Financial Metrics: What Do They Really Tell Us?
Rodrigo Machado Tavares, BEng, CEng, PhD
Technical Director (Head - Fire Safety) at Arcadis
This article only represents my own views on this topic.
This article was written by an ordinary human being without the use of any AI tool.
Businesses need to grow and this is the principle of any business based on Capitalism and free market (clearly taking into account ethical practices and fair trade etc.), despite all the “nice to have” or “nice to hear” aspects, which are mainly based on the political agendas (either generated by the companies’ internal KPI’s* and/or??the external factors “imposed” by societies) we tend to face nowadays. I will not go into this route here as it is also just a matter of reading and getting familiar with what is happening globally speaking. The point here is that any business needs to grow for its own survival, to say the least, particularly in such competitive societies and also considering our digital era.?
?*KPI's Key-Performance Indicators.
Businesses can achieve growth by: (i) expanding their operations in terms of services (or products) offering; (ii) increasing resourcing; (iii) covering other areas/regions. All these can be done in different ways such as collaborations with other businesses via Joint Ventures (JV’s), acquisitions of smaller companies, subcontracting personnel and/or other companies etc. The point is that businesses will always be businesses as the word clearly define what businesses are. Their growth is fundamentally measured in terms of financial performance, and this is what makes a business successful for investors as they do consider the financial performance of businesses as one aspect (if not the main aspect) when making their decisions whether to invest or not in a business. There are few financial indexes, or metrics, which are taken as references to provide an estimated good picture of the financial performance of businesses. And these metrics will tell us if the business is doing well or not financially speaking; in other words, if the planned Net Revenue is going to be achieved and if the business is making healthy profits.?
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The profitability of a business is measured either by the EBITA (Earnings Before Interests, Taxes and Amortization) or by the EBITDA (Earnings Before Interests, Taxes, Depreciation and Amortization). Without going into depth, but in summary, the first index, EBITA, is considered for consultancies, for example, where the “product” is a service, something which is not tangible, non-physical. The second index, EBITDA, is considered for factories, for example, where the product is an actual materialised good, so it is tangible, physical. These are part of any P&L (Profit and Loss) financial report for a business, summarising the incomes and the losses of a business during a period of time, usually in every quarter of a year. The investors do review these figures carefully.?
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Furthermore, any business needs to take these figures seriously. And to make things work efficiently, a business model must be developed in detail where roles and responsibilities are well defined, tasks are well established, feasible goals such as the Net Revenue target must be defined, costs are minimized as much as possible etc. All these items and many others are paramount for growth of businesses. They are what we can call as the “behind the scenes” of all the financial metrics. The behind the scenes are, in other words, the business model and without it well defined and operating efficiently, it will be challenging (not impossible) to reach the planned Net Revenue and have a wealthy profit based on the EBITA or the EBITDA (depending on the type of business). (I would say that a “wealthy” profit would be anything above 20%). Ironically, yes, we can still reach a planned Net Revenue as well as create a wealthy EBITA or EBITDA, but depending on the context, this can be achieved because of employees’ expenses, i.e., people working longer hours and/or taking roles and functions which are not part of their actual roles, thus some of them end up carrying out tasks which should be delegated to other colleagues. For example, a good business model should allocate specialised staff to cover marketing. We should not expect non-marketing people doing the marketing. When the business model allows scenarios like this to happen, despite the financial metrics provide good “green” data, pleasing investors, these scenarios will probably not function sustainably for much longer.
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Within this context, it is core to understand how the financial metrics actually work. In other words: what are they really telling us? How were they achieved? Is the business model sustainable? Can we grow based on the actual business model? If so, for how long? If not, what are the action plans to improve and/or make changes in the business model?
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Questions like these are relevant to be raised, understood and addressed.
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Within this context, if KPI’s cannot effectively support a business to grow sustainably (i.e., with wealthy profits without neglecting/compromising the wellness of the employees), these KPI’s become everything but actual KPI’s; they just become another numerical construct which are more related to what I call “business numerology” than anything else. Financial metrics do need to be factual and clearly based on numbers, nevertheless, it is paramount to consider how we capture these figures and more important as well we do need to filter what comes behind these figures as well: what is the business model?
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Rodrigo Machado Tavares
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