Entrepreneurs' objective when establishing a company is obvious, they want to earn money. In order to make money, an enterprise has to perform well. However, this is only possible when required funds are available. Therefore, it is important to keep an eye on a business's financial performance and improve it whenever possible.
Financial performance is a subjective measure of how well a company uses assets and generates revenues. It is an evaluation of its financial position regarding variables such as assets, liabilities, equity, expenses and revenues.
Financial performance is highly determined by the way finances are managed. Financial management relates to applying general management principles to the financial resources of a company. It includes strategic planning, organising, directing and controlling of financial undertakings in a firm.
How to improve financial performance?
In order to improve financial performance, financial managers should undertake a specific process. The process includes several steps listed below.
Financial Performance: Financial objectives
Financial objectives are the goals or targets related to the financial performance of a business. They are the goals that enterprises set for success and growth. If there are no clearly defined objectives, it is impossible to move further and improve. Setting objectives enables companies to develop and widen their perspectives. However, financial objectives are not related to businesses only. Financial objectives can also be set by individuals.
Imagine you want to go on a trip with your friends. You need money to pay for transport, accommodation, food and other expenses during the trip. Moreover, you really like pastries from Greggs and you go there and buy one every day during the lunch break. However, it is more important to you to go on a trip than eat a pastry every single day. For this reason, you change your behaviour and go to Greggs twice a week only. This way, instead of spending most of your money on the pastries, you save money for the trip.
As you can see, having financial objectives has an influence on what you do on a daily basis. It determines your behaviour and where and how much money you spend. Following the example, if you did not set the objective and went to Greggs every day like you used to, you would not be able to save money for the trip. The same applies to companies, if they set a specific financial goal, they need to adjust and change the way they behave in order to achieve it.
There are several types of financial objectives:
Revenue objectives - maximising revenues,
Cost objectives - minimising costs,
Profit objectives - maximising profits,
Cash flow objectives - improving cash flow,
Investment objectives - making better investments,
Capital structure objectives - structuring capital in a certain way.
Financial performance analysis
Financial performance analysis is a process of analyzing and evaluating a company's financial position. It focuses on reviewing, assessing and comparing financial statements - a collection of data and figures organized according to recognized accounting principles. The analysis helps to determine whether a company is making a profit or loss. It shows how the company is spending, investing and earning money. Knowing how the company is performing, we are able to make better economic decisions and assess its potential.
There are two types of financial statements:
Income statement - showing the profit earned and loss sustained by a business entity over a particular period (usually 12 months),
Balance sheet - showing assets and liabilities of a business at a specific point in time (usually the end of the financial period).
The analysis may also include calculating and analyzing financial ratios:
And analyzing other aspects such as:
Cash flow - a real or virtual movement of money. It is when an amount of cash and cash equivalents is being transferred into and out of a business,
Budgets - in other words, financial planning, forecasting of cash received and cash payable, of incomes and revenues, and of the resulting state of the financial health of a company,
Break-even - a number of units the firm has to produce and sell before it recovers its total costs.
Financial Performance: Sources of finance
Sources of finance are the provision of finance for a business to fulfill its requirement for short-term working capital and fixed assets and other investments in the long term.
There are two types of sources of finance:
Internal sources - funds coming from the inside of the company. For example, capital brought by the owner, retained profit, discount selling and selling of fixed assets
External sources - funds coming from the outside of the company. For example, long term sources such as equity shares, debentures and term loans, or short-term sources such as bank overdraft and trade credit
Financial Performance: Cash flow and profit improvement
Both cash flow and profit determine the financial performance of a company and therefore, they are the key factors to be improved. This is because a business needs cash to keep operating. When it doesn't have the cash it requires to operate, then it will come to a halt or might even have to close.
There are the key financial decisions that should be made to improve cash flow and profits:
Designing the product in a way that will bring healthy profit margins,
Receiving payment in an expected way that lowers the risk of having to chase invoices,
Setting a transparent, coherent, and systematic way for managing the financials,
Having an efficient sales approach.
Non-financial measures of performance
Non-financial measures are metrics that cannot be expressed in monetary units.
Non-financial measures are equally important as they fill in the gaps which are not covered by the financial measures. Even though an enterprise makes a profit and the numbers are growing, it does not necessarily mean that it is successful.
A 20-year-old company manufactures and sells furniture. It sells all the pieces of furniture it produces and has built customer trust, but its profits are not exceptionally high. Therefore, it decided to raise prices by 20%. Initially, customers continued to buy the furniture but then they realized how overpriced it was and consequently lost their trust in the company. This led to them switching to a different company.
As you can see, it is crucial to take non-financial measures into consideration. Neglecting them might not only result in a lack of customer satisfaction but also in financial losses.
Examples of non-financial measures:
Financial performance - key takeaways
- Financial performance is a subjective measure of how well a company uses assets and generates revenues.
- Financial management includes strategic planning, organizing, directing and controlling of financial undertakings in a firm.
- Financial objectives, financial performance analysis, sources of finance and cash flow and profit improvement are the key steps to improve financial performance.
- The income statement and balance sheet are the two most important financial statements.
- Non-financial measures of performance are metrics that cannot be expressed in monetary units. They are equally important as they fill in the gaps which are not covered by the financial measures.
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