Measuring Financial Performance - Assignment Example

Measuring Financial Performance Table of contents Introduction ………………………………………………………………….…..3 Importance of financial performance appraisal ..................................................…3 Employees’ motivation……………………………………………………..….….3 Charting progress……………………………………………………………….....4 Enhancing good relations……………………………………………………….…4 Profitability ratios………………………………………………………………;…5 Working capital ratios………………..…………………………………………….6 Limitations of financial ratios…………………………………………………...…7 Overtrading………………………………………………………………………....8 Conclusion…………………………………………………………………………10 Reference list……………………………………………………………………….11 Introduction The financial progress of a firm is very crucial in determining future growth. The aim of any firm is to maintain a positive financial performance throughout the business life. In essence, the future life of a business concern is usually uncertain and, therefore, it is necessary to conduct regular financial appraisal to assess the financial progress of a company. Sandler & Keefe (2004) argue that performance appraisal can be described as a systematic process that involves monitoring and assessing performance of individuals towards achieving the established organisational goals. Several studies have revealed that performance appraisal has become very popular among modern business enterprises. Essentially, it is imperative to note that there are various benefits that a firm enjoys for having an organised appraisal of its financial performance. Apparently, some of the reasons why it is imperative for companies to appraise their financial performance include employees’ motivation, enhancing good relations and charting progress. Importance of financial performance appraisal Employees’ motivation Appraisal of the financial performance assesses the performance of the employees in various departments. In this regard, employees are obliged to be accountable for the financial transaction then engage in daily. Therefore, it can be observed that appraisal of financial performance promotes employees’ efficiency. In essence, financial performance appraisal is an effective motivational technique for employees. In most cases, companies offer attractive packages such as bonuses and paid holidays to employees who portray outstanding performance. As a result, the workforce is motivated to perform to the best of its ability to benefit from the rewards offered by the company. Moreover, performance appraisal motivates the management to establish structures that promote positive development of the company. Charting progress Financial performance appraisal aids in tracking the progress of a company on the basis of financial transaction. In essence, regular appraisal facilitates comparison of financial performance between various fiscal periods. In this regard, a company gets the foundation to base future cash flow projections. Basically, financial planning is usually based on the past cash flow patterns and, therefore, financial performance appraisal proves to be an effective planning tool. In addition, it is a measure of improvement that employees and the company can use to assess their ability to deliver. In addition, decisions such as demotions, salary increment and promotions are usually based on the performance appraisal reports. Therefore, it is clear that financial performance appraisal can be an appropriate approach to ensuring positive progressive results. Enhancing good relations Financial performance appraisal involves the management team meeting the company’s employees. Essentially, regular meetings between the employees and the company management create good relations in the workplace. Moreover, effective communication is enhanced thereby promoting appropriate means of problem-solving within the organization. Consequently, the employees get a chance to share work experience and challenges thereby promoting the quality of performance. In essence, it can be observed that financial performance appraisal is a sound mechanism for bringing the company’s workforce together. In addition, it strengthens the union between the employer and the employees’ thereby boosting performance. Profitability ratios John Lewis Partnership plc Annual Report and Accounts 2014. Source: https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=4&cad=rja&uact=8&ved=0CDUQFjAD&url=http%3A%2F%2Fwww.johnlewispartnership.co.uk%2Fcontent%2Fdam%2Fcws%2Fpdfs%2Ffinancials%2Fannual%2520reports%2FJLP-annual-report-and-accounts-2014.pdf&ei=p0lnVfvPHIeU7QaL7oLABA&usg=AFQjCNH0wNB_y22wp3XxZD_qM9GfR8AWFw&sig2=Qbi_YQ4O6bSCAU60wh6cFQ&bvm=bv.93990622,d.ZGU a) Gross profit ratio 2014 Gross profit ratio = gross profit/ sales *100 3018.9/ 10171.5*100= 29.679988 2013 Gross profit ration= 2825.4/9541.3*100 =29.612317 b) Net profit ratio 2014 Net profit ratio= net profit/sales*100 -9.7/10171.5*100 =-0.0953645 2013 Net profit ratio = 3.7/9541.3*100 =0.03877878 c) Return on Net Assets (RONA) 2014 329.1/ (5524-1705.6)*100 =8.6187932 2013 RONA= 343.3/ (5363.6-1633.9) =9.2044937 Working capital ratios a) Debtor days 2014 Debtor days = (Trade debtors/credit sales)*365 = (225.9/10171.5)*365 =8 days 2013 Debtor days = (191.1/9541.3)*365 =192.1/9541.3*365 =7 days b) Creditor days 2014 Creditor days = trade creditors/purchases * 365 =135.5/10171.5*365 =5 days 2013 Creditor days= 119.3/9541.3*365 =6 days c) Stock turnover days 2014 Stock turnover days= inventory/cost of sales * 365 =554/6008.9*365 =34 days 2013 Stock turnover days = 514/5640.1*365 =33 days Limitations of financial ratios Narrow coverage Apparently, financial ratios are only fit for companies that deal with limited line of products or services. Essentially, companies that deal with a number of lines of production may not enjoy the benefits of using the financial ratios for analysis. Actually, the more complex an organization is, the more complex it is to employ ratio analysis techniques. Therefore, it can be learnt that the use of financial ratios is not appropriate for large companies. Basically, large companies have many transactions taking place simultaneously and, therefore, assessing the progress of such transactions can be very challenging. In this case, use of financial ratios cannot serve as effective analysis tools. Unreliable Ratio analysis is based on the available financial statements of the company. In this regard, malicious recording of transaction in the company’s books of account might result in misleading analysis (Ogilvie & Chartered Institute of Management Accountants. (2008). In essence, a company might manipulate its financial records to please the promoters or external investors. In this regard, using the various ratios to analysis such records will be erroneous since there are founded on malice. Therefore, ratio analysis is not a perfect mechanism for assessing a company’s progress since it is difficult to ascertain the credibility of the financial records. For this reason, companies should never over rely on ratio analysis to evaluate performance. It is customarily logical to employ a variety of mechanisms to analyse a company’s financial performance rather than over relying on a single mechanism. Seasonal changes The financial performance of a company is affected by many factors. Therefore, these factors affect the cash flows generated every financial year. As a result, understanding the seasonal changes of cash flows for a company might be very difficult. In this regard, ratio analysis is not effective in assessing financial performance of a company that experience irregular and unpredictable cash flows. Moreover, seasonal changes affect the historical ratio analysis of the company. Overtrading This refers to a situation where a company’s sales grow at a rate that the company is not able to finance. The situation leads to accumulation of accounts payable or accounts receivables thereby leading to insufficiency of working capital (Harvard Business School, 2009). Some of the causes of overtrading include over-investment in fixed assets, excessive drawings and misappropriation of business funds. Essentially, over-investment in fixed assets leaves the company with little or no capital to run the daily operations. In this regard, the company ends up in overtrading. In addition, excessive drawings cause financial shortage thereby resulting overtrading in the long run. Moreover, misappropriation of funds also causes over trading. Basically, misappropriation of funds leaves important projects unattended to thereby causing financial troubles a company. Conclusion Business concerns have established diverse mechanisms to handle challenges that they face in their daily operations. Financial performance appraisal has emerged as one of the best strategies for measuring a company’s progress. In essence, business scholars have cited various benefits for using performance appraisal in assessing financial progress. Some of the benefits include employees’ motivation, tracking a company’s progress, and promoting friendly relations among the employees and between the employees and the employer. Basically, financial ratios aid in the analysis of financial performance of a firm. However, the ratios are associated with several limitations that affect their efficiency. Research has shown that financial ratios do not handle the problem of misleading recording of financial transactions. In addition, ratio analysis for large companies is ineffective. Moreover, ratio analysis does not address the problem of unpredictable cash flows of a company. In this regard, companies should be cautious on basing their financial plans on the ratio analysis results. In fact companies should have various alternatives for tracking financial progress and performance. Over relying on one method can be very disastrous to the future development of a company. Reference list: Ogilvie, J., & Chartered Institute of Management Accountants. (2008). Management accounting - financial strategy. Oxford: CIMA. Sandler, C., & Keefe, J. (2004). Performance appraisal phrase book: The best words, phrases, and techniques for performance reviews. Avon, Mass: Adams Media. Harvard Business School. (2009). Performance appraisal: Expert solutions to everyday challenges. Boston, Mass: Harvard Business Press. John Lewis Partnership plc Annual Report and Accounts (2014). 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