From financial reporting to compliance-related data, you’re awash in a sea of figures. But as seasoned CFO realizes, not all metrics are created equal. In fact, Doug Stewart, CFO of Superior Oil in Indianapolis, is a firm believer that focusing on a trinity of metrics can help you streamline your financial frame of mind.
Above all, Stewart suggests focusing on your P/E ratio (price-earnings ratio), current ratio and asset to equity ratio. These ratios helped Stewart guide his company through the turbulent waters of the Great Recession.
“When you go into a time period like that, if you’re running the business in a way you really ought to, in our opinion, you have the resources to weather that storm. It’s when you don’t do that, and you think you’re always going to be growing, you’ll be in trouble. It’s the companies that don’t prepare and don’t ask themselves, ‘Hey, what if something happens, are we going to be OK’—the companies that didn’t ask those questions are the ones that had the biggest problems.”
For Stewart, these ratios are prescriptive internal metrics that help him focus on managing risk ahead of external events he can’t control.
As a CFO, your current ratio might be the most basic live-or-die metric to focus on, especially when it comes to risk management: your company’s current assets minus current liabilities. If your current ratio is less than 1, you need to focus all your energy in creating additional cash flow in the next year.
In an interview with Accounting Web, Brad Schaefer, an analyst with the financial information company, Sageworks Inc, admits that this metrics has drawbacks. “For example, by including inventory in the calculation, it may provide a distorted understanding of the company’s very short-term cash flow,” he said.
As The Strategic CFO defines it, P/E ratio functions as “an indicator of how much investors pay for a share compared to the earnings a company generates per share, is as important in stock trading as it is in equity financing markets. It tells investors how expensive a stock is. The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings.”
To a certain extent, P/E/ ratios are relative to industries. But generally, companies with a high price-earnings ratio typically have investors who are suspecting higher earnings in the future; companies with lower price-earnings ratios have investors who have less auspicious outlooks. The higher a P/E ratio, the riskier an investment analysts or investors might find a particular company.
How does this affect a CFO? In a number of ways, of course, but for starters, consider how this trend played out last November. A rising P/E ratio evidenced risk for CFOs, as the metric reached one of its highest marks since September 2009. In this case, as the Wall Street Journal noted, CFOs were likely paying too much as they repurchased stock. As a CFO of a privately owned or publicly owned company, you want to keep your P/E ratio in check to manage risk.
Equity to Asset Ratio
Your asset to equity ratio is the networth of the business over the firm’s total assets. At core, it’s a measure of solvency. The higher the ratio, the stronger the business.
According to an article published by Michigan State University, “any ratio less than 70 percent puts a business…at risk and may lower the borrowing capacity [of] a business.”
Putting Ratios In Perspective
Interestingly, at the end of his interview with Accounting Web, Schaefer notes that all your ratios are only as useful as your industry data. Accessing this kind of industry data also happens to be one of the benefits of working with a third party spend analysis and strategic sourcing firm. “Without comparing your own business to others, how will you know if an account receivable days of fifteen is great, average, or high?” Schaeger says.
Still, taken together, these three metrics can help CFOs steer their firms through the hardest of times, Stewart says.
“If you pay attention to those every month and manage in such a way that you keep those ratios strong, then things work out,” Stewart tells Vantage Cost.
Question: As a CFO, What are the most important metrics to you? What metrics matter most to your CFO?