6 Flashcards
What are the advantages of team based structures and fatter hierarchies
Managers of teams have better local information about markets and operations to enable them to manage their areas more effectively
Provides managerial training for future higher-level managers
May lead to greater motivation and job satisfaction for unit managers
Allows corporate managers more time for strategic issues
Delegation allows organisation to react quicker to opportunities and problems as they arise
What are the disadvantages of team based structures and fatter hierarchies
Managers may focus too narrowly on their own units performance rather than on attaining organisations overall goals
Some tasks and services may be duplicated unnecessarily
What is goal congruence
Represents consistency between managers personal goals and goals of organisation
Helps ensure that decentralised organisations are effective
What are the agency problems behavioural changes
Goal congruence may be difficult to achieve in a decentralised organisation due to self interest
Productivity is affected by all team members but inputs such as effort is hard to observe
Team members therefore have incentives to free ride
Principal agent problem can lead to agency costs(decline in firms value due to agent pursuing his/her own interests)
Is it goal congruence achievable
Probably unrealistic. Self interested individuals often don’t change their preferences
What do financial performance reports show
Key financial results appropriate for type of responsibility centre
What are cost centres
Budgeted and actual costs that relate to operations
What are profit and investment centres
Wider range of financial information in line with managers specific responsibilities
What are summary profit based measures used for
To evaluate the performance of profit and investment centres
Profit
Return on investment
Residual income
Economic value added
What are ways to improve return on investment
Increase return on sales by increasing selling price or sales revenue, or decreasing expenses
Increase investment turnover (sales revenue to invested capital) by increasing sales revenue or reducing invested capital
However, actions taken with sole purpose of making these ratios more favourable in short term may have adverse effects on performance in future years
What are the advantages of return on investment
Encourages managers to focus on profits and assets required to generate those profits
Promotes an understanding of relationship between revenues, costs and assets
Can be used to evaluate relative performance of investment centres even when those business units are of different sizes
What are the disadvantages of return on investment
Encourages manages to focus on short-term financial performance at expense of long-term viability and competitiveness
Encourages managers to defer asset replacement – to maintain high ROI and apparent high-performance
Discourages managers from investing in projects which are acceptable from organisations point of view but decrease investment centres ROI
How do you minimise the behavioural problems of ROI
Use ROI as one of several performance measures that focus on both short-term and long-term performance
Always use market value (not depreciated value) of assets
Use alternative financial methods such as residual income or economic value added
What is residual income
Amount of profit that remains after subtracting an imputed interest charge
What is imputed interest charge
Company’s rate of return expected from its investments
This is based on either minimum required rate of return on invested capital or weighted average cost of capital
What are the advantages of residual income
Takes account of organisations required rate of return in measuring performance hence more likely to promote goal congruence, compared to ROI
Encourages investment in projects which yield a positive residual income to organisation
What are the disadvantages of residual income
It’s an absolute monetary measure so cannot be used to assess relative performance of businesses that are of different sizes unlike ROI
Formula is biased in favour of larger businesses unlike ROI
Can encourage short-term orientation/focus as with ROI
What is economic value added
Used to be called residual income
Extends residual income by incorporating adjustments to traditional profit measures – to convert historic accounting profit to an approximation of economic profit, removing distortions that arise my measuring profit based on a GAAP
Adjustments typically include spreading costs over periods in which economic value is realised
What figures should you include in RAI, RA and EVA
Profits and assets (invested capital) must be specified for ROI, RI and EVA
To measure managerial performance, only controllable profits and assets should be included
To measure economic performance, all profits and assets and possibly an allocation of corporate assets should be included
What are profit statements
Shows profits for major responsibility centres (divisions and departments) and for entire organisation
Costs are reported by cost behaviour (that is, variable costs are reported separately from fixed costs)
Indicates relative contribution of various divisions and departments to overall profit
What are the problems of the financial performance measurements
Each measure emphasises only one perspective of performance
Focus on financial outcomes of past actions and not on determinants of outcomes
Provides limited guidance for future actions
May encourage short-term actions which decrease shareholder and customer value
What do you managers need to do to improve and understand performance
Manage determinants of performance
Also use non financial performance measures
