Financial Performance Measurement and Profitability Management in Business
This module focuses on performance measurement in business, introducing key concepts such as the income statement, ROI, determinants of profitability, time value of cash, and investment analysis with NPV and IRR. It covers the nature of financial performance, short-term performance statements like income statements, information derived from them, and various performance ratios. Additionally, it discusses investment ratios, gearing ratios, and distribution/retention ratios to evaluate business performance effectively.
Download Presentation
Please find below an Image/Link to download the presentation.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author. If you encounter any issues during the download, it is possible that the publisher has removed the file from their server.
You are allowed to download the files provided on this website for personal or commercial use, subject to the condition that they are used lawfully. All files are the property of their respective owners.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author.
E N D
Presentation Transcript
Module 1: Session 7 Performance Measurement and Profitability Management Module 1: Session 7 1 3/17/2025
Session objectives Introduce the income statement as short term measure of performance. Appreciate ROI as central performance ratio Identify determinants of profitability in road construction. Introduce time valued cash as long term measure of performance Appreciate and select profitable investments based on NPV and IRR Introduce position statements Module 1: Session 7 2 3/17/2025
The nature of financial performance The central purpose of going into business is to increase shareholders wealth. To measure performance of a business is to assess how much wealth it is generating for its owners. Business performance will depend on how well the business is making three core decisions: The choice of assets to invest in. The structure of its capital between equity and debt. The choice to pay out or retain its wealth gains. Module 1: Session 7 3 3/17/2025
The short term performance statement An income statement summarizes the trading performance for a stated period. The net of its revenue and expenses is the bottom line that could be a profit or a loss. The larger the profit the better the performance. A business must regularly prepare an income statement to inform stakeholders of its trading performance. For a company, financial statements are prepared once a year, audited and tabled before the owners in an annual general meeting. Module 1: Session 7 4 3/17/2025
Information derived from an income statement Other than showing the profit or loss made it is possible to derive from the statement: 1) Size of the business by turnover. 2) Structure and nature of its costs. 3) Pricing policy from the gross profit margin 4) Labour productivity 5) Level of activity with reference to balance sheet resources 6) The trend of the business Module 1: Session 7 5 3/17/2025
Possible performance ratios Gross margin (pricing policy) Costs to revenue ratios eg: 1. Materials to revenue 2. Labour to revenue Activity and productivity ratios 1. Assets turnover 2. Stock turnover 3. Revenue per employee or per km. 4. Cost per employee or per km. Module 1: Session 7 6 3/17/2025
Other performance ratios Investment ratios 1. Return on capital employed 2. Return on owners (equity) funds Gearing ratios 1. Interest cover 2. Interest to revenue Distribution/retention ratios Dividend or cash pay out ratio to profit Module 1: Session 7 7 3/17/2025
Central performance ratio (ROI) Return on investment (ROI) ratio indicates the profits of the business relative to the investment in the business. What did you put in and what do you get out? ROI= (profits after tax/equity)x100. ROI is the central performance measure of performance to the owners of a business. The higher the ratio, the better the business is performing. Module 1: Session 7 8 3/17/2025
Determinants of profitability in construction Quality of quantity surveying and bids Pricing policy Stock of jobs Technical and managerial competences Speed of execution Quality assurance Cost control Idle time minimization Variations management Access to funding Capital structure (gearing) Module 1: Session 7 9 3/17/2025
Long term performance The long term performance of a business is measured by the net cash generated from it. If it is a project it is the net cash generated over its lifetime. The higher the cash generated, the better the business or the investment. The earlier the cash the better the project. Fixed assets are useful only if they also bring in or save more cash than was spent on them. But money has a time value, cash tomorrow is different from cash now! Module 1: Session 7 10 3/17/2025
Net present value (NPV) Cash received or paid out in future is discounted by a factor to make it have the same value with money now. The discounting factor will be the cost of capital for the business. Present value is the discounted value of a future cash receipt or a future cash payment. For example, if the cost of capital is 20%, the present value of shs 60,000 received in one year s time is shs 50,000 (that is 60,000/1.2). Module 1: Session 7 11 3/17/2025
Net present value (NPV) The discounted value of future net cash flow (receipt less payment) is called the net present value (NPV). NPV can be negative or positive. A business is profitable in the long term if the stream of cash it generates has a positive NPV. The higher the NPV the more profitable the business is. Module 1: Session 7 12 3/17/2025
Internal rate of return (IRR) The cost of capital of the business is used to discount its net cash flows to get its NPV. The cost of capital that will return an NPV of zero is called the internal rate of return (IRR). IRR is the highest rate at which the business can borrow to finance a project and make a profit. A project is profitable to the business if it has an IRR higher than the cost of capital of the business. Module 1: Session 7 13 3/17/2025
Position Statement The position statement gives the worth of the business at a point in time and how it is financed. The position statement is commonly known as the balance sheet. The assets equals the liabilities of the business. The balance sheet is the summary of the investment of the owners of the business to whom it owes the net assets. It is used by many stakeholders to position and interpret a business Module 1: Session 7 14 3/17/2025
Information Derived from the Balance Sheet The size and wealth of the business and the net worth of its owners. its liquidity and solvency. The level of indebtedness and the nature of its financial risk through its funding structure. its investment preferences and sum total of its history. The trend of the business. The business as a going concern. Module 1: Session 7 15 3/17/2025
Group assignment 1.Analyse the income statement of Munaku Ltd. and assess the profitability of the business. 2.Identify practices that either enhance or hinder profitability in the road construction sector. 3.Given project A and B determine which of the two could Munaku contractors undertake and why. 4.Given project C and D, indicate which one Munaku Ltd. would select and why. 5. If you had limited funds, rank the four projects in order of preference. Module 1: Session 7 16 3/17/2025
END Q&A Module 1: Session 7 17 3/17/2025
Munakus Discounted cash flows Year Cash flow per year in shs' 000 0 (150,000) (150,000) (200,000) (160,000) 1 (20,000) 90,000 55,000 29,000 2 90,000 55,000 57,000 32,000 3 72,000 70,000 68,000 45,000 4 60,000 68,000 71,000 69,000 5 78,000 30,000 73,000 98,000 6 65,000 32,000 88,000 99,000 Net income 195,000 195,000 212,000 212,000 NPV(30%) (23,876) 22,155 (30,262) (27,211) NPV(15%) 49,189 83,504 50,571 49,977 IRR Module 1: Session 7 18 3/17/2025 Rationing (%ge) 32.8 55.7 25.3 31.2
