balance scorecard and strategic analysis of operating income (1)

8/13/2019 Balance Scorecard and Strategic Analysis of Operating Income (1)

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Balance Scorecard and Strategic

Analysis of Operating Income


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Strategy

- Strategy describes how an organization

matches its own capabilities with the

opportunities in the marketplace to

accomplish its overall objectives.

- A thorough understanding of the industry

is critical to implementing a successful

strategy


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Five Aspects of Industry Analysis

1. Competitors

2. Potential entrants into the market

3. Equivalent products

4. Bargaining power of customers

5. Bargaining power of input suppliers


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Basic Strategies:

1. Product Differentiation2. Cost leadership


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The Balanced Scorecard

- The balanced scorecard translates an

organizations mission and strategy into a

set of performance measures thatprovides the framework for implementing

its strategy

- It is called the balanced scorecard

because it balances the use of financial

and nonfinancial performance measures to

evaluate performance


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The balanced scorecard is a strategic

planning and management system

used:

- To align business activities to the vision and

strategy of the organization,- Improve internal and external communications

and,

-Monitor organization performance against

strategic goals.The balanced scorecard automates and

centralizes the issuance and tracking of

objectives, targets, measures and initiatives.


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The Balanced Scorecard

The scorecard measures an organizations

performance from four perspectives:

1. Financial

2. Customer

3. Internal Business Perspective

4. Learning and Growth


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The Financial Perspective-Evaluates the profitability of the strategy

- Uses the most objective measures in the

scorecard

-The other three perspectives eventually

feed back into this dimension

-Objective: Increase shareholder value;Measures: Increase in operating income


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The Customer Perspective-Identifies targeted customer and market

segments and measures the companys success in

these segments-Objectives: Increase market share and increase

customer satisfaction;

- Measures: Market share in communication

networks segment and Customer satisfactionsurvey


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The Internal Business

Prospective

Focuses on internal operations that create value for customers

that, in turn, furthers the financial perspective by increasingshareholder value.

Includes three sub processes:

1. Innovation2. Operations

3. Post-sales service


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The Learning & Growth

Perspective- Identifies the capabilities the organization must

excel at to achieve superior internal processes

that create value for customers and shareholders.- Objectives: Align employee and

organization goals; Improve manufacturing

processes

- Measures: Employee satisfaction survey;Improvements in process controls


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Aligning the Balanced

Scorecard to Strategy

- Different strategies call for different scorecards.

What are some of the financial perspectivemeasures?

1. Operating income

2. Revenue growth

3. Cost reduction is some areas

4. Return on investment


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What are some of the customer perspective measures?

1. Market share

2. Customer satisfaction

3. Customer retention percentage

4. Time taken to fulfill customers requests


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Scorecard to StrategyWhat are some of the internal business perspective measures?

Innovation Process

1. Manufacturing capabilities

2. Number of new products or services

3. New product development time

4. Number of new patents


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Operations Process:

1. Yield2. Defect rates

3. Time taken to deliver product to customers

4. Percentage of on-time delivery

5. Setup time6. Manufacturing downtime


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What are some of the learning and growth perspective

measures?1. Employee education and skill level

2. Employee satisfaction scores

3. Employee turnover rates

4. Information system availability5. Percentage of processes with advanced controls


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Features of a Good

Balanced Scorecard-Tells the story of a firms strategy, articulating

a sequence of cause-and-effect relationships:

the links among the various perspectives thatdescribe how strategy will be implemented

- Helps communicate the strategy to all

members of the organization by translating

the strategy into a coherent and linked set of

understandable and measurable operational

targets


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Features of a Good

Balanced Scorecard- Must motivate managers to take actions thateventually result in improvements in financialperformance

Predominately applies to for-profit entities,but has some application to not-for-profitentities as well

- Limits the number of measures, identifying only

the most critical onesHighlights less-than-optimal tradeoffs thatmanagers may make when they fail to consideroperational and financial measures together


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Drawbacks of Balanced

Scorecard Implementation

-Managers must include both costs and benefits

of initiatives placed in the balanced scorecard:costs are often overlooked

- Managers should not ignore nonfinancial

measures when evaluating employeesManagers should not use too many measures


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Evaluating Strategy

Strategic Analysis of Operating Incomethreeparts:

1. Growth Componentmeasures the

change in operating income attributablesolely to the change in the quantity ofoutput sold between the current and priorperiods.

2. Price-Recovery Componentmeasuresthe change in operating incomeattributable solely to changes in prices ofinputs and outputs between the currentand prior periods


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Evaluating Strategy

Strategic Analysis of Operating Income

3. Productivity Componentmeasures the

change in costs attributable to a change in

the quantity of inputs between the

current and prior periods


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Evaluating the Success

of a StrategyAssume the following operating incomes:

Year 2012 Year 2013

Revenues:

(1,000,000 $26) $26,000,000

(1,100,000 $24) $26,400,000

Expenses:

Materials 4,050,000 3,631,320

Other 16,000,000 16,000,000

---------------- -----------------Operating Income $5,950,000 $ 6,768,680

Increase in operating income: $ 818,680


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Assume that for 2012, FWB produced

and sold 1,000,000 units at $26 per unit.

During the year 2013, FWB producedand sold 1,100,000 units at $24 per unit.

What is the revenue effect of growth?


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Growth Component

Revenue effect of growth component

= (Actual units of output sold in 2013

Actual units of output sold in 2012)

Output price in 2012

(1,100,0001,000,000) $26 =

$2,600,000 F

This component is favorable because

it increases operating income.


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Growth Component

Cost effect of growth component =Actual units of

input or capacity that have been used in 2012 to

produce year 2013 output assuming the same

input-output relationship that existed in 2012Actual units or capacity to produce 2012 output X

Input prices in 2012


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Growth Component

To produce 1,100,000 units in 2013 compared

with the 1,000,000 units produced in 2012

(a 10% increase), Dallas would require a

proportional increase in direct materials.

Assume that 3,000,000 square centimeters of

materials were used to produce the 1,000,000

units in 2003 at a cost of $1.35per square centimeter.


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Growth Component

Assume that manufacturing conversion costs,

selling and customer service costs and research

and development costs were $16,000,000and remained stable during 2013.

What is the cost effect of the growth component?

3,000,000 110% = 3,300,000 centimeters

(3,300,0003,000,000) $1.35 = $405,000 U


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Operating Income and GrowthWhat is the net increase in operating income

as a result of growth?

Revenue effect of growth component $2,600,000 FCost effect of growth component 405,000 U

Increase in operating income

due to growth component $2,195,000 F


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Price-Recovery Component

Revenue effect of price-recovery

component

= (Output price in 2013Output price in

2012)

Actual units of output sold in 2013

What is the revenue effect of the

price-recovery component?

($24$26) 1,100,000 = $2,200,000 U


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Cost effect of price-recovery component = (Input

prices in 2013Input prices in 2012) X Actual

units of inputs or capacity that would

have been used to produce year 2013 output

assuming the same input-output relationship

that existed in 2012

* Assume that in the year 2013, direct materials

costs were $1.31 per square centimeter.


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What is the cost effect of the price-recovery

component?($1.31$1.35) 3,300,000 = $132,000 F


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Operating Income and

Price-Recovery ComponentWhat is the total effect on operating income of the price-

recovery component?

Revenue effect

of price-recovery component $2,200,000 U

Cost effect

of price-recovery component 132,000 F

Decrease in operating income

due to price-recovery component $2,068,000 U


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Productivity Component

Productivity component = Actual units of inputs

or capacity to produce year 2013 output

- Actual units of inputs or capacity to

produce year 2013 output

X Input prices in 2013


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Assume that 2,772,000 actual square centimeters

of direct materials were used in the year 2013.

Actual price was $1.31/square centimeter.


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What is the productivity component

of cost changes?

(2,772,0003,300,000) $1.31 = $691,680 F

There is a $691,680 increase

in operating income due tothe productivity component.


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Change in Operating Income

Increase in operating income

$818,680

Growthcomponent

$2,195,000 F

Price-recoverycomponent

$2,068,000 U

Productivitycomponent

$691,680 F


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Relationships Between

Inputs and Outputs

- Engineered costs pertain to processes that are

detailed, physically observable, and repetitive.

- Discretionary costs are associated with

processesthat are sometimes called blackboxes, because

they are less precise and not well understood.


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Managing Unused Capacity

Downsizing (Rightsizing) is an integrated approach

of configuring processes, products, and people to

match costs to the activities that need to be

performed to operate effectively and efficiently in

the present and future.


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balance scorecard and strategic analysis of operating income (1)

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