Financial performance: Thriving business momentum!

A study of strategy performance (4/4): Financial performance

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Financial Performance:

Our study now reaches the bottom line of the P&L and yet another essential aspect of every business: shareholders. As you may know, dividends are served from a company’s net income. Dividends is the price to pay for shareholders money, that exact same money any business needs to be able to invest and grow. The principles are the very same as for the Momentum Investing strategy we saw in introduction, the investors choice is guided by both level of risk and expected return. 

The only really desirable situation for the person running a business is without a doubt to have a high Momentum, i.e. high financial performance, thus being able to redistribute value to the shareholders and in turn attracting more investors, and more easily convince banks. However, in that concerns, investors and banks have a very different behaviors: if banks are actually rather looking for a rental than for the company value their financing helps to create, investors have other ways to generate profit from their investment than dividends and can actually make money only by trading the shares. In other words, in the first place it is possible to consider that investors would indifferently see net income redistributed or reinvested in the company as long as they see a proportional increase in the net present value of their investment.

Financial Performance ratio

Of course we know it isn’t that simple and to some extent, investors are always risk-avert. Therefore, in most cases they prefer cashing dividends immediately than waiting for an uncertain future profit. Nonetheless, there are situations when the CEO can argue with the shareholders about the best ways to use company income. If dividends are a necessary evil, the CEO’s main objective is company’s long term growth, keeping dividends at the lowest possible level and keeping as much as possible of Net Income available for reinvestment in the business.

In addition, the decision taker may want to calculate performance ratios to get more accurate insight and interpretation:

P, the Financial Performance ratio must be compared to an Expected Return on Investment Potential index, where k is the index – k is the investment profitability n periods ago.

>>Coming soon : A study of strategy efficiency>>

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 Frederic Hugo Hoffmann, MBA

Frédéric specialized in initiating and developing new activities within organizations, leading organizational change and innovation.

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