Client Approaches to Measuring Performance
LEARNING OBJECTIVE 2
Explain how clients measure performance and how it
impacts the auditor’s risk assessment.
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The key performance indicators (KPIs) used by a client to
monitor and assess its own performance and the performance
of its senior staff provide auditors with insights into the
accounts their client focuses on when compiling its financial
statements and which accounts are potentially at risk of
material misstatement.
Some KPIs are common to many clients, such as return on
assets and return on stockholders’ equity. Other KPIs will vary
from industry to industry and client to client.
It is very important for auditors to understand which KPIs a
client is most concerned about so the audit can be planned
around relevant accounts.
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LO 2
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Illustration 4.5 KPIs Vary by Industry
LO 2
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Profitability
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LO 2
It is common for companies to use profitability measures to assess
their performance and that of their senior staff.
A company’s management will track revenues from month to month
to identify and explain trends.
The earnings per share (EPS) ratio (net income available to common
stock shareholders divided by weighted average common stock
shares issued) reflects the earnings return on each issued share.
The price–earnings (PE) ratio (market price per share of stock divided
by earnings per share) shows how much a stockholder is willing to
pay per dollar of earnings.
The cash earnings per share (CEPS) ratio (operating cash flow divided
by outstanding shares) shows the cash flow capacity of a company for
each issued share.
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Illustration 4.6 Client Key Performance
Indicators (KPIs)
Ratio
Formula
Earnings per share EPS 
Reflects the earnings return on each common share issued. When a client’s EPS
Net income available to common stock shareholders
ratio is in decline, auditors may be concerned that management is
Weighted - average common stock shares issued
under pressure to manipulate earnings.
ratio
Description
Shows how much a stockholder is willing to pay per dollar
Price - earnings PE 
ratio
Market price per share of stock
Earnings per share
of earnings. For example, a PE ratio of 10 means investors
are willing to pay 10 times current earnings for a company’s
shares. When a client’s PE ratio is in decline, auditors may be
concerned that management is under pressure to manipulate earnings.
Cash earnings per share  CEPS 
ratio
LO 2
Operating cash flow
Outstanding common stock shares
Shows the cash flow capacity of a company for each common share outstanding.
CEPS may be a more reliable indicator of a company’s financial health
because it excludes noncash components such as depreciation and amortization.
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Liquidity, Solvency, and Cash Flow
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LO 2
Liquidity is the ability of a company to pay current debts when they
fall due.
Solvency is the ability of a company to meet long-term financial
obligations.
The cash flow provided, or used, by operating activities indicates a
company’s ability to generate cash.
For analysis purposes, the cash flow from operations amount can be
adjusted for any one-time influences on cash flow from operations to
determine sustainable cash flow from operations.
Companies often agree to debt covenants with lenders when taking
on loans. That is, they promise to maintain specified profitability,
liquidity, or other financial ratios, or to seek the lender’s permission
before taking on new borrowings or acquiring other companies.
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