The main purpose of a business is to generate profit, in other words, indicate a healthy business performance. To do this, businesses attract investors and use the investment to fund their activities. By the end of every financial year, they report a profit or loss. The earnings made from those activities indicates their level of performance and how successful they are in providing a return on the investments made on the business. It also makes it possible to compare business performances. Certain performance indicators can show how well a business is doing. These are profit margin on net sales, return on asset, return on investment, and return on equity.
Profit margin on net sales
One method of evaluation and comparison of business performance is based on the amount of profit made in relation to the amount of sales. The gross profit – profit without administrative cost deduction – obtained through business activities indicates whether a company has been successful in earning enough money to cover the cost of goods sold (COGS) and to return a profit. Using this ratio, the profit or loss can be determined in relation to sales. This ratio enables businesses to investigate the reasons behind a low profit margin resulting in poor financial performance. Low sales or high cost of goods sold can affect net income, and therefore, cashflow generation.
Return on Asset (ROA)
In order for a business to operate, it has to allocate a notable portion of its capital to acquire assets which enable it to perform its main activities. Therefore, it is crucial for a company to make use of its assets to the fullest to generate a profit. The more efficient the operations, the more the production, and in the end, the more the profit. A business that does not make the most of its available assets or fails to operate at full capacity will fail to generate a large amount of profit. This is a suitable indicator to use when comparing business performances. This ratio, however, is not of use to businesses where knowledge workers are involved. ROI is determined by dividing net profit to asset value. It is also sometimes referred to as the return on investment (ROI).
Return on Equity (ROE)
Another measure for business performance is the return on equity. Shareholders or owners of equity have invested in the business with the hope to receive healthy returns. If a company fails to perform in a way that enables it to offer attractive figures on profit, it can weaken the shareholders’ view of the business. A company is responsible for providing benefits to both customers and shareholders. Therefore, it needs to operate efficiently, make sure sales is high, and indicate profitability.
Shareholders will be glad to see their investment generate healthy returns even if they receive less amount of dividend than they expected. If they believe that the company is moving towards prosperity, they will be content with having profits reinvested in the business. ROEs can be compared historically to determine business performance, but they can be used to compare performance among companies of the same industry as well. In this case, the degree of leverage should also be taken into account.
Business performance indicators allow businesses to make historical comparisons as well as comparisons among businesses of similar industries. It is measured using ratios which regard profit – gross or net profit – in relation to other variables such as sales, asset value, or equity.
Business English Course books:
– Business Vocabulary in Use: Advanced
– Professional English in Use: Law
– Professional English in Use: Finance