The Performance Prism

The Performance Prism is a second generation performance measurement and management framework that has been developed by Neely, Adams and Kennerley to further aid organisations in their pursuit of measuring the overall performance of their operations. The creators of this model suggest that for organisations operating within almost any given industry, the most important aspect of management is to deliver on the expectations of the stakeholders associated with that organisation. The Performance Prism is designed to help with the complex relationships that organisations often possess with their various stakeholders within the context of its operating environment. It provides an innovative and holistic framework that directs management attention to what is important for long term success and viability and helps organisations to design, build, operate and refresh their performance measurement systems in a way that is relevant to the specific issues that they face within their given industry.

This model attempts to distinguish itself from other similar models such as the Balanced Scorecard by offering a unique perspective on a measuring system that can ultimately be adopted as a way of operating within an industry, rather than just measuring performance of the organisation. The balanced scorecard, with its four perspectives, focuses on finance, customers, internal processes and innovation and learning. In doing so it downplays the importance of other stakeholders, such as suppliers and employees. The business excellence model combines results, which are readily measurable, with enablers, some of which are not. Shareholder value frameworks incorporate the cost of capital into the equation, but ignore all aspects relating to stakeholders.… Read the rest

What is Financial Structure?

Financial structure refers to the way as to how the firm’s assets are financed. It includes both, long-term as well as short-term sources of funds. In other words, it refers to the left hand side of the Balance Sheet as represented by total liabilities. However, a more frequently used term is capital structure which is slightly different from financial structure. If short-term liabilities are removed from firm’s financial structure, what one obtains is its capital structure.

So, financial structure is defined as the amount of current liabilities, long-term debt, preferred stock and common stock used to finance a firm. In contrast, capital structure refers to the amount of long-term debt, preferred stock and common stock used to finance a firm’s assets. Thus, capital structure is only a part of the financial structure and it represents the permanent financing of the company. Another term Capitalization refers to total long-term funds required by the firm. Whereas, capital structure refers to ‘make-up of capitalization’ i.e. types and proportion of different securities to be issued.

There cannot be a uniform financial structure which suits the requirements of all firms. In other words the financial structure has to be formed in such a way that it suits the needs of a particular firm meaning thereby that the firm should seek an optimum or an ideal financial structure for itself. Financial structure particularly the capital structure decision is a significant financial decision since it affects the shareholders’ return and risk and consequently the market value of the firm.… Read the rest

Evaluating a Company’s Capital Structure using Ratios

A business organization may be financially sound today but it may loose strength tomorrow because of losses. Therefore it is necessary to maintain a judicious balance between the owned capital and borrowed capital. The following ratios have been calculated to analyze the capital structure of a company.

1. Capital Gearing Ratio

Capital Gearing Ratio of an organization measures the relationship between equity share capital to preference capital and loan capital. ‘Capital gearing’ refers to the ratio between the variable cost bearing capital and fixed cost bearing capital of the organization and helps to frame the capital structure of the organization. Capital gearing may be of three types:

  1. High Gearing Capital, which indicates the excess of interest bearing long-term finance over the equity funds;
  2. Low Gearing Capital, which indicates the excess of equity funds over the interest bearing long-term finance; and
  3. Evenly Geared, which indicates the equality between the interest bearing long-term finance and equity funds.

As regards the role of capital gearing in the successful operation of the organization, it is as significant as the use of gears in the speed of an automobile. Just as gears are used in an automobile for maintaining the speed because an automobile starts at low gear and when it start running fast, in the same way when an organization is incorporated, it is begun with more equity capital and less interest bearing finance. But as the business moves ahead, fixed cost bearing finance such as preference capital, debentures and term loans etc., increases and the equity capital either remains constant or increases at a very low speed.… Read the rest

Factors Determining Financial Structure of a Company

Capital structure refers to the mixture of long term funds represented by equity share capital, preference share capital and long term debts. As a matter of fact, capital structure planning is one of the major tasks which involve determination of the right proportion of different securities. Each Corporate security has its own merits and demerits. Too much inclusion of any one kind of security in the capital structure of a company may prove unprofitable or subsequently risky. Therefore, a prudent financial decision should be taken after considering all the factors in view.

Capital structure should always be made in the interest of equity shareholders because they are the ultimate owners of the company. However, the interest of other groups, including employees, customers, creditors, society and government should also be duly considered. In this way, efforts should be made to have capital structure most advantageous. Within the constraints, maximum use should be made of leverage at a minimum cost.

As there cannot be uniformity regarding capital structure decision, which suit the requirements of all companies, Capital structure should be formed to suit the needs of every individual company together with giving due place to borrowed funds in its capital structure.

Factors Determining Capital Structure

Capital structure has to be decided initially at the time when a company is incorporated. The initial capital structure should be designed very carefully wherever funds have to be procured, the financial manager should study the pros and cons of various sources of finance and pick up the most advantageous source keeping in view the target capital structure.… Read the rest

Financing of Current Assets

Current assets of enterprises may be financed either by short-term sources or long-term sources or by combination of both. The main sources constituting long-term financing are shares, debentures, and debts form banks and financial institutions. The long term source of finance provides support for a small part of current assets requirements which is called the working capital margin. Working capital margin is used here to express the difference between current assets and current liabilities. Short-term financing of current assets includes sources of short-term credit, which a firm is mostly required to arrange in advance. Short-term bank loans, commercial papers etc. are a few of its components. Current liabilities like accruals and provisions, trade credit, short-term bank finance, short-term deposits and the like warranting the current assets are also referred to a short-term term sources of finance.Spontaneous financing can also finance current assets, which includes creditors, bills payable, and outstanding receipts. A product firm would always opt for utilizing spontaneous sources fully since it is free of cost. Every concerns that can no more be financed by spontaneous sources of financing has to decide between short-term and long-term source of finance along with relevant proportion of the two. There are three approaches of financing current assets that are popularly used. They are;

1. Matching Approach

As the name itself suggests, a financing instrument would offset the current asset under consideration, bearing financing instrument bearing approximately same maturity. In simple words, under this approach a match is established between the expected lives of current asset to be financed with the source of fund raised to finance the current assets.… Read the rest

DuPont Analysis – Return on Equity (ROE) Analysis

Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont analysis is a useful tool in providing both an overview and a focus for such analysis.

History of DuPont Analysis

The DuPont model of financial analysis was made by F. Donaldson Brown, an electrical engineer who joined the giant chemical company’s Treasury department in 1914. A few years later, DuPont bought 23 percent of the stock of General Motors Corp. and gave Brown the task of cleaning up the car maker’s tangled finances. This was perhaps the first large-scale re-engineering effort in the USA. Brown devised formulae to analyse the source of shareholder returns generated by these companies. These formulae or methods came to be known as DuPont system of analysis. Ensuing success launched the DuPont model towards prominence in all major U.S. corporations. It remained the dominant form of financial analysis until the 1970’s. The DuPont analysis is known by many other names, including DuPont Equation, DuPont Framework, DuPont Identity, DuPont Model, DuPont Method, or Strategic Profit Model.… Read the rest