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Operating Index
Definition
The Operating Index shows a company's performance on a financial metric or key performance indicator (KPI) compared with the median or average performance of that metric in the Peer Universe over a period of time. The chart below depicts an example of an Operating Index.
Description
The Operating Index graph shows the development of the median or average of the financial metric in the peer universe as a solid blue line. Typically, the first and the third quartile limits, thus the 25th and the 75th percentile, are marked as lines or the borders of a shaded blue area as illustrated in the diagram below. These market values are shown against the metrics of the company under evaluation. The company values are shown in the Operating Index as orange dots, connected with an orange line.
The Operating Index is calculated with actual values or with the deltas of the values from one period to the previous one.
Application
With the Operating Index, false conclusions form misleading signals in financial reporting can be avoided which can arise when only the internal KPI development is considered. As shown in the graph above, such fallacies can happen easily. Viewed from the internal perspective, margins are highest in 2003 and 2007. Viewed against the market however, the margin is worst in 2007. Internally viewed, the margin is lowest in 2005. Against the market, the margin performance is actually best in that year (the highest against the Operating Index or almost at the 3rd quartile or 75th percentile, respectively). It is also apparent that the performance in 2004 was just as good as in 2003 although the margin contracted from 6.3% to 5.4%. The reason is the contraction of the Operating Index by a similar difference in that year. In Obermatts experience, such false conclusions arise in about four out of five internal KPI comparisons. Obermatt supports its clients to avoid such fallacies in their performance measuring (see indexed bonus targets or indexed strategy controlling).
The Operating Index is also used to assess a financial plan for strategy or indexed investment valuation by comparing the plan data against the historic market values of the respective metrics. Obermatt uses the Operating Index for acquisition due diligence to illustrate to the client typically private equity firms and strategic investors - the feasibility of a certain financial projection. The Operating Index is also applied to large investment projects to test or reject the assumptions.
Examples
To exemplify the development of a typical Operating Index, we cite the Swiss luxury goods company Richemont (PDF download). Hermann J. Sterns article in the German Corporate Governance magazine comments on the application of the Operating Index for Executive Management and the Board (German: PDF download). On the Social Science Research Network, there is a white paper on how the Operating Index is used in bonus systems (Download PDF). In Finanz und Wirtschaft Raiffeisen Bank Group is quoted as example for the Operating indexed bonus targets based on the Opeating Index for Swiss Banks (PDF download).
Book recommendation (German): Marktorientiertes Value Management, 2007, Wiley (order)
Ask for your customized Index at Obermatt. Your first Operating Index is free of charges. (Contact).
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