In order to evaluate the performance of their subsidiaries or profit centers, the groups currently use mainly two synthetic indicators, the ratio of economic profitability and free cash flow (the indicators of creation of shareholder value as well as the economic value created are less used because more difficult to understand by operational staff). These two indicators have the same levers of improvement but express themselves in a different form.
The Economic Profitability Ratio
This indicator includes all the levers of economic performance. A profit center manager is expected to improve profitability while controlling capital expenditure and ensuring good management of the WCR. To the head of a profit center to identify and implement the various levers of improvement of its activity. Expressing economic performance in the form of a percentage makes it possible to compare the profitability of activities of different sizes, to confront sectoral standards.
Free Cash Flow (FTD)
It is equal to the cash flow generated by the available activity once financed the investment expenses of the period. Different variants of calculation exist: taking into account all the investments or only those of renewal, exclusion of the receivables and intra-group supplier debts, … .. The levers of improvement are identical: profitability, control of the investments and management of the BFR. Ultimately, a profitable business generates cash.
The FTD tends to be used more today. Expressing performance in terms of cash flow is also used for the financial management of the group. By aggregating the FTD of all the subsidiaries, the group finance department determines the need for consolidated financing.
These two indicators evaluate the overall performance of an activity over a period. However, they do not include the future consequences of the investment choices (or divestments) made. These choices must be made based on profitability or “sustainable” cash generation. Thus, the sale of commercial real estate improves profitability and immediate cash flow but is not always relevant in the medium term depending on the rents that the company will have to pay afterwards. The profitability of an investment decision can only be evaluated by taking into account all of its projected cash flows over a multi-year horizon through indicators such as the internal rate of return (IRR), the Net Present Value (NPV). To learn more such business terms and specially managing your business, you may visit Business Study Notes. Business Study Notes is all about business education and exams studies online. Also you may have tips and tricks for managing your business as well polishing your entrepreneurship skills.