FINANCIAL PERFORMANCE MEASURES

NIGEL A.L. BROOKS THE BUSINESS LEADERSHIP DEVELOPMENT CORPORATION

FINANCIAL PERFORMANCE MEASURES Of interest to lenders, investors, and management Lenders, investors, and other interested parties review financial measures of performance of enterprises for making credit, acquisition, and divestiture decisions. These measures are also of interest to regulators, such as taxing authorities, who use them for trend analysis. If lenders, investors, and regulators are reviewing certain measures of financial performance of an enterprise, then management must be also. The managerial role is about applying resources to activities to achieve results, and is conducted within the context of planning and policy development and performance measurement activities.

As activities are executed, management should be evaluating performance and making adjustments accordingly. Financial performance for competitive advantage Each industry has a set of fundamental economic characteristics that determine its growth and profitability. Financial performance measures should be used to determine how an enterprise can outperform competitors based upon asset performance, profit, and cash flow advantages.

Growth is measured in terms of increase in the size and share of the market. Profitability is measured in terms of prices and economic costs which include the cost of capital and the extent to which a differentiated product can attract a premium price over a market commodity. Steady state is where the residual value of the enterprise grows at a stable rate. Basis for profitability Accounting profit equals net income the generally accepted accounting principles (GAAP) basis for comparison of enterprises in the same and different industries. Net income consists of operating income and gains from investment asset sales less income tax expense. Economic profit equals accounting profit less opportunity cost of capital value created in excess of an investor's required return. EBITDA a hybrid between net income and cash flow a tool used when evaluating enterprises independent of their balance sheet structures especially useful in asset sale situations. Most measures are expressed as ratios. Note that some measures apply only to publicly traded enterprises, unless equivalents can be obtained based upon valuations, or from an actual or assumed offer.

Value Price to earnings (PE) ratio measures how much an investor is willing to pay for earnings:

Price per share Divided by earnings per share (net income after tax) Average shares outstanding Fully diluted (all options and warrants exercised)

Note: it is useful to compare a PE ratio to the interest rate on an annuity at a certain level of risk. For example: a PE ratio of 20 is equivalent to 5% simple interest, assuming the same level of risk. Price to book value ratio measures market value as a ratio of equity capital (paid-in, retained earnings, and repurchased) on a GAAP basis: Price per share Divided by book value

Price to sales ratio measures volatility in cyclical enterprises: Price per share Divided by sales per share

Price to operating cash flow ratio valuation based upon operations: Price per share Divided by operating cash flow (cash provided by operations net income plus depreciation expense plus amortization expense unadjusted for accruals and deferrals)

Profitability measures an enterprise's overall effectiveness in business development and operations Return on sales revenue gross profit margin: Gross profit on sales revenue Divided by gross or net sales revenue

Return on sales revenue operating profit margin: Operating profit Divided by gross or net sales revenue

Return on sales revenue net profit margin: Net income (net profit) Divided by gross or net sales

Net interest margin: Net interest income Divided by average interest earning assets

Return on equity: Net income Divided by total average equity

Return on financial capital (enterprise from an investee's context): Net income Or: net operating profit after taxes (NOPAT) Divided by: average financial capital

Return on invested capital (enterprise from an investor's context): Net income Or: net operating profit after taxes (NOPAT) Divided by: average invested capital

Risk-adjusted return on capital: Economic return on capital Divided by economic capital

Return on assets: Net income Divided by total average assets

Retention (in the context of investments): Increase in the value of an investment: Expressed as a percentage per annum Or: expressed as a annual percentage yield (incorporating the effect of compound interest)( 6

Return on investment: Or: Present value of future returns discounted at cost of capital Less: cost of investment Note: the full cost basis of the asset should be included in the calculation Capitalization rate: Net operating income Divided by cost or value of income producing asset Net benefits equals: benefits less costs Divided by: costs

Retention rate: Net income less dividends Divided by: net income

Reinvestment rate: Retention rate Multiplied by: return on equity

Dividend yield: Annual dividend per share Market price per share

Dividend payout ratio: Annual dividend Divided by net income

Contribution margin: Sales revenue less variable expenses Divided by sales revenue

Liquidity measures an enterprise's ability to meet its short-term obligations Current ratio: Current assets Divided by current liabilities

Quick test (2 or greater for liquidity strength): Current assets less inventory Divided by current liabilities

Leverage measures the extent to which an enterprise has been financed by debt Debt to equity ratio: Debit capital (capitalization ratio) Or: long-term debt (debt capital and other debt) Or; long-term debt plus short-term debt Or: long-term debt plus short-term debt plus short-term borrowings Divided by equity capital (total equity)

Liabilities to equity ratio: Total liabilities Divided by total equity

Financial leverage: Total assets Divided by total equity

Operating leverage: Percentage change in operating income Divided by percentage change in sales

Interest coverage (1.5 or greater to be able to cover interest expense): Earnings before interest and income tax or EBITDA Divided by interest expense

Funded debt measure of debt service (ability to repay debt) financed by financial institutions: Long-term debt Or: long-term debt plus short-term debt Or: long-term debt plus short-term debt plus short-term borrowings Divided by EBITDA

Activity measures how effective an enterprise is using its resources Inventory turnover measures how many times inventory is replaced in a given period, indicating the degree to which inventory includes slow moving items: Sales revenue Or: cost of products sold Divided by average inventory

Asset turnover measures sales or total revenue generated by assets hence the usefulness of assets: Sales revenue Or: total revenue Divided by fixed assets Or: total assets Average collection period measures average time period for which receivables are outstanding: Accounts receivable Divided by average daily sales

Turnover (UK) Sales revenue Or: resources used Divided by resources available

10

Efficiency: Cost and expenses Divided by revenue

Solvency measures an enterprise's ability to meet its obligations as they come due Equity to assets ratio: Total equity Divided by total assets

Debt to assets ratio: Long-term debt Or: long-term debt plus short-term debt Or: long-term debt plus short-term debt plus short-term borrowings Divided by total assets

Profitability analysis DuPont Model: Return on equity Equals financial leverage multiplied by return on assets Return on assets Equals asset turnover multiplied by net profit margin

11

Market Market share: Number of relationships Divided by total number available

12

For more information... For information about audiobooks, books, earticles, ebooks, and eseminars offered by The Business Leadership Development Corporation visit www.etailia.com For more information about the discipline of enterpriship visit www.enterpriship.com To assess your individual competencies in thirty minutes or less, claim your opportunity for instant access when you go to www.individualcompetencies.com

13

About Nigel A.L Brooks... Nigel A.L Brooks is a management consultant to entrepreneurs, business enterprise owners, executives, and managers, and the enterprises they serve. He specializes in developing the entrepreneurial, leadership, and managerial competencies that build sustainable advantage from vision to value. He is an author and a frequent speaker. He obtained his professional experience as a partner at Andersen Consulting (now Accenture, Ltd.), as a vice president at Booz Allen Hamilton, Inc. (now Booz and Company), as a senior vice president at the American Express Company, as president of Javazona Cafes, Inc., and as president of The Business Leadership Development Corporation. He has been a contributing editor for the Bank Administration Institute magazine, and has served on boards of entrepreneurial networks. He was educated at the University of Exeter, Devon, United Kingdom. His clients are in the financial services, food services, high-tech, manufacturing and distribution, pharmaceuticals, oil and gas, professional services, retail and wholesale, transportation, and government industries. He has experience in North and Latin America, Europe and Asia-Pacific. www.nigelalbrooks.com About The Business Leadership Development Corporation (BLD)... The Business Leadership Development Corporation is a professional services firm that works with entrepreneurs, lifestyle business enterprise owners, executives, and managers, and the enterprises they serve. BLD develops entrepreneurial, leadership, and managerial competencies that achieve performance excellence by building sustainable advantage from vision to value through: Strategic Management Consulting Executive Coaching and Mentoring Professional Training via The Center For Business Leadership Development (CBLD) Motivational Speaking www.bldsolutions.com

14

THE BUSINESS LEADERSHIP DEVELOPMENT CORPORATION 13835 NORTH TATUM BOULEVARD 9-102 PHOENIX, ARIZONA 85032 USA www.bldsolutions.com (602) 291-4595 Copyright 2008-11: The Business Leadership Development Corporation All rights reserved