Traditional mainstays of quantitative approaches to organizational performance measurement have been accounting measures of performance. However, over the previous two decades, a lot of focus has been placed on the creation and application of non-financial measures of performance that can be used to both inspire employees and provide information about how well businesses (and other) organizations are performing. Such developments have been prompted by both the organization’s top and bottom levels. Utilizing specific performance indicators that are typically not measured in monetary terms, performance management is frequently carried out at the operational level. Although financial performance is unavoidably a key factor at the highest levels, there has been an increasing realization that other significant factors in the efficient operation of the organization cannot be adequately captured by such measures. As a result, non-financial performance measures have advanced significantly while the advancement of better financial measures has been relatively neglected. However, the recent attention given to management consultants Stern Stewart’s promotion of economic value added (EVA®) as a broad indicator of company performance can be interpreted as a sign of a renewed focus on the financial aspects of performance.
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Divisional Performance Measurement – ACCA Management Accounting (MA)
What are performance measures?
Professionals use metrics called key performance indicators (KPIs) to monitor their progress toward goals. Numerous financial KPIs are frequently used by organizations to assess their performance and financial health. Information obtained through accounting procedures and financial statements could be one of these metrics. These performance indicators can take into account a number of factors, such as profitability, efficiency, and liquidity. Organizations can better understand where their business is doing well or poorly by using financial or accounting KPIs to measure performance. They can therefore create financial objectives or modify goals as necessary.
14 ways to use accounting to measure performance
The accounting measures of performance listed below can be used to evaluate your financial situation:
Gross profit margin
[(total revenue – cost of goods sold) / revenue] x 100 = gross profit margin
Net profit margin
(Net Profit / Total Revenue) x 100 = Net Profit Margin.
or
[(revenue – cost of goods sold – operating and other expenses – interest – taxes) / revenue] x 100 equals net profit margin.
Operating cash flow
Operating cash flow is the amount of money available for spending that a company has made through normal business operations. This idea assesses whether the company has enough money to cover necessary costs, such as operating costs, growth opportunities, and financing activities. A favorable outcome demonstrates that the company can finance its expansion, while a unfavorable outcome suggests that it may need to secure additional funding in order to continue operating. Businesses can compute operating cash flow using the following formula:
Operating cash flow is calculated as operating income multiplied by depreciation, taxes, and changes in working capital.
Working capital
Working capital, which represents an organization’s immediately available cash, serves as a gauge of its liquidity. This performance measure can be used by organizations to determine whether they have enough assets to cover both short-term and daily expenses. Positivity in working capital indicates that a company can pay its debts and fund expansion. Meanwhile, low working capital indicates a potential for bankruptcy and suggests that the company may find it difficult to pay its debts. Working capital can be calculated for businesses using the following formula: Working capital = current assets – current liabilities.
Current ratio
Current ratio = current assets / current liabilities
Quick ratio
(Cash and equivalents plus marketable securities plus accounts receivable) / current liabilities is the quick ratio.
or
Current liabilities / (current assets – inventory – prepaid expenses)
Debt-to-equity ratio
The debt-to-equity ratio calculates how much a company borrows compared to how much it invests in equity or owns funds to fund its operations. Additionally, this ratio enables businesses to determine whether they have sufficient equity to pay off debt in the event of a downturn. A high debt-to-equity ratio indicates that a company frequently uses debt to finance its expansion, which can be risky. Organizations’ balance sheets contain the data required for this ratio. The current ratio can be determined for businesses using the formula below:
Debt-to-equity ratio = total liabilities / total shareholders equity
Return on equity
Organizations use the profitability ratio return on equity (ROE) to gauge their financial performance. By dividing a company’s net income by its average shareholders equity, one can determine whether its level of income is appropriate for its size. The income statement of an organization shows its net income for the fiscal year, while the balance sheet shows shareholders’ equity. A high ROE demonstrates that the company makes the most of its shareholders’ investments and uses them to successfully expand and grow the business. The formula below can be used by businesses to determine return on equity:
Return on equity = net income / average shareholders equity
or
Net income is calculated as net income [((starting equity + ending equity) / 2)]].
Return on assets
Although it looks at an organization’s net profits and total assets, return on assets (ROA) is another profitability ratio. This ratio can be used by businesses to assess how effectively they use their available assets and resources to generate profits. They usually display these results as a percentage. A higher ROA indicates a better return on assets or greater efficiency, which enables the company to generate more profit with the same level of investment. The formula below can be used by businesses to determine return on equity:
Return on assets = net income / total assets
or
Net income divided by [((starting total assets + ending total assets) / 2)] is the return on assets.
Financial leverage or equity multiplier
Total assets minus total shareholder equity is referred to as financial leverage or equity multiplier.
Inventory turnover
The inventory turnover ratio allows organizations to monitor and evaluate the flow of inventory into and out of their facilities. The inventory turnover ratio calculates how frequently a company sells and replaces its inventory over a given time frame. While a high turnover rate can indicate strong sales or insufficient inventory, a low turnover rate may indicate that the company has weak sales or excess inventory. Organizations can use this data to evaluate the effectiveness of their production processes or their capacity for sales. Businesses can use the following formula to calculate inventory turnover:
Inventory turnover = cost of goods sold / average inventory
or
Cost of goods sold / [((beginning inventory + ending inventory) / 2)] is the measure of inventory turnover.
Accounts payable turnover
A declining accounts payable turnover indicates that the company is taking longer than usual to pay off its debts. This decrease may occasionally be brought on by modifications to the contract with the vendor, but it may also be an indication of financial problems for the company. The latter situation may require changes to enable quicker payments. An increase in the organization’s accounts payable turnover shows that payments are being made earlier than in previous periods. This outcome demonstrates strong financial performance and proficient debt and cash flow management. Businesses can use the following formula to calculate inventory turnover:
Total supply purchases divided by [((beginning accounts payable + ending accounts payable) / 2)] gives the accounts payable turnover.
Accounts receivable turnover
The amount that a customer owes a company for products or services they have ordered but have not yet paid for is represented by accounts receivable. The accounts receivable turnover ratio is a metric that businesses can use to gauge how quickly these payments are received. A high ratio can show how effective the organization is at collecting payments during the given time period. It might also demonstrate that the company has more clients who pay their debts promptly.
A low ratio, however, may indicate that the company is not effective in collecting these debts. As a result, it might need to modify its procedures and policies to increase effectiveness. Additionally, it might need to reevaluate these clients’ creditworthiness. Businesses can use the following formula to calculate inventory turnover:
Net credit sales divided by the average amount owed make up accounts receivable turnover.
Total asset turnover
Net sales or revenue / average total assets equals total asset turnover.
or
Net sales or revenue divided by [((starting total assets + ending total assets) / 2)] is the total asset turnover.
FAQ
What are accounting performance measures?
An analysis’s numeric result, known as a performance measurement, shows how well an organization is accomplishing its goals.
What are 5 performance measures?
Input, Output, Efficiency, Quality, and Outcome are the five distinct types of measures that have been identified, defined, and will be used throughout Iowa State Government.
