a) The historical analysis of performance in comparison with the organizations current and past performance
In financial analysis, the direction of changes over a period of years is of crucial importance.
Time series on trend analysis of ratios indicate the direction of this change.
The measure of performance over a period of time help to determine whether a firm is progressing as expected. Trend analysis is carried out to determine the following:
- How the firm has been performing over time.
- The accuracy of past predictions by looking at estimates against actual performance
- The data obtained can be used for financial forecasting
Trend analysis is particularly applicable to the items of the profit and loss account. The trends of sales and net income may be studied in the light of two factors: the rate of fixed expansion in the growth of the business and the general price level.
A number of firms may show a persistent growth over a period of years but get a true trend of growth, the sales figures must be adjusted by a suitable index of general prices i.e. deflated for rising price levels. A graph of the resulting figures will give the true trend of growth devoid of price change. If the general price level is not considered in the trend analysis, it may mislead management. In carrying out a trend analysis, three issues should be considered.
1. Describe the trend e.g. is the liquidity position improving or declining?
2. Give possible causes on the trend.
3. Give the implication of the trend.
b) The analysis of industry norms in comparison with the relative performance of organizations in the same industry:
The performance of one firm is compared to some selected firms in the same industry at the same point in time. This kind of comparison is known as cross-sectional analysis.
In most cases, it is more useful t compare ratios with the ratios of a few selected competitors, who have similar operations. This kind of comparison indicates the relative financial position and performance of the firm. A firm can easily resort to such a comparison as it is easy to get published financial statements of the similar firm.
A cross sectional analysis assists a firm to identify its key success factors and its weaknesses vis a vis its major competitors and the industry.
To ascertain the relative financial standing of a firm, its financial ratios are compared with a competitor. Taking the market shares of the firms into consideration, ratios such as Return on Investment and Return on Equity are computed to get the relative standing of a firm. The procedure is relatively simple as it entails collecting data of the firms just for a specific year.
It is worth noting that ratios will be more reliable when trends in time are analyzed. Ratios at a point in time can mislead the analyst because they may be high or low for some exceptional circumstances at that point in time. An impressive financial position may rapidly erode over time while a weak position may be steadily improving.
c) Benchmarking is the search for best practices - it allows your organization to see what others are doing, what is working for them and what to avoid. Benchmarking is best defined as:
“The process of identifying, understanding, and adapting outstanding practices and processes from organizations anywhere in the world to help your organization improve its performance.”
Ideally performance should be compared with an organization that is acknowledged to be the best in the class of activity in question. The exercise should concentrate on areas of business that are of key strategic importance.
Competitive benchmarking is when comparisons are made with those of a direct competitor.
Internal benchmarking compares one part of a business with a different part of the same business.
Process or activity benchmarking involves comparing an internal function with that of the best practitioner (not necessarily a direct competitor). It does not matter which industry the best practitioner is in. This type of benchmarking helps to identify the best practices in any type of organization that has established a reputation foe excellence in specific business activities e.g. marketing, engineering, human resources e.t.c.
Steps in Benchmarking
1. Identify a very specific area to benchmark.
2. Establish a work team comprised of strategic, functional and tactical representatives from all affected areas.
3. Determine the company to study.
4. Once best practices have been identified, collect and analyze the data, the plot company’s performance against best practices. Identify improvement opportunities.
5. Determine the level of effort required to re-engineer the best practices to suit the given firms unique circumstances.
6. Do a cost benefit analysis and implement the priorities established.
Kavungya answered the question on April 26, 2021 at 11:21
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