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The following is a guest post by Vanessa Mackay. Enjoy!
There are three primary measures of financial performance in every organization’s financial statements:
- Return on equity, and
- Balance sheet strength
While these are crucial quantities to evaluate, by themselves, they cannot provide full information. The two considerations that do not directly appear on financial statements are non-financial performance measures, such as employee turnover rates. These have a real effect on your bottom line.
ROE and the DuPont Identity
Of course, return on equity is an important ratio to assess, but it almost always is expressed as net income ÷ total equity. The DuPont Identity provides a simple approach to arriving at ROE using more detailed information. The benefit for the financial manager is that the DuPont Identity demonstrates that ROE is affected by three inputs: operating efficiency, asset use efficiency, and financial leverage. If, for any reason, ROE is unsatisfactory in any respect, the DuPont Identity highlights the area in which to look for the reasons.
All of the values necessary for deriving ROE using the DuPont Identity can be found on the balance sheet or directly derived from balance sheet reporting points. The DuPont Identity reduces to [(Net Income ÷ Sales) x (Sales ÷ Assets) x (Assets ÷ Total Equity)]. The result is the same as dividing net income by total equity, but it provides much greater insight for assessing the organization’s performance.
There are several non-financial measures that affect financial results, either directly or indirectly. Some of these are:
- Employee motivation
- Employee turnover rates, and
- Customer retention rates
Highly motivated employees not only work better, they also are likely to provide management with workable ideas regarding more efficient operation. Everyone knows that replacing employees is a costly activity, but the inconsistency it creates in organizational learning can serve to inhibit the organization’s progress in employee motivation and customer retention.
All marketers are well aware that it is more costly to locate and secure a new customer than to retain an established one. Certainly, the organization needs to develop new customers on a continuing basis, but customer retention also needs to be a point of ongoing performance management. Maximizing both customer acquisition and customer retention leads to greater performance.
How about you all? How does your company measure it’s performance? Do you think too much or not enough emphasis is placed on financial measures?
Share your experiences by commenting below!
Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.
- Overall, I think this post gives a well rounded view of the various considerations to keep in mind when evaluating how a/your company is doing.
- I believe it is well stated above that while profit, ROE, etc are very important, they are not the only thing to keep in mind when seeing how a company is doing. This could be particularly important when trying to value the company and assess whether or not to invest in it.
- For my blogging endeavors, since it is run as a one-person sole proprietorship, the only real concrete financial performance measure I like to look at is monthly revenue, expenditures, and profit positions.
- The thing I want to keep an eye on is that I keep expenditures around 20% of gross revenue (as a general target.
- Since the business I run mostly requires the investment of my time, I’ve found the 20% expenses/revenue ratio works well.
- However, there are MANY non-financial performance measures, which, truthfully, are much more important to me than financial measures, since blogging is not my main career/job. You can view these performance measures in my blogging goals 2012 post from early in January.
- Some of these include number of guest posts I do for other sites, amount of comments, and site visitors/readership.