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Financial Performance

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Financial Performance

Entrepreneurs' objective when establishing a company is obvious, they want to earn money. In order to make money, an enterprise has to perform well. However, this is only possible when required funds are available. Therefore, it is important to keep an eye on a business's financial performance and improve it whenever possible.

Financial performance is a subjective measure of how well a company uses assets and generates revenues. It is an evaluation of its financial position regarding variables such as assets, liabilities, equity, expenses and revenues.

Financial performance is highly determined by the way finances are managed. Financial management relates to applying general management principles to the financial resources of a company. It includes strategic planning, organising, directing and controlling of financial undertakings in a firm.

How to improve financial performance?

In order to improve financial performance, financial managers should undertake a specific process. The process includes several steps listed below.

Financial Performance: Financial objectives

Financial objectives are the goals or targets related to the financial performance of a business. They are the goals that enterprises set for success and growth. If there are no clearly defined objectives, it is impossible to move further and improve. Setting objectives enables companies to develop and widen their perspectives. However, financial objectives are not related to businesses only. Financial objectives can also be set by individuals.

Imagine you want to go on a trip with your friends. You need money to pay for transport, accommodation, food and other expenses during the trip. Moreover, you really like pastries from Greggs and you go there and buy one every day during the lunch break. However, it is more important to you to go on a trip than eat a pastry every single day. For this reason, you change your behaviour and go to Greggs twice a week only. This way, instead of spending most of your money on the pastries, you save money for the trip.

As you can see, having financial objectives has an influence on what you do on a daily basis. It determines your behaviour and where and how much money you spend. Following the example, if you did not set the objective and went to Greggs every day like you used to, you would not be able to save money for the trip. The same applies to companies, if they set a specific financial goal, they need to adjust and change the way they behave in order to achieve it.

There are several types of financial objectives:

  • Revenue objectives - maximising revenues,

  • Cost objectives - minimising costs,

  • Profit objectives - maximising profits,

  • Cash flow objectives - improving cash flow,

  • Investment objectives - making better investments,

  • Capital structure objectives - structuring capital in a certain way.

Financial performance analysis

Financial performance analysis is a process of analyzing and evaluating a company's financial position. It focuses on reviewing, assessing and comparing financial statements - a collection of data and figures organized according to recognized accounting principles. The analysis helps to determine whether a company is making a profit or loss. It shows how the company is spending, investing and earning money. Knowing how the company is performing, we are able to make better economic decisions and assess its potential.

There are two types of financial statements:

  • Income statement - showing the profit earned and loss sustained by a business entity over a particular period (usually 12 months),

  • Balance sheet - showing assets and liabilities of a business at a specific point in time (usually the end of the financial period).

The analysis may also include calculating and analyzing financial ratios:

  • Return on capital employed,

  • Net profit margin,

  • Gross profit margin,

  • Current ratio.

And analyzing other aspects such as:

  • Cash flow - a real or virtual movement of money. It is when an amount of cash and cash equivalents is being transferred into and out of a business,

  • Budgets - in other words, financial planning, forecasting of cash received and cash payable, of incomes and revenues, and of the resulting state of the financial health of a company,

  • Break-even - a number of units the firm has to produce and sell before it recovers its total costs.

Financial Performance: Sources of finance

Sources of finance are the provision of finance for a business to fulfill its requirement for short-term working capital and fixed assets and other investments in the long term.

There are two types of sources of finance:

  • Internal sources - funds coming from the inside of the company. For example, capital brought by the owner, retained profit, discount selling and selling of fixed assets

  • External sources - funds coming from the outside of the company. For example, long term sources such as equity shares, debentures and term loans, or short-term sources such as bank overdraft and trade credit

Financial Performance: Cash flow and profit improvement

Both cash flow and profit determine the financial performance of a company and therefore, they are the key factors to be improved. This is because a business needs cash to keep operating. When it doesn't have the cash it requires to operate, then it will come to a halt or might even have to close.

There are the key financial decisions that should be made to improve cash flow and profits:

  • Designing the product in a way that will bring healthy profit margins,

  • Receiving payment in an expected way that lowers the risk of having to chase invoices,

  • Setting a transparent, coherent, and systematic way for managing the financials,

  • Having an efficient sales approach.

Non-financial measures of performance

Non-financial measures are metrics that cannot be expressed in monetary units.

Non-financial measures are equally important as they fill in the gaps which are not covered by the financial measures. Even though an enterprise makes a profit and the numbers are growing, it does not necessarily mean that it is successful.

A 20-year-old company manufactures and sells furniture. It sells all the pieces of furniture it produces and has built customer trust, but its profits are not exceptionally high. Therefore, it decided to raise prices by 20%. Initially, customers continued to buy the furniture but then they realized how overpriced it was and consequently lost their trust in the company. This led to them switching to a different company.

As you can see, it is crucial to take non-financial measures into consideration. Neglecting them might not only result in a lack of customer satisfaction but also in financial losses.

Examples of non-financial measures:

  • Market share,

  • Customer satisfaction,

  • Company reputation,

  • Category ownership,

  • New product adoption rate,

  • Innovation.

Financial performance - key takeaways

  • Financial performance is a subjective measure of how well a company uses assets and generates revenues.
  • Financial management includes strategic planning, organizing, directing and controlling of financial undertakings in a firm.
  • Financial objectives, financial performance analysis, sources of finance and cash flow and profit improvement are the key steps to improve financial performance.
  • The income statement and balance sheet are the two most important financial statements.
  • Non-financial measures of performance are metrics that cannot be expressed in monetary units. They are equally important as they fill in the gaps which are not covered by the financial measures.

Frequently Asked Questions about Financial Performance

Financial performance in an organisation is measured by reviewing, assessing and comparing financial statements  - a collection of data and figures organized according to recognized accounting principles. The analysis helps to determine whether a company is making a profit or loss. It shows how the company is spending, investing and earning money. 


Financial management includes strategic planning, organising, directing and controlling financial undertakings in a firm.  

Some examples of financial performance metrics include:

  • Return on capital employed,

  • Net profit margin,

  • Gross profit margin,

  • Current ratio.

An organisation's financial performance can be monitored by reviewing, assessing and comparing financial statements. 


There are two types of financial statements:


  • Income statement

  • Balance sheet 


The analysis to monitor the financial performance also includes calculating and analyzing financial ratios such as:

  • Return on capital employed,

  • Net profit margin,

  • Gross profit margin,

  • Current ratio,

  • Cash flow,

  • Budgets,

  • Break-even


Non-financial measures such as the following are also important to monitor financial performance:

  • Market share, 

  • Customer satisfaction, 

  • Company reputation,

  • Category ownership, 

  • New product adoption rate,

  • Innovation.


Financial performance is a subjective measure of how well a company uses assets and generates revenues. It is an evaluation of its financial position regarding variables such as assets, liabilities, equity, expenses and revenues. 

Financial metrics used to measure financial performance:


  • Return on capital employed,

  • Net profit margin,

  • Gross profit margin,

  • Current ratio,

  • Cash flow,

  • Budgets,

  • Break-even


Non-financial metrics used to measure financial performance: 


  • Market share, 

  • Customer satisfaction, 

  • Company reputation,

  • Category ownership, 

  • New product adoption rate,

  • Innovation.


Final Financial Performance Quiz

Question

List some tips on how to improve financial performance.


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Answer


  • Lower your expenses

  • Set appropriate pricing

  • Try to get a financial support 

  • Keep an eye on your market

  • Keep up with economics

  • Regularly analyse your financial performance

  • Do not take risky projects if your company makes little profit

Show question

Question

Give a definition of financial objectives.

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Answer

Financial objectives are the goals or targets related to the financial performance of a business.

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Question

List all the six types of financial objectives.


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Answer

Revenue objectives, cost objectives, profit objectives, cash flow objectives, investment objectives and capital structure objectives.

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What are the three types of revenue objectives?


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Answer

Revenue growth, sales maximization and market share.

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Give an example of a cost objective.


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Answer

Cutting variable costs to £50 per unit.

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Give an example of an objective rate of profitability.


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Answer

Achieving an operating profit margin of 15%.

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What are the ways to improve cash flow?


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For example, reducing borrowings and inventory.

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What are the two types of investment objectives?


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Level of capital expenditure and return on investment.

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How can a capital be structured?


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It might consist of equity and/or debts.

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Which of the objectives are usually used by small businesses and/or start-ups?


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Answer

Cash flow objectives and capital structure objectives.

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Give an example of a personal financial objective.


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Answer

For example, saving for retirement or a trip.

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Give an example of non-financial objectives.


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For example, customer satisfaction and community involvement.

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List steps of setting financial objectives.


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Deciding on what the money is going to be used for, categorizing the financial goals, setting deadlines, prioritizing the goals and knowing how much you have now and how much you want to have.

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Question

What are the three types of financial goals regarding a period of time within which they are to be achieved?


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Short-term financial goals (six months to five years), mid-term financial goals (five to ten years), long-term financial goals (more than ten years).

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Give an example of a benefit of setting financial goals.


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Answer

Shaping everyday choices, determining how much to save.

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List two disadvantages of setting financial objectives.


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Answer

It might prevent you from spending money and make you feel dissapointed when not achieved.

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What are the two types of influences of financial objectives?


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Internal and external.

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Give an example of internal influences.


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Business ownership.

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Give an example of external influences.


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Political change.

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What is financial performance analysis?

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Answer

It is a process of analyzing a company’s financial position.

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What is the purpose of analysing financial statements?


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Understanding a business model, verifying whether a company is making a profit or loss and then making better economic decisions.

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Question

What are the two main financial statements showing a company’s financial performance?


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Income statement and balance sheet.

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What are the main elements of the income statement?


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Turnover, cost of sales, gross profit, net profit.

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What are the main elements of the balance sheet?


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Current assets, non-current assets, inventory, trade receivables, trade payables, current liabilities, non-current liabilities, shareholders’ funds.

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What is the main difference between an income statement and balance sheet?


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Income statement shows a company’s financial activities over a specific period of time whereas the balance sheet shows its financial position in a particular moment.

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What are the four main financial ratios?


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Return on capital employed, net profit margin, gross profit margin and current ratio.

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What are the sections of the financial report?


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Company overview, investment, valuation, risk analysis, details and summary.

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What is a cash-flow?

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Answer

Cash-flow is a movement of money.

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What is a basic cash flow formula?


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Answer

Free cash flow = operating cash flow - capital expenditures

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What is a cash flow statement?


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Answer

Likewise, by the income statement, cash flow statements show the profit earned and sustained loss by a business entity over a particular period (usually 12 months) and how this figure is concluded. However, instead of showing revenues and costs, the cash flow statement includes cash inflows and outflows.


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What is a budget?


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Answer

Budget is a form of financial planning and forecasting.

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What are the three types of budgets?


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  • Balance budget
  • Surplus budget
  • Deficit budget

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What is a cash budget?


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A cash budget is an estimation of a business's cash flows over a period of time.

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What are the advantages of budgets?


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  • Budgets help to manage the cash flow

  • Budgets may identify possible shortage of cash

  • Budgets allow planning

  • Budgets help to reach goals

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What are the disadvantages of budgets?


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  • Budgets can prevent a company from spending

  • Budgets can change and therefore be misleading

  • Budgets can eliminate rewards

  • It can be hard to estimate the amount of money to be spent and create a budget

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What is break-even analysis?

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It is a calculation of how many units a company has to produce and sell to recover its total costs.

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What is a fixed cost?

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Rent

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What is a target profit?

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Target profit is an expected amount of profit that the shareholders and/or managers of a business expect to achieve by the end of a specified accounting period.

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Question

What are the advantages of break-even analysis?


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Answer

  • It provides a measurement of profit and losses at different levels of production and sales

  • It predicts the effect of changes in sales prices

  • It analyzes the relationship between fixed and variable costs

  • It predicts the effect of cost and efficiency changes on profitability

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What are the disadvantages of break-even analysis?


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Answer

  • It assumes that sales prices are constant at all levels of output

  • It assumes production and sales are the same

  • It may be time consuming

  • It can only apply to a single product or single mix of products

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Define sources of finance.


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Answer

Sources of finance are the provision of finance to an organization to fulfill its requirement for short-term working capital and fixed assets and other investments in the long-term.

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Define internal sources of finance.

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Answer

The internal sources of finance signify the money that comes from inside the organization.

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Are internal sources of finance the cheapest?


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Answer

Yes, Internal finance can be considered as the cheapest type of finance, this is because an organization will not have to pay any interest on the money.

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Is internal financing the most significant source of finance for startups?


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Yes, because the business will not have the assets or trading record which will help to get a bank loan.

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Why is the retained profit a desirable form of financing?


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This is because there is no interest charge.

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Define external sources of finance.


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External sources of finance signify the money that comes from outside the organization.

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How can an organization benefit from its retained profit?


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The organization can decide to reinvest this profit into the business. This type of source of finance also does not have interest charges, therefore, it is a desired type of finance.

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How are family and friends an external source of finance for an organization?


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An organization can get a loan or get the money that might not need to be given back or is paid back with low or no interest from family and friends.

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What are the types of external sources of finance?


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Short-term and long-term

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Is equity share a common source of external financing?


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Answer

It is a common source for established businesses, not all businesses can utilize this form of financing because of regulations.

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