Question

1) Table 2.1 (in the Grant text) compares companies according to different profitability measures. a. Which two of the six performance measures do you think are the most useful indicators of how well a company is being managed? b. Is return on sales or return on equity a better basis on which to compare the performance of the companies listed? c. Several companies are highly profitable yet delivered very low returns to their share-holders during 2014. How is this possible?

Answer 1

Step 1

Key performance Indicators are a Company's measurable goals. These are related to organization's strategy which help the management to assess the achievement of goals which are revealed through performance management tools.

Most goals are achieved not through the efforts of a single person, but by multiple people in a variety of departments across the organization. It is agreed in principle that cascading and aligning goals across multiple owners creates a " shared accountability" that is vital to a company's success.

Step 2

a The following two performance measures are very useful indicators of company management:

1. Increase in market share

If company manage to capture major share of market demand, it prove that the company is well managed and its products are in high demand in market. It also established that the customer satisfaction is very high.

2. Employee-employer relationship

Better the employee-employer relationship, better the company management on all fronts-production goal achievement, customer satisfaction, cost reduction, quality management etc. It increase the reliability of market, better store management, better production, achievement of desired profit, better returns to the shareholders.

b. Is return on sales or return on equity a better basis on which to compare the performance of the companies listed?

Ultimate aim of any investor is returns. Return on equity, which depends on return on sales, measures the return that shareholders get from the business and overall earnings. It helps investors compare profitability of companies in the same industry. The ratio highlights the capability of the management. Return on equity is calculated by dividing net income by shareholders equity.

The main benefit comes when earnings are reinvested to generate a still higher return, which in turn produces a higher growth rate. However, a rise in debt may also reflect in higher return, but that should also be carefully noted and analysed.

c. Several Companies are highly profitable yet delivered very low returns to their shareholders during 2014. How is this possible?

While high profit is indicator of good financial position of the company, as the increasing profits are the best indication that the company can pay higher dividend. But it is not only indicator predicting good financial health of the Company. Even though the company are highly profitable, yet it may not be in a position to give high returns to the share holders due to following reasons:

- Increase in sundry debtors. As increase in sales may be on credit, due to which there is increase in debtors and liquidity position of the company has worsened even though the profit and loss statement has shown high profit.

- Increase in closing stock. Further the increase in closing stock also results in high profit, but it results in blockade of cash and bank balance. This results in non availability of liquid funds to enable the company to provide higher dividend.