In my previous article, I highlighted the critical role of financial reports in assessing business performance and health. However, to extract meaningful insights from these reports, it is crucial to concentrate on key performance indicators (KPIs). These KPIs serve as valuable metrics that enable businesses to track progress, evaluate financial performance, and make informed strategic decisions. This article delves into the various types of KPIs found in financial reports and elucidates their role in providing actionable insights and facilitating effective financial management.

Revenue

Revenue represents the income generated by individuals or businesses through the sale of products and/or services over a specific period. There are two main categories of revenue: gross and net revenue. Gross revenue encompasses the total income and includes all expenses associated with generating revenue, such as discounts, production costs, and staff expenses. On the other hand, net revenue accounts for the income after deducting all expenses related to it.

For portfolio investors, income can take three basic forms:

  • Dividend revenue from stocks.
  • Interest income is typically generated by debt securities like bonds, savings accounts, and money market accounts.
  • Capital gain occurs when an investment is sold for a higher price than its initial purchase price.

Certain investments can generate multiple types of income. For example, if you own stocks of ABC company, you will receive dividends, and if you sell the shares at a profit, it results in a capital gain. Revenue holds significant importance as it sustains a business and is closely tied to profitability. Higher revenue is generally associated with higher profits.

Expenses

Expenses refer to the money spent by businesses to generate revenue, essentially representing the cost of doing business. In the context of portfolios, expenses include costs related to buying and selling securities, commissions, purchase and redemption fees, exchange fees, and management fees, among others.

Managing expenses is crucial as even small ongoing fees can substantially impact an investment portfolio over time. Expenses directly influence profitability, and one of the major expenses for portfolio holders is portfolio management fees, usually calculated as a percentage of total assets managed. It is important to carefully evaluate expenses to optimize the portfolio’s performance and minimize costs.

Taxes & Duties

Investment portfolios are subject to various taxes and duties, such as withholding taxes on dividends and stamp duty in certain stock markets and jurisdictions. It is important to note that while family office trusts and their underlying companies may be tax-free structures, the trusts themselves are often subject to taxes, particularly withholding taxes on received dividends and stamp duty. In many cases, these taxes cannot be reclaimed due to double taxation or jurisdictional limitations. Thus, the notion that trusts are completely tax-free is incorrect.

This raises important considerations for investors. Is it advisable to hold high dividend-paying stocks in a tax-free structure? Perhaps opting for a taxable structure where withholding taxes can be reclaimed (around 30-35%) would be more beneficial. Additionally, when choosing between two investments, one being a high-dividend stock and the other a high-growth stock without dividends, the latter may prove to be a better choice in the long run.

Profit

Profit can be calculated by subtracting expenses from revenue. It is a key metric used to assess a business’s success. There are two types of profit to consider:

  • gross or operating profit, which is the revenue minus expenses directly associated with production or services provided, and
  • net profit, which deducts operating expenses, taxes, and interest from revenue.

When evaluating investment portfolios, the focus is on net gain/loss and the overall return. Profit serves as a measure of a business’s success, and a positive bottom line on the income statement indicates a thriving business.

Capital

In financial reporting, capital refers to the funds a business possesses to support day-to-day operations and fuel future growth. Working capital, equity (net worth), and debt are the three main types of capital. Working capital covers short-term operational expenses, equity represents assets minus liabilities, and debt capital pertains to borrowed money.

For portfolio holders, capital comprises the collection of investments or financial assets held, including stocks, bonds, property, gold, and cash equivalents. Capital is crucial for assessing a company’s ability to finance growth and increase its wealth.

Cash Flow

Cash flow represents the movement of cash and cash equivalents in and out of a business at any given time. There are three types of cash flow to consider: operating, investing, and financing. Positive cash flow indicates that more money is flowing into the business than going out. It is an essential metric alongside profit to gauge a business’s performance. While profit showcases success, cash flow provides insights into the business’s short and long-term financial outlook.

The key distinction between profit and cash flow lies in the element of time. Profit demonstrates a business’s success but does not indicate whether it has the necessary funds to sustain itself in the long run. These financial reporting metrics hold valuable information for understanding and analyzing business performance. To gain a comprehensive overview, it is important to analyze and comprehend all these metrics.

Maintaining a Comprehensive View of Financial Records without Losing Focus on Details

Understanding key parameters in financial statements is vital for comprehending business performance. However, the value of accounting reports depends on the level of granularity present within the records.

When it comes to accounting for family offices/trusts, we have observed several approaches:

  • Level 1: This level involves providing monthly valuations in financial reporting, where performance is calculated based on overall inflows and outflows throughout the month. While this method is straightforward and quick, it lacks time-weighted analysis. Significant deductions at the beginning or end of the month can significantly impact portfolio performance, but such insights cannot be obtained with this accounting approach.
  • Level 2: Level 2 financial reporting involves booking each transaction separately but recording only the net amount instead of multiple entries for each transaction. For example, only the net amount is recorded when purchasing a stock, not the individual fees like stamp duty. This approach may result in gaps in knowledge regarding fee structures and their occurrence.
  • Level 3: Level 3 represents the most comprehensive level of financial reporting, where every transaction and related item is meticulously recorded. This is the recommended method as it offers full granularity, enabling an in-depth analysis of income and expenses related to the portfolio. With this detailed reporting, clients can effectively manage and maximize their portfolios.

To illustrate the benefits of Level 3 reporting, let’s consider a situation encountered by The Cecily Group. We identified a significant disparity in transaction fees charged by two banks holding portfolios with similar turnover. Through detailed analysis, we pinpointed the source of the problem and demonstrated the costs associated with the portfolios. By reducing minimum fees by half, our client achieved comparable costs between the two banks. Full granularity and detailed analysis empower clients to identify hidden costs, such as withholding taxes and banking fees.

Level 3 accounting provides the depth of analysis necessary to assess performance and risk measures, something not typically found in conventional accounting reports. Our system encompasses accounting, securities accounting, and reporting valuation. Our executive reports give clients a comprehensive overview of their financial accounts. These reports highlight essential information requiring immediate attention for the quarter, presented in an easily understandable and visually appealing format. Our reporting system caters to clients with varying levels of experience in portfolio management and financial knowledge.

For instance, clients can compare the cash flow statement from their financial reporting with the overview in their quarterly executive report. This visual representation allows them to track the flow of funds, understanding where the money originated and where it was allocated.

It’s not just about having the data; it’s about comprehending it effortlessly and focusing on the details that require action. With the executive reports from the Cecily Group, clients can achieve analytical mastery over their financial accounts and attain the comprehensive “birds’-eye view” they desire. As Albert Einstein said: “Out of the complexity, find simplicity!”