Question

What all is involved in assessing the performance of a firm? What specific aspects of performance are important? Within this process, what role does financial analysis play? What are some of the important financial ratios that should be looked at and what things might these reveal about the firm?

Answer 1

In today’s world, where competition in business sphere is increasing day by day, it is important for companies to have a holistic understanding of their business performance. Traditionally businesses used to evaluate their performance using financial measures like sales growth, ROI, etc. However these measures were focused only on the financial performance of business and overall snapshot of the company’s performance was not gauged. So, various other measures like balanced scorecard, market share analysis as well as net profit percentage are implemented in companies to have a 360 degree analysis of the performance of the business.

• Balanced scorecard or BSC is a strategic tool developed to comprehensively evaluate the performance of business. It is used to evaluate the strategy and performance of the business on 4 perspectives.
  • The learning and growth perspective: It focuses on the various intangibles of company which have considerable influence on business.
  • The financial perspective: This perspective is focused upon the revenue and profits generated by business.
  • The customer perspective: It highlights the aspect of how the business is fulfilling the needs of its customers.
  • The internal process perspective: This perspective identifies the strengths and weaknesses of the internal processes of business.
• Market share analysis is another method through which the company’s overall performance can be gauged. It highlights the image which the company holds in the market. This analysis considers the following perspectives:

• Key market players
• Market share
• Total market size
• Market growth rate

• Net profit percentage is focused on evaluating the financial performance of the company. It is the ratio of profit after tax and the value of net sales of the company in a financial year. This financial analysis considers the actual profit made by the company in the given financial year.

Net Profit ratio = (Net profit / Net Sales) * 100

Financial ratios are used by the company to quantify the overall financial standing of the company. Data from the financial statements of the company like balance sheets, P/L statements are used to calculate the financial ratios. Some of the commonly used financial ratios are:

• Solvency ratio
• Return on assets ratio
• Return on equity ratio