4. Performance measurement
4.1 general financial ratio analysis
4.1.1 Working capital management
•current ratio= current assets/current liabilities
•quick ratio=(current assets-stock)/ current liabilities
A higher ration indicates better liquidity, however, a very high ratio indicates high levels of inventories and receivables, high cash levels which could be put to better use.
It is also worth considering: seasonal nature of the business, non-current liabilities and when they fall due and how will they be financed.
•stock holding period=(average stock held/cost of sales)ｘ365days
•stock turn over= cost of sales/average stock held
an increasing number of days implies that inventory is turning over less quickly, this is regarded as bad sighs in lack of demand for the goods, poor inventory control, inventory obsolescence and related write offs.
However, it may not necessarily be bad where: management are buying inventory in large quantities to take advantage of trade discount; management have increased inventory levels to improve service to customers.
•debtors collection period= closing trade debtors/ average daily sales
A lengthening collection period is usually a bad sign as it suggests lack of proper credit control, it may be due to: a deliberate policy to extend the stated credit period to attract more trade; one major new customer being allowed different terms.
A falling collection period is usually a good sigh, though it could indicate that the firm is suffering a cash shortage.
•creditors’ payment period=closing trade creditors/ average daily purchase
A long credit period may be good as it represents a source of free finance, or the enterprise is unable to pay more quickly because of liquidity problems.
However, if the credit period is long, the firm may develop a poor reputation as slow payer and may not be able to find new suppliers; existing supplier may decide to discontinue supplies; the firm may be losing out on worthwhile cash discounts.
4.1.2 Profitability ratio
•ROCE= profit/ capital employed
This ratio shows how efficiently a business is using its resources. If the return is very low, the business may be better off realizing its assets and investing the proceeds in a high interest account.
•Gross profit percentage= Gross profit/ Sales revenueｘ100%
This ratio is the margin that the enterprise makes on its sales, low margin suggests poor performance but may be due to expansion cost or trying to increase market share.
•Trading profit percentage=(profit before interest, investment income and tax)/ sales revenue
This is affected by factors such as the depreciation which is open to considerable
subjective judgment.
4.1.3 Long-term financial stability
gearing
4.1.4 Debt holder ratio
•interest cover= profit before interest and tax/interest paid
In general, a high level of interest cover is good, but a high interest cover ratio
may be interpreted as a company failing to exploit gearing opportunities to fund
projects at a lower cost than from equity finance.
•interests yield=interest paid/market price
This measure looks from the return as if the loan stock was bought at current market price and held for one year, totally ignoring whether the debt is redeemable and how close redemption might be.
4.1.5 Shareholder ratio
•dividend per share= dividend for the year/number of ordinary share
•dividend cover= profit for ordinary shareholders/dividend for the year
profit for ordinary shareholders should deduce the preference dividend. This cover can show the security for the ordinary dividend.
•dividend yield= dividend per share/ current share priceｘ100%
•return on equity=profit after tax and preference dividends/ordinary share capital
it is of particular relevance to the ordinary shareholders of a company.
•EPS
•PE ratio=current share price/ EPS
PE ratio is based on current EPS but the stock market is pricing the share on expectation of future EPS. If the market considers that a company has significant growth prospects, the market price of the share will rise.
•net assets per share= net assets/ number of ordinary share

4.1.6 other management performance measures: ROI and RI
(1) ROI= Profit before interest and tax/ average book value of capital invested
•ROI measures the efficiency of an entity, a division or a project in generating
profits, it enables comparisons to be made with divisions or companies of different sizes.
•it is used externally and is well understood by users of accounts.
•The primary ratio split down into secondary ratios for more detailed analysis.
ROI=Profit/ turnover ｘ Turnover/ capital employed
•ROI forces managers to make good use of existing capital resources and focuses attention on them, particular when funds for further investment are limited.
•ROI encourages reduction in the level of assets such as obsolete equipment.
•ROI disincentives to invest- a divisional manager will not wish to make an investment which provides an adequate return as far as the overall company is concerned if it reduces the division’s current ROI. By the same token existing assets which generate a reasonable may be sold if ROI can be improved by doing so.
•ROI improves with age.
•Corporate objectives of maximizing total shareholders’ wealth or the total profit of the company are not achieved by making decisions on the basis of ROI.
(2) RI= Profit-( notional interest chargeｘcapital employed)
The interest charge deducted represents the opportunity cost of using the capital.
RI is widely used, particularly to assess the performance of individual units and managers within an entity,
Pros and cons
Residual income overcomes many of the disadvantages of ROI.
•It reduces the problem of under investing or failing to accept projects with ROIs greater than the group target but less than the division’s current ROI.
•As a consequence it is more consistent with the objective of maximising the total profitability of the group.
•It is possible to use different rates of interest for different types of asset.
•The cost of financing a division is brought home to divisional managers.
However, it will suffer from the same problems associated with profit and asset measurement, and potential conflict with NPV investment decisions, as the ROI.

4.1.7 Limitation of financial ratio measures
•Profit and capital employed are arbitrary figures, they depend on the accounting policies adopted by an entity.
•The accounting periods covered by the financial statements may not reflect representative financial positions.
•Ratios based on historic cost accounts do not give a true picture of trends from year to year.
•Ratios based on the financial statements only reflect those activities which can be expressed in money terms, they don’t give a complete picture of the activities of a business.
•Ratios based on the financial statements only reflect historical information, investors and other users of financial statements are likely to be more interested in an entity’s future prospects.
4.1.8 General procedure for ratio analysis
First step: calculate the ratio
Second step: assess the ratio, it can be compared with:
•previous years’ ratio
•company’s target ratio
•other company in same industry, but should point out: considering different accounting policy, different age of plant, and so on.
Third step: If the ratio is favorable, you should point out that it may be a result of certain policy adopted by the company introduced in the question, and may be other possible influencing factors which have adverse effect. Commonly, you should mention more information needed to develop the ratio analysis.
If the ratio is unfavorable, you should point out that it may be a result of certain policy adopted by the company introduced in the question, and may be other possible influencing factors which have favorable effect. Commonly, you should mention more information needed to develop the ratio analysis.
4.2 non-financial ratio analysis
4.2.1 Competitiveness
•sales growth by product or service
•measures of customer base
•relative market share and position
4.2.2 Productivity
•production-volume ratio =Actual output measured in standard hours/ Budgeted production hoursｘ100
•capacity ratio=Actual hours worked/ Budgeted hoursｘ100
•efficiency ratio= Actual output measured in standard hours/ Actual production
hoursｘ100
4.2.3 Quality of service
•proportion of repeat business
•customer waiting time
•proportion of deliveries on time
•number of customer complaints received
•rejection as a percentage of production or sales
4.2.4 Personnel
•staff turnover
•overtime
•train time per employee
•days absence
•measures of job satisfaction
4.2.5 Marketing effectiveness
•trend in market share
•number of customers
•client contact hours per salesperson
4.2.6 Innovation
•proportion of new products and services to old ones
•new product or service sales levels
4.3 Benchmarking
4.3.1 Definition: benchmarking is the practice of identifying an appropriate organization whose performance may be used as a comparator, or benchmark, for this purpose.
4.3.2 Obtain information for benchmarking
Generally from organization within the same group of companies or from similar but non-competing industry.
4.3.3 Intra-group benchmarking, inter-industry benchmarking