177

A MODIFICATION OF EFFICACY COEFFICIENT MODEL

FOR ENTERPRISE PERFORMANCE EVALUATION

Xiaosong Zheng, PhD, Lecturer

UTS-SHU SILC Business School

Shanghai University, China

Jaan Alver, PhD, Professor, Director

School of Economics and Business Administration

Tallinn University of Technology, Estonia

Introduction Enterprise performance evaluation, which aims to make an objective, fair and

accurate judgment on operating performance of an enterprise during a period according

to the evaluation system designed for the company, is a comprehensive evaluation

system of enterprise operating conditions based on enterprise management efficiency

(Liu, 2011). Williams (1998) pointed out that the detailed content of performance

evaluation includes debt paying ability, operation ability and profitability of a company

and until the 1980 and the consequence had been related to employees’ remuneration.

The main methods used in enterprise performance evaluation are e.g. DuPont financial

analysis, Balanced scorecard (BSC), Economic value added (EVA) (Alsharf, 2015). In

late 1980s, not only investors and creditors had concern about evaluation of enterprises

but all other stakeholders did. Due to the specific situations of state-owned enterprises

(SOE), performance evaluation of SOE is now achieving more and more attention from

managers. This is particularly true for performance evaluation of SOEs in China

because of China’s unique political, economic and cultural situations. The performance

evaluation of SOEs in China has roughly experienced the following stages: the

combined operation autonomy and planned economy during early years for reform and

opening-up; a clear direction made based on modern enterprise management system in

1993 to 1998; reform of SOEs has been further deepened in 1999 and the evaluation

index was first used in this year; From 2006 to today, such index system is becoming

more and more mature. Enterprise integrated performance evaluation scoring method,

combined with efficacy coefficient method and comprehensive analysis and judgment

method, is commonly used in China (Su, 2011).

Under the circumstance of market economy, companies are paying more and

more attention to scientific performance management in consideration of the long run

development. However, a lot of advanced foreign performance management methods

are not suitable for China. Currently, the financial index method used commonly in

China is set by the government and it lacks an efficient comprehensive performance

evaluation system (Wang, 2010). Therefore, how to build a comprehensive and

suitable performance evaluation system for China becomes a key problem, and it is the

main research purpose and content of this paper.

This paper first studies the main foreign performance evaluation methods and

their limitations. Then it focuses on introduction of the quantitative performance

evaluation model which is based on the efficiency coefficient method. After that, a

case study of China’s Sinopec will be carried out using the model and comments and

suggestions will be given on the pros and cons and improvement of the model. Finally,

qualitative performance evaluation will be used to provide a comprehensive evaluation

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on Sinopec’s performance so that the problems of SOE performance evaluation can be

identified and summarized.

Literature Review

There are a few main enterprise efficiency evaluation methods such as the

DuPont Analysis, BSC, and EVA. DuPont analysis was used in 1999 by DuPont

Engineering Polymers and then it was named. Kien pointed out that DuPont Analysis

is a classical method to evaluate a company’s profitability and shareholders’ equity

return level (Kien, 2011). To be specific, DuPont analysis is based on the rate of equity

return makes profit rate to net worth and equity multiplier basic points to disintegrate

performance model and analyze the impact of all factors on rate of equity return (Xu,

2009). DuPont analysis is an effective comprehensive financial analysis and is a

milestone in the history of enterprise performance evaluation. However, there are the

following defaults of DuPont analysis: it neglects external evaluation and is a

postmortem analysis; it can only apply in accounting analysis and it is hard to analyze

objectively and comprehensively; poor emphasis on cash flows leads to the

consequence that a company’s earnings quality and developing ability cannot be

reflected; long-term value is neglect due to a heavy focus on short-term accounting

data; intangible assets are playing an important role in improving long-term

competitiveness but they cannot be valued through DuPont analysis.

Balanced scorecard (BSC) was coined by Kaplan and Norton (1996). It links the

financial evaluation with customer satisfaction, internal business procedure, innovation

and learning ability to help the improvement of product, procedure, customer and

market exploit. Wei (2012) states that BSC prevents sub-optimization effectively

because all the factors that affect company competitiveness are in one report. For

example, the action that a company reduces sales on account to improve accounts

receivable turnover and causes large amount of revenue will be fewer under such a

method. Other advantages are listed as follow: BSC explains how shareholders are

satisfied through financial indicators; companies’ close relationship with customers

through calling for feedback can improve the company’s market share (Wei, 2012);

internal measurement index helps reflecting the efficiency of decisions that affect

customer feedback, for instance, once found customers’ poor feeling on products,

managers can remedy and take actions on time; BSC can evaluate operating conditions

through innovation (Liu, 2011). Nevertheless, BSC is not suitable for strategy

formulation. Kaplan and Norton (1996) pointed out that BSC needs consensus

strategies while companies’ strategies change according to market and their own needs.

Economic value added (EVA), which is created by Stern Stewart & Co. Brewer

(2009) states that shareholders put more and more emphasis on whether resources are

maximally used and whether enterprises create value under the entrusted agency

management system. EVA evaluation method, based on the evaluation of enterprise

value creation, makes the maximal balance between adjusted net profit after tax and the

cost of capital to achieve the goal of companies’ performance evaluation. EVA has

three advantages: 1) it emphasizes sustainable development of a company. For

instance, it capitalizes the research expenditure and technology upgrading costs while

adjusting after tax net profit reduces the effect on performance. 2) It enables the

facticity of results through adjusting relative financial data. 3) EVA takes opportunity

cost of equity into account. EVA enables managers to make reasonable financial

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planning, improve the efficiency of capital usage (Brewer, 2009). However, Griffith

(2004) indicated the limitations of EVA: 1) the complex adjusting items, like 160

adjusting items of Stern Stewart’s net operating profit after tax, are too hard for

managers who lack professional financial knowledge to understand. 2) In EVA,

estimation of Weighted Average Cost of Capital (WACC) needs to consider risk

differences among industries and it is quite complex. Although the fixation of WACC

in different industry released by China’s State-owned Assets Supervision and

Administration Commission (SASAC) simplified the calculation, it separates the

relationship between cost of capital and market time and leads to the neglect of cost

control in high risk companies. 3) EVA is more suitable for highly independent

enterprises (Wang and Li, 2007).

In 2003, the SASAC started to assess the operations of SOEs in China. In 2006,

a system of containing financial and management indices in key SOE performance

evaluation was released. Key components of the indices are shown in the following

Table 1.

Table 1. Integrated Performance Evaluation Indices and Weights Table

The evaluation

content and

weight

Financial performance (70％) Management

performance (30%)

Basic indicators Weight Modified

indicators Weight

Evaluation

indicators Weight

Profitability 34

return on equity 20

The sales

margin 10

strategic

management

development

and

innovation

operating

decision

risk control

basic

management

human

resources

industry

impacts

social

contribution

18

15

16

13

14

8

8

8

Surplus cash

cover 9

rate of return on

total assets 14

Cost profit

ratio 8

capital return 7

Asset

quality 22

total assets

turnover 10

Non-

performing

asset ratio

9

accounts

receivable

turnover

12

current asset

turnover 7

Return on

assets in cash 6

The debt

risk profile 22

asset-liability

ratio 12

quick ratio 6

Cash flows

Coverage

Ratio

6

number of times

interest earned 10

Interest-

bearing debt

ratio

5

Contingent

liabilities ratio 5

Business

growth 22

The growth rate

of sales 12

Sales profit

growth 10

Capital

preservation

increment rate

10

Total assets

growth rate 7

Technical

input ratio 5

Source: Ministry of Finance, SETC, Ministry of Personnel, SDPC, P.R.C., 2009

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Since 2009, SOE performance evaluation should use the multi-index evaluation

method. The method is under constant development and modification in these years

(SASAC, 2009).

The Efficacy Coefficient Method

Efficacy coefficient method shows comprehensive conditions of study object

according to the principle of multi-objective programming (Zhu, 2007). In our method

we use efficiency coefficient method as financial performance indicators while

management performance indicator is on comprehensive analysis and judgment. For

measuring financial performance indicators, first we calculate the actual value of

performance indicators according to need. Secondly, we determine perfect, good,

average, low and bad value of different indices according to the industry. Thirdly, we

calculate the sum of basic index score (Table 2) and revised index score to get

quantitative index score (Table 3).

Table 2. The Basic Index Formula

Total

basic

index

score

Category

Basic indicators

Index weight k

Up file standard coefficient j

File standard coefficient i

Up file basic score h k*j

File basic score g k*i

Up file standard value f The best industrial value

File standard value e Average industrial value

Actual value d Actual value

Efficacy Coefficient c (d-e)/(f-e)

Modified value b c*(h-g)

Σa Single index score a g+b

Table 3. Modified Index Score

Total

modified

score

Category

Modified index

a The scores of some basic indicators

b The part weight

a/b The coefficient of some basic index analysis

c Efficacy Coefficient

d File standard coefficient

* A single correction coefficient

e Modified index weighting

# An index weighted correction coefficient

Σ# A part of the comprehensive correction coefficient

Σ& & The revised score

*: 1.0+(d+c*0.2-a/b)

#: e/b*(*)

&: a*(Σ#)

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The formula of measuring management performance indicators and the formula

of measuring comprehensive performance score are shown in Figure 1 and Figure 2

respectively.

Figure 1. The Formula of Measuring Management Performance Indicators

Figure 2. The Formula of Measuring Comprehensive Performance Score

The comprehensive performance evaluation model has a number of advantages.

First, it can revise the score according to the complexity of the object, making the

result more comprehensive. Secondly, the score is more objective and reasonable and it

is more acceptable for managers. Thirdly, the multiple dimensions of evaluation

criteria greatly reduce the error, enabling a more accurate analysis. Fourthly, the model

can be processed through Excel or by hand so it can be extensively applied.

A Case Study of Sinopec

In this section we will do a case study on China’s Sinopec using the above

model. Sinopec is one of the largest energy companies in China and its main

businesses are oil and gas exploration, storage and transportation (including pipeline

transport). Sinopec issued H shares and A shares in 2000 and 2001 respectively. It has

86.7 billion shares totally, among which 75.84% is for its group, 19.35% is foreign

share and 4.81% is domestic public shares (Sinopec, 2011).

Since Sinopec is considered a large SOE, the financial criteria values are

determined in Table 6. The average coefficient of the standard is 1.0 for perfect value,

0.8 for good value, 0.6 for average, 0.4 for low, and 0.2 for bad values. This paper

analyzes Sinopec through four aspects listed in the Table 4 and distributes the weights

according to these four aspects.

According to the audited financial statements of Sinopec in 2011, 22 single

financial indices were calculated as shown in Table 5.

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Table 4. Financial Performance Indicators and Weights Table The evaluation

content and

weight

Financial performance (70％)

Basic index Weight Modified index Weight

Profitability 34

Return on equity 20 The sales margin 10

Surplus cash cover 9

Rate of return on total

assets 14

Cost profit ratio 8

Capital return 7

Asset

quality 22

Total assets turnover 10 Non-performing asset

ratio 9

Accounts receivable

turnover 12

Current asset turnover 7

Return on assets in cash 6

Debt risk 22

Asset-debt ratio 12

Quick ratio 6

Cash Flows Coverage

Ratio 6

Number of times

interest earned 10

Interest-bearing debt

ratio 5

Contingent liabilities

ratio 5

Business

growth 22

The growth rate of

sales 12 Sales profit growth 10

Capital preservation

increment rate 10

Total Assets Growth

Rate 7

Technical Input Ratio 5

Table 5. Single Financial Index Values Items Financial index Actual value

Profitability

Return on equity 0.1601

Rate of return on total assets 0.1058

Sales profitability 0.0403

Surplus cash cover 1.4152

Cost profitability ratio 0.0429

Capital return 0.6170

Asset quality

Total asset turnover (time) 2.3689

Turnover of account receivable 149.64

Return on assets in cash 0.1429

Current asset turnover 8.6846

Non-performing asset ratio No non-performing asset

Debt risk

Debt-to-assets ratio 0.5491

Number of times interest earned 1.0989

Cash Flows Coverage Ratio 0.3523

Quick ratio 0.2894

Interest-bearing debt ratio 1.1694

Contingent liabilities ratio No contingent liabilities

Business growth

Sales revenue growth 0.3128

Capital preservation increment rate 1.1265

Total Assets Growth Rate 0.1468

Sales profit growth rate -0.0038

Technical Input Ratio 0.0053

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Table 6. Enterprise Performance Evaluation Standard of Sinopec

Items

Perfect

value

(1.0)

Good

value

(0.8)

Average

value

(0.6)

Lower

value

(0.4)

Bad

value

(0.2)

1 Profitability

Return on equity (%) 16.4 12.5 9.5 6.5 -0.2

Rate of return on total assets (%) 15.3 11.6 9.2 6.3 -0.1

Main business profitability (%) 29.5 23.0 16.5 9.0 4.0

Surplus cash cover 5.8 3.4 1.6 0.3 -1.5

Ratio of profits to cost (%) 17.6 13.1 9.9 6.8 -0.3

Capital return (%) 22.8 18.7 14.5 5.1 3.8

2 Asset quality

Total assets turnover (times) 1.0 0.7 0.5 0.2 0.1

Accounts receivable turnover (times) 41.5 34.7 29.7 22.1 15.0

Non-performing asset ratio (new system) (%) 0.1 1.4 3.1 5.1 9.8

Current asset turnover (times) 7.5 6.5 5.6 4.4 3.3

Return on assets in cash (%) 29.5 16.5 8.7 4.3 -4.6

3 The debt risk profile

Asset-liability ratio (%) 34.7 42.8 51.1 61.4 67.7

Number of times interest earned 9.9 8.7 7.1 5.0 0.7

Quick ratio (%) 108.2 80.9 62.0 47.7 24.8

Cash Flows Coverage Ratio (%) 48.4 38.7 31.2 23.5 -4.9

Interest-bearing debt ratio (%) 21.6 31.9 44.4 59.2 63.9

Contingent liabilities ratio (%) 0.3 5.8 11.0 6.6 19.1

4 Business growth

Sales growth rate (%) 49.3 45.2 38.6 19.6 25.0

Capital preservation increment rate (%) 113.7 111.6 107.4 101.0 97.5

Sales profit growth (%) 28.6 22.0 16.0 9.6 3.3

Total Assets Growth Rate (%) 27.0 20.6 15.3 12.6 0.3

Technical Input Ratio (%) 1.6 1.3 1.1 0.8 0.1

5 Supplement information

Inventory turnover ratio (times) 20.7 16.4 9.7 8.3 3.4

Rate of capital accumulation (%) 19.4 16.1 11.9 4.5 -2.2

Three years of average growth of capital (%) 20.9 17.6 13.4 6.6 -0.6

Three years average sales growth rate (%) 25.0 18.2 14.4 6.1 0.8

Non-performing asset ratio (the old system) (%) 0.2 2.1 3.2 11.2 19.0

Source: SASAC, financial supervision and evaluation, 2011

The calculation process of financial performance indicators is presented in the

Table 7.

Efficacy Coefficient Method can be improved from two aspects. First, the

selection of standard coefficient should be more realistic and secondly special

standards should be set for single financial performance evaluation, especially when

enterprises need to use financial data for warning. A focus of the research is on how to

use efficacy coefficient method for financial warning purpose. The traditional way to

select financial standard indicators is the average method which contains errors

because the five grade values are not equally distributed. However, Partial large

Cauchy distribution membership function can process the grades quantization.

Therefore, it can be used to select financial standard indicators. The model is shown as

follows:

. (1)

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PM is the index value * 100. In this model, there are five classes and x=1-5 can

represent the five classes.

Table 7. Calculation Process of Financial Performance Indicators Index formula Calculation process

Return on equity = Net margin / Average net assets × 100% Average net assets = (Year beginning equity+Year ending equity) / 2

= 71,697 / (474,399 + 421,127) / 2 = 0.160122654

Rate of return on total assets = (Total profit + Interest expense) / The

average total assets × 100% Average total assets = (Year beginning

total assets＋Year ending total assets) / 2

= (102,638 + 9,241) / (1,130,053 + 985,389)/2= 0.10577364

Rate of return on sale = Net Income from main operations / Income

from main operations × 100%

= 100,966 / 2,505,683

= 0.040294802

Surplus cash cover = NOCF / (Retained profits + Non-controlling

equity)

= 151,181 / (71,697 + 35,126)

= 1.415247653

Ratio of profits to cost = total profit / The total cost × 100%

The total cost = Main business cost + Tax and extra charges of main

business + Operating expenses + Administration expenses + Financial expenses

= 102,638 / (2,093,199 +189,949 + 38,399 + 63,083 + 6,544)

= 0.042923685

Capital return = Net profit / Average capital × 100%

Average capital＝[Year beginning paid-up capital + Year beginning capital reserve) + (Year ending paid-up capital + Year ending capital

reserve] / 2

= 71,697 / (86,702 + 29,414 + 86,702 +

29,583) / 2

= 0.617011114

Total assets turnover (time) = Main business net income / The

average total assets

= 2,505,683 / (1,130,053 + 985,389) / 2

= 2.368945119

Turnover of account receivable (time) = Main business net income /

Average balance of receivables Average balance of receivables =

(Year beginning balance of receivables+ Year ending balance of receivables) / 2

= 2,505,683 / (16,829 + 16,660) / 2

= 149.6421512

Return on assets in cash = NOCF / The average total assets × 100% = 151,181 / (1,130,053 + 985,389) / 2

= 0.142930886

Current asset turnover (time) = Main business net income / The average total current assets

= 2,505,683 / (327,588 + 249,450) / 2 = 8.684637753

Non-performing asset ratio = Year ending non-performing asset ratio / Year ending total assets

No non-performing asset

Debt-to-assets ratio = Total liabilities / Total assets × 100% = 620,528 / 1,130,053

= 0.549114068

Number of times interest earned = Total earnings before interest and

tax / interest expense = (net profits + interest expenses + income tax expense) / interest expenses

= (71,697 + 985,389 + 25,774) / 985,389

= 1.098916266

Cash Flows Coverage Ratio = NOCF / current liabilities ×100% = 151,181 / 429,073

= 0.352343308

Quick ratio = Quick assets / Current liabilities × 100%

Quick assets= Current assets – Inventory

= (327,588 – 203,417) / 429,073

= 0.289393646

Interest-bearing debt ratio = (Short-term borrowing + One year long-

term liability + Long-term loan + Bonds payable + Interest payable) /

Total liabilities × 100%

= (100,137 + 54,320 + 43,388 + 36,985 +

490,810) / 620,528

= 1.169391228

Contingent liabilities ratio = Balance of contingent liabilities / Total

Equity No contingent liabilities

The growth rate of sales = (Main business revenue this year – Main

business revenue last year) / Main business revenue last year × 100%

= (2,463,767 – 1,876,758) / 1,876,758

= 0.312778206

Capital preservation increment rate = The state-owned capital and

equity deducted objective increase or decrease factors /beginning of

state-owned capital and equity × 100%

= 474,399 / 421,127 = 1.1265

Total Assets Growth Rate = (Total assets at the end of year – total assets at the beginning of year) / total assets at the beginning of year

× 100%

= (1,130,053-985,389) / 985,389

= 0.146809027

Sales profit growth ratio = (Main business profit this year – Main business profit last year) / Main business profit last year × 100%

= (100,966 – 101,352) / 101,352 = -0.003808509

Technical Input Ratio = Combined technology

spending this year / Main business net income × 100%

= 13,341 / 2,505,683

= 0.0053242968

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The performance score combines financial and management performance

indicators, however, the management performance indicators are subjective. Therefore,

financial performance indicators should have a separate evaluation system. The

efficacy coefficient method can still play a great role in financial early warning.

There are 5 steps in the application of the efficacy coefficient method in financial

early warning and these are 1) reclassification of financial adjustment indicators, 2)

determine the various types of variable values, 3) calculate financial early warning

efficacy coefficient, 4) Use weighted average method to calculate the comprehensive

efficacy coefficient, 5) risk analysis of the company’s financial performance using the

integrated efficacy coefficient. According to principles, at least 7 experts should give

score for qualitative management performance evaluation index score. The evaluation

index score for Sinopec is shown in Table 8.

Table 8. Expert Evaluation Index Score

Evaluation

index

Grade（parameter）

Management

performance

(30%)

weigh

t

perfect(1.0) good(0.8) middle(0.6) low(0.4) bad(0.2)

Strategy

management

development &

innovation

operating

decision

risk control

basic

management

human

resources

industry

influence

social

contribute

18

15

16

13

14

8

8

8

√

√

√

√

√

√

√

For example, in management performance in “strategic management” the score 4

means excellent, 2 good, 1 medium. These number were given by 7 experts in

Sinopec. Thus, strategic management expert evaluation score =

[(18×1.0×4)+(18×0.8×2)+(18×0.6×1)]÷7=15.94. Assume that seven other indicators

results are 14.14, 14.63, 12.0, 13.08, 6.0, 7.5, 6.4, respectively, total score will be the

sum of these score: 89.69.

According to the comprehensive score value = financial index * weight + non-

financial indexes* weight, the comprehensive score of Sinopec is 75.438. Based on

Table 9, the score of Sinopec is in Grade B and can be improved.

From the results of performance evaluation, Sinopec performed relatively well in

2011 and controlled financial risks effectively. In addition, its strategies brought profits

and increased shareholders confidence on Sinopec’s future. However, there are some

problems, especially in debt risks and operating increase. As a large enterprise,

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Sinopec should well control the debt ratio. However, from the scores calculated above,

its debt ratio is higher than average, far from perfect. In addition, number of times

interest earned, another indicator to show debt risk, reflects the ability to pay debts, just

exceeds the average and is quite far away from perfect. Sinopec should put more

emphasis on debt risk control. Technical Input Ratio indicates the potential of an

enterprise to some extent. In 2011, Sinopec invested large amount of money and labor

to develop technical skills but the ratio was still lower than the average, which shows

Sinopec should focus on technical innovation to maintain its competitiveness.

Table 9. Enterprise Comprehensive Performance Rating Table

Level Grade Score

Perfect（A)

A++ Above 95

A+ 90-94

A 85-89

Good（B)

B+ 80-84

B 75-79

B- 70-74

Middle（C)

C 60-69

C- 50-59

Lower（D) D 40-49

Bad（E) E Below 39

“Central enterprise integrated performance evaluation management interim

measures” of SASAC is a tool for investors to further financial supervision. It has

several advantages: First, the performance evaluation method basing on efficiency

coefficient method fully emphasizes the profitability of SOEs. Profitability, account for

34% in evaluation standards, is quite important because perfect profitability can

guarantee profits of all stakeholders. Secondly, cash flow indicators, being extruded,

can reflect operating conditions effectively. For example, when evaluating debt risks,

Cash Flows Coverage Ratio is used. However, the current system can be improved,

especially the financial risk of the SOEs. After calculating financial performance

indicators, financial risk can be calculated with the model given above and it can

provide risk supplements for financial performance analysis. In addition, we think that

income from main operations, the growth of total assets and technical innovation

should be focused apart from the growth of main business revenue and capital value in

evaluation.

Conclusions

This paper reviews the basic concept of enterprise performance evaluation and

analyzes the limitations of three main performance evaluation methods. It discusses

that the efficacy coefficient method can be widely applied in performance evaluation of

SOEs and suggestions on the improvement of current enterprise performance

evaluation method are provided according to China’s national conditions. In this paper,

a comprehensive enterprise evaluation model is presented. The model is validated by

using Sinopec as a case study. It is found that using the model financial risks can be

efficiently identified. Research findings are discussed and summarized at the end of the

paper. For further studies, more research on the relation between financial indicators

and industries can be conducted to improve the effectiveness of financial analysis. A

187

basic framework of weight distribution should be established to reduce the impact of

subjective factors on final results.

Acknowledgement: The research is financially supported by Shanghai

University and Tallinn University of Technology.

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188

A MODIFICATION OF EFFICACY COEFFICIENT MODEL

FOR ENTERPRISE PERFORMANCE EVALUATION

Xiaosong Zheng

Shanghai University, China

Jaan Alver Tallinn University of Technology, Estonia

Abstract

Enterprise performance evaluation is a key research area in accounting and

finance. Although there are a few methods available many of these are not suitable for

China due to its unique political, economic and cultural situations. It is not appropriate

for China to directly copy the foreign performance evaluation methods. Therefore, it is

urgent for the country to develop a model which is suitable for its current situation and

can efficiently evaluate enterprise performance especially for those State-Owned

Enterprises. The paper first studies the main enterprise performance evaluation

methods and their pros and cons. Then it focuses on the introduction of a

comprehensive performance evaluation model which is based on the efficiency

coefficient method. After that, a case study of China’s Sinopec is carried out to validate

the model. Research findings are discussed and summarized at the end of the paper,

together with an outline of future research directions.

Keywords: SOE, efficiency coefficient method, performance evaluation,

Sinopec