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KEY PERFORMANCE INDICATORS AND VALUE CREATION

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BEST WAYS TO UTILIZE FINANCIAL DATA TO ENHANCE BUSINESS VALUE

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YOUR PRESENTERS

LARISA RAPOPORTMBA, CPA, CGMAASSURANCE PARTNERlrapoport@dzhphillips.com

SHERLICE NICHOLSMBA, CPA OUTSOURCED ACCOUNTING MANAGERsnichols@dzhphillips.com

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Why are KPIs important?

Different types of KPIs

How to choose KPIs

AGENDA

How can KPIs help?What are they?

Balanced ScorecardBenchmarking Case Study

Value Creation Model –

introduction

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WHY KPIS ARE IMPORTANT?

KPIs are the backbone of any company• Measurement tool• Helps visualize• Road to improvement

Part of strategy

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WHAT ARE KPIS

According to Investopedia:

“KPIs are set of quantifiable measures that a company or industry uses to gauge or compare performance in terms of meeting their strategic and operational goals”

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WHAT ARE KPIS (CONTINUED)

Measures of an area of a business

Some examples:• Customer satisfaction• Employee development• Utilization

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WHAT ARE KPIS (CONTINUED)

Examples (continued)• Quality• Business unit effectiveness• Financial health• Market share

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HOW MANY ARE ENOUGH?

Start brainstorming with 50

Narrow it down to around 10-15

See which ones you already have and which ones you need to develop

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EXAMPLES OF KPIS FROM PUBLICLY TRADED COMPANIES

Macy’s

Costco

Microsoft

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2007-01 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 TTMTax Rate % 31.67 31.14 30.97 35.83 36.18 36.49 35.11 36.15 36.23 35.69Net Margin % 3.69 3.39 -19.3 1.49 3.39 4.76 4.82 5.32 5.43 3.96 2.99Asset Turnover (Average) 0.86 0.92 0.99 1.08 1.19 1.23 1.29 1.31 1.3 1.29 1.33Return on Assets % 3.17 3.11 -19.24 1.61 4.04 5.88 6.2 6.97 7.08 5.1 3.98Financial Leverage (Average) 2.41 2.81 4.77 4.53 3.73 3.72 3.46 3.46 3.99 4.84 4.87Return on Equity % 7.72 8.06 -66.01 7.49 16.56 21.91 22.28 24.16 26.25 22.27 17.75Return on Invested Capital % 5.68 6.27 -25.05 5.29 9.22 11.55 12.08 13.15 13.59 10.58 8.64Interest Coverage 1.9 3.28 5.4 5.81 6.87 7.05 5.62 4.29

-80

-60

-40

-20

0

20

40

60Key Ratios - Profitability – Macy’s

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2007-01 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 TTMOperating Cash Flow Growth % YOY -687 803 628Free Cash Flow Growth % YOY -75 -267Cap Ex as a % of Sales 5.16 4.2 3.6 1.96 2.02 2.89 3.4 3.09 3.8 4.11 3.97Free Cash Flow/Sales % 8.73 4.31 3.95 5.49 4 5.03 4.76 6.04 5.84 3.22 4.17Free Cash Flow/Net Income 2.37 1.27 -0.2 3.92 1.18 1.06 0.99 1.13 1.08 0.81 1.39

-800

-600

-400

-200

0

200

400

600

800

1000Key Ratios – Cash Flow – Macy’s

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2007-01 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 Latest QtrCurrent Ratio 1.17 1.18 1.31 1.55 1.36 1.4 1.55 1.52 1.57 1.34 1.32Quick Ratio 0.27 0.2 0.34 0.46 0.37 0.51 0.43 0.47 0.48 0.29 0.26Financial Leverage 2.41 2.81 4.77 4.53 3.73 3.72 3.46 3.46 3.99 4.84 4.87Debt/Equity 0.64 0.92 1.88 1.8 1.26 1.12 1.12 1.08 1.35 1.65 1.62

0

1

2

3

4

5

6Key Ratios – Liquidity/Financial Health – Macy’s

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2007-01 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 TTMDays Sales Outstanding 20.56 6.79 6.61 6.19 5.47 5.25 4.87 5.28 5.6 6.62 5.24Days Inventory 121.42 120.8 119.51 122.56 115.39 114.51 115.04 118.56 119.84 121.94 122.86Payables Period 114.82 105.6 97.72 74.53 46.49 41.43 41.9 50.64 53.71 53.83 43.37Cash Conversion Cycle 27.17 22 28.4 54.23 74.38 78.33 78.01 73.2 71.72 74.72 84.72Receivables Turnover 17.75 53.7 55.19 58.94 66.67 69.49 74.93 69.05 65.21 55.15 69.7Inventory Turnover 3.01 3.02 3.05 2.98 3.16 3.19 3.17 3.08 3.05 2.99 2.97Fixed Assets Turnover 2.29 2.34 2.32 2.35 2.73 3.06 3.33 3.46 3.57 3.51 3.54Asset Turnover 0.86 0.92 0.99 1.08 1.19 1.23 1.29 1.31 1.3 1.29 1.33

0

20

40

60

80

100

120

140Key Ratios – Efficiency – Macy’s

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8/28/2016 8/30/2015 8/31/2014 9/1/2013Current Ratio 98% 101% 122% 119%Quick Ratio 40% 48% 63% 60%Cash Ratio 30% 39% 51% 46%

0%

20%

40%

60%

80%

100%

120%

140%COSTCO – Liquidity Ratios

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8/28/2016 8/30/2015 8/31/2014 9/1/2013Gross Margin 13% 13% 13% 13%Operating Margin 3% 3% 3% 3%Pre-Tax Margin 3% 3% 3% 3%Profit Margin 2% 2% 2% 2%Pre-Tax ROE 30% 24% 26% 28%After Tax ROE 19% 22% 17% 19%

0%

5%

10%

15%

20%

25%

30%

35% COSTCO - Profitability Ratios

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Microsoft Investor Metrics(in millions, except for percentages and run rate) Q2'15 Q3'15 Q4'15 FY15 Q1'16 Q2'16

CommercialCommercial bookings growth (y/y)* -10% -1% / 10% -6% / 0% -5% 2% / 10% 12% / 19%Commercial unearned revenue $19,262 $18,223 $23,313 $23,313 $20,999 $19,557Contracted not billed >$24,000 >$23,000 >$24,500 >$24,500 >$23,500 >$25,500Commercial revenue mix

Annuity 78% 82% 82% 81% 86% 83%Non-Annuity 22% 18% 18% 19% 14% 17%

Productivity & Business Processes and Intelligent CloudOffice Commercial products and cloud services revenue growth (y/y)* -1% / 0% -2% / 1% -4% / 1% -1% -2% / 5% -1% / 5%Office Consumer products and cloud services revenue growth (y/y)* -12% / -9% -29% / -24% -30% / -23% -17% -13% / -4% -14% / -8%

Office 365 Commercial seat growth (y/y) 88% 84% 74% 74% 66% 59%Office 365 Consumer subscribers 9.2 12.4 15.2 15.2 18.2 20.6Dynamics products and cloud services revenue growth (y/y)* 13% / 17% 13% / 20% 6% / 15% 12% 3% / 12% 3% / 11%Server products and cloud services revenue growth (y/y)* 9% / 11% 12% / 16% 4% / 9% 9% 6% / 13% 3% / 10%Enterprise services revenue growth (y/y)* 10% / 12% 7% / 13% -1% / 5% 7% 9% / 16% 10% / 16%Commercial cloud annualized revenue run rate (in billions) $5.5 $6.3 >$8.0 >$8.0 >$8.2 >$9.4

More Personal ComputingWindows OEM Pro revenue growth (y/y) -13% -19% -21% -15% -7% -6%

Windows OEM non-Pro revenue growth (y/y) -13% -26% -27% -16% -4% -3%Windows volume licensing revenue growth (y/y)* 3% / 3% -2% / 1% -8% / -4% 0% -3% / 4% -4% / 3%Surface revenue $1,104 $713 $888 $3,613 $672 $1,352Xbox Live monthly active users 37 37 37 37 39 48Search advertising revenue (ex TAC) growth (y/y)* 27% / 28% 29% / 34% 30% / 28% 29% 23% / 29% 17% / 21%

* Includes non-GAAP constant currency growth (GAAP% / Constant Currency%)Certain amounts have been rounded for presentation purposes

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HOW TO CHOOSE KPIS

Which KPIs to select:• Relevant• Aligned • Goal? • Make it measurable (target a %, #) –• Process

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HOW TO CHOOSE KPIS (CONTINUED)

Financial KPIs come first

Outputs?

Inputs?

Document:• Definition• How measured• Frequency of measurements• Review and oversight• Responsibilities

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS

Ratio Caculation InterpretationRatio Increase

Means

Achieved

Actual price received- Supplier cost * 100

Used to compare to buying margin % by retailers Good performance

margin % Actual price received

Average Total (project) sales Effectivness Good perfomance Project size Number of projects measure - as size

drives utilization

Average store sizeActual sales space Indicator of a retailer's Large changes

average number of stores core proposition

mean shift in core proposition

Buying margin Expected retail price - Supplier cost * 100 Used as benchmark Good performance

% expected retail price for achieved margin %

Contribution Sales - Cost of sales -variable costs *100 profitablility measure Good performance

margin % Sales - shows true return on sales

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS (CONTINUED)

Contribution Contribution profit =Contributio

n profit x Sales Productivity measure Good performancemargin return Inventory Sales inventory - shows true return on on inventory capital tied up investment 'Earn' x 'Turn' in inventory(CMROII)

Contribution Contribution profit =

Contribution profit x Sales Productivity measure Good performance

margin return Working Capital Sales Working capital - shows true return on

on working working capital capital (CMROWC)

Days payableAccounts Payable x 365 days Shows time taken Good performance

outstandingCost of Sales to pay suppliers (up to a limit, beyond

(DPO) that could be bad)

Days salesAccounts Receivable x 365 days Shows time taken to Bad performance

outstanding Sales collect payments(DSO) from customers

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS (CONTINUED)

Gross marginSales - Cost of sales

x 100 Basic profitability measure - indicates Good performance

% Sales value added

Gross margin Gross profit =Gross profit x Sales Productivity measure - Good performance

return on Inventory Sales Inventory Shows basic return oninventory capital tied up investment 'Earn' x 'Turn' in inventory(GMROII)

Inventory days Inventoryx 365 days

Shows time taken Bad performance

(DIO)Cost of sales to sell inventory

Inventory turn 365 daysShows speed at which inventory is turning over

Good performanceInventory days

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS (CONTINUED)

Mark-up%

Sales -Cost of sales x 100 Shows amount of Good performanceCost of slaes profit added to cost of

product

Net margin % Sales - Cost of sales - Overhead - Interest x 100 Profitability of Good performanceSales business activity for a

period

Operating Sales - Cost of sales - Overhead x 100 Profitability of trading Good performancemargin % Sales operations for a period

Potential growth Net margin after tax % x Working capital return Rate of of sales growth Good performancecapacity that can be financed

internally

Profit per Gross profit or DPP Profitability of sales Good performancesquare foot Average sales space (square feet) space in a retailer

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS (CONTINUED)

Final contract price paid by customer Proportion of billableRecoverability Total resources used x Standard prices work that customers Good performance

will pay for

Return on Net profit before tax Productivity of capital Good performancecapital employed Total assets - Non-interest -bearing liabilities employed in the business(ROCE)

Operating profit after tax Productivity of Return on Invested capital capital employed in invested capital the trading operations(ROIC) = Net profit after tax + Interest of the business (or Good performance

Total assets- Excess cash- Non-interest-bearing current liabilities allocated to the relevant part of the business)

Return on net Operating profit Productivity of assets Good performanceassets (RONA) Cash + Working capital + Fixed Assets employed in the

business

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APPENDIX A – DISTRIBUTORS FINANCIAL RATIOS (CONTINUED)

Sales per Sales Productivity of sales Good performancesquare foot Average sales space (square feet) space in a retailer

Sales Booked sales plus probability of expected sales Size of order book Good performancepipeline Average monthly targeted sales and expected sales

UtilizationBillable time x 100 Productivity of Good performanceStandard time people ina service

business

Value creation Operating profit after tax - (invested capital x WACC) Profit generated in Good performance(VC) excess of cost of capital

employed

Working capital 365 days Shows speed at which Good performanceturn WC days WC is turning over

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HOW TO CHOOSE KPIS (CONTINUED)

KPIs incorporate both financial and non-financial

It’s important to understand that KPIs measure operational results in addition to financial results

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HOW KPIS HELP?

Assess how the company is doing• Real meaning behind the numbers• Competition?• Focus on to improve?• Shows direct relationship and impact on value creation or destruction

Allows you to build better relationships with • Key suppliers• Customers• Employees

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METRICS ON HOW BUSINESS PERFORMS

Quality metrics

Service metrics

Financial metrics

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QUALITY METRICS

Production efficiency: • percentage of defective or returned products• ship to promise• shipping accuracy

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SERVICE METRICS

Customer retention

Customer satisfaction ratings on time in full

Customer purchasing frequency

Repeat customer rate

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SERVICE METRICS (CONTINUED)

Visit to order time/lead time

Sales order fill rates

Buyer demographics

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FINANCIAL METRICS

Profitability• Gross margin %• Sales, general & administration %• EBIT margin• EBITDA margin• Return on total assets• Return on capital• Return on equity

Market value• P/E multiple• Market capitalization

Efficiency• Total asset turnover• Fixed asset turnover

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FINANCIAL METRICS (CONTINUED)

Liquidity• Current ratio• Quick ratio

Cash cycle• Days sales outstanding• Days payables outstanding• Days inventory outstanding

Leverage• Debt / EBITDA• EBITDA / Interest Expense

Capital Structure• Debt / Equity• Debt / Capital

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METRICS – WHAT TO FOCUS ON

Choose metrics that bring value to your business

Choose metrics that impact your business decisions

What is your biggest issue/concern?

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IF UNSURE ON WHERE TO START

Perform industry benchmarking analysis• Your CPA can assist you with this• If you belong to industry association, it should have resources• Identify areas of improvement

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BENCHMARKING – HOW TO CHOOSEPrivately held companies in your industry

Industry leader in your field

Leaders not necessarily in your field that are you taking on initiatives that can be applicable to you

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BALANCED SCORECARDThe balanced scorecard is a strategic planning system used to align business activities to the vision and strategy of the organization, improve internal and external communications, and monitor organization performance against strategic goals.

It’s a good tool to organize your thoughts, including your targets and initiatives, and action plan

It addresses four different sections: financial, customer, internal business process and business and growth

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CASE STUDY – APPENDIX B

• Food distributor• Experiences modest growth• Can borrow external financing at around

at 4% rate• Had a lower NOI than in the past

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APPENDIX B – CASE STUDY

Sales 19,500 100.00%Cost of sales 18,492 94.83%Gross profit 1,008 5.17%Overheads 952 4.88%Operating profit 56 0.29%Interest 12 0.06%Profit before taxes 44 0.23%Taxes 16 0.08%Profit after taxes 28 0.14%

Current assets Cash 401 376 Inventory 1,408 1,200 AR 1,897 3,706 2,011 3,587

Fixed assets 423 434 4,157 4,021

Current liabilities

Accounts payable 1,550 1,814

Other 764 2,314 902 2,716

LT liabilities 59 75

Retained earnings 28 456 Capital 1,756 774

4,157 4,021

871

929

929

2015

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CASE STUDY – APPENDIX B (CONTINUED)

• What is the company experiencing?• What should the company focus on?• Market share/growth – goal to grow 10%• Profitability – goal to improve gross margin by 1%• Improve financial health by speeding up the cash cycle by

improving efficiency, for example, by improving turns• What is the result? – let’s look at the 2016 balance sheet

and income statement and the value creation chart

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APPENDIX B – CASE STUDY

Sales 21,500 100.00% Cost of sales 20,008 93.06% Gross profit 1,492 6.94%Overheads 980 4.56%Operating profit 512 2.38%Interest 24 0.11%Profit before taxes 488 2.27%Taxes 32 0.15%Profit after taxes 456 2.12%

Current assets Cash 376 Inventory 1,200 AR 2,011 3,587

Fixed assets 434 4,021

Current liabilities Accounts payable 1,814

Other 902 2,716

LT liabilities 75

Retained earnings 456 Capital 774

4,021

Net current assets 871

Invested capital

total assets less excess cash-non-interest bearing liabilites 929 OR capital + LT liabilities -cash 929

WC (AR+ Inv - AP) 1,397

2016

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VALUE CREATION - APPENDIX C

NOPATOperating Profit after Tax

40 0.21%480 2.23%

Operating Profit

56 0.29%512 2.38%

Gross Profit

1,008 5.17%1,492 6.94%

Sales

19,500 100%21,500 100%

Cost of Sales

18,492 94.83%20,008 93.06%

Overheads

952 4.88%980 4.56%

ROIC %

2.77% 51.67%

Value Creation

-18443

WC

1,755 331,379 23

Receivables (DSO)

1,897 362,011 34

Inventory (DIO)

1,408 281,200 22

Payables (DPO)

1,550 311,814 33

Total Assets

4,157 4,021

Fixed Assets

423 434

Cash

401 376

AP

1,550 1,814

Other Current Liabilities

764 902

Excess Cash & Non-int Liabilities

2,715 3,092

WACC %

4.00% 4.00%

Capital Employed

1,442 929

*

Top amount - prior year - 2015Bottom amount - current year - 2016

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SENSITIVITY ANALYSIS

What ratios are not in accordance with expectations?

Inventory turns?

Margins ?

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WHAT WE DISCUSSED

• Why are KPI’s important • What are KPI’s• How to choose KPI’s• Review of a case study• Introduction to the value creation model

Resources - Use your CPA!

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WE LOOK FORWARD TO WORKING WITH YOU!

Larisa Rapoport, MBA, CPA, CGMAPartner

T: (415)624-2240E: lrapoport@dzhphillips.com

DZH Phillips, LLP135 Main Street, 9th FloorSan Francisco, CA 94105

www.dzhphillips.com

Sherlice Nichols, MBA, CPAOutsourced Accounting Manager

T: (415)655-6212E: snichols@dzhphillips.com