Key Performance Indicators (KPIs) explained
Jazoodle provides a number of Key Performance Indicators (KPIs) that will help you understand the performance of a business over time. The information provided details the definitions and assumptions that are associated with the various KPIs Jazoodle provides.
You will also see a traffic signal system too help identify risks and issues with a company. The information provided also illustrates how these levels have been set within the Jazoodle application.
Understanding both the level of profitability within a business as well as the drivers of that profitability is critical. Jazoodle’s profitability KPIs will give insights into these drivers and help identify the necessary actions to improve profit levels.
Gross Profit Margin Shows you, over time, how efficient a company’s stock/inventory purchasing is. The higher the gross profit margin, the better. For service companies, where there may be no inventory/stock of direct input, this will show at 100%. Whereas for businesses such as supermarkets/grocers, gross profit margin will often be lower due to the extent of direct stock costs.
Net Profit Margin Describes the amount of value generated by a business within a period after all direct cost of sales, general overheads/expenses, depreciation and financing costs are taken into account. Net profit does not necessarily indicate the positive levels of cash generated by a business. However, it is a reliable time-based measure for gaining an understanding into the overall value that the business is providing to its stakeholders.
Jazoodle uses the derived Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) figure for its net profit margin calculations. This helps dilute the effect of accounting choices on core performance.
COGS:EBITDA Compares the Cost of Goods Sold (COGS) in relation to Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). If net margins are falling, this will partially show you if the problem is in stock purchasing, or as a result of general overhead problems. Please read in conjunction with the gross profit margin definition.
Expenses:EBITDA If your net profit margins are falling, the relationship between Expenses and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) will help identify if there is an issue with general overheads and expenses, especially if the COGS:EBITDA or Net Profit measures are stable or reducing.
COGS:Net Profit This ratio is as per the COGS:EBITDA measure, but with the effects of depreciation and accounting choices also taken into account.
For instance, if COGS:Net Profit is falling, but Expenses:EBITDA is stable, this may indicate that depreciation expense is increasing, which in turn could either mean a capital investment program (which could be positive for the business) or change in depreciation policy (which could have a negative impact).
This measure should also be assessed in conjunction with changes in other expenses, which may indicate if financing costs are increasing. For example, the Debt : Equity measure could be checked to confirm if this is the case.
Expenses:Net Profit This ratio is as per the Expenses : EBITDA measure, but with the effects of depreciation,and accounting choices also taken into account. This will help identify if core overheads are under control and stable, over time. When assessing this measure, also be aware that an increase in staffing may have contributed to the outcome, perhaps in anticipation of an expansion in the business or major sales push, but has yet to impact the accounts or base performance indicators.
EPS (Earnings Per Share) For public companies, Earnings Per Share is a measure that assesses how much revenue is earned in relation to its underlying equity capital structure. The higher the EPS, the better the general health of the business.
Please note, it is not possible for Jazoodle to identify how many shares may have been issued by the company. For this reason it has been assumed that the number of shares issued in a business is equal to the shareholders’ capital amounts. This may not be accurate but, if used consistently over time, should provide a great way of understanding underlying profit performance, relative to the amount of funds that have been invested in the business from an equity perspective.
PE (Price/Earnings) Ratio Based upon the assumptions used to create the EPS measure, this calculation is also based upon a strict asset value of the business and relates to the number of shares that are assumed to have been issued, and is then related to the EPS measure outlined above. Generally, the higher the Price/Earnings ratio the more likely it is that the company will be expected to further improve its performance in future years.
Cashflow:Total Assets The Cashflow to Total Assets indicator provides and understanding of how cash is generated relative to the asset base of the company. Generally, the higher the indicator, the more efficient the asset base of the company is in generating revenues. Generally, this should be greater than 1 – i.e. $1 of asset generates $1 of revenue.
Please note, that as Jazoodle does not import cashflow statements, the cashflow has been modelled from operating activities using a standard formula, and will not exactly match the figures that you may see reported in your Statement of Cashflows from your accounting package.
Liquidity is simply a means of understanding a company’s susceptibility to either current of future financial distress, and the risk profile of the business. It should be noted however that a single “safe” liquidity measure does not exist across all industries. For instance, some industries traditionally and successfully trade at low liquidity levels, whereas the same figure may be a sign of distress in another sector.
Liquidity Ratio The Liquidity Ratio gives a relative measure of liabilities compared to assets. Generally, you would be looking for a figure greater than 1, for instance a company has at least enough assets to cover its liabilities. However it is very important to also understand how liquid these assets are. For instance, if all of the creditors demanded payment at the same time, how much could realistically be raised in enough time to pay them? Would this cover the liabilities? Overcoming this can be achieved by using a Quick Ratio (see below). Please also note that some industries traditionally trade on very low or high measures.
Quick Ratio The Quick Ratio overcomes some of the issues with the Liquidity Ratio measure and only assesses those assets which have the potential to be liquidated quickly. This ratio ideally should not include inventories as sales of inventory rarely achieve the value that may be on the books. A figure above 1 again is considered to be acceptable. However, the higher the value, the better.
Interest Coverage This measures the ability for a company to service its debt from normal operations and is based on the EBITDA measure of profitability, i.e. not influenced by accounting choices. Ideally a level above 1 is considered to be the very minimum that should be looked for in a company.
Efficiency ratios are a great way of analysing the underlying operational or investment efficiency of a business. For instance, Jazoodle assesses the efficiency that a company has in collecting its debts, or how effective its capital programs are in generating revenues.
Receivables Turnover (RT) The Receivables Turnover measure assesses the level of cash sales relative to credit. For instance, if total sales are $100 and a company has $50 in accounts receivables, the measure would be 2 – or cash sales are twice as common as credit sales. A low figure may indicate that underlying cashflow issues may surface from time to time.
Please note that it is not possible for Jazoodle to identify how many sales are created by offering credit to a company’s customers. However, this can be estimated by relating the total revenue to the number of debtors that a business currently has in place. Therefore, the Receivables Turnover is based upon this assumption.
Asset Turnover Ratio (ATR) This is a great measure to use to help assess the effectiveness of a business to generate cash/sales from its asset investments. Look for an increase over time. Generally, a figure greater than 1 (preferably a lot greater) is advantageous, and shows that a company has generally invested wisely in its capital investments. If this measure declines over time, it is worth understanding where the decline is coming from. For instance, if Return on Assets is also falling, it is worth questioning whether the decline is coming from a reduction in profit margins or a change in asset turnover – or even a combination of the two.
Inventory Turnover Ratio (INVTURN) If stock is held for sale, a critical measure is likely to be the inventory Turnover Ratio, or the measure of how quickly stock sells over time. The larger the measure, the older the stock is likely to be. Therefore, should a competitor launch a better product, a company may be saddled with stock it cannot sell.
Days Sales in Receivables Taking the Receivable Turnover (RT) ratio further, it’s possible to estimate the number of days it takes to recover trade debtors’ accounts. The higher the figure, the less efficient the business is in collecting its client debts. Watch for his over time and look for any deterioration. An overhaul of accounts receivables processes or client communications may be needed. Alternatively, it could reflect the winning of a large account, with a client who perhaps takes longer than average to pay, but who may always do so. If this is possibly the case, assess in conjunction with other measures, such as profitability measures or liquidity measures.
Days Sales in Inventory In conjunction with the Inventory turnover ratio, this measures the number of days it takes to sell stock. The greater the number, the older the stock is likely to be.
Asset Utilisation Ratios
Overall investment returns are assessed using asset utilisation ratios. These ratios give insight into how well the company performs in generating returns from its operational activities.
Return on Equity After Tax (REAT) indicates how profitable the company is based upon the generation of revenue from shareholder equity. Assess this over time, and look for increasing or declining trends. Should there be changes in this, assess revenue or costs trends. If these are consistent, and returns are still changing, assess the total amounts of equity for the business over the same period. Has this changed disproportionately to revenue / cost changes? Finally the ROE, if all other areas are consistent, could indicate a greater reliance on debt financing over time. Please see notes on Gearing too (detailed below).
Return on Equity (EBITDA) As REAT, but normalises the data and removes the effect of accounting decisions and income taxes.
Return on Assets (After Tax) Return on Assets (ROA) is useful for understanding underlying business performance. Check for decreases or increases over time. Is the current figure adequate – which should be above the cost of capital (debt or equity)? ROA will be directly affected by revenues and costs, and therefore profit margins over time.
Return on Assets (EBITDA) As above, but normalises the data and removes the effect of accounting decisions and income taxes.
Solvency ratios are used to measure the ability of a company to meet its long-term debts and how resilient the company may be to economic or financial shocks in its environment.
Business Health Indicator This weighted score, based upon much academic research, is believed to be a good predictor for identifying whether a company is likely to become insolvent, and for assessing the long-term health of the business. A figure below 1.8 is considered to show a business being in poor health. Generally, a score of between 1.8 and 3 is considered normal. If the score is above 3, the business appears very robust with no imminent danger of failure.
Financial Structure Ratios
Understanding the financial structure of a business is critical for assessing how a company finances its future growth, or market sustainability activities.
Debit to Equity (DTE) This measures the total amount of debt the company is carrying, relative to the amount of total equity within it. A figure greater than 1 shows the company is mainly structured via debt instruments. If the indicator is below 1, the company is mainly equity-based. Use this measure to assess the appetite to debt funding. If the figure is too high this could indicate a risk, with the company being too highly geared or reliant on debt funding.
Gearing The proportion of equity funding relative to the asset base of the company. The higher the number generally denotes that greater level of debt has funded the asset base.