Ch15: Performance Management

Question 1

(1) FINANCIAL PERFORMANCE INDICATORS (FPI) - ROCE -

Formula for Calculating RETURN ON EQUTIY (ROE)

Answer 1

ROE = ( Profit AFTER Tax / (Share Capital + Reserves) ) * 100

Question 2

(1) FINANCIAL PERFORMANCE INDICATORS (FPI) - ROCE -

Formula for Calculating RETURN ON CAPITAL EMPLOYED (ROCE)

Answer 2

ROCE = ( PBIT / CAPITAL EMPLOYED ) * 100

CAPITAL EMPLOYED = TOTAL ASSETS - TOTAL LIABILITIES

Question 3

(1) FINANCIAL PERFORMANCE INDICATORS (FPI) - ROCE -

What does ROCE show?

Answer 3

ROCE shows how well a business is utilising the funds invested in it.

Question 4

(1) FINANCIAL PERFORMANCE INDICATORS (FPI) - ROCE -

What does a decreasing or static ROCE show?

Answer 4

Company has profitability problems.

Could be due to reduced profit margins or reduced asset turnover.

Question 5

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

Formula for calculating NET PROFIT MARGINS (NPM)

Answer 5

NPM = ( Net Profit AFTER Tax / Revenue ) * 100

Question 6

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

What does NPM show?

Answer 6

NPM shows the overall profit as a percentage of revenue.

It describes profit after deducting all costs.

Question 7

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

What does high NPM indicate?

Answer 7

• High sales prices.
• Total costs are under control.

Question 8

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

Process of improving the NPM ratio?

Answer 8

• Increasing selling prices.
• Reducing costs.

Question 9

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

Formula for calculating GROSS PROFIT MARGINS (GPM)

Answer 9

GPM = ( Gross Profit / Revenue ) * 100

Question 10

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

What does a high GPM indicate?

Answer 10

• High sales prices.
• Production costs are under control.

Question 11

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

Process of improving the GPM ratio?

Answer 11

• Increasing selling prices.
• Reducing cost of sales.

Question 12

(2) FINANCIAL PERFORMANCE INDICATORS (FPI) - PROFIT MARGINS -

What does a falling GPM indicate?

Answer 12

• Selling price at which the company sells its goods at is declining.
• The cost of making or buying the goods is increasing.
• Products are losing popularity.

Question 13

(3) FINANCIAL PERFORMANCE INDICATORS (FPI) - ASSET TURNOVER RATIO -

Formula for calculating Asset Turnover Ratio

Answer 13

ASSET TURNOVER RATIO = SALES REVENUE / CAPITAL EMPLOYED

CAPITAL EMPLOYED = TA - TL

Question 14

(3) FINANCIAL PERFORMANCE INDICATORS (FPI) - ASSET TURNOVER RATIO -

What does the Asset Turnover Ratio show?

Answer 14

Indicates whether or not the capital invested is appropriate.

Question 15

(3) FINANCIAL PERFORMANCE INDICATORS (FPI) - ASSET TURNOVER RATIO -

How to improve the Asset Turnover Ratio?

Answer 15

• Increasing sales.
• Reducing Total Assets.
• Increasing Current Liabilities

Question 16

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

What does the Liquidity Ratio show?

Answer 16

The amount of cash a company company can obtain quickly to settle its debts (and also meet other unforeseen demands for cash payments too).

Question 17

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

What does the Current Ratio measure?

Answer 17

Measures a company’s ability to pay short-term obligations or those that are due within 1 year.

E.g. Inventory, Cash

Question 18

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

Formula for calculating Current Ratio and what does it indicate?

Answer 18

CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES

< 1 [ CA < CL] = DOES NOT have the capital at hand to meet its short-term obligations.

> 1 [CA > CL] = Company HAS the financial resources to remain solvent in the short-term.

Question 19

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

What does the Quick Ratio / Acid Test indicate?

Answer 19

It is an indicator of a company’s short-term liquidity position and measures a company’s ability to meet its short-term obligations with its MOST LIQUID ASSETS.

Question 20

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

Formula for calculating the Quick Ratio / Acid Test and what does it indicate?

Answer 20

QUICK RATIO = ( CURRENT ASSET - INVENTORY ) / CURRENT LIABILTIES

= 1 → NORMAL = Indicates that the company is FULLY EQUIPPED with enough assets that can be liquidated to pay its current liabilities.

> 1 → VERY GOOD = CAN instantly get rid of their current liabilities.

< 1 → NOT GOOD = CANNOT pay off its current liabilities in the short-term. Cash flow difficulties

Question 21

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

Formula for calculating the Inventory Holding Period (DAYS)

Answer 21

INVENTORY HOLDING PERIOD (DAYS) = ( AVERAGE INVENTORY / COST OF SALES ) * 365 DAYS

Question 22

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

What does the Inventory Holding Period measure?

What does a SHORTER Inventory Holding Period mean?

Answer 22

• Measures the amount of time inventory is held before it is sold, measured in days.
• SHORTER PERIOD =
  (1) LOWER HOLDING COST of inventory.
  (2) FASTER inventory can be CONVERTED INTO CASH.

Question 23

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

What does the Receivables Collection Period measure?

What does a SHORTER Receivables Collection Period mean?

Answer 23

• Measures the amount of time receivables are held before they are collected, measured in days.
• SHORTER PERIOD =
  (1) LOWER FINANCING COSTS of receivables.
  (2) FASTER receivables are CONVERTED INTO CASH.
  (3) LOWER RISK of Bad Debt.

Question 24

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO -

Formula for calculating the Receivables Collection Period (Days)

Answer 24

RECEIVABLE COLLECTION PERIOD (DAYS) = ( AVERAGE RECEIVABLES / CREDIT SALES ) * 365 DAYS

Question 25

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO - Formula for calculating the Payable Payment Period (DAYS)

Answer 25

PAYABLE PAYMENT PERIODS (DAYS) = ( AVERAGE PAYABLES / CREDIT PURCHASES ) * 365 DAYS

Question 26

(4) FINANCIAL PERFORMANCE INDICATORS (FPI) - LIQUIDITY RATIO - What does the Payable Payment Period measure? What does a LONGER Payable Payment Period mean?

Answer 26

-Measures the amount of time payables are held before it is paid, measured in days - LONGER PERIOD = (1) LOWER FINANCING COSTS of receivables. (2) MORE CASH RETENTION.

Question 27

(5) FINANCIAL PERFORMANCE INDICATORS (FPI) - GEARING RATIOS - What do the Gearing Ratios indicate?

Answer 27

Measures the proportion of long-term borrowed funds (which pay a fixed return) to equity capital (shareholders' funds) and provide information about a company's financial risk due to debt burden. = Means the portion of a company's finance provided by debt.

Question 28

(5) FINANCIAL PERFORMANCE INDICATORS (FPI) - GEARING RATIOS - Formula for calculating the Gearing Ratio

Answer 28

GEARING RATIO = DEBT / EQUITY

Question 29

(5) FINANCIAL PERFORMANCE INDICATORS (FPI) - GEARING RATIOS - What do the Operating Gearing Ratio measure?

Answer 29

Ratio which is calculated to quantify BUSINESS RISK.

Question 30

(5) FINANCIAL PERFORMANCE INDICATORS (FPI) - GEARING RATIOS - What does a high Operating Gearing Ratio indicate?

Answer 30

Indicates that a large proportion of the organisations operating costs are FIXED.

Question 31

(5) FINANCIAL PERFORMANCE INDICATORS (FPI) - GEARING RATIOS - Formula for calculating the Operating Gearing Ratio.

Answer 31

OPERATING GEARING RATIO = CONTRIBUTION / PBIT

Question 32

Strengths of using Ratios

Answer 32

- Easier to understand than absolute measures. - Easier to look at changes overtime. - Puts performance into context. - Can be used as targets.

Question 33

Limitations of using Ratios

Answer 33

- Must be carefully defined as its not useful on its own. - Based on historical costs (won't give an accurate reflection of the future). - FPIs may lead to excessive focus on cost reductions - short term reductions may be achieved at the expense of long-term performance due to effect on staff morale, quality and other factors. - FPIs ignore drivers of business success - e.g. Quality, Delivery, Customer Satisfaction.

Question 34

Reasons for the use of Non-Financial Performance Indicators (NFPIs)

Answer 34

- FPIs focuses on little few variables - primarily focuses on monetary terms and ignores other variables. - Lack of Information on Quality. - Ignores changes in a competitive environment. - Better indicator of future prospects (e.g. falling quality = lower profits). - Information can be provided quickly, easier to calculate and it is a lot easier for non-financial managers to understand and use effectively. - Less likely to be manipulated.

Question 35

Examples of NFPIs for Product Quality

Answer 35

- Percentage of items rejected by quality control. - Number of items returned by customers.

Question 36

Examples of NFPIs for Product Delivery

Answer 36

- Percentage of customer orders delivered on time. - Waiting time for order to delivery.

Question 37

Examples of NFPIs for Customer Satisfaction

Answer 37

- Number of customer returning. - Number of complaints.

Question 38

Examples of NFPIs for After-Sales Services

Answer 38

- Waiting time. - Number of complaints. - Customer surveys to measure their satisfaction.