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Question 1: Why is a mission statement important to developing a performance measurement system?

Answer 1: A mission statement defines the purpose of the business organization and identifies how the organization intends to meet its customers' needs through its products or services. It is the basis for setting the organizational strategy. This mission statement must be communicated and understood by all employees.

The first step toward designing a performance measurement system is for an organization to have a well-defined mission statement that is communicated and understood by all employees. A mission statement defines an organization's purpose for being in business. One company's mission statement is very simple: "We will provide branded products and services of superior value and quality that improve the lives of the world's customers" (Purpose, Values and Principles, n.d.). The company's values, goals and objectives, and performance measurements are all based on that simple mission statement.

Question 2: Why should management focus on long-run performance measurements rather than short-term measurements?

Answer 2: Long-run performance measurements tend to be more proactive and use leading indicators rather than lagging indicators. Leading indicators include measurements of quality, delivery, price, and service to customers to grow market share and invest resources to improve technology and superior product design. Short-term lagging indicators such as current financial ratios would lead management to maximize current profits without looking toward the future well-being of the company and its competitive place in the industry.

Question 3: When deciding on nonfinancial performance measurements, what criteria are important?

Answer 3: Managers should take into consideration the following criteria:

• Measurements should be quantitative and not qualitative because people are more comfortable with quantitative measurement.

• The measurements must be specific, easily understood, and communicated to those who will be affected.

• Measurements should be easily obtained and reported in a timely

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manner. Too many measurements are confusing, time consuming, and counterproductive.

• Management should develop measurements that are key to meeting the goals of the department or organization.

Question 4: How do you approach a performance analysis?

Answer 4: The approach to performance analysis begins with the organization's mission, purpose, and values. Based on these, management develops budgets, estimates, and plans that support the objectives of the organization.

Actual performance of each responsibility center is then determined based on the variances to the budget, estimate, and plan. Generally, this is done at the end of each accounting cycle (monthly, quarterly, and annually).

Budgets are generated on an annual basis, estimates are made each quarter, and plans are put together monthly in support of the budget and estimate. Each is based on the economic environment at that time. Many organizations compare actual performance to each. The plan, estimate, and budget can be the same depending on the economic environment. Changes are made only if the business dictates that major changes are required.

Question 5: Why is it important for a company to use multiple measures of performance?

Answer 5: The success of a business is dependent on a lengthy list of complex factors. Multiple measures of performance allow an organization to review this large variety of factors leading toward successfully meeting its mission, goals, and objectives.

Question 6: What are the challenges and difficulties of measuring performance in a multinational company?

Answer 6: The challenge or difficulty comes from the differences in the following:

• Accounting practices in different countries • The cost of financing a project • The laws surrounding labor and taxes

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• The work ethics of the employees of different cultures • The stability of the country's political system • Currency exchange rates, labor rates, and inflation rates • The standard of living in each country

Question 7: Why are businesses moving away from automatic pay increase systems and moving toward an incentive compensation plan?

Answer 7: The increasing global-pricing competition is causing businesses around the world to look for ways to decrease costs and increase quality and service to customers. A properly designed incentive compensation plan will decrease costs and increase quality and service to the customer. The older automatic pay increase systems did not link performance to pay and did not motivate employees to improve their performance.

In addition, an important part of establishing a performance measurement system is to include a compensation strategy that motivates and rewards individuals for their performance against establishing goals. A compensation strategy should lower overall costs and raise profits by encouraging higher levels of performance and loyalty.

The pay-for-performance plan should include financial rewards such as an employee stock ownership plan (ESOP), bonuses, and incentive pay increases linked to the financial and nonfinancial established measurements.

The nonfinancial rewards including recognizing good performance through compliments, department lunches, and certificate of achievement rewards are just as important as financial rewards. A good compensation strategy includes both monetary and nonfinancial rewards that are linked to meeting or exceeding established performance measurements.

Question 8: What is the benefit to an organization to have a compensation plan that includes both cash and an ESOP?

Answer 8: The most important benefit to the organization is that it makes the employees of the company part owners. This motivates the employee to increase the profitability of the company in an effort to increase the market value or share price. This type of incentive program is usually based in part on individual performance and overall company performance, thereby, linking the employee to the overall performance of the company.

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Secondly, the payment made to the employee stock ownership plan (ESOP), whether the payment includes cash or stock options in a tax-deductible payment for the company, increases net income and can be a deferred tax or pretax income to the employee.

Question 9: Using a balanced scorecard (BSC) approach, which classification should each be assigned?

Answer 9:

• quality • cost • manufacturing process delivery performance • financial accounting services • people productivity and development • inventory management • marketing/sales and customer service

A balanced scorecard (BSC) approach to performance measurement divides performance measurements into four perspectives: financial perspective; customer perspective; internal perspective; and learning, innovation, and growth perspective.

• Quality is part of the customer perspective. It is quantified by customer complaints and warrant claims.

• Cost is part of the internal perspective. It is quantified by profit margin and variances from standard cost.

• Manufacturing process delivery performance is part of the internal perspective. It is quantified by length of process time and on-time customer delivery.

• Financial accounting services are a part of the financial perspective. It is quantified by report accuracy and timeliness.

• People productivity and development is part of the learning, innovation, and growth perspective. It is quantified by employee advancement and product innovation.

• Inventory management is part of the internal perspective. It is quantified by inventory turnover and customer order fill percentages.

• Marketing/sales and customer service is part of the customer perspective. It is quantified by customer loyalty and sales increases.

Question 10: What is residual income (RI), return on investment (ROI), and

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economic value added measurements?

Answer 10: Residual income (RI) is the profit earned that exceeds an amount charged for funds committed to a resource or profit center. RI = Income – (Target Rate * Asset Base). Simply put, a company sets an expected target rate of return on an investment in an asset. The RI is the return above that expected rate. If a company sets an expected rate of 10%, and the asset produces an annual return of 15%, then the RI is the 5% difference.

Rate of return (ROI) is a ratio relating income generated by an investment to the resources or assets used to produce that income. ROI = Income / Assets Invested. If the annual income is $10,000, and the investment was $100,000, then the ROI is 10% ($100,000 / $10,000).

Economic value added is similar to RI. It is a measure of the profit produced above the cost of capital. Simply put, if a company borrows funds to invest in a new piece of equipment in which the rate to borrow is 7.0%, and the equipment produces a return of 10%, then the residual income is the 3% of that difference that was gained by investing in the equipment. RI is usually stated in dollar terms.

All three of these measurements have limitations. They are short-term lagging indicators and use financial information that can be manipulated or managed in the short run. They measure a single department or operation and can be very different from the performance of the total company or organization, and the investment in the resource or asset can be hard to relate to a specific product or department. An example would be a research and development (R&D) investment.

Reference

Purpose, values and principles. (n.d). Retrieved from P&G Web site: http://www.pg.com/company/who_we_are/ppv.jhtml