There have been several in-depth studies that analyzed the financial performance of hundreds of companies around the world. Insights were provided by these companies into the key metrics and strategies used by the best performers. The following were found to be the most sustainable value creators, and where focus is concentrated in those companies successfully creating value. The key numbers to watch are:
- Net income
- Cash flow from operations
- Total assets
- Total liabilities
- Total equity
Using these six key numbers, four ratios are tracked and trended:
- Asset turnover (revenue/assets)-the higher the turnover, the better utilization of assets experienced.
- Profit margin (net income/revenue)-the greater the margin, the more profits available to fund growth.
- Cash-flow yield (cash flow from operations/net income)-the higher the yield, the more success enjoyed in managing working capital (ie., current assets minus current liabilities).
- Debt-to-equity (total liabilities/total equity)-the higher the ratio, the more of other peoples’ money (leverage) being used to finance growth.
Successful organizations do well on all these numbers. If you are not doing well on the ratios, then drilling down into the six key numbers is needed.
The entire management team needs to understand how the ratios and underlying key numbers connect to value creation.
Standards of performance can be created by looking at historical numbers over time, which will reveal ranges and trends. Then look for comparable measures within your industry to see how you fare against industry peers. Follow this up by setting some annual targets for 1 to 5 years. In other words, “do what the big dogs do” whether you are local or national in scope, and whether you are for-profit or not-for-profit.
This sets the discipline for making good decisions with the goal being to achieve outstanding long-term return on investment.
Your present performance measures may have defects; and there may be no quick remedies. CFO-Pro can provide a strategic perspective on your financial performance measures. If you are interested in connecting the strategy of your company with the financial reports, and to speak to how your company intends to create value, please contact me directly at firstname.lastname@example.org or 630-269-7646.