Week 10 Flashcards
Benefits of using non-financial performance measures?
- Prediction. Financial measures may not offer forward-looking, actionable information in a timely manner. Non-financial measures can be leading indicators of future financial performance.
- Causal Identification. Financial measures do not generally track the actions that are part of a strategy, and are limited in identifying what is causing the financial performance. Non-financial measures track actions that are part of a strategy, identifying what is causing the financial performance.
Examples of financial measures
- Net Income
- EBITDA
- Gross Margin
- Return on Assets
- Revenues from new products
- Cost reductions from process innovations
Net income equation
Net income = total revenue - total expenses
Other names for net income?
Net profit, earnings or the bottom line
Why look at Net Income?
- Net Income indicates whether, after all is said and done, thecompany is building owner’s equity or not.
- Net Income matters to investors because stocks are usually considered to be a discounted value of future net income.
- Net Income affects the cash position of the firm—which is important for staying liquid; even firms with assets well in excess of their liabilities can run out of liquidity.
- However, a focus on Net Income may not be so relevant especially for early-stage companies because many operate with negative Net Income for several years.
EBITDA equation
EBITDA = Net income + Interest + Taxes + Depreciation + Amortization
Why look at EBITDA? Does it help us in a way that Net Income does not?
- EBITDA focuses on things that managers can influence – sales and the direct and operating costs.
- EBITDA excludes things that the managers cannot influence very much or at all, such as interest payments, depreciation of equipment, and taxes.
- This provides a measure that managers can then take more ownership of.
- However, a focus on EBITDA can be a problem because it ignores issues such as taxes and financing that managers should keep in mind as they try to work within the company’s limitations.
Gross margin equation
Gross margin = (Total revenue - COGS) / Total Revenue
Why look at Gross Margin?
- Gross Margin helps us to identify whether the company is selling products that have a high mark up over the amountof resources they directly consume.
- Gross Margin can therefore indicate whether managers are successfully driving customers toward the higher margin products. This type of “upselling” is important in many industries.
- However, a focus on Gross Margin can be a problem if it causes managers to deviate from a low-cost, high-volume strategy or to raise prices without justification.
Return on assets equation
Return on assets = Net Income / Total Assets
Why look at Return on Assets?
- Return on Assets helps to identify whether a company is using its assets efficiently.
- A low return on assets suggests that a company may want to cut off a product that uses assets less efficiently so that those assets can be shifted to where the return is higher.
- However, a focus on Return on Assets can be a problem if it causes a company to forgo an investment that does not pay off for a while. That investment would temporarily decrease Return on Assets, but could be important for innovation and long-term growth.
Revenues from new products
Revenues from new products are those that are from products that have been introduced recently. The definition of “recent” can be chosen by the company—e.g., six months, one year, two years.
Why look at revenues from new products?
- Revenues from new products help us to identify whether the company has healthy levels of growth.
- This measure can indicate that the company is meeting demand for a new type of product, or is successfully taking market share away from competitors.
- However, a focus on revenues from new products might shift the company away from its brand—what it is known for—and what loyal customers expect from it.
Cost Reduction from prcoess innovations
Cost reductions from process innovations are cost reductions that are due to increasing the efficiency of production rather than scaling it down.
Why look at cost reductions from process innovations?
- Cost reductions from process innovations help us to identify whether the company is identifying systems for operating more efficiently.
- This measure is particularly important with process automation that is possible due to advances in computing and production technology.
- However, a focus on cost reductions from process innovations can create unwanted tradeoffs. For example, what does the process innovation require? Is it putting more pressure on workers, is it requiring investments in technology?
