Page 121 - APM Integrated Workbook STUDENT S18-J19

Financial performance measures in the private sector
2.2 Measuring profitability
The primary objective of a profit seeking company is to maximise
profitability. A business needs to make a profit to be able to provide a
return to any investors and to be able to grow the business by
reinvestment.
Profitability measures –
whole organisation
Advantages
Gross and operating  Easy to calculate.
profit
 Widely understood.
 Ignores largely
uncontrollable figures,
e.g. tax, interest.
 Can calculate as a profit
margin.
ROCE (return on capital  Easy to calculate.
employed)
 Measures how well a
= operating profit ÷ firm is utilising
(capital employed) × 100 resources invested in it.
 Often used by external
investors/analysts.
EPS (earnings per share)  Easy to calculate.
= (PAT – preference  Calculation precisely
dividends) ÷ weighted defined by accounting
average number of standards.
ordinary shares
EBITDA, i.e. earnings  A measure of
before interest, tax, underlying performance
depreciation, amortisation since it is a proxy for
and write-offs (such as cash flow generated
goodwill) from operating profit.
 Ignores tax and interest
since these are
externally generated
and therefore not
relevant to the
underlying success of
the business.
Disadvantages
 Poor correlation to
shareholder wealth.
 Can be distorted by
accounting policies.
 Poor correlation to
shareholder wealth.
 Can be distorted by
accounting policies.
 Possible dysfunctional
behaviour and/or a
cutting back in
investment if used as a
performance target.
 Poor correlation to
shareholder wealth.
 Accounting treatment
may distort measure.
 Poor correlation to
shareholder wealth.
 Comparison between
organisations difficult
due to differences in
accounting policies and
the calculation of an
absolute figure.
 It can be easily
manipulated by
aggressive accounting
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