|
|Return before interest and taxes||Cash flow multiples||Burden coverage|
|Return on current value basis||Market to book value||Fixed changes coverage|
|EVA and economic profit||Relative price movements||Cash flow analysis|
|Cash flow return on investment||Value drivers|
|Free cash flow||Value of the firm|