Key Management Ratios: Master the management metrics that drive and control your business

401 Pages·2003·1.6 MB·English

by  Ciaran Walsh

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Key Management Ratios
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8584 Prelims (i-xiv) 21/11/02 12:38 pm Page iii
Key management ratios
Master the management metrics that drive
and control your business
Ciaran Walsh
An imprint ofPearson Education
London (cid:2) New York (cid:2) Sydney (cid:2) Singapore (cid:2) Tokyo (cid:2) Singapore (cid:2) Hong Kong (cid:2) Cape Town
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First published in Great Britain in 1996
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© Ciaran Walsh 2003
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About the Author
Ciaran Walsh is Senior Specialist Finance at the Irish Management
Institute, Dublin.
He is trained both as an economist and an accountant (BSc (Econ)
London, CIMA) and had 15 years’ industrial experience before joining the
academic world.
His work with senior managers over many years has enabled him to
develop his own unique approach to training in corporate finance. As a
consequence, he has lectured in most European countries, the Middle
East and Eastern Europe.
His main research interest is to identify and computerize the links that
tie corporate growth, and capital structure into stockmarket valuation.
He lives in Dublin and is married with six children.
He can be contacted at [email protected] or at ciaran-walsh.com
About the Author v
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To our grandchildren
Rebecca
Isobel
Benjamin
Eleanor
Sophie
Eve
Hanna
Holly
Grace
Aaron
8584 Prelims (i-xiv) 21/11/02 12:38 pm Page vii
Contents
Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xi
Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiii
Key for symbols . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiv
PART I FOUNDATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
1 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Why do you need this book? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
The form and logic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
The philosophy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Excitement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Data that makes sense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
2 Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
The balance sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Balance sheet structure – fixed assets . . . . . . . . . . . . . . . . . . . . . . . .18
Balance sheet structure – liabilities . . . . . . . . . . . . . . . . . . . . . . . . . .20
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24
3 Balance sheet terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26
The terms used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26
4 Profit and loss account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36
Working data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42
The US Consolidated Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44
Sectoral/geographical data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44
Contents vii
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PART II OPERATING PERFORMANCE . . . . . . . . . . . . . . . . . . . . . .47
5 Measures of performance . . . . . . . . . . . . . . . . . . . . . . . . . . . .49
Relationships between the balance sheet and profit and
loss account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50
The ratios ‘return on total assets’ and ‘return on equity’ . . . . . . . .51
Balance sheet layouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54
6 Operating performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59
Return on investment (ROI) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61
Return on equity (ROE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62
Return on total assets (ROTA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64
Standards of operating performance . . . . . . . . . . . . . . . . . . . . . . . . .66
7 Performance drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81
Operating performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82
Operating profit model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
PART III CORPORATE LIQUIDITY . . . . . . . . . . . . . . . . . . . . . . . . . .95
8 Cash flow cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97
Corporate liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99
The cash cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
Measures of liquidity – long and short analysis . . . . . . . . . . . . . . .110
9 Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
Short-term liquidity measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114
Current ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116
Quick ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118
Working capital to sales ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120
Working capital days . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122
10 Financial strength . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125
Interest cover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .126
‘Debt to equity’ ratio (D/E) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .128
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Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .134
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136
11 Cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137
The cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139
Sources and uses of funds – method . . . . . . . . . . . . . . . . . . . . . . . .140
Opening and closing cash reconciliation . . . . . . . . . . . . . . . . . . . . .144
Long and short analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .146
Financial reporting standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150
PART IV DETERMINANTS OF CORPORATE VALUE . . . . . . . .153
12 Corporate valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156
Share values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158
13 Financial leverage and corporate valuation . . . . . . . . . .175
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Financial leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
V chart . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
Market to book ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182
14 Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189
Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .190
Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
Growth equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196
Application to acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .202
PART V MANAGEMENT DECISION-MAKING . . . . . . . . . . . . .205
15 Cost, volume and price relationships . . . . . . . . . . . . . . . .207
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209
Costing illustration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210
Contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .214
Break-even (B/E) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .220
Contribution to sales percentage (CPS) . . . . . . . . . . . . . . . . . . . . . .226
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .240
Contents ix