1. Evaluating Financial Performance
Financial Management Program
Management Department
Faculty of Economic
Petra Christian University
Surabaya, 2009

2. Learning Objectives
Understand important financial performance measures and their uses, by life cycle stage
Describe how financial ratios are used to monitor a venture performance
Identify specific cash burn rate measures and liquidity ratios and explain how they are calculated and used by the entrepreneur
Identify and describe the use and value of conversion period ratios to the entrepreneur

3. Learning Objectives
Identify specific leverage ratios and explain their use by lenders and creditors
Identify and describe measures of profitability and efficiency that are important to the entrepreneur and equity investors
Describe limitations when using financial ratios

4. User of Financial Performance Measures by Life Cycle Stage
Type of Financing
Financial Ratios & Measures
Users of Financial Ratios & Measures
Development & startup stage
Seed financing & startup financing
Cash burn rates and liquidity ratios
Conversion period ratios
Entrepreneur
Business angels
Venture capitalists (VCs)
Survival stage
First round financing
Cash burn, liquidity, & conversion ratios
Leverage ratios
Profitability & efficiency ratios
Entrepreneur, angels, VCs,
Commercial banks
Rapid growth stage
Second round, mezzanine, & liquidity stage financing
Investment bankers

5. Using Financial Ratios
Financial ratios relationships between two or more financial variables or between financial variables and time Trend analysis examination of a venture’s performance over time

6. Using Financial Ratios
Cross-sectional analysis comparison of a venture’s performance against an- other firm at the same point in time Industry comparables analysis comparison of a venture’s performance against the average performance of other firms in the same industry

7. Income Statement 2007 2008 Net sales Cost of goods sold Gross profit
Administrative expenses
Marketing expenses
Research & development
Depreciation
EBIT
Interest expense
Income before taxes
Income taxes (30% rate)
Net income
45.000
32.000
20.000
14.000
42.000
12.000
30.000
9.000
21.000
65.000
39.000
27.000
17.000
47.000
8.000
19.000

8. Balance Sheets ASSETS 2006 2007 2008 Cash & marketable securities
Receivables
Inventories
Total current assets
Gross plant & equipment
Less: accumulated depreciation
Net plant & equipment
Total assets
Liabilities and Equity
Payables
Short term bank loan
Accrued liabilities
Total current liabilities
Long term debt
Owners’ equity
Total Liabilities & equity
10.000
60.000
70.000
28.000
47.000
40.000
8.000
95.000
75.000
42.000
57.000
44.000
9.000
90.000
5.000
59.000
84.000
80.000

9. Statements of Cash Flow
Cash flow from operating activities
2007
2008
Net income
+ depreciation
Increase in Receivables
increase in Inventories
+ increase in payables
+ increase in accrued liabilities
Net cash flow from operations
Cash flow from investing activities
Increase in gross equipment
Net cash flow from investing activities
Cash flow from financing activities
+ increase in short-term bank loan
Decrease in long term debt
Net cash flow from financing
Net change excluding cash account
Beginning cash and marketable securities
Ending cash and marketable securities
21.000
14.000
10.000
1.000
6.000
4.000
-6.000
19.000
17.000
27.000
66.000
56.000
-5.000
5.000

10. Cash Burn Rates and Liquidity Ratios
Cash a venture expends on its operating and financing expenses and its investments in assets
Cash burn rate
Cash burn for a fixed period of time, typically a month
Cash burn = income statement-based operating, interest, and tax expenses
+ increase in inventories
- (changes in payables and accrued liabilities)
+ capital expenditures

11. Measuring Venture Cash Burn and Build Amounts and Rates
= net sales – increase in receivables
Net sales less the increase in receivables
Cash build
Cash build for a fixed period of time, typically a month
Cash Build Rate
= cash burn – cash build
When cash burn exceeds cash build in a specified time period
Net cash burn
Net cash burn for a fixed period of time, typically a month
Net cash burn rate

12. Traditional Measures of Liquidity
Ratios that indicate the ability to pay short-term liabilities when they come due
Liquidity Ratios
Current Ratio
average current assets
average current liabilities
Quick Ratio
= average current assets
- average inventories
: average current liabilities
Net Working Capital (NWC) to Total Assets Ratio
- Average current liabilities
: average total assets

13. Conversion Period Ratios
Ratios that indicate the average time it takes in days to convert certain current asset and current liability accounts into cash
Operating cycle
Time it takes to purchase required materials, assemble, and sell the product plus the time needed to collect receivables if the sales are on credit
Cash conversion cycle
Sum of the inventory-to-sale conversion period and the sale-to-cash conversion period less the purchase-to-payment conversion period

14. Operating Cycle Cash Work-in-progress Materials Finished Goods
(Credit Sales)
Receivables

15. Measuring Conversion Times
Inventory-to-sale Conversion Period
Average inventories/(Cost of goods sold/365)
Sale-to-cash Conversion Period
Average receivables/(net sales/365)
Purchase-to-payment Conversion Period
(Average payables + average accrued liabilities)/(COGS/365)
Cash Conversion Cycle
Inventory to sale Conversion Period + sale to cash conversion period – purchase to payment conversion period

16. Leverage Ratios Leverage ratios
Ratios that indicate the extent to which the venture has used debt and its ability to repay its debt obligations
Loan principal amount
Dollar amount borrowed from a lender
Dollar amount paid on the loan to a lender as compensation for making the loan
Interest

17. Measuring Financial Leverage
Total-debt-to-total-assets ratio
= average total debt/average total assets
Equity multiplier
= average total assets/average owners’ equity
Debt-to-equity ratio
= total debt to total assets/(1-total debts to total assets)
Current liabilities to total debt ratio
= average current liabilities/average total debt
Interest
= EBITDA/interest
Fixed charges coverage
= EBITDA + lease payment/(interest + lease payments +
[debt repayments/(1- tax rate)]

18. Profitability and Efficiency Ratios
Ratios that indicate how efficiently a venture controls its expenses and uses its assets
Income statement measures of profitability
Gross profit margin
= (net sales – COGS)/net sales
Operating profit margin
= EBIT/net sales
Net profit margin
= net profit/net sales
NOPAT margin
= EBIT(1- tax rate)/net sales

19. Efficiency and Return Measures
Sales-to-Total-Assets Ratio = net sales/ average total assets Operating Return on Assets = EBIT/average total assets Return on Assets (ROA) = net profit/average total assets = net profit/net sales x net sales/average total assets Return on Equity (ROE) = net income/average owners equity = net profit margin x asset turnover x equity multiplier

20. Thank You