How to calculate performance when losses are reduced

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

26 August 2007

“We signed a performance contract to keep the losses in our company below Sh200 million. In the last financial year, we achieved a better result of Sh50 million loss. What is percentage change?” asks a reader who would like to remain anonymous.

Now this would be an easy question if it was talking about profit. In that case, we would proceed as follows:

First, calculate the difference between actual profit and target profit. Second, divide the result by the target profit. And finally, multiply by 100 percent. The same calculation can be applied in the present case where the company is making losses. But we have to bear in mind that the numbers are negative.

Thus, in the first step, we calculate (-Sh50 million) – (-Sh200 million). This is equivalent to (-Sh50 million) + (Sh200 million) = +Sh150 million. Remember; adding a negative number is equal to subtracting and, conversely, subtracting a negative number is equivalent to adding.

In the second step, we divide the result by the target loss, that is, (+Sh150 million)/(-Sh200 million). The answer is –0.75 or negative 75 percent.

Now a negative change is usually not a good thing in company financial results. But here we are talking about losses. So the reader has made a commendable achievement – he has achieved a loss that is 75 percent below the targeted figure. Imagine how the owners of the business would feel if it had been a 75 percent increase in profits.

But the reader wants more than that. He needs to express his “percentage performance”. That is, by what ratio has he exceeded the targeted loss? To get the answer, we compare again with the calculation in a profitable company.

In the case of increase in profits, he could have stated that he has achieved a 175 percent performance – a value is obtained by simply adding 100 percent to 75 percent. But if we do the same to the case of reduced losses, we get 100 + (–75) = 25. That is, the performance is only 25 percent!

That doesn’t seem right. It would appear that we should have subtracted the 100 percent…but then that seems to be “cooking” figures to arrive at the desired answer.

A better way therefore, would be to start with the loss before the reader took over the company. That figure has not been supplied, but suppose, it was Sh300 million. Then the agreed target (Sh200 million loss) can be seen as a commitment to reduce the loss by 33 percent.

The actual result of a Sh50 million loss is an 83 percent reduction. Thus our reader has achieved a performance of 83 divided by 33, equals 250 percent. Now that much higher than the earlier 175 percent…and it is a more accurate statement of the accomplishment.