EVALUATING FINANCIAL
PERFORMANCE
Financial Management Program
Management Department
Faculty of Economic
Petra Christian University
Surabaya, 2009
Learning Objectives




Understand important financial performance
measures and their uses, by life cycle stage
Describe how financial ratios are used to monitor a
venture performance
Identify specific cash burn rate measures and liquidity
ratios and explain how they are calculated and used
by the entrepreneur
Identify and describe the use and value of conversion
period ratios to the entrepreneur
Learning Objectives



Identify specific leverage ratios and explain their
use by lenders and creditors
Identify and describe measures of profitability and
efficiency that are important to the entrepreneur
and equity investors
Describe limitations when using financial ratios
User of Financial Performance Measures by
Life Cycle Stage
Life Cycle Stage
Type of
Financing
Financial Ratios
& Measures
Users of Financial
Ratios & Measures
Development &
startup stage
Seed financing &
startup financing
Cash burn rates and
liquidity ratios
Conversion period
ratios
Entrepreneur
Business angels
Venture capitalists
(VCs)
Survival stage
First round financing
Cash burn, liquidity,
& conversion ratios
Leverage ratios
Profitability &
efficiency ratios
Entrepreneur, angels,
VCs,
Commercial banks
Rapid growth stage
Second round,
mezzanine, &
liquidity stage
financing
Leverage ratios
Profitability &
efficiency ratios
Entrepreneur, angels,
VCs,
Commercial banks
Investment bankers
Using Financial Ratios
Financial ratios
relationships between two or more financial
variables or between financial variables and time
Trend analysis
examination of a venture’s performance over time
Using Financial Ratios
Cross-sectional analysis
comparison of a venture’s performance against another firm at the same point in time
Industry comparables analysis
comparison of a venture’s performance against the
average performance of other firms in the same
industry
Income Statement
2007
Net sales
Cost of goods sold
Gross profit
Administrative expenses
Marketing expenses
Research & development
Depreciation
EBIT
Interest expense
Income before taxes
Income taxes (30% rate)
Net income
438.000
285.000
153.000
45.000
32.000
20.000
14.000
42.000
12.000
30.000
9.000
21.000
2008
575.000
380.000
195.000
65.000
39.000
27.000
17.000
47.000
20.000
27.000
8.000
19.000
Balance Sheets
ASSETS
Cash & marketable securities
Receivables
Inventories
Total current assets
Gross plant & equipment
Less: accumulated depreciation
Net plant & equipment
Total assets
Liabilities and Equity
Payables
Short term bank loan
Accrued liabilities
Total current liabilities
Long term debt
Owners’ equity
Total Liabilities & equity
2006
2007
2008
10.000
60.000
70.000
140.000
205.000
28.000
177.000
317.000
10.000
75.000
95.000
180.000
205.000
42.000
163.000
343.000
5.000
105.000
140.000
250.000
255.000
59.000
196.000
446.000
47.000
40.000
8.000
95.000
100.000
122.000
317.000
57.000
44.000
9.000
110..000
90.000
143.000
343.000
84.000
110.000
10.000
204.000
80.000
162.000
446.000
Statements of Cash Flow
Cash flow from operating activities
Net income
+ depreciation
- Increase in Receivables
- increase in Inventories
+ increase in payables
+ increase in accrued liabilities
Net cash flow from operations
Cash flow from investing activities
-Increase in gross equipment
Net cash flow from investing activities
Cash flow from financing activities
+ increase in short-term bank loan
-Decrease in long term debt
Net cash flow from financing
Net change excluding cash account
Beginning cash and marketable securities
Ending cash and marketable securities
2007
2008
21.000
14.000
-15.000
-25.000
10.000
1.000
6.000
19.000
17.000
-30.000
-45.000
27.000
1.000
-11.000
0
0
-50.000
-50.000
4.000
-10.000
-6.000
0
10.000
10.000
66.000
-10.000
56.000
-5.000
10.000
5.000
Cash Burn Rates and Liquidity Ratios
Cash burn
Cash a venture expends on its operating and financing expenses and its investments in
assets
Cash burn rate
Cash burn for a fixed period of time, typically a month
Cash burn
= income statement-based operating, interest, and tax expenses
+ increase in inventories
- (changes in payables and accrued liabilities)
+ capital expenditures
Measuring Venture Cash Burn and
Build Amounts and Rates
Cash build
Net sales less the increase in receivables
= net sales – increase in receivables
Cash Build Rate
Cash build for a fixed period of time, typically a month
Net cash burn
When cash burn exceeds cash build in a specified time period
= cash burn – cash build
Net cash burn rate
Net cash burn for a fixed period of time, typically a month
Traditional Measures of Liquidity
Liquidity Ratios
Ratios that indicate the ability to pay short-term liabilities
when they come due
Current
Ratio
average current assets
average current liabilities
Quick Ratio
Net Working Capital
(NWC) to Total Assets
Ratio
= average current assets
= average current assets
- average inventories
: average current liabilities - Average current liabilities
: average total assets
Conversion Period Ratios
Conversion period ratios
• Ratios that indicate the average time it takes in days to convert
certain current asset and current liability accounts into cash
Operating cycle
• Time it takes to purchase required materials, assemble, and sell the
product plus the time needed to collect receivables if the sales are
on credit
Cash conversion cycle
• Sum of the inventory-to-sale conversion period and the sale-tocash conversion period less the purchase-to-payment conversion
period
Operating Cycle
Cash
Materials
Receivables
(Credit Sales)
Work-in-progress
Finished
Goods
Measuring Conversion Times
Inventory-to-sale Conversion Period
• Average inventories/(Cost of goods sold/365)
Sale-to-cash Conversion Period
• Average receivables/(net sales/365)
Purchase-to-payment Conversion Period
• (Average payables + average accrued liabilities)/(COGS/365)
Cash Conversion Cycle
• Inventory to sale Conversion Period + sale to cash conversion period –
purchase to payment conversion period
Leverage Ratios
Leverage ratios
Ratios that indicate the extent to which the venture has used debt and its
ability to repay its debt obligations
Loan principal amount
Dollar amount borrowed from a lender
Interest
Dollar amount paid on the loan to a lender as compensation for making the loan
Measuring Financial Leverage
Total-debt-to-total-assets ratio
= average total debt/average total assets
Equity multiplier
= average total assets/average owners’ equity
Debt-to-equity ratio
= total debt to total assets/(1-total debts to total assets)
Current liabilities to total debt ratio
= average current liabilities/average total debt
Interest
= EBITDA/interest
Fixed charges coverage
= EBITDA + lease payment/(interest + lease payments +
[debt repayments/(1- tax rate)]
Profitability and Efficiency Ratios


Ratios that indicate how efficiently a venture controls its expenses and uses
its assets
Income statement measures of profitability
 Gross profit margin
= (net sales – COGS)/net sales
 Operating profit margin
= EBIT/net sales
 Net profit margin
= net profit/net sales
 NOPAT margin
= EBIT(1- tax rate)/net sales
Efficiency and Return Measures
Sales-to-Total-Assets Ratio
= net sales/ average total assets
Operating Return on Assets
= EBIT/average total assets
Return on Assets (ROA)
= net profit/average total assets
= net profit/net sales x net sales/average total assets
Return on Equity (ROE)
= net income/average owners equity
= net profit margin x asset turnover x equity multiplier
Thank You