16
Financial Performance
Measurement chapter
Foundations of Financial Performance
Measurement
OBJECTIVE 1: Describe the objectives,
standards of comparison, sources of
information, and compensation issues in
measuring financial performance.
Exhibit 1: Selected Segment Information
for Goodyear Tire & Rubber Company
Exhibit 2: Listing from Mergent’s
Handbook of Dividend Achievers
Exhibit 2: Listing from Mergent’s
Handbook of Dividend Achievers
Exhibit 2: Listing from Mergent’s
Handbook of Dividend Achievers
Foundations of Financial Performance
Measurement
• Financial performance measurement
comprises all the techniques that users of
financial statements employ to show
relationships in an organization’s financial
statements and to relate those relationships
to the organization's financial objectives.
Foundations of Financial Performance
Measurement
• Users of financial statements are classified
as either internal or external.
– Internal users include top managers who set
and strive to achieve financial performance
objectives, middle-level managers of business
processes, and employee stockholders.
– External users include creditors and investors
wanting to assess how well managers
accomplished their financial objectives and
customers forming cooperative agreements
with the company.
Foundations of Financial Performance
Measurement
• Management is responsible for devising,
executing, monitoring, and reporting on a
complete financial plan for a business that
focuses on the following:
– Liquidity—ability to pay bills when due and to
meet unexpected needs for cash
– Profitability—ability to earn a satisfactory net
income
– Long-term solvency—ability to survive for
many years
Foundations of Financial Performance
Measurement
• Management is responsible for devising,
executing, monitoring, and reporting on a
complete financial plan for a business that
focuses on the following: (cont.)
– Cash flow adequacy—ability to generate
sufficient cash through operating, investing,
and financing activities
– Market strength—ability to increase the wealth
of owners
Foundations of Financial Performance
Measurement
• Creditors and investors use financial
statement analysis in two ways.
– To judge past performance and current position
– To judge future potential and the risk
associated with it
Foundations of Financial Performance
Measurement
• Decision makers judge performance in (at
least) three ways.
– Rule-of-thumb measures
– Analysis of past performance
– Comparison with industry norms (discuss
limitations)
Foundations of Financial Performance
Measurement
• Source of Information
– A company’s annual report provides a
significant amount of information.
– Interim financial statements may indicate
recent changes in earnings.
Foundations of Financial Performance
Measurement
• Incentive bonuses and stock options for top
executives are typically based on the
company's achievement of certain financial
goals. For public companies, a
compensation committee of independent
directors must establish remuneration
policy for top-level executives, and the
components and criteria used must be
reported to the SEC.
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Tools and Techniques of Financial
Analysis
OBJECTIVE 2: Apply horizontal analysis,
trend analysis, vertical analysis, and ratio
analysis to financial statements.
Exhibit 3: Comparative Balance Sheets
with Horizontal Analysis
Exhibit 3: Comparative Balance Sheets
with Horizontal Analysis
Exhibit 3: Comparative Balance Sheets
with Horizontal Analysis
Exhibit 4: Comparative Income
Statements with Horizontal Analysis
Exhibit 4: Comparative Income
Statements with Horizontal Analysis
Exhibit 4: Comparative Income
Statements with Horizontal Analysis
Exhibit 5: Trend Analysis
Figure 1: Graph of Trend Analysis Shown
in Exhibit 5
Figure 2: Common-Size Balance Sheets
Presented Graphically
Exhibit 6: Common-Size Balance Sheets
Figure 3: Common-Size Income
Statements Presented Graphically
Exhibit 7: Common-Size Income
Statements
Tools and Techniques of Financial
Analysis
• Horizontal analysis shows absolute and
percentage changes from one year to the
next.
– The first of the two years being considered is
called the base year.
– The percentage change is computed by
dividing the amount of the change by the base
year amount.
Tools and Techniques of Financial
Analysis
• Trend analysis is an application of
horizontal analysis over several consecutive
years.
– This approach uses an index number, with the
base year set at 100 percent, against which
changes in related items are measured.
Tools and Techniques of Financial
Analysis
• Vertical analysis calculates percentage
relationships within a single statement.
– The result is a common-size statement.
• On a common-size balance sheet, total assets and
total liabilities and equity in their respective areas
of the balance sheet are labeled 100 percent.
• On a common-size income statement, net sales or
net revenues are labeled 100 percent.
• Common-size statements can be presented in
comparative form.
Tools and Techniques of Financial
Analysis
• Ratio analysis shows meaningful
relationships between financial statement
components.
– Ratios are useful in evaluating a company’s
financial position and operations and in
comparing financial data for several years or
for several companies.
– The primary purpose of ratios is to identify
areas needing further investigation.
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Comprehensive Illustration of Ratio
Analysis
OBJECTIVE 3: Apply ratio analysis to
financial statements in a comprehensive
evaluation of a company’s financial
performance.
Figure 4: Starbucks’ Operating Cycle
Exhibit 8: Liquidity Ratios of Starbucks
Corporation
Exhibit 8: Liquidity Ratios of Starbucks
Corporation
Exhibit 9: Profitability Ratios of Starbucks
Corporation
Exhibit 10: Long-Term Solvency Ratios of
Starbucks Corporation
Exhibit 11: Cash Flow Adequacy Ratios of
Starbucks Corporation
Exhibit 12: Market Strength Ratios of
Starbucks Corporation
Comprehensive Illustration of Ratio
Analysis
• Ratio analysis provides information about a
company’s liquidity, profitability, longterm solvency, cash flow adequacy, and
market strength.
Comprehensive Illustration of Ratio
Analysis
• There are five major types of ratios.
– Liquidity ratios
•
•
•
•
•
•
•
•
Current ratio
Quick ratio
Receivable turnover
Days’ sales uncollected
Inventory turnover
Average days’ inventory on hand
Payables turnover
Average days’ payable
Comprehensive Illustration of Ratio
Analysis
• There are five major types of ratios. (cont.)
– Profitability ratios
•
•
•
•
Profit margin
Asset turnover
Return on assets
Return on equity
Comprehensive Illustration of Ratio
Analysis
• There are five major types of ratios. (cont.)
– Long-term solvency ratios
• Debt to equity ratio
• Interest coverage ratio
Comprehensive Illustration of Ratio
Analysis
• There are five major types of ratios. (cont.)
– Cash flow adequacy ratios
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•
•
•
Cash flow yield
Cash flows to sales
Cash flows to assets
Free cash flow
Comprehensive Illustration of Ratio
Analysis
• There are five major types of ratios. (cont.)
– Market strength ratios
• Price/earnings ratio
• Dividends yield
©2011 Cengage Learning All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.