f5 performance measurementj2015chp17

WHY PM? Part of CONTROL process

HOW ? VARIANCE ANALYSIS FPI, NFPI,

3Es,BSC BALANCED SCORECARD

TewYouHoo/PerformanceMeasure 1

• It aims to establish how well

something/somebody is doing in

relation to a planned activity.

• Is a vital part of control process.

• May be divided into:

1. Financial (monetary) performance

indictors (FPI)

2. Non-financial (non-monetary)

performance indictors (NFPI)


FPI

NFPI

Short –termism( manipulation) vs long term

view

Balanced scorecard

Building blocks-service

Value for money-charities, public sector,ngo

Transfer pricing-when dealing with

oragnization with divisions or different depts


CRITERIA FOR PMEASURES…How should they be

set?


MUST look at COST BENEFITS of coming up with measures

USUALLY measured in relation to sales or investment, number of employee etc

Must be compared against company’s goals and plans.

Relevant

Must look at both ST and LT performance

Must be fair.-mgrs evaluated on what they can control.

Managers must respond to measure…(must lead to something).only if useful ,mgr will respond.

Estimates if used must be realistic.


Different measures are appropriate for different businesses

Factors to consider:1. Measurement needs resources.

Costs & benefits of providing resources to produce a performance indicator must be weighed up

2. Performance must be measured in relation to something.Overall performance should be measured against the objectives of the organisation & the plans that result from those objectives.


3. Measures must be relevant.

4. Measurement needs responses, but managers will only respond to measures that they find useful.

5. ST & LT achievement should be measured.

6. Measures should be fair.

Should only include factors which managers can control & for which they can be held responsible.

7. A variety of measures should be used.

8. Realistic estimates may be required for measures to be employed. Eg COC & impact of non-financial items.


NONFINANCIAL VS

FINANCIAL( quantitative)


Advantages

1. Easily verified.

2. Understandable.

3. Measurable & is more objective.

4. Can be used to identify trends.

5. Make inter-firm comparisons.

Disadvantages

1. Can be manipulated to show what is mgrs want.

2. Ignores qualitative measures.

3. Figures may be affected by inflation.

4. May be difficult to set realistic standards for evaluation in some cases…uncertainties


Profit – Depends on accounting policies adopted.

Revenue – More meaningful if shown as a % of industry’s market share.

Cost– must distinguished between controllable &

uncontrollable. - must be analysed into material, labour, V OH & F OH.


Contribution

– contribution to sales shows the contribution

generated for every £ of sales.

Cash Flow

– as a measure of the company’s liquidity

position

Share price


1. Budgeted sales, costs & profits.

2. Standards in a standard costing system.

3. Trend over time.

4. Results of other parts of business.

5. Results of other business.

6. Economy in general.

7. Future potential.


Ratio analysis can be used to evaluate performance of an organisation.

4 categories of ratios:

1. Profitability

2. Liquidity

3. Efficiency

4. Gearing/leverage



•ROCE Net profit margin

•GROSS PROFIT margin

•EPSProfitability

•Current ratio

•Quick ratio

•Cash balanceLiquidity

• Asset turnover

• inventory turnover

•Error rate

•Completion time per job

Efficiency

•Debt ratio Debt/Debt+ equity

• Interest coverGearing

Shows the profitability of the product/services of the

business & efficiency of utilising resources in earning profits

PBITROCE = -------

CE

CE = Shareholders Funds + Long-term Liabilities

= FA + WC

It measures return available for shareholders & debtholders.


ROSE =

Profit aft tax & preference dividend

----------------------------------------------------

Ordinary share capital & revenue reserves

It measures return to ordinary shareholders.


PBIT

Net Profit Margin = -------- x 100%

(Sales margin) Sales

It measures company’s success in earning profit form its operations.

GP

Gross profit Margin = -------- x 100%

Sales


A business needs liquid assets to meet its

debts when they fall due.

CA

Current ratio = -----

CL

It measures ability of a firm to use its CA to pay off CL when they fall due.


CA – Inventory – Prepaid expenseQuick ratio = -----------------------------------------

-(Acid Test) CL

It measures ability to repay immediate obligations

using cash or near cash assets.


A/c Receivables Payment Period

Ave a/c receivables

= ------------------------ x 365

Credit Sales

It measures average length of time it takes for

a

firm’s debtors to pay their debts.


Ave InventoryInventory T/O Period = ------------------ x 365

COGS

It measures how vigorously a business is trading.

A/c Payables Payment Period

Ave a/c Payables = --------------------- x 365

Credit Purchase

It measures no. of days the firm takes to pay its creditors.


Net Asset T/O = Sales / Net Assets

TA T/O = Sales / TA

FA T/O = Sales / FA

Net WC T/O = Sales / Net WC

It measures how efficient the assets were used to

generate

sales.


Profit margin x Asset T/O =

ROCE

PBIT Sales PBIT

------- x -------- = --------

Sales CE CE


Used to describe relative importance of debt & equity in capital structure & to measure financial risk of a firm.

Provisions can be ignored, eg, deferred taxation.

Gearing is the relationship between shareholders capital + reserves & debt.

A highly geared company has a large proportion of its total capital provided by loans or debentures.

High gearing increases risk for equity shareholders.

Equity shareholders gain when ROI > interest& lose when ROI < interest.


DebtGearing = ----------------- x 100%

Debt + Equity

Debt = Loan + Preference Shares + Bank O/DEquity = Ordinary Share Capital + All Reserves

Debt-equity ratio = Debt/Equity

Interest Cover = PBIT/Interest Charges

It measures ability of firm’s profit to sustain interest payment.


A highly geared co must earn enough profits

to cover its interest charges before anything

is available for equity.

If return on investment is > cost of debt

capital, then ROE .

Gearing increases probability of financial

failure.


Measure cost structure (fixed & variable) of firm.

Firms with high proportion of FC relative to VC has high operating gearing.


Operating gearing = Contribution / PBIT

Contribution = Sales – VC

Risk of making low profits or losses due to nature of the business.

Used to measure cost structure (fixed & variable) of firm.

Firms with high proportion of FC relative to VC has high operating gearing.

Break-even point will be high also. Profit performance is sensitive to relatively

small changes in level of sales.

E.g. of fixed operating costs: Administrative salaries • Depreciation Insurance premiums • Property

taxes Rent • Lease Charge


Operating gearing = Contribution / PBIT

Contribution = Sales – VC

If a high degree of costs are fixed & hence do not decline when demand decline → ↑ business risk.

If contribution is high but PBIT is low, FC is high & only just covered by contribution. Business risk is high.

If contribution is not much bigger than PBIT, FC is low & fairly easily covered by contribution.

Business risk is low.


WHICH IS BETTER? BOTH complement each

other

WHICH IS EASIER TO GENERATE? Perhaps F

WHAT ARE SOME EXAMPLES OF FPI? ROI,NPM

WHAT ARE SOME EXAMPLES OF NFPI?

ADV OF FPI NFPI

DISADV OF FPI NFPI


Expressed in absolute terms such as dollars, units, %, ratios & indices.

Reasons for growing emphasis on NFPIs.1. Concentration on too few variables.

If focus on financial indicators, managers ignore variables that cannot be expressed in monetary terms..

2. Lack of information on quality. Traditional responsibility accounting systems fail to provide information on quality.


3. Changes in cost structures.

Modern technology requires massive

investment & product life cycles are shorter.

A greater proportion of costs are sunk,

planned, engineered or designed into product

before production. At the time product is

produced, it is too late to control costs.

4. Changes in competitive environment.

Financial measures do not convey full picture

of a co’s performance.


5. Changes in manufacturing environment.

New manufacturing technologies focus on minimising throughput times, inventory levels & set-up times. If focuses on costs, managers may concentrate on cost reduction & ignore other important strategic manufacturing goals.

6. NFPIs are a better indicator of future prospects.

Financial indicators tend to focus on ST & this may damage LT profitability.


MONETARY , NON MONETARY


NFPIs can be provided quickly for managers.

Easier for non-financial managers to

understand & to use effectively.

Anything can be compared if it is meaningful

to do so.


ERRORS/FAILURE

Equipment failure

Defects

Complaints

Warranty claims

Returns

Stockouts

Lateness/waiting

Misinformation

Miscalculation

Absenteeism

TIME

Second

Minute

Hour

Shift

Cycle

Day

Month

Year


QUANTITY

Range of products

Parts/components

Units produced

Units sold

Services performed

Kg/litres/metres

m2/m3

Documents

Deliveries

Enquiries

PEOPLE

Employees

Employee skills

Customers

Competitors

Suppliers


Labour T/O – no. of staff leaving the firm & being replaced

divided by the average no. of employees. Absolute measures

– units produced, no. of defects, idle hour etc.

Material wastage – normal loss as a % of throughput, is a

measure of inefficiency.Market share

– firm’s revenue as a % of the market. Capacity level

– normally expressed in % form.


Quality of product

Relations with suppliers

Reliability of suppliers

Customer goodwill

Employee involvement and motivation

Effectiveness of quality control


Advantages

1. Provide an additional measure of

performance.

2. Take into account human behaviour

which is crucial for staff motivation etc.

Disadvantages

1. Difficulty in measurement.

2. Very subjective.


1. Sales - price & volume variance

- customer rejects/ returns : sales

- delivery delays : delivery on schedule

2. Material - price & usage variance

- no. of rejects

- timing & reliability

3. Labour - rate & efficiency variance

4. OH - expenditure & efficiency variance

- machine down time : total machine hours


Capacity ratio = AH worked X 100

Budgeted Hrs

Productivity volume ratio = SH of actual output X

100

Budgeted Hrs

Efficiency ratio – SH of actual output X 100

Actual Hours


Traditional accounting performance measurement systems do not measure skills, morale & training of workers, which can be valuable to an organisation as its intangible assets.

Employee attitudes & morale can be measured by surveying employees.

Education, skills levels, promotion & training, absenteeism & labour T/O can be monitored.


TQM embraces every activity of a business,

performance, so performance measures

cannot be confined to production process

but also cover sales & distribution,

administration, efforts of external

suppliers & reaction of external customers.


1. Measuring quality of incoming supplies.Quality control includes procedures for acceptance & inspection of goods inwards & measurement of rejects.

2. Monitoring work done as it proceeds.‘In-process’ controls include statistical controls & random sampling, amount of scrap & reworking in relation to good production. Measurements can be by product, by worker or work team, by machine type, department.

3. Measuring customer satisfaction.


Critical success factors (CSFs) refer to

specific activities, procedures or areas

that a business or organization depends

on for its continued survival. Critical

success factors are unique to each

organization, and will reflect the

current business and future goals.


CSF is the limited no. of areas in which

results, if they are satisfactory, will ensure

successful competitive performance for the

business.

They are vital areas in a co. where “things

must go right” for the business to flourish.

CSFs will be identified from the goals &

objectives of the organisation.


CSF Eg. of Critical Performance Indicators

Services • No. of customers,

• no. of new customers,

• no. of customers lost,

• repeat business from existing customers,

• market share,

• purchases per customer,

• time to serve customers during peak

periods,

• time to respond to customer orders,

• time taken to resolve customer complaints.48


Quality • No. of customer complaints per 1,000

orders filled,

• customer satisfaction surveys,

• percent on-time delivery,

• returns,

• warranty claims,

• no. of defective units supplied to customers as

a % of total units supplied,

• % of products which fail early or excessively.



Cost Ratio of costs to revenues,

ratio of amount of material in final product

to amount of material purchased,

cost of a particular activity,

customer profitability,

ratio of labor allowed for work done to total

labor,

sales per hour during peak operations.


MANAGERS FOCUSING MORE ON THE ST

GOALS RATHER THAN LONG TERM GOALS at

the detriment of long term success


Short-termism is when there is bias towards ST rather than LT performance.

EXAMPLES Decisions which sacrifice of longer-term goals

Objectives: 1. Postponing or abandoning capital expenditure

projects, which would eventually contribute to growth & profits, to protect ST CF & profits.

2. Cutting R & D expenditure to save operating costs & so reducing prospects for future product development.


3. Reducing quality control, to save operating costs but adversely affecting reputation & goodwill.

4. Reducing level of customer services, to save operating costs but sacrificing goodwill.

5. Cutting on training costs or recruitment but results in skills shortage.

If rewards are linked to performance, managers may manipulate results, egchanging timing of capital purchases, building up inventories & speeding up or delaying payments & receipts.


1. Making ST targets realistic.

2. Providing sufficient management information

to allow managers to see what trade-offs they

are making. Managers must be aware of LT aims

& ST targets.

3. Evaluating manager’s performance in terms of

contribution to ALSO LT & ST objectives.

4. Link manager’s rewards to share price to

encourage goal congruence.

5. Set quality based targets & financial targets.


Robert Kaplan & David Norton, introduced a

new performance measurement system,

consisting of both financial and non-

financial measures.

This system, called the balanced scorecard,

evaluates the business performance from 4

broad perspectives:

1. Financial

2. Internal business

3. Customer

4. Innovation & growthTewYouHoo/PerformanceMeasure 55


Financial

ROI, ROCE, Current, EPS, NET PROFIT MARGIN etc

Customer

Number of customers, no of complaints, Returns, New customers

Internal Business

Assembly time, Throughput

Innovation & growth

New products, sales units, new markets –other regions, research development activities


Financial Customer

Internal Business

Innovation & growth

Uses the financial measures like

profitability, growth


Measures focusing processes aimed at achieving

financial and customer goals


Measures focusing on how well the

company has tried to meet customer

needs


Measures which indicates whether the

company will be as important in the future

Looking at new products in the pipeline,

new markets to be ventured,

renewal of processes or systems


Financial Perspective Examines how well the organisation is

meeting its shareholder needs.Financial performance measure eg ROCE, CF,

profitability, growth & profit forecast are used.

Internal Business Perspective Examines the level of efficiency on the

execution of its core activities.Measured through manufacturing cycle times,

unit costs, reject rates, set-up times, manufacturing lead times & efficient usage of machines.


Customer Perspective Meeting customers needs.Ability of company to meet customer

satisfaction is essential to be able to stay competitive.

Measured by undertaking customer surveys, customer satisfaction indices, market share trends & prompt delivery.

Innovation & Growth Perspective (originally named innovation & learning)

Look at organisation’s ability to improve & create value.

Considers the business’s capacity to maintain its competitive position through acquisition of new skill & development of new products.


Information from each of these perspectives

is vital to organisation’s continued success.

An effective BS is one that tailored to

organisation’s mission, strategy, & internal &

external environments.

One of the major problems of BS is that

under the innovation and growth

perspective, it always provides inconsistent

set of performance measures.


Financial

Goals

Survival

Succeed

Prosper

Perspective

Measures

CF

Monthly sales growth

Market share & ROI


Customer Perspective

Goals

New products

Responsive supply

Customer partnership

Measures

% of sales from new

Products

On-time delivery

No. of cooperative

engineering efforts


Internal Business

Goals

Technology

capability

Manufacturing excellence

Design productivity

New product

introduction

Perspective

Measures

Manufacturing configurations

Vs competition

Cycle time, Unit cost, Yield

Engineering efficiency

Actual introduction schedule vs plan


Innovation &

Goals

Technology

leadership

Manufacturing learning

Product focus

Time to

market

Growth Perspective

Measures

Time to develop next generation of products

Process time to maturity

% of products that = 80% sales

New product introduction vs

competition


1. Management must define the

organisation’s primary objective.

2. Organisation must understand how

stakeholders & processes contribute to its

primary objectives.

3. Must develop a set of secondary objectives

that are the drivers of performance on

primary objectives.


4. Must develop a set of measures to monitor

performance on both primary & secondary

objectives.

5. Must develop a set of processes, along

with their attendant implicit & explicit

contracts with stakeholders, to achieve

those primary objectives.

6. Must make specific &, therefore, public

statements about its belief concerning how

processes create results.



PROBLEM EXPLANATION

Conflicting

measures

Some measures such as research funding & cost

reduction may conflict.

Difficult to determine the balance which will achieve the

best result.

Selecting

measures

Have to devise appropriate measures & agree on no. of

measures used

Care must be taken that the impact of the results is not

lost in a sea of information.

Expertise Measurement is only useful if it initiates appropriate

action. Non-financial managers may have difficulty with

the usual profit measures. With more measures to

consider this problem will be compounded.

Interpreta-

tion

Even a financially-trained manager may have difficulty

in putting the figures into an overall perspective.

STANDARDS, REWARDS, DIMENSIONS


TewYouHoo/Scope of performance measurement 77

DIMENSIONS

Competitiveness

Financial performance

Flexibility

Resource utilisation

Innovation

Quality of service

STANDARDS REWARDS

Ownership Clarity

Achievability Motivation

Equity Controllability

TewYouHoo/Scope of performance measurement78

It aims to improve the performance measurement systems of service businesses

It suggests that the performance system should be based on 3 concepts of dimensions, standards & rewards

Dimensions fall into 2 categories:

1. Results

i. Competitiveness

ii. Financial performance

2. Determinants

i. Flexibility

ii. Resource utilisation

iii. Innovation

iv. Quality of service


DIMENSIONS

Dimensions are the areas that yield specific performance

metrics for a company

By focusing on the improvement of the determinants the results can be achieved

STANDARDS

Once the dimensions of performance have been selected,

performance standards are set to facilitate performance

evaluation


When setting standards must consider:

1.OWNERSHIP

To ensure employees take ownership of standards, they need to participate in budget & standard setting processes

More likely to accept the standards, more motivated & morale is improved

Disadvantage of participation – offers opportunity for introduction of budgetary slack

2. ACHIVABILITY

Standards need to be high enough to ensure there is sense of achievement in attaining them, but not so high that it is demotivating because they are unachievable

3. EQUITY

Performance of different business units should not be measured against the same standards if some units have an inherent advantage unconnected with their own efforts.

TewYouHoo/Scope of performance measurement

81

REWARDS

Rewards are linked to performance, ie achievement of

standards

Should define how the achievement of standards will be

rewarded (reward system)

1. Motivation

The reward system should motivate staff by rewarding them

for successful achievements

2. Clarity

The targets & reward system should be clearly understood

by the staff so that they feel motivated

3. Controllability

The rewards should be related to areas of responsibility that

the staff controls in order to achieve that motivation

1. Profitability

i. Profit ii. Value of WIP

iii. Return on net assets

2. Liquidity

i. Debtors days ii. Creditors days

iii. Total WC

3. Capital structure

i. debt/equity

ii. LT to ST debt

4. Market ratios

i. PE

ii. ROCE


1. Sales growth

2. Market share

3. Repeat business

4. Number of customers

MEASURES FOR FLEXIBILITY DIMENSION

1. Delivery speed

2. Volume flexibility (coping with demand)

3. Response to customer specifications


1. Productivity

2. Utilisation rate

3. Service rendered per labour-hour

EXAMPLE - RESOURCE UTILISATION MEASURES

Business Input Output

Accounting firms Man hours available Chargeable hours

Hotels Rooms available Rooms occupied

Railway companies Train miles available Passenger miles

Banks Number of staff Number of accounts


Individual innovations should be measured in terms of whether

they bring about improvements in the other 5 dimensions

Innovation process can be measured in terms of:

1. Cost

i. Average development cost per service

ii. Development cost of individual service

iii.% of turnover spent developing new service/products/processes

2. Effectiveness

i. How many new services developed per annum

ii. How many new services that are successful

iii.Proportion of new services to total services provided

3. Speed

i. Concept to service launch time

ii. Time to adopt new concept from outside the firm


1. Reliability

2. Competence

3. Customer relation/feedback

4. Number of complaints

5. Customer retention rate

6. Responsiveness

7. Friendliness

8. Cleanliness



The performance measures like flexibility towards volume

of production, flexibility towards specification, flexibility

towards speed of delivery & responsiveness of customer

order, are qualitative factors

It is difficult to measure a qualitative factor & set a

target in qualitative areas

Therefore it is common that qualitative targets & the

quality factors are not expressed in monetary terms

The existence of such a factor is reported alongside the

quantitative factors

Often qualitative factors are given more importance than

the quantitative figures & a decision is influenced

accordingly by the qualitative factors


The cost of doing a quality job, conducting quality improvements & achieving goals must be carefully managed, so that the LT effect of quality on the company is a desirable one

These cost must be a true measure of the quality effort & are best determined from an analysis of the costs of quality

Such an analysis provide:

A method of assessing the effectiveness of the management of quality

A means of determining problem areas, opportunities, saving & action priorities

Cost of quality is a powerful tool to raise awareness of the importance of quality

Quality related activities that will incur costs may be split into prevention costs, appraisal costs & failure costs


Dimension of

Performance

Types of Measures.

RESULTS Competitiveness Relative market share &

position, sales growth.

Financial

Performance

Profitability, liquidity,

capital structure, market

ratios.


Dimension of

Performance

Types of Measures

DETERMINANTS Quality of

Service

Reliability, competence,

responsiveness,

aesthetics/appearance,

cleanliness/tidiness, comfort,

friendliness, communication,

courtesy, access, availability,

security.

Flexibility Delivery speed flexibility, coping

with demand, response to

customer specification.


Dimension of

Performance

Types of Measures

DETERMINANTS Resource

Utilization

Productivity, efficiency.

Innovation Performance of

individual innovations,

performance of

innovation process.

1. The employee must understand his job & the reward system & believe that it measures what he controls & contributes to the organisation.

2. Must measure the employee’s inputs or outputs.

3. Must reflect the organisation’s critical success factors.

4. Must set clear standards for performance that the employee accepts.

5. Must be able to measure the objects of measurement systematically & accurately.

6. When appropriate, reward group performance.


1. Clarifying objectives of the organization.

2. Developing agreed measures of activity.

3. Greater understanding of the processes.

4. Facilitating comparison of performance in

different organisations.

5. Facilitating the setting of targets for the

organisation & its managers.

6. Promoting accountability of the

organisation to its stakeholders.


f5 performance measurementj2015chp17

Education

qualitative measures

variety of measures

performance indicator

overall performance

realistic estimates

control processhow

realistic standards

cost benefits