Organizational control is the systematic process through which managers regulate organizational activities to make them consistent with expectations established in plans, targets and standards of performance (Kuratko, 2001). These organizational expectations are a collection of goals and accountabilities represented in the budget, which help establish performance metrics, document actual performances, allow comparison between the estimated and actual performance, and allow for corrective actions (Jones-George-Hill, 2003).
Measures of financial performance are those ratios against which actual performance can be meaningfully measured against the expectations of the budget. These measures are objective measures of performance, and a careful analysis of a combination of these ratios may help dis¬tinguish between firms that will eventually fail and those that will continue to survive, sometimes as early as five years before a firm fails trouble can be detected from the value of these financial ratios (Keating).
These performance ratios measure profit, liquidity, leverage and activity and the combination tell a significant story as to the overall health of an organization. Profitability ratios demonstrate the efficiency of the use of resources to generate profits from organizational inputs of materials to value added activities (Jones-George-Hill, 2003). These are Return on investment and Gross Profit Margin. ROI, or “return on investment,” measures competitive advantage because it allows managers to compare performance against other similar organizations.
Although firms will differ on how that calculation is reached internally and what activities are considered profit drivers. For instance, in her 2010 book Open Leadership, Charlene Li argues that a social media campaign goes beyond marketing in that it reduces other costs by not only building affinity but can reduce other costs using Ford Motor Company and Comcast as an example (Li, 2010). Gross Profit Margin is the difference between the amount of revenue generated from the product and the resources used to produce the product.
For the current quarter, Apple Computer is projecting an increase in GPM from their expectations of 36% to 37% with further expectation that will increase to 38% next quarter (Barrons, 2011). The iPad generated $4. 4-Billion in revenue last quarter with 80% of the Fortune 100 deploying the computer (Goldman, 2011). With strong business acceptance and revenue performance for a market that didn’t exist a year ago, the GPM associated ith such a product increases far more quickly. Real Networks, on the other hand, has had significant difficulty maintaining its gross profit margin indicating it either cannot control costs or that it has been forced to lower prices (Phillips, 2011). Apple has had no downward price pressure and costs have been kept under control (Hadhazy, 2010). Liquidity ratios measure the overall organizational preparedness to meet the short-term obligations of the organization.
The higher the ratio, the greater the organizational ability to cover short-term debts, but a high liquidity ratio also indicates a significant proportion of assets are being used in non-productive ways (Yahoo Finance). Two common liquidity measures are the current ratio and the quick ratio. The current ratio is the difference between current assets and current liabilities and it speaks to the question of whether there are enough assets to pay claims on short-term debts without selling inventory.
The ratio expression indicates how much money is available versus how much short term debt is outstanding. A ratio of 2:1 indicates $2 in assets for every $1 in debt. The Motley Fool dissects Real Networks stock performance while determining whether or not to sell the stock. One positive sign for the company is a high current ratio – 3. 13 (Phillips, 2011). However, while the company has “miniscule” debt, the company’s equity has been shrinking over the past 5-years, so a question to ask is do they have too high a current ratio, bearing in mind that represents non-productive assets?
There are enough assets to pay short-term claims, but the stock performance lags the S&P by almost 2/3 – raising the question in my mind if they have too much non-performing assets on hand which need to be reevaluated. The quick ratio answers the question of whether an organization can pay claims without selling inventory. Inventory is not necessarily worth the amount represented on the books, and removing it from this calculation gives a better view of whether or not an organization has liquid assets available.
If a company has too much of its liquidity tied up in inventory, it will be dependent on selling that inventory to finance its operations and will have a low quick ratio (Motley Fool). Leverage ratios measure the use of debt or equity to finance operations, with the use of debt becoming problematic if profits cannot cover the interest on the debt (Jones-George-Hill, 2003). Two common such ratios are debt-to-assets ratio and times-covered ratio. Debt to assets shows to what extent the organization is financed with debt, with a lower number being more favorable.
With a low number, an organization and its investors can be more confident a company can weather difficult times. Real Networks, as discussed earlier, has a debt to equity ratio close to zero, largely because there is close to no debt – this is a company which can weather some difficult times, however while the debt remains low, the equity is decreasing as well signaling there may be some continuing difficult times (Phillips, 2011). The times-covered ratio measures the extent to which a company’s can meet its current debt obligations with available net income.
If the times-covered ratio declines to less than 1, then the company is unable to meet its interest costs and is technically insolvent (Jones-George-Hill, 2003). Activity ratios are a measure of an organizations utilization of resources to create value. For a company to be profitable, it must be able to manage its inventory, because it is money invested that does not earn a return. So, inventory turnover measures how well a company is moving its inventory so the assets are not carried as non-performing assets and days sales outstanding measures how quickly that inventory is converted to payment on what it owed.
I worked for a small printing company which was dependent on its ability to collect on outstanding projects – age of account was an important measure of the company’s health and much effort was placed on collecting. Inventory was not an option as each job was unique to the client and was good only for that client. These measures help direct the activities of the organization and help set the goals of the organization. The indicate the health of the company, by measuring the management effectiveness in meeting the organizational goals.