What is financial performance?
By definition, financial performance is a complete evaluation of a company's overall financial health. In other words, financial performance measures how well a firm manages its assets, such as liabilities, expenses and incomes, to achieve maximum revenues
Financial performance can be used for both internal and external purposes. For people involved in a company's operation, the measurement determines the company's well-being. However, it also provides investors and people from outside the company with valuable information on the investment potential hidden in the business.
Why is financial performance important?
Measuring financial performance provides all the parties involved with a company's operations with valuable insights regarding its past, present and future.
On the one hand, financial performance shows a company's past standing, provides managers with key benchmarks for their business or its respective parts and, last but not least, can be used to evaluate their work or the quality of their operations. As such, it can act as a base for planning current endeavors or even choosing new projects in general.
On the other hand, financial performance can also provide executives with insights into the future. It can help them determine overall trends in the business, analyze particular types of operations and discover seasonal tendencies that affect the company. As a result, it can help managers check whether the profitability, as well as other indicators, is on the track to growth.
Financial condition vs profitability: basic approach
If you represent a professional service company, you probably consider net revenue a base for measuring financial performance. You are not wrong - profitability makes up a huge chunk of financial performance, as long as it's understood and calculated properly.
Let’s see how the expert approached the topic.
What is profitability in a service company?
According to David Allan and his book “Managing the professional service firm”, the ultimate measure of profitability is profit per partner. As simple as this definition may seem, it is not as one dimensional as it appears. In fact, it contains three other main factors that we need to take into account. These are: margin, productivity and leverage.
To improve the profit per partner ratio, all the factors involved need to be consequently improved. However, numerous companies fail to do that. Let’s see how that can change.
Profit margins in financial performance
Net profit margin is generally what the companies focus most on - and wrongfully so. For example, a well-managed company with low margins often earns more money than its counterparts with high profit margin - and lots of money running down the drain. Does it make the net profit margin a reliable indicator? Of course not.
The net profit margin is mostly a consequence of productivity and leverage, and rarely shows the condition of the company as a whole. The margin improves as the revenue per person (and per worked hours) grows, and the same happens when the number of staff compared to partners drops.
Then why are margins relevant in the first place, and why does every income statement, cash flow statement and balance sheet focus on them so much?
Profit margins also include overheads (costs of office, equipment, software, etc.) and, unfortunately, waste. Of course, the latter should be avoided at all cost, particularly by limiting excess space and equipment - and that is one of the best ways of improving profit margin and financial performance as a whole.
However, keep in mind that cost cutting only affects cash flow statements in the short-term, but it is incapable of improving a company's condition in the long run. Still, if you’re looking for quick cash, this might be the right action to take.
Productivity in financial performance
Productivity in professional service companies is usually defined as a ratio of fees to staff - or, alternatively, the value multiplied by utilization. Still, it is rarely brought up in income statements, or company’s financial statements in general.
However, if you are already somewhat familiar with the topic, you may ask whether it is the same as the utilization itself. The answer to this question is no - utilization (sometimes also referred to as chargeability) is a short-run issue that does not affect the financial performance as a whole.
While we cannot improve the chargeability itself (unless you convince your employees to work 24/7), it can be a base for other beneficial changes. When the value of every working hour grows, productivity is also on the rise. Of course, this won’t happen on its own; processes such as specialization, skill building, innovation and introducing value-added services.
Leverage in financial performance
Last but not least, revenue and financial performance are affected by the leverage - the rate of partners to staff.
However, while this definition may sound simple, the details are not as transparent. That’s because there is no single leverage for every company - it simply depends on the type of services and industry. For example:
- highly specialized businesses (i.e. cutting edge, high risk companies) need to have a high partner-to-junior ratio,
- more general businesses that tend to focus on more repetitive actions need to have a low partner-to-junior ratio.
Then how to improve the leverage in the company? The key is finding the right mix of skill levels that can ensure both the quality and the quantity of all the operations in your business. By doing so, you can improve profit margins and the profitability as a whole, for both short and long term.
How to measure financial performance as a whole?
Now that the theory is already behind us, we move on to what should really interest you - the methods of measuring financial performance.
While there are many methods of measuring different aspects of various financial measures, only one is capable of providing your company with a bigger picture of all the operations - it is called the financial performance analysis.
What is a financial performance analysis?
Financial analysis is basically an audit that gathers financial information from the entire company to determine the profitability and the general financial condition of the entire business. In other words, financial performance analysis can provide executives with answers to questions such as:
- What is the financial position of the company at this point in time?
- What factors affected the current financial position of the company?
- What operations are the most beneficial and the most harmful for a company's finances?
- How is financial performance changing over a period of time?
- What affects the cash flow statement, and why?
- What drives the change in the finances of the company?
At the same time, it also analyzes key financial documents, such as balance sheet, income statement or cash flow statement.
Long story short, if you want to improve financial performance in your company - financial performance analysis is for you.
Types of financial analysis
For the financial performance analysis to be accurate, it needs to focus on different areas of the business - that is why we generally divide the process into a few types. These include the analysis of:
- working capital - company’s current assets (i.e. cash and bills that are still to be paid by customers) minus inventories and current liabilities,
- financial structure - debts, equities and overall financial liquidity in the company,
- activity analysis - the analysis of operations impacting incomes and expenses,
- profitability analysis.
The analysis of all these fields and their current ratios combined can provide a company with a comprehensive view of all its operations and costs that it generates.
Still, for a financial performance analysis to be accurate, you cannot just use any data you come across to draw conclusions. Such research needs to be based on accurate sources rooted in the actual projects and actions. In other words, that’s when you should first take a closer look at your company’s financial statements.
Measuring financial performance with indicators - how to do it?
While financial statements are an excellent way to summarize a company's operations over a period of time, they still require some input data that cannot be made up on the spot. On the other hand, companies with the best financial performance tend to monitor their financial progress more often.
While these two cases may seem to require different approaches, they, in fact, simply require the right measurements.
What are financial performance indicators?
Financial performance indicators (often referred to as KPIs) are quantifiable measurements created to monitor the well-being of a company's finances.
Their main purpose may differ depending on the type of indicator you may have in mind. Typically, they are used to track, evaluate and determine the performance of the business as a whole or its particular elements, such as projects, teams, operations, and more.
Just like the performance itself, its indicators are crucial for both internal and external parties involved with a company's operation. On the one hand, they help managers monitor their business, keep an eye on assets liabilities, key ratios and more; on the other hand, they provide investors with valuable information they use to make their decisions.
Additionally, such metrics are often brought up in a balance sheet, income statement, inventory reports and other documents that matter for both managers and investors in the industry alike.
But let’s not focus too much on the theory - let’s take a look at the examples of financial performance indicators instead.
Financial performance indicators - examples
Numerous financial performance indicators can be used almost universally, regardless of the type of the company in questions.
The most common metrics include:
- gross profit - company’s revenue minus production costs,
- gross profit margin - ratio measuring the company’s revenue minus costs of sales. It can be calculated by dividing gross profit by the revenue and multiplying the result by 100.
- net profit - company’s revenue minus all business expenses and taxes,
- leverage - total assets divided by total equity,
- operating cash flow - recurring incomes generated by repetitive or regular business operations,
- debt-to-equity ratio - a company’s total liabilities divided by its shareholder equity,
- working capital - current assets minus current liabilities, the money assets are financed with,
- current ratio - current assets divided by current liabilities,
- inventory turnover - the number of times a company sells its average inventory in a fiscal year. In this metrics, cost of sales is divided by the sum of beginning and ending inventory divided by 2,
- return on assets - net profit divided by half of the sum of beginning and ending assets,
- return on equity - net profit divided by shareholder equity.
All of these metrics often appear on balance sheet, income statement, or in reports summarizing total assets, working capital, inventory, status of management and more.
Benefits of measuring financial performance
After reading the paragraphs above, you may be a little overwhelmed with the variety of factors your company needs to measure in order to monitor its financial performance. Then why is it worth the effort in the first place?
- No disappearing cash. Have you ever wondered what happened to the money that was once on your company’s account? With financial performance in place, you can see exactly which magic trick caused it to disappear.
- Wiser spendings. Monitoring financial performance can help you discover unexpected expenses you may want to avoid in the future. It is particularly helpful for monitoring finances in non-project departments, such as marketing, HR or sales.
- No uncharted territories in your business. Introducing financial performance in your company can help you track the operations and spendings in all the teams and departments. There’s no room for the unknown in the business!
- New opportunities at hand. Sometimes the financial performance may surprise you with some good news - you may have some extra money assigned to teams and departments that simply do not spend it. Use it for workshops, investments or new hires and help your business grow even more.
- Realistic costs. We know that adding overheads to your budgets may add some confusion to the equation. With financial performance at hand, you can see exactly how other spendings increase your expenses in teams that actually generate revenue.
Improve measuring financial performance with Primetric
While measuring financial performance might seem like a complicated process, we assure you that you do not have to do all of these calculations in Excel - that would be exhausting, time consuming and difficult to do right. Fortunately for you, you do not have to use endless tables in the process. There are better tools you can use - and Primetric is one of them.
What can you achieve in Primetric?
With Primetric, you can automatically gather all the financial information for your employees, teams, projects, departments and more and generate reports that cover the contents of all the key financial statements and more.
With Primetric, you can:
- estimate the costs of your projects, create budgets for them and settle them with a project expense tracker,
- issue invoices and monitor their status (applies also to invoices integrated with Jira!),
- forecast revenue and monitor it for a month, a quarter, a year or any other period,
- estimate costs, including project and company overheads and work of support departments (HR, marketing, sales, and more),
- create advanced or even customized reports you can use to see the project progress, or the work of particular employees,
- monitor both non-billable and billable hours in your business,
- manage project budget in existing and tentative projects,
- track time spent on projects and tasks and see the costs they generate.
If you are a COO, you can do even more in the tool. For example, you can:
- compare the planned revenue to the real one,
- see which projects are the most profitable, and which ones damage company’s financial performance,
- get an overview of the incomes generated by people, teams, projects, and the entire company,
- browse the up-to-date data stored in the system and updated whenever a change is made.