Financial graph on technology abstract background represent financial crisis, financial meltdown Financial performance measurement is the key to successful management of any business, yet it inappropriately practiced by some businesses.
Affluent managers know that the process of control or keeping business on track toward achieving its objective requires the setting of the performance target, measuring of performance and comparing the actual performance against target performance.
ALSO READ: Pension schemes up investment at bourse If we budgeted to manufacture 10 units of a product to serve 20 customers in a week but only made 10 units and served only five customers, we are off target and this requires a managerial response. The problem is that accountants report incomplete information and at times false information to the extent that shareholders and potential investors will never know how their firm is performing. Even listed companies that are subject to public scrutiny do not publish targeted profits.
They only report the actual profit and this makes it difficult to establish whether the managers are meeting the business objectives. For the purpose of valuing a share in a company, the financial analysts would find a forecast profit number more useful than the actual profit number reported. Some managers even manipulate the numbers they include in their financial statements. Some business managers report losses when there is none while others report profit instead of losses.
Fortunately for such managers, we are yet to reach a stage where auditors scrutinise their financial statements. Why do managers, shareholders and those who lend money to businesses focus on financial performance measures of a business? Rational argument ALSO READ: Centum profit decline blamed on tense political environment, rate cap law The rational argument is that only profitable businesses survive and that it is important knowing whether a business is making money or not.
Profit or loss reported by a business is the key financial performance indicator because it is the business profit that interrogates directly the company’s long-run objective. The long-term objective of any business is to make money and survive. Survival would imply a fit between the business and the environment. A well articulated financial performance measure does provide a summary of the business as a whole. Correct measurement of performance or profit determines whether the business pays the correct amount of tax to the government, thus contributing to the society. No business wants to pay more taxes than it should and no government wants to collect less tax than it should, thus the profit reported must be correct to avoid the collapse of businesses.
In any case, financial measures such as profit generated by the business depict the effectiveness of the organisation strategies and operating tactics. When companies such as Kenya Airways, Uchumi and Mumias report huge losses, it is a clear signal that the organisation strategies or tactics are inappropriate. ALSO READ: Islamic finance meet puts spotlight on Kenya This means that they must change their strategies and management. What owners and managers must agree on is that the business must earn good returns. Capital always has alternative uses, so corporate managers must be concerned about whether the returns being earned on invested capital in a business unit exceeds the cost as measured by the returns available from alternative uses. Promote discipline The other reason for measuring the returns on capital is to promote discipline in the organisations and among managers. It is a question of shareholders asking managers, “we gave you this amount of money to do business, how much are you giving us back.” This explains why managers whose business report losses for two years consecutively, should on their motion resign, yet in this country, we see managers lord over their losses for even five years. There are companies out there that neither pay dividends nor experience increases in share price, but managers continue to sit pretty. It is the high time market players started asking managers of listed firms to account for changes in share prices, reward managers of companies that pay dividends and experience a significant increase in share price and punish those whose companies decline in value. ALSO READ: Britam to splash Sh3.5 billion on real estate However, in the process of determining whether a business is profitable, accountants struggle to identify both business expenses and incomes, with profit being the difference between income and expenses. Capturing methods This has never been easy. Where data capturing methods and reporting are unresolved, then managers have a window to distort the information they include in the financial statements. This explains why we need ethical managers. Profit is the difference between expenses and income, thus the accuracy and reliability of such profit that a business reports depends on the process. Those who capture and report accounting transactions must be competent, independent and ethical. The output of a reliable and well-managed accounting system is a quality believable profit. Bad managers can distort business expenses and income to a level that shareholders are unable to establish profitability of their business until the creditors complain about non-payment of their dues. -The writer teaches at the University of Nairobi