B. Performance Management

Question 1

What is a product profitability analysis?

Answer 1

Shows which products are the most profitable, which need to have their prices and costs reevaluated, and which should get the greatest amount of marketing and support attention.

Analysis: Sales - VC = CM - Traceable FC = Contribution after all relevant costs (NOTE: Analysis excludes all “non-traceable” fixed costs)

Question 2

What is a “business unit profitability analysis”? What specific measures are used to analyze a business unit?

Answer 2

Shows which strategic business units (SBU’s) are most profitable, which need to have their prices and costs reevaluated, and which should receive the most attention.

Specific measures:
A) Contribution Margin (CM) = Revenues - VC; useful because eliminates FC that are beyond management’s control
B) Direct / Controllable Profit (DCP) = CM - Traceable FC; *the measure that should be used to analyze an SBU
C) Income Before Taxes = DCP - All Other Costs Other Than Taxes; makes SBU seem accountable for costs uncontrollable by manager
D) Net Income = IBT - Taxes; makes SBU seem accountable for costs uncontrollable by manager (same as IBT)

Question 3

What is a “customer profitability analysis”?

Answer 3

Evaluates the costs and benefits of providing goods or services to a specific customer or customer segment.

Two primary objectives:

1) Measuring customer profitability
2) ID’ing effective and ineffective customer related activities and services

Benefits include non financial and financial measures. (Ex. Customer may be unprofitable in the short run, but could be beneficial in the long run by bringing in other customers)

Question 4

What is “return on investment” (ROI)?

Answer 4

Measures profitability by dividing the net profit of the business by the investment in assets made to attain that income.

ROI = Net Income / Total Assets

Other Notes:

• Can be measured in the short- or long-term
• Return on Assets (ROA) = Net Income / Avg. Assets
• Return on Equity (ROE) = Net Income / Common Equity S/H
• Financial Leverage = Assets / Equity (Avg. SH Equity)
• Issue: Could lead managers in SBU’s with existing ROI’s to reject new projects if new projects ROI is lower than the SBU’s ROI (thus having a dilutive effect) even if the new project is best for overall organization

Question 5

What is “residual income”?

Answer 5

The dollar amount of income less a chosen required rate of return for an investment.

RI = NOI - (Assets x RRR)

Question 6

Compare the advantages and disadvantages between residual income (RI) and return on income (ROI).

Answer 6

The nature of the company’s business and industry will affect how the company perceives ROI. (ex. a particular industry may have lower than average ROI’s and the market will view slightly higher ROI more favorable even if it is lower than ROI’s for most industries)

Focusing ONLY on ROI is generally NOT a good business policy; should consider other factors (nonfinancial and financial), too.

Disadvantage of ROI: Managers of SBU’s with higher profits may reject capital investments that do not promise as good or better ROI’s than the rate being currently earned–even if the investment is strategically beneficial to organization as a whole.

RI gives managers the incentive to select any project that generates returns above the required rate of return (RRR). Difficult to compare different SBU’s within an organization using RI, though.

ROI & RI Problems: Involves maximizing profits while minimizing investments

Question 7

What is a balance scorecard (BSC)? Describe it in detail.

Answer 7

Provides companies with a simple tool to show specific financial and nonfinancial indicators.

Focuses on four (4) balanced categories:

1) Financial measures
2) Customer measures
3) Internal business process measures
4) Learning & development measures

Identifies critical success factors (CSF) and arranges them into a SWOT (strengths, weaknesses, opportunities, and threats) analysis.

After defining the CSFs, measurement units are assigned to each CSF

Question 8

Describe the four balanced categories of a balanced scorecard (BSC).

Answer 8

Four Major Categories:

1) Financial Measures: all cause-and-effect relationships should be linked to financial measures
2) Customer Measures: market share, acquisition, satisfaction, retention, profitability
3) Internal Business Process Measures: innovation, operatings, postsale service
4) Learning and growth measures: developed AFTER ID’ing company’s financial customer, and internal process stategic goals. The last step tested. Three categories = Employee skill sets, Information System Capabilities, Empowerment, Motivation, and Organizational Alighment