Reports from entrepreneurs - which metrics should an investor expect to see and how should the report be interpreted?
Reports to shareholders should provide investors with the relevant information that sets out how a business is performing and informs its prospects. This should be with reference to the strategic plans and forecasts that investors bought into. Unlike statutory annual accounts, there is no prescribed format or regularity, so the content will vary depending on the sector and scale of the business; however, there are common areas that are relevant to all businesses.
An update on the trading results (or profit and loss account) of the business is a fundamental component of investor reports as this is a key component of financial performance. Trading updates might be provided on a monthly, quarterly or half-yearly basis, with more regular updates required where circumstances dictate (for example with the business or the environment in which it operates are changing quickly, or if the business has limited cash).
Profit and loss accounts should be presented for both the reporting period (eg the month) and the year-to-date. The main items reported on include revenue, gross profit, EBITDA (indicative of cash profit) and net profit, together with further analysis as appropriate, for example, breakdowns of revenue by geography, product and breakdowns of costs by nature.
When analysing the trading results it is helpful to compare the actual results against prior year performance and budget in order to benchmark the business’s performance. A narrative commenting on variances is helpful in explaining trends and variances.
Key performance indicators (KPIs)
In order to add flavour to the trading results, shareholder reports should include analysis of the KPIs. These typically consist of both financial and non-financial metrics that help illustrate the performance of the business
Financial metrics that should be presented to shareholders include revenue growth rates, gross margin, and EBITDA margin. However, KPIs should be tailored to the business and the sector, for example:
- a restaurant business may report on metrics such as number of covers, wages as a percentage of sales, wet and dry margin;
- an IT managed services business may report on recurring revenue, first year order value, revenue per employee and churn.
A business should also report on its cash flows, again comparing actual to prior year and budget. ‘Cash is king’ and therefore as well as looking back, companies with limited cash resources, or where over-trading is a risk, should include forward-looking cash forecasts. Again, relevant KPIs should add colour, such as operating cash flow as a percentage of EBITDA (known as cash conversion) and capex as a percentage of revenue.
Finally, a balance sheet summarises a business’ financial position, an indicator of its financial strength. KPIs are likely to focus on working capital (current assets and current liabilities) such as stock or debtor days (respectively the number of days’ stock or debtors not yet sold or collected).
Reports to shareholders should include supporting commentary, to guide the shareholders through the various results and KPIs presented in the report. This commentary provides investors with explanations for the trends and developments observed, and their impact on the outlook for the business going forward.
Further commentary may also be provided, to update the investor on strategic initiatives being undertaken by the business, such as expansion plans, staff recruitment, or efficiency improvement projects, as well as key risks faced, such as competitors’ activities.
Interpreting the report
Ideally the commentary provided by the entrepreneur should make interpretation easy. However, additional insight can be gained by observing longer term trends in the data, as well as benchmarking performance against industry averages, or even competitors’ results; public companies annual reports can be a great source of information.
Whatever a report says, it is no substitute for a face-to-face discussion with the entrepreneur when you can see the whites of their eyes and feel the passion!
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