Contents
Cover
Series
Title Page
Copyright
Dedication
Preface
Acknowledgments
CHAPTER ONE: Introduction
CHAPTER TWO: Asset Utilization Measurements
SALES TO WORKING CAPITAL RATIO
SALES TO FIXED ASSETS RATIO
SALES TO ADMINISTRATIVE EXPENSES RATIO
SALES TO EQUITY RATIO
SALES PER PERSON
SALES BACKLOG RATIO
SALES RETURNS TO GROSS SALES RATIO
REPAIRS AND MAINTENANCE EXPENSE TO FIXED ASSETS RATIO
ACCUMULATED DEPRECIATION TO FIXED ASSETS RATIO
CAPITAL TO LABOR RATIO
FRINGE BENEFITS TO WAGES AND SALARIES EXPENSE
SALES EXPENSES TO SALES RATIO
DISCRETIONARY COST RATIO
INTEREST EXPENSE TO DEBT RATIO
FOREIGN EXCHANGE RATIOS
OVERHEAD RATE
GOODWILL TO ASSETS RATIO
OVERHEAD TO COST OF SALES RATIO
INVESTMENT TURNOVER
BREAK-EVEN POINT
MARGIN OF SAFETY
TAX RATE PERCENTAGE
CHAPTER THREE: Operating Performance Measurements
OPERATING ASSETS RATIO
SALES TO OPERATING INCOME RATIO
SALES MARGIN
GROSS PROFIT PERCENTAGE
GROSS PROFIT INDEX
INVESTMENT INCOME PERCENTAGE
OPERATING PROFIT PERCENTAGE
OPERATING LEVERAGE RATIO
NET INCOME PERCENTAGE
CORE OPERATING EARNINGS
PROFIT PER CUSTOMER VISIT
PROFIT PER PERSON
CORE GROWTH RATE
QUALITY OF EARNINGS RATIO
CHAPTER FOUR: Cash Flow Measurements
CASH FLOW FROM OPERATIONS
FREE CASH FLOW
CASH FLOW RETURN ON SALES
FIXED CHARGE COVERAGE
EXPENSE COVERAGE DAYS
CASH FLOW COVERAGE RATIO
CASH RECEIPTS TO BILLED SALES AND PROGRESS PAYMENTS
CASH TO CURRENT ASSETS RATIO
CASH FLOW TO FIXED ASSET REQUIREMENTS
CASH FLOW RETURN ON ASSETS
CASH TO WORKING CAPITAL RATIO
CASH REINVESTMENT RATIO
CASH TO CURRENT LIABILITIES RATIO
CASH FLOW TO DEBT RATIO
REINVESTMENT RATE
STOCK PRICE TO CASH FLOW RATIO
DIVIDEND PAYOUT RATIO
CHAPTER FIVE: Liquidity Measurements
ACCOUNTS RECEIVABLE TURNOVER
AVERAGE RECEIVABLE COLLECTION PERIOD
DAYS DELINQUENT SALES OUTSTANDING
DAYS SALES IN RECEIVABLES INDEX
ACCOUNTS RECEIVABLE INVESTMENT
ENDING RECEIVABLE BALANCE
INVENTORY TO SALES RATIO
INVENTORY TURNOVER
INVENTORY TO WORKING CAPITAL RATIO
LIQUIDITY INDEX
ACCOUNTS PAYABLE DAYS
ACCOUNTS PAYABLE TURNOVER
CURRENT RATIO
QUICK RATIO
CASH RATIO
SALES TO CURRENT ASSETS RATIO
WORKING CAPITAL PRODUCTIVITY
DAYS OF WORKING CAPITAL
WEIGHTED WORKING CAPITAL
DEFENSIVE INTERVAL RATIO
CURRENT LIABILITY RATIO
REQUIRED CURRENT LIABILITIES TO TOTAL CURRENT LIABILITIES RATIO
WORKING CAPITAL TO DEBT RATIO
RISKY ASSET CONVERSION RATIO
NONCURRENT ASSETS TO NONCURRENT LIABILITIES RATIO
SHORT-TERM DEBT TO LONG-TERM DEBT RATIO
ALTMAN'S Z-SCORE BANKRUPTCY PREDICTION FORMULA
CHAPTER SIX: Capital Structure and Solvency Measurements
TIMES INTEREST EARNED
CASH COVERAGE RATIO
DEBT COVERAGE RATIO
ASSET QUALITY INDEX
ACCRUALS TO ASSETS RATIO
TIMES PREFERRED DIVIDEND EARNED
DEBT TO EQUITY RATIO
FUNDED CAPITAL RATIO
RETAINED EARNINGS TO STOCKHOLDERS' EQUITY
PREFERRED STOCK TO TOTAL STOCKHOLDERS' EQUITY
ISSUED SHARES TO AUTHORIZED SHARES
CHAPTER SEVEN: Return on Investment Measurements
NET WORTH
BOOK VALUE PER SHARE
TANGIBLE BOOK VALUE
RETURN ON ASSETS EMPLOYED
RETURN ON INFRASTRUCTURE EMPLOYED
RETURN ON OPERATING ASSETS
RETURN ON EQUITY PERCENTAGE
RETURN ON COMMON EQUITY
FINANCIAL LEVERAGE INDEX
EQUITY GROWTH RATE
EARNINGS PER SHARE
PERCENTAGE CHANGE IN EARNINGS PER SHARE
ECONOMIC VALUE ADDED
EVA MOMENTUM
RELATIVE VALUE OF GROWTH
DIVIDEND PAYOUT RATIO
DIVIDEND YIELD RATIO
CHAPTER EIGHT: Market Performance Measurements
INSIDER STOCK BUY-SELL RATIO
INSTITUTIONAL CAPTURE RATE
MARKET VALUE ADDED
ENTERPRISE VALUE/EARNINGS RATIO
STOCK OPTIONS TO COMMON SHARES RATIO
COST OF CAPITAL
SALES TO STOCK PRICE RATIO
PRICE/EARNINGS RATIO
CAPITALIZATION RATE
CHAPTER NINE: Measurements for the Accounting/Finance Department
PURCHASE DISCOUNTS TAKEN TO TOTAL DISCOUNTS
PERCENTAGE OF PAYMENT DISCOUNTS MISSED
TRANSACTIONS PROCESSED PER PERSON
TRANSACTION ERROR RATE
AVERAGE TIME TO ISSUE INVOICES
AVERAGE EMPLOYEE EXPENSE REPORT TURNAROUND TIME
PAYROLL TRANSACTION FEES PER EMPLOYEE
TIME TO PRODUCE FINANCIAL STATEMENTS
PERCENTAGE OF TAX FILING DATES MISSED
PROPORTION OF PRODUCTS COSTED PRIOR TO RELEASE
INTERNAL AUDIT SAVINGS TO COST PERCENTAGE
INTERNAL AUDIT EFFICIENCY
DEDUCTION TURNOVER
BAD DEBT PERCENTAGE
PERCENT OF RECEIVABLES OVER XX DAYS OLD
ALLOWANCE EXHAUSTION RATE
PERCENTAGE COLLECTED OF DOLLAR VOLUME ASSIGNED
CASH COLLECTED PER AGING BUCKET
COLLECTION EFFECTIVENESS INDEX
BEST POSSIBLE DSO
PARTIAL PAYMENT AGREEMENT PERCENTAGE
PERCENT OF CASH APPLIED ON DAY OF RECEIPT
AUTO CASH HIT RATE
UNMATCHED RECEIPTS EXPOSURE
COST OF CREDIT
EARNINGS RATE ON INVESTED FUNDS
BROKERAGE FEE PERCENTAGE
BORROWING BASE USAGE PERCENTAGE
CHAPTER TEN: Measurements for the Engineering Department
BILL OF MATERIALS ACCURACY
LABOR ROUTING ACCURACY
IDEA KILL RATE
PERCENTAGE OF NEW PRODUCTS INTRODUCED
PERCENTAGE OF SALES FROM NEW PRODUCTS
PERCENTAGE OF NEW PARTS USED IN NEW PRODUCTS
PERCENTAGE OF EXISTING PARTS REUSED IN NEW PRODUCTS
AVERAGE NUMBER OF DISTINCT PRODUCTS PER DESIGN PLATFORM
PERCENTAGE OF PRODUCTS REACHING MARKET BEFORE COMPETITION
RETURN ON INNOVATION INVESTMENT
INTANGIBILITY INDEX
SCIENCE LINKAGE INDEX
RATIO OF ACTUAL TO TARGET COST
WARRANTY CLAIMS PERCENTAGE
TIME FROM DESIGN INCEPTION TO PRODUCTION
PERCENTAGE OF FLOOR SPACE UTILIZATION
CHAPTER ELEVEN: Measurements for the Human Resources Department
EMPLOYEE TURNOVER
AVERAGE TIME TO HIRE
LATE PERSONNEL REQUISITIONS RATIO
SENDOUTS PER HIRE
INTERN HIRING PERCENTAGE
RATIO OF SUPPORT STAFF TO TOTAL STAFF
EMPLOYMENT COST EFFECTIVENESS
CHAPTER TWELVE: Measurements for the Logistics Department
PRODUCTION SCHEDULE ACCURACY
ECONOMIC ORDER QUANTITY
NUMBER OF ORDERS TO PLACE IN A PERIOD
ECONOMIC PRODUCTION RUN SIZE
RAW MATERIAL INVENTORY TURNS
RAW MATERIAL CONTENT
FINISHED GOODS INVENTORY TURNS
OBSOLETE INVENTORY PERCENTAGE
PERCENTAGE OF INVENTORY > XX DAYS OLD
PERCENTAGE OF RETURNABLE INVENTORY
EXCESS INVENTORY INDEX
INVENTORY ACCURACY
PERCENTAGE OF CERTIFIED SUPPLIERS
ELECTRONIC DATA INTERCHANGE SUPPLIER PERCENTAGE
DISTRIBUTION TURNOVER
SUPPLIER FILL RATE
ON-TIME PARTS DELIVERY PERCENTAGE
PURCHASED COMPONENT DEFECT RATE
INCOMING COMPONENTS CORRECT QUANTITY PERCENTAGE
PERCENTAGE OF ACTUAL PAYMENTS VARYING FROM PURCHASE ORDER PRICE
PERCENTAGE OF PURCHASE ORDERS ISSUED BELOW MINIMUM DOLLAR LEVEL
PROPORTION OF CORPORATE CREDIT CARD USAGE
PERCENTAGE OF RECEIPTS AUTHORIZED BY PURCHASE ORDERS
FREIGHT AUDIT RECOVERY RATIO
PICKING ACCURACY FOR ASSEMBLED PRODUCTS
ORDER FILL RATE
AVERAGE TIME TO SHIP
ON-TIME DELIVERY PERCENTAGE
DOCK-TO-DOCK TIME
PERCENTAGE OF PRODUCTS DAMAGED IN TRANSIT
PERCENTAGE OF SALES THROUGH DISTRIBUTORS
CHAPTER THIRTEEN: Measurements for the Production Department
CONSTRAINT PRODUCTIVITY
TAKT TIME
CONSTRAINT REWORK PERCENTAGE
CONSTRAINT SCHEDULE ATTAINMENT
CONSTRAINT UTILIZATION
OPERATIONAL EQUIPMENT EFFECTIVENESS
DEGREE OF UNBALANCE
THROUGHPUT EFFECTIVENESS
MANUFACTURING CRITICAL PATH TIME
MANUFACTURING EFFICIENCY
BREAK-EVEN PLANT CAPACITY
MANUFACTURING EFFECTIVENESS
PRODUCTIVITY INDEX
UNIT OUTPUT PER DIRECT LABOR HOUR
AVERAGE EQUIPMENT SETUP TIME
UNSCHEDULED MACHINE DOWNTIME PERCENTAGE
MEAN TIME BETWEEN FAILURES
ACCEPTABLE PRODUCT COMPLETION PERCENTAGE
WORK-IN-PROCESS TURNOVER
WORK-IN-PROCESS TO STANDARD WORK-IN-PROCESS
SCRAP PERCENTAGE
FIRST-TIME-THROUGH YIELD
WARRANTY CLAIMS PERCENTAGE
MAINTENANCE EXPENSE TO FIXED ASSETS RATIO
INDIRECT EXPENSE INDEX
REORDER POINT
ON-TIME DELIVERY RATIO
CHAPTER FOURTEEN: Measurements for the Sales and Marketing Department
MARKET SHARE
CUSTOMER TURNOVER
ADVERTISING VALUE EQUIVALENCY
NET PROMOTER SCORE
BROWSE-TO-BUY CONVERSION RATIO
RECENCY
DIRECT MAIL EFFECTIVENESS RATIO
INBOUND TELEMARKETING RETENTION RATIO
PROPORTION OF COMPLETED SALES TO HOME PAGE VIEWS
QUOTE TO CLOSE RATIO
PULL-THROUGH RATE
SALES PER SALESPERSON
SALES PRODUCTIVITY
SALES EFFECTIVENESS
SALES TREND PERCENTAGE BY PRODUCT LINE
PRODUCT DEMAND ELASTICITY
DAYS OF BACKLOG
CHAPTER FIFTEEN: Measurement Analysis with an Electronic Spreadsheet*
FINANCIAL STATEMENT PROPORTIONAL ANALYSIS
FINANCIAL STATEMENT RATIO ANALYSIS
AUTOMATED RATIO RESULT ANALYSIS
LEVERAGE ANALYSIS
TREND ANALYSIS
FORECASTING
CASH FLOW ANALYSIS
CAPITAL ASSET ANALYSIS
COMPOUNDING ANALYSIS
INVESTMENT ANALYSIS
RISK ANALYSIS
Appendix: Measurement Summary
Glossary
About the Author
Index
Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
Previous Edition: Business Ratios and Formulas: A Comprehensive Guide, Second Edition.
ISBN-13: 978-0-470-05517-5. Published by John Wiley & Sons, Inc. Copyright © 2007.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400,
fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Bragg, Steven M.
Business ratios and formulas : a comprehensive guide / Steven M. Bragg. – 3rd ed.
p. cm. – (Wiley corporate F&A series)
Includes index.
ISBN 978-1-118-16996-4 (hardback); ISBN 978-1-118-22683-4 (ebk); ISBN 978-1-118-23982-7 (ebk);
ISBN 978-1-118-26442-3 (ebk)
1. Business mathematics. I. Title.
HF5691.B73 2012
650.01'513–dc23 2011042682
Preface
THIS BOOK IS INTENDED for all corporate managers who need to understand the performance levels of their departments. It contains performance measurements for the accounting, engineering, logistics, production, and sales departments. These measurements cover not only financial matters, but also those related to efficiency, effectiveness, capacity, and market share. In addition, the book includes measurements related to asset utilization, operating performance, cash flows, liquidity, capital structure, return on investment, and market performance. These latter categories are of great interest not only to the accounting and finance departments, but also to a company's creditors and investors.
There are nearly 250 measurements itemized in this book. Each one is accompanied by a complete description, an explanation of the calculation, an example, and cautions regarding its use. The cautions are of particular use, as they describe the elements of a measurement that can be modified to deliver misleading results, different measurements that may work better in certain situations, use on a trend-line basis, and other measurements that should be used to reinforce indicated results.
The book also describes how to use an electronic spreadsheet to compile a standard set of measurements, using Microsoft Excel as the template. This is especially useful for investors and financial personnel who need to compile information about a company's long-term performance.
Anyone who wishes to create a complete set of performance-tracking measurements for an entire company or for a specific function can use this book as a reference source. Managers can choose the correct blend of measurements to achieve an information set that can be used for feedback on strategy initiatives and specific efficiency projects, as well as for performance evaluations. This is the ideal tool for measuring corporate performance.
Centennial, Colorado
March 2012
CHAPTER ONE
Introduction
EVERY DEPARTMENT IN EVERY business produces some kind of information that can be used by its manager to measure performance. This information may be related to operational considerations within the department, the financial condition of the entire company, or the performance of a company's suppliers and customers. Unfortunately, managers may not be aware of the multitude of measurements that can be used to track these different levels of performance or of the ways that these measurements can yield incorrect or misleading information.
This book is intended to help managers select the best possible set of measurements for a given situation. Chapters 2 through 14 itemize a series of performance measurements for different aspects of a company. Chapter 2 contains asset utilization measurements that can be used to determine a company's ability to sustain its sales, the level of asset and expense usage required to do so, and the sustainability of its current sales and expense levels. There are also specialized ratios that deal with such issues as sales returns, repairs and maintenance, fringe benefits, interest expense, and overhead rates.
Chapter 3 contains operating performance measurements, which describe an organization's operating performance in such areas as sales, gross margins, investment income, operating profit, and net profit.
Chapter 4 contains cash flow measurements, which are useful in determining the ability of a company's cash flows to keep it in business. These measurements should be used in conjunction with the liquidity measurements in Chapter 5, which focus on additional measurements related to cash flows, such as a company's ability to collect accounts receivable in an efficient manner, use its inventory within a short time, pay its accounts payable when due, and generally maintain a sufficient amount of liquid funds to pay off short-term liabilities. Chapter 6 contains capital structure and solvency measurements, which determine the relationship between a company's debt and equity, as well as the comparative proportions of different types of stock. It also addresses a company's ability to remain solvent and so can be used in conjunction with Chapters 4 and 5.
Chapter 7 contains return on investment measurements, which encompass net worth, several types of return on assets and equity, earnings per share, economic value added, and return on dividends. Chapter 8 addresses a company's financial market performance by describing such measurements as the price/earnings ratio, several variations on the stock options to common shares ratio, market value added, and the cost of capital.
Chapters 9 through 14 cover measurements for individual departments. These chapters are devoted to performance measurements for the accounting, engineering, human resources, logistics, production, and sales departments. In contrast to Chapters 2 through 8, which are devoted to measurements that are primarily used by the accounting and finance functions, Chapters 9 through 12 are more concerned with such issues as work capacity levels, efficiency, and effectiveness, which in many cases require no financial information at all. For example, measurements in Chapter 12, which deals with logistics, cover such topics as production schedule accuracy, on-time parts delivery percentage, and picking accuracy for assembled products.
Chapter 15 covers a variety of topics related to measurements using the Microsoft Excel electronic spreadsheet, including how to set up comprehensive sets of measurements that can be used for proportional, leverage, ratio, and trend analyses. It also covers a variety of spreadsheet formulas and report formats for forecasting, cash flow analysis, capital asset purchase analysis, interest compounding, investment analysis, and risk analysis.
The book concludes with an appendix and glossary. The appendix lists the names and formulations of every measure in the book, sorted by chapter. This list should only be used with the precautions given for them in their respective chapters to ensure their proper use. The glossary covers the definitions of the terms found in many of the measurements listed in this book, to clarify the exact types of information needed.
The chapters containing measurements (Chapters 2 through 14) are all structured identically. Each begins with a table that lists the measurements described in it, which one can use to quickly access a needed calculation. Thereafter, each chapter is broken down into the discussions of individual measurements. Within each measurement section there is a description, formula, example, and discussion of cautionary items. The description typically notes how the measurement is used and who uses it. The formula shows any variations on the calculation and what types of data to include or exclude from it. The example is generally a complete scenario that describes how the measurement is used in a simulated business situation. Finally, any cautionary items are noted; these can include the ways in which the measurement can be altered to yield incorrect results, or what other measurement should be used with it in order to yield a more comprehensive set of information.
The reader may use this book to search for a single calculation, which can be used for highly targeted needs. However, a better approach is to peruse the entire book, with the objective of developing a complete set of measurements that will yield a more comprehensive view of a company's entire operating and financial situation. For example, a CFO might be interested in a company's stock market performance and therefore watch only the price/earnings ratio. This single measurement, however, focuses only on the perception of investors with regard to a company's future earnings potential. A more rounded set of measurements might include the days of sales backlog (since it indicates future changes in sales volume), production capacity utilization (since it shows the ability of the company to produce its incoming sales), and the days of accounts receivable (since it shows the company's ability to convert sales into cash). The exact set of measurements will change in accordance with a company's industry, size, operational configuration, and degree of financial leverage, but one issue will remain the same: A single measurement is not enough to yield a clear view of a company's financial and operating condition.
Many of the ratios in this book are of the nonfinancial variety, such as mean time between failures, the science linkage index, and the quote to close ratio. Managers have a difficult time creating a linkage between these nonfinancial measures and improvement. A common result is for managers to impose a broad range of nonfinancial measurements upon a company, hoping that some behavior changes will result in improved financial performance. A better approach is to conduct a detailed review of the financial performance drivers of a business, and to only measure the results of nonfinancial measurements that are likely to have a direct impact on those financial measures. For example, a consulting business is experiencing significant delays in the completion of customer projects, which delays revenue generation; the delays are caused by a high level of employee turnover, requiring long lead times to bring in qualified replacement staff. Thus, a reasonable nonfinancial measurement in this case is the annual employee turnover percentage, since there is a direct linkage between it and revenue generation.
Once nonfinancial measurements are selected, be sure to verify that improvements in the activities being measured are actually resulting in altered financial performance. There is often merely an assumption that enhancements to a nonfinancial activity will improve financial performance, but no one has actually tested the assumption. This verification step will ensure that measures that do not assist in improving financial results are thrown out.
A major problem with measurement systems is inconsistency of application. If a company has multiple locations, then it must have a system in place for ensuring that the same measure is calculated in exactly the same way in every location. Local managers can be quite skilled at tweaking measurement systems to reveal the best possible results, frequently by excluding some data from measurements, altering the date ranges over which data is collected, or altering the measurements themselves. This issue can be monitored through the use of occasional internal audits, or with centralized measurement systems that keep local managers from being involved in the measurement process.
Even if a company has developed a reasonable set of measurements, this does not mean that they should never be changed. On the contrary, measured items will generally garner a great deal of management attention and then improve to the point at which they no longer change—thereby resulting in a stale set of measurements. For example, inventory accuracy can improve only to 100%. At that point, the measurement is needed on a monitoring basis to ensure that it does not degrade, while a new measurement can be created to be the focus of corporate attention. However, there will be a few measurements, usually involving sales levels and break-even points, that will always be the centerpiece of any measurement system, since they bring attention to bear on the most crucial revenue and cost elements of the business. Thus, a properly designed measurement system should include a few key items that will be constant for many years, accompanied by other measures that are used for internal improvement purposes and will change in concert with corporate objectives.
A final warning: Do not become so enamored of measurement systems that you burden the company with a wild profusion of measurements that track every conceivable activity, since this causes several problems. First, no one knows which of the measures are most useful for tracking the company's ability to achieve its mission. Therefore, they try to perform well under all of the measures, resulting in resources being allocated to the improvement of some measures that have no bearing on financial performance. Second, employees may engage in irrational behavior in order to achieve high scores through the measurement system, even if they must downgrade their performance in areas not being measured.
This book is filled with almost 250 financial and operational measurements that have proven to be of considerable use to the author in tracking the performance of many companies in a variety of industries. If you would like to see other measurements in the next edition of this book, please send your request to the author at bragg.steven@gmail.com.
