Financial Performance Indicators

Question 1

Financial performance indicators are typically grouped to measure the following aspects of performance:

Answer 1

1. Profitability
2. Liquidity
3. Solvency
4. Markets

Question 2

Management considerations when setting performance measures

Answer 2

1. Measure only controls cost/income
2. Measure should reflect the full economic performance of division/business
3. Performance information should be timely
4. Performance measures should promote goal congruence (align to organisations strategic objectives)

Question 3

Evaluation of financial performance indicators

Answer 3

-> do not inform future performance
-> financial date time lag
-> number of metrics may cause info overload
-> companies may use accounting policies

Question 4

Factors that may prompt senior management to introduce a divisional structure:

Answer 4

-> decision makers at divisional level have more awareness of their markets and services and of local problems (closer to and have better understanding of day today operational problems)
-> should have greater speed of decision making and responses to changing events as no need to refer decisions upwards
-> should allow senior management to concentrate on strategic problems affecting the organisation as a whole
-> should help junior managers to develop in roles of responsibility
-> improve motivation of divisional managers

Question 5

Potential problems that may arise with a divisionalised organisational structure

Answer 5

-> duplication of functions
-> potential loss of info needed by senior managers to make strategic decisions
-> loss of goal congruence
-> time required by senior management to resolve disputes between divisions
-> potential loss of control by delegating decision making

Question 6

Return on investment

Answer 6

= profit / investment

1. ROI is a relative measure of performance that can be compared with other investments (ADV)
2. Managers may be motivated to make decisions that make the company worse off (DIS)

Question 7

Residual income

Answer 7

= profit - cost of capital charge on investment

1. Different cost of capital percentage can be applied to different investments that have different levels of risk (ADV)
2. RI should be compared with budgeted/targeted levels which reflect the size of the divisional investment (DIS)