Divisionalisation- performance measurement Flashcards
What is decentralisation/ divisionalisation?
When decision making is not confined to a few top executives but spread throughout the organisation.
Basis of decentralisation
1) Product
2) Geographical region
3) Customer type
4) Sales channel
Advantages
1) Local knowledge
2) Efficiency of decision making
3) Increase motivation
4) Allows for comparison of performance between decisions
5) Training opportunities for junior management
Disadvanatges
1) Loss of goal congruence
2) Loss of economies of scale
3) Duplication of services
4) Profit measurement
5) Communication and conflict
6) Transfer pricing
What is the central responsibility (parent company)?
They are responsible for strategic direction of company and raising of finance.
What is the divisional responsibility?
- Manufacturing operations
- Selling and promotion
- Hiring and firing
- Maintenance
- Customer relations
What makes a good performance measure?
1) Incentive to make right decisions
2) Controllability
3) Long term as well as short term focus
ROI formula
Profit/ Investment
What is used to evaluate the performance of divisional managers?
Controllable ROI
What is used to evaluate the economic performance of the division?
ROI
Residual income formula
RI= profit - imputed interest on investment
Imputed interest formula
Cost of capital x investment
Disadvantage of ROI
1)Leads to a focus on short term divisional performance at the expense of long term goals.
2) Doesn’t take into account different cost of capital percentages for different risk
3) Requires a target to assess performance
Advantages of ROI
1) Widely used and accepted
2) Relative measure so allows for comparisons
3) Can be broken down into secondary ratios for more analysis
Problems with both ROI and RI
1) Different accounting policies can confuse comparisons e.g. NBV for measure of assets
2) Little consistency in choice of profit and investment measures
3) Exclude intangible assets
4) Does not provide reason for performance
What is the improvement on ROI and RI?
Economic Value Added
What is EVA?
It extends RI by incorporatiing adjustments to the accounting profit to reflect economic value generated by the company.
Formula for EVA
(Conventional divisional profit +/- Accounting adjustments) - cost of capital charge on adjusted divisional assets
Features of good performance measure
1) Incentive to make right decisions
2) Controllable
3) Long term as well as short term
What is measured with divisional controllable profit?
The performance of the divisional manager
What is measured by divisional profit contribution?
The costs that are directly linked to a division
What is measured by divisional net profit before tax?
Allows for performance comparison with other companies
Disadvantages of ROI and RI
- Historical measure to predict future
- Influenced by accounting policies (depreciation, stock value)
- Enhanced by delayed discretionary expenditure (manipulation)
- Improves investment over time
Balanced ways of reporting
- Intangible asset scorecard
- Performance pyramid
- Tableau de bord
- Results and determinants framework
- Balanced scorecard
