ACCA Strategic Professional · Advanced Performance Management

Financial performance measurement: formula sheet

Full chapter guide

Key formulas

Gross margin: Gross profit ÷ Revenue × 100; Shows pricing power and direct cost control.
Operating margin: Operating profit (PBIT) ÷ Revenue × 100; Includes overheads, so it shows overall cost control.
ROCE: Operating profit (PBIT) ÷ Capital employed × 100; Capital employed = total assets − current liabilities, or equity + long-term debt. Use the same definition each year.
ROCE breakdown: ROCE = Operating margin × Asset turnover; Use it to say whether the change came from margin or from asset use.
Asset turnover: Revenue ÷ Capital employed; Measured in times. Higher means assets generate more sales.
Current ratio: Current assets ÷ Current liabilities; There is no universal ideal. Compare with the sector and the trend.
Quick ratio: (Current assets − Inventory) ÷ Current liabilities; Removes inventory, the least liquid current asset.
Receivable days: Trade receivables ÷ Credit revenue × 365; Use total revenue if credit sales are not given, and say so.
Inventory days: Inventory ÷ Cost of sales × 365; Long days can mean weak demand or poor stock control.
Payable days: Trade payables ÷ Cost of sales × 365; Stretching payables helps cash but may harm supplier relationships.
Cash operating cycle: Inventory days + Receivable days − Payable days; The time cash is tied up in operations.
Gearing (two common forms): Debt ÷ Equity, or Debt ÷ (Debt + Equity); State which form you use and apply it consistently.
Interest cover: Operating profit (PBIT) ÷ Finance costs; Shows how easily interest is paid from profit.
EPS: Profit attributable to ordinary shareholders ÷ Number of ordinary shares; Use the weighted average number of shares if it changed during the year.
P/E ratio: Share price ÷ EPS; Reflects market expectations of growth and risk.
Dividend yield: Dividend per share ÷ Share price × 100; Cash return to a shareholder who buys at the current price.
Dividend cover: EPS ÷ Dividend per share; Shows how many times earnings cover the dividend.
Return on investment (ROI): ROI = Divisional profit ÷ Capital employed × 100%; Define profit and capital employed in your answer, for example controllable profit and net assets. Say which version you use.
Residual income (RI): RI = Divisional profit − (Capital employed × Cost of capital); Positive RI means the division earns more than the required return. It is an absolute figure, so it favours larger divisions.
Decision rule for ROI: Accept a project if its return > the group's cost of capital (group view). A division using ROI accepts only if project ROI > current divisional ROI.; The mismatch between these two rules is the main cause of dysfunctional decisions under ROI.
Decision rule for RI: Accept a project if it gives positive RI, that is, return > cost of capital; This matches the group view, assuming the cost of capital is set appropriately.
Return on investment: ROI = Divisional profit ÷ Capital employed × 100%; State which profit and which capital you use. Use controllable profit for the manager and traceable profit for the division. Be consistent in the numerator and denominator.
Residual income: RI = Divisional profit − (Capital employed × Required rate of return); Profit is usually before interest, because the capital charge already covers the cost of finance. The answer is in money.
Economic value added: EVA = NOPAT − (WACC × Economic capital employed); NOPAT is adjusted operating profit less tax. Economic capital is net assets plus the adjustments, such as capitalised R&D.
Project decision rules: ROI rule: accept if project return > division's current ROI. RI/EVA rule: accept if project return > required return or WACC (RI/EVA rises).; The mismatch between these rules is the core behavioural point examiners test. The rule matching the group's interest is the second.
Capital employed basis: Capital employed = Total assets − Current liabilities (or net assets, as stated in the question); Follow the question. Using opening, closing or average capital changes the answer, so say which one you used.
Market value added (MVA): MVA = market value of equity + market value of debt − capital invested; Capital invested usually means the adjusted book value of equity plus debt. Use the same definition of capital on both sides of the calculation. An equity-only version is: market value of equity − equity capital invested.
Total shareholder return (TSR): TSR = (closing share price − opening share price + dividends received) ÷ opening share price; Gives the return for the period as a percentage. Use dividends per share for the same period. Over several years, state whether you show the total or an annualised return.
Capital gain and dividend yield split: TSR = (P1 − P0) ÷ P0 + D1 ÷ P0; The first part is capital gain, the second is dividend yield. Use this to explain where the return came from.
Economic value added (EVA): EVA = NOPAT − (WACC × capital invested); NOPAT is net operating profit after tax, adjusted for items such as R&D and advertising where the question asks. Compare with MVA.
Link between MVA and EVA: MVA = present value of future EVAs, discounted at WACC; A theoretical link. It holds only if the market's expectations match the EVA forecasts.
Free cash flow to the firm (FCFF): FCFF = EBIT × (1 − tax rate) + depreciation − capital expenditure − increase in working capital; Use a decrease in working capital as an addition. Check whether the question defines FCF differently.
Free cash flow to equity (FCFE): FCFE = FCFF − interest × (1 − tax rate) + net new borrowing; This is the cash available to shareholders only. Use it when the question focuses on equity.
Basic CFROI: CFROI = gross cash flow ÷ gross investment; This is a simplified version. The full CFROI is an IRR on gross assets over their life with a terminal release of non-depreciating assets.
Value test for CFROI: CFROI > cost of capital → value created; Compare like with like. A real CFROI should be compared with a real cost of capital.
Cash value added (CVA): CVA = operating cash flow − replacement annuity − capital charge, where capital charge = cost of capital × gross investment; Definitions vary. State the formula you use.
CVA ratio: CVA ratio = operating cash flow ÷ (replacement annuity + capital charge); A ratio above 1 means the cash inflow covers both replacement and financing costs.
Economy: Economy = actual cost of inputs compared with planned or benchmark cost of inputs (for the required quality); Measures spending only. Use a cost per unit of input, such as cost per nurse hour or price per kg of supplies. Lower is better only if quality is held.
Efficiency: Efficiency = outputs ÷ inputs (or cost per unit of output = total cost ÷ outputs); Outputs are the activity done, such as patients treated or students taught. Compare with budget, prior periods or similar bodies.
Effectiveness: Effectiveness = extent to which outputs achieve the stated objectives or outcomes; Often a percentage of target achieved, such as % of patients recovered or pass rate. Needs a clear objective to measure against.
Value for money: VFM = economy + efficiency + effectiveness, assessed together; Not a single number. Judge the balance and trade-offs.

Quick revision

ROI = profit ÷ capital employed, and it can lead managers to reject projects that are good for the company but lower their ROI.
Residual income = divisional profit − (capital employed × required rate of return).
Residual income supports goal congruence better than ROI because accepting any project that earns above the required return increases it.
EVA is an economic profit measure that uses adjusted accounting figures, such as NOPAT and capital, and a cost of capital charge.
MVA is the market value of the firm less the capital invested in it.
TSR combines dividends and share price change over a period, compared with the starting share price.
Value-based management focuses decisions and rewards on creating shareholder value.
Free cash flow is cash generated after investment needed to keep and grow the business, and is available to the providers of finance.
Profit measures can be manipulated by accounting choices, while cash is harder to alter but can be timing-sensitive.
Financial measures look backward, are short-term and may ignore quality, customers and innovation.
Ratios are only useful when compared with a trend, a budget, a competitor or an industry benchmark.
Public sector bodies often use value for money: economy, efficiency and effectiveness.

Common mistakes

Listing ratios and calculating them with almost no comment. Fix: Spend most of your time on the why and the so-what. Use the three-line comment: change, cause, implication.
Using inconsistent definitions, such as different capital employed in each year. Fix: State your definition once and apply it to every year. Show the formula in your workings.
Listing generic limitations without applying them to the scenario. Fix: For every point, add a fact from the case and its consequence. Marks go to application, not lists.
Saying ROI is bad and RI is perfect. Fix: Show that RI also has limits: it favours large divisions, depends on how capital employed and the cost of capital are measured, and uses the same accounting data.
Deducting interest from profit before calculating RI. Fix: The capital charge already covers the cost of finance, so use profit before interest. Check what the question gives and adjust.
Comparing RI figures of divisions of different sizes as if they showed efficiency. Fix: Say that RI is not good for size comparison. Use ROI alongside it, or compare each division with its own target.
Using only the market value of equity when calculating firm-level MVA. Fix: Add the market value of debt to equity, then subtract total capital invested. If using the equity-only version, state that clearly and use equity capital only.
Leaving out dividends in the TSR calculation. Fix: Always add dividends received in the period to the share price change in the numerator, then divide by the opening price.
Adding depreciation back but forgetting to deduct capital expenditure in FCF. Fix: Treat the FCF formula as a checklist: tax on EBIT, add depreciation, deduct capex, deduct working capital increase.
Using net book value in CFROI instead of gross investment. Fix: CFROI uses gross, ideally inflation-adjusted, asset cost. Net book value falls with depreciation and makes returns look better each year.

Exam tips

Read the requirement for the user. A lender, an investor and a board each need different ratios and a different conclusion.
Choose a small set of ratios that fit the story. Calculating every ratio wastes time and earns few extra marks.
Use scenario facts as evidence for each explanation. This earns both technical marks and professional skills marks for analysis and commercial acumen.
Show the definition and one line of working for each ratio, so marks are available even if the figures are wrong.
End with a clear recommendation or conclusion and mention one or two limitations, such as one-off items or the use of historical figures.
Always tie each limitation to a fact in the scenario. Generic lists score poorly in APM.
When numbers are given, calculate both ROI and RI. Then comment on the conflict between them.
Separate short-termism, distortion and manipulation clearly. Examiners reward precise use of terms.