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Key Performance Indicators

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A revison presentation on key performance indicators for clients of Aqhuman Financial Training

A revison presentation on key performance indicators for clients of Aqhuman Financial Training

Published in: Economy & Finance

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  • 1. www.aqhuman.com Key performance indicators Aqhuman financial training & coaching
  • 2. www.aqhuman.com Key performance indicators: operating margin Operating margin = operating profit % revenue Aqhuman financial training & coaching
  • 3. www.aqhuman.com Key performance indicators: operating margin Operating margin = operating profit % revenue Aqhuman financial training & coaching It is a measure of “value added”: the party that does most should earn most Building up brand strength often enhances operating margin (hence the large ad. spend on branded goods)
  • 4. www.aqhuman.com Key performance indicators: return on capital employed To understand roce we first need to look at a 3rd version of the balance sheet. First the asset=liability version: Aqhuman financial training & coaching Assets Property, plant and equipment Cash at bank Receivables (“debtors”) Inventories (“stocks”) Liabilities: Trade payables (Creditors) Short term debt Long term debt Shareholders’ Equity
  • 5. www.aqhuman.com Key performance indicators: return on capital employed We keep the funding on one side and move the operational stuff to the other: Aqhuman financial training & coaching Assets Property, plant and equipment Cash at bank Receivables (“debtors”) Inventories (“stocks”) Liabilities: Trade payables (Creditors) Short term debt Long term debt Shareholders’ Equity -Trade payables Capital employed Capital employed
  • 6. www.aqhuman.com Key performance indicators: return on capital employed We keep the funding on one side and move the operational stuff to the other: Aqhuman financial training & coaching Assets Property, plant and equipment Cash at bank Receivables (“debtors”) Inventories (“stocks”) Liabilities: Trade payables (Creditors) Short term debt Long term debt Shareholders’ Equity -Trade payables Capital employed Capital employed Now the left hand side is our operational assets (“above the line”) and the right just the funding
  • 7. www.aqhuman.com Key performance indicators: return on capital employed A tidied up version: The total of both sides is called the capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - Payables Debt Shareholders’ Equity This side comes at a cost; the weighted average cost of capital (“wacc”)
  • 8. www.aqhuman.com Key performance indicators: return on capital employed A tidied up version: The total of both sides is called the capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - Payables Debt Shareholders’ Equity Leaving this side to pay for that wacc. So the yield of the operating side has to cover the wacc. “Above the line” produces OPERATING PROFIT
  • 9. www.aqhuman.com Key performance indicators: return on capital employed A tidied up version: The total of both sides is called the capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - Payables Debt Shareholders’ Equity So the yield of the operational side is operating profit/capital employed
  • 10. www.aqhuman.com Key performance indicators: return on capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - payables Debt Shareholders’ Equity Every pound taken into the company as funding; either as debt or equity... Costs WACC per £
  • 11. www.aqhuman.com Key performance indicators: return on capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - payables Debt Shareholders’ Equity Remember this is a balance sheet so... Is represented by a pound on the operational side Must yield ROCE per £ Costs WACC per £
  • 12. www.aqhuman.com Key performance indicators: return on capital employed Aqhuman financial training & coaching Property, plant and equipment Cash at bank Receivables Inventories - payables Debt Shareholders’ Equity And that pound needs to yield at least the wacc Must yield ROCE per £ Costs WACC per £
  • 13. www.aqhuman.com Return on capital employed To summarise: Return on capital = operating profit % employed (roce) capital employed Where capital employed = debt + equity Aqhuman financial training & coaching
  • 14. www.aqhuman.com Gearing Gearing is a measure of how we finance our business. There are two standard definitions: Gearing = Debt % or Debt % Equity Debt + equity Aqhuman financial training & coaching
  • 15. www.aqhuman.com Gearing Which is more expensive, debt or equity? For a given company it is equity. Why? Aqhuman financial training & coaching Return RiskEquityDebt
  • 16. www.aqhuman.com Gearing Equity is more expensive because shareholders take more of a risk; they are the last to get a share of the profits each year and they are the last to get a pay out of assets in the event of a liquidation Aqhuman financial training & coaching Return RiskEquityDebt
  • 17. www.aqhuman.com Gearing In other words because equity investors have taken more of a risk they expect a higher return and so the company must find more profit to accommodate that expectation Aqhuman financial training & coaching Return RiskEquityDebt
  • 18. www.aqhuman.com Gearing So why do companies not have huge gearing ratios if debt is cheaper? Because life is not that simple! Aqhuman financial training & coaching Return RiskEquityDebt
  • 19. www.aqhuman.com Gearing As your gearing increases so does the risk profile of your company increase; investors are getting nervous that their interest or dividends are not going to be paid because of the extra loans that need to be serviced Aqhuman financial training & coaching Return RiskEquityDebt
  • 20. www.aqhuman.com Gearing Look what happens to the risk return graph when you increase gearing: Aqhuman financial training & coaching Return RiskEquityDebt #1 before
  • 21. www.aqhuman.com Gearing Look what happens to the risk return graph when you increase gearing: Aqhuman financial training & coaching Return RiskEquityDebt #1 One more loan #2 Each loan is more expensive as the chance of getting paid is lowered
  • 22. www.aqhuman.com Gearing Look what happens to the risk return graph when you increase gearing: Aqhuman financial training & coaching Return RiskEquityDebt #1 One more loan #2 Equity gets more expensive as the shareholders are now at the back of a longer queue
  • 23. www.aqhuman.com Gearing But despite the previous analysis, we find that by increasing the gearing we do lower the cost of capital. Why? Because the cost of debt, interest, is tax deductible. In other words the payment is effectively subsidised by the government. This subsidy has the effect of lowering WACC until gearing gets so high as to cancel the “tax shield” effect. Aqhuman financial training & coaching
  • 24. www.aqhuman.com Free cash flow Let us consider the key elements of the cash flow statement: First... Cash from operations Aqhuman financial training & coaching This is the “engine room” of the business. Your customers need to be paying you more in cash than you are paying your suppliers – or else where how is the deficit to be funded?But we also need to take account of those items that are non- discretionary
  • 25. www.aqhuman.com Free cash flow Cash from operations Less interest Less tax Less depreciation = Free cash flow Aqhuman financial training & coaching But why depreciation?
  • 26. www.aqhuman.com Free cash flow Cash from operations Less interest Less tax Less depreciation = Free cash flow Aqhuman financial training & coaching It gives us an estimate of how much we need to spend each year just to replace existing fixed assets (we take the replacement of old assets as non- discretionary otherwise our business becomes non-productive)
  • 27. www.aqhuman.com Aqhuman Financial Training Aqhuman’s principal is Kevin Amor, FCA. Kevin qualified as a chartered accountant with PWC. He spent 12 years working in commerce at financial controller/director level. Kevin now has more than 12 years experience in financial training. He trains managers at all levels and gives 1 to 1 financial coaching to senior executives. He also teaches corporate finance and accounting for a number of business schools’ MBA programmes. Aqhuman financial training & coaching