Chapter 13: Performance measurement and control Flashcards
General considerations for all ratio analysis
1) figures used from a particular point in time - not necessarily representative throughout a period
2) ratios little use in isolation - compare YoY to find trends or competitors results
3) can be manipulated by management- window dressing
4) indicate areas of further investigation rather than a definitive answer
What is gross profit margin
Gross profit as a % of turnover
Gross profit/ turnover *100
aim: high GPM- either sales price are high or production costs are under control
What is operating profit margin
Operating profit (turnover- expenses) as a % of turnover
Operating profit/ turnover * 100
aim: High OPM- sales prices are high or production costs are under control
What is return of capital employed (ROCE)
measures profitability
operating profit as a % of capital employed
shows op profit generated from each $1 of assets employed
Good for investors- under/over performance
operating profit/ capital employed * 100
capital employed= total assets- current liabilities or total equity+ LT debt
If OP not given (profit before finance charges & tax) use net profit instead
Aim: high ROCE- increased OP (sales price of cost control) or reduced capital employed (repaying LT debt)
ROCE= operating profit margin x asset turnover
What is asset turnover
measure of efficiency
shows turnover generated from each $1 assets employed
turnover/ capital employed
aim: high- increased turnover (launch new products/ successful ad campaign) or reduced capital employed (repaying LT debt)
What is an inventory holding period
measues efficiency
Inventory/ cost of sales * 100
shows average no of days inventory items are held for
increase: problems selling stock, increased obsolete inventory, want to increase turnover e.g remove slow moving stock/ unpopular items
Decrease: desirable- improved ability to turnover inventory, no cash tied up in inventory, could show difficulties managing liquidity and not have the ash to hold optimum inventory level
What is the receivables (debtor) collection period
measure of efficiency
receivables/ credit sales * 365
shows average period taken for debtors to pay what they owe.
increase- company struggling to manage its debts- credit checks on customers to ensure they’ll pay on time, improved credit control i.e invoice on time, chase up bad debts
decrease- improved management of receivables but if it’s well below industry average could show them to be uncompetitive and impact profit
What is the payables (creditor) payment period
measure of efficiency
payables/ credit purchases * 365
shows average period for a company to pay its purchases. If credit purchases not available use purchases or cost of sales
increase- company struggling to pay debts when due or taking advantage of better credit period offered
decrease- improved payments but don’t pay too early ( credit is a useful source of finance)
What is the current ratio
Measure of liquidity
current assets/ current liabilities
shows the company’s ability to meet ST liabilities as they’re due
aim- ratio >1 - but depends on the type of industry
decrease YoY- shows they they’re below industry average (liquidity problems). Company should try and improve liquidity e.g pay debtors when due or better manage receivables to reduce bad debts
What is the quick ratio (acid test)
measure of liquidity
current assets don’t include inventory (poor ST liquidity)
(current assets- liquidity)/ current liabilities
shows the company’s ability to meet ST liabilities as they’re due
aim- ratio >1 - but depends on the type of industry
decrease YoY- shows they they’re below industry average (liquidity problems). Company should try and improve liquidity e.g pay debtors when due or better manage receivables to reduce bad debts
What is operating gearing
measures gearing/ risk
shows extent to which a firm’s operating costs are fixed rather than variable- affects level of business risk in firm
1) fixed costs/ variable costs
2) fixed costs/ total costs
3) % change in EBIT/ % change in revenue
4) contribution/ EBIT
firms with a high proportion of FC known as having a high operating gearing
What is financial gearing
LT debt as a % of equity
debt/ equity * 100
or
debt / (debt+equity) * 100
debt includes LT debt, bank overdraft (net of cash balances) and preference shares
Equity includes issued ordinary share capital, share premium and reserves of the company (e.g retained earnings)
high gearing - relies heavily on debt to finance its LT needs. increases risk since interest & capital repayments must be made on debt, no obligation on equity
improve ratoi via reducing LT debt and raising LT finance using equity
What is interest cover
measure of gearing/ risk
operating profit (before finance charges & tax) / finance cost
decrease- company is facing increased risk of not being able to meet its finance payments as they’re due
improved via increasing operating profit e.g better cost management, reduced finance via reduced debt
What is dividend cover
measure of gearing/ risk
net profit (available to ord shareholders (profit after tax and preference divs)/ dividend
decrease- indicates company is facing increased risk of not being able to pay its div payments to shareholders
Issues of financia performance indicators to monitor performance
1) short-termism - linkig managers and rewards- focus may not be LT e.g cut investment or purchase cheaper/ poorer quality materials
2) manipulating results - accelerate revenue = from 1 year could be included in prev year to improve that performance
delaying costs= could record in next year to improve performance and meet target for this year
understating provision / accrual= would improve performance to achieve targets
manipulation of accounting policies = closing inventory values overstated so increased profits for year
3) not conveying the full picture- doesn’t include factors driving LT profitability e.g customer satisfaction/ quality
Examples of non- financial performance indicators
wide range of products
strong brand name/ image
low prices
quick delivery
customer satisfaction
What ia a balanced scorecard?
provides management with a set of info covering all relevant areas of performance
1) customer- what do they value about us
2) internal business process- what processes do we need to excel at to achieve our financial and customer objectives
3) innovation and learning - how can we continue to improve and create future value
4) financial- how to create value for shareholders
Benefits of the balanced scorecard
focuses on factors including non financial ones- enables LT success
provides internal and external info
Problems of the balanced scorecard
choosing measure can be difficult
obtaining info can be difficult e.g customer feedback
info overload from large no of measures that can be chosen
conflict between measures- e.g profitability can increase ST where training costs decrease
What is the building block model
By Fitzgerald and Moon
design & analysis of performance management systems
Based on 3 blocks:
1) dimensions
2) standards
3) rewards
What is the dimensions block in the building block model
goals for the business & suitable measures for each performance dimension
Areas that yield specific metrics for a company
Profit, competitiveness, quality, resource utilisation, flexibility, innovation
1) downstream results (competitive & financial performance)
2) upstream determinants (quality of service, flexibility, resource utilisation and innovation - 4 more drivers)
What is the standards block in the building block model
targets for the metrics chosen from the dimensions
employees need to view standards as achievable, fair and take ownership
What is the rewards block in the building block model
employee motivators to work towards standards set
clearly understood by staff
related to their areas of responsibility to achieve that motivation
clarity, motivation, controllability
What are examples of standards (measures) for competitive performance (goal)
Market share
sales growth
customer base
What are examples of standards (measures) for financial performance(goal)
profitability
liquidity
risk
What are examples of standards (measures) for quality of service (goal)
reliability
responsiveness
competence
What are examples of standards (measures) for flexibility (goal)
volume and delivery speed
What are examples of standards (measures) for resource utilisation (goal)
productivity
efficiency
What are examples of standards (measures) for innovation(goal)
ability to do so and perform it
What are 3 important external considerations
1) stakeholders - individuals/ groups that have an interest in the business e.g customer, shareholders, Gov, community etc
2) Market conditions- impacts performance
3) competitors- e.g they reduce price so our volume drops
How can sustainability be incorporated into balanced scorecard
current scorecards are still shareholder wealth based
4 perspectives to include it into the scorecard
1) customer perspective - take interest of sustainability stakeholders into account e.g green/ environmentally conscious customers; local communities; Gov regulators
2) Internal business process perspective - have environ impacts been considered? e.g waste, recycling, pollution- do HR processes consider best practices around H&S, diversity, equal opps?
3) learning & growth perspective- training and development programmes promote sustainability as part of the culture of the org. Do innovations result in efficiencies that reduce waste/ pollution?
What sustainability KPIs can be used
Energy- consumption/ saved due to implemented improvements
Water- consumption/ footprint, % of water reused or recycled
Waste - generated, type & disposal method, production rate
Emissions- toxic emissions, CO2 emissions, GHG emissions, carbon footprint
Materials- raw material usage, % of non-renewable and recycled materials used, product recycling rate %
Supply chain- 5 of suppliers that comply wiht established sustainability strategy, supply chain miles
Social -no of H&S incidents (workplace safety), no of sick days (employees health & well being)
