Chartwell Capital Solutions Newsletter Article by Cathy O'Brien - Monitor A&E Company Performance with Key Ratios
Posted 3-8-2011 | By Cathy O’Brien | Download Article
As published in Chartwell Capital Solutions Newsletter
Architects and engineers know that without a strong foundation the stability of a structure is compromised. The same applies to the financial foundation of their company. To monitor financial stability, leaders need access to key information throughout the year.
Following are four key financial ratios important to monitoring company performance and financial stability.
- Debt to Equity – Total Liabilities / Equity
- Asset Turnover – Assets / Revenue
- Profit Margin – Income / Revenue
- Cash Flow Yield – Cash Flow from (used by) operating activities / Income (Loss)
Continuous measurement of these four ratios indicates trends giving leaders a clear view of their financial foundation month-to-month. Because each metric is independent of the other, the results help identify weak links or high-performing areas. With these indicators, architecture and engineering (A&E) companies can drill down to factors affecting performance.
Debt to Equity
Debt to equity measures the amount of resources provided by creditors and owners. It indicates a company’s level of risk and a firm’s ability to meet their debt obligations. Bankers use this ratio to determine the credit-worthiness of a firm. Lower is better.
Look at opportunities to reduce interest rates. Reducing your interest rate and shortening payoff time of the loan will increase the monthly principal portion of payments thereby reducing the debt to equity ratio.
Asset Turnover
This ratio shows how efficiently the firm is using its assets to generate revenue. Compared to best practices in the industry, it indicates over-investment or inefficient use of assets.
Increase asset turnover by eliminating unnecessary asset purchases. Many times companies are more focused on purchasing assets to find deductions for offsetting current revenue. Don’t let your firm fall into this trap. Before purchasing new assets evaluate how the assets will serve the needs of the company and ask the question; will it help drive efficiencies?
Profit Margin
This key ratio measures the overall effectiveness of the firm’s operations. It shows the efficiency and consistency of how the firm controls their costs.
Increasing profit margins starts by evaluating expenses, identifying increased trends and eliminating unnecessary expenditures. Before making harsh decisions to eliminate staff, firms must first evaluate staff productivity and process improvements. Efficient process improvements will increase productivity and free up capacity for growth opportunities.
Cash Flow Yield
Cash flow yield captures the quality of the income. It answers the question: “Are operating activities generating sufficient cash flow?” The longer it takes to receive payment for services the lower the ratio. High performing A&E firms need to have tight reigns on their cash flow with no wide swings.
Effective cash management helps A&E firms avoid disaster during economic downturns and takes advantage of their financial strength in good times.
Cash flow projections are essential to A&E firms. It is important to determine adequate cash on hand and gain overall control of a firm’s overhead costs.
The real value in benchmarking happens when a firm interprets the results and decides on a course of action that focuses on continuous improvement. Accurate financial information allows the firm’s principals to make sound business decisions that meet long-term goals and ultimately increases shareholder value. They also support the firm’s plan execution and reduce financial risk which puts them in a class with other high-performing A&E firms.