Financial Performance

Understanding Financial Performance

  • Profit and Loss account - A financial statement that summarises income and expenses over a specific period. The outcome shows whether the business made a profit or a loss.

  • Balance sheet - A financial snapshot at any point in time that shows what a business owns (assets), what it owes (liabilities), and the owner’s investment (equity).

  • Cash flow forecast - A plan that projects how and when cash will move in and out of the business. It helps to identify potential shortfalls and plan for them in advance.

Measure of Financial Performance

  • Gross profit margin - This is the difference between sales and the cost of goods sold. It shows what profit is left after direct costs have been covered.

  • Net profit margin - This is the percentage of revenue left after all expenses are deducted from sales. It shows the profitability of a business after all costs.

  • Return on capital employed (ROCE) - This is a measure of a company’s profitability in relation to the capital it is utilised. It shows how effectively a business is using its capital to generate profit.

  • Current ratio - This measures a company’s ability to pay short-term liabilities with short-term assets. A healthy current ratio is typically between 1.2 and 2.

  • Acid test ratio - Similar to the current ratio, but excludes inventory from the list of assets. It provides a stricter measure of a company’s short-term liquidity.

Interpreting Financial Performance

  • Interpretation through ratio analysis helps businesses identify areas of strength and weakness in their financial performance.

  • Trend analysis involves comparing financial information over periods of time to identify patterns and predict future performance.

  • Comparing a business’s performance against the industry average or key competitors (benchmarking) can offer valuable insights.

Impacting Factors on Financial Performance

  • Sales revenue: Fluctuation in sales can greatly affect financial performance.

  • Costs - Managing costs efficiently can increase profit margins.

  • Economic Environment - Inflation, exchange rates and economic recessions can impact financial performance.

  • Competition - The pricing strategies and marketing campaigns of competitors can impact a business’s sales and profits.

Improving Financial Performance

  • Cost control - Reducing unnecessary expenses to improve profit margins.

  • Increasing sales - This can be achieved through effective marketing strategies or improving product quality.

  • Debt management - Good debt management can minimise interest payments and improve cash flow.

  • Efficient use of resources - This can lead to cost savings and improved financial performance.