The most important measure of performance is the Bottom Line. This is called the bottom line because it is the bottom line which appears on a Profit and Loss Statement, also called an Income Statement. The bottom line shows the amount of Net Profit (after taxes have been paid) which the business has generated during that particular reporting period. This number reports what the company has earned during the stated period of time. These earnings are sometimes stated on a per share basis. This allows one to compare to other companies by comparing their respective Price/Earnings ratios. Or, one could compare companies by comparing their respective earnings expressed as a percentage of sales or as a percentage of capital invested. For example, company ABC's earnings were 6% of revenues as compared to 5% for the industry average. Or ABC's return on investment for the period was 25% (i.e. earnings as a percentage of capital invested) as compared to its main competitor which only returned 22% to its investors.
There are also non-bottom line numbers which are often important and need to be studied. These would include gross margins (percent gross profit) or perhaps various expenses, such as Research and Development expressed as a percentage of sales. If we are producing communications systems with gross margins of 45% and R+D expenditures of 9% and our competitor is achieving gross margins of 52% and R+D expenditures of 8%, we better figure out what we're doing wrong.
In making comparisons to other companies, one should be careful not to compare apples with bananas (like comparing Apple to Microsoft). The companies should be in the same business (e.g. systems, software, hardware, communications, etc, etc). In any event, depending on our management position in the organization, we will focus on those performance measures which are important to us. The sales manager will be sensitive to overall sales, sales expenditures, and gross margins. The production manager will be concerned with cost of sales, gross margins, and operating expenses. The VP Engineering will be concerned with development costs, unit costs, and margins. And, the CEO will worry about everything.
Financial Health is reported on the company's Balance Sheet. Balance Sheets and Profit and Loss statements must always be considered together. One measures health and the other measures performance.
Just as blood flows through the veins of a person, cash flows through the veins of a company. Although a company's balance sheet may look strong (i.e. lots of assets and few liabilities), the most important asset is cash and short term deposits, followed by cash to be realized within one month (e.g. getting paid on recent sales). The cash-on-hand obtained from the balance sheet can be divided by a company's monthly expenses to determine a rough estimate of how long the company can survive at its current level of operation. Developing companies, such as biotech ventures, generally have sufficient cash on hand that they can operate for years before having to generate income from sales.
For More Information....
There are many examples of financial statements and performance reports. The reader is urged to read the financial media for regular reports on companies. Many firms now have their financial reports on web sites. In Canada, public companies are required to file their financial reports on a quarterly basis and these can now be conveniently found on the SEDAR website. For U.S. companies, such information can be found on the EDGAR website. Most public companies publish their financial reports on their own corporate websites as well. Not long ago, it wasn't so easy to get this wealth of timely information. Isn't the worldwide web wonderful?
Gimme the numbers! With respect to reading and understanding financial
statements, the Canadian Securities Institute
has a great publication which explains the numbers.