l9 : performance measurement & management Flashcards
what is the key performance indicator in a decentralised and multi-divisional firm?
profitability
give 5 advantages of decentralisation.
- top management freed from everyday problems to focus on strategic issues
- lower level management gains experience
- motivation
- better information
- evaluation of performance
give 4 disadvantages of decentralisation.
- loss of bigger picture
- lack of coordination
- conflict of interest & agendas
- communication
what is a managers main objective for a a decentralised, multi-divisional firm?
preserving divisional autonomy whilst ensuring firm-wide optimisation
what is the equation for ROI?
net profit / investment in net assets
OR
(sales / investment in net assets) x (net profit / sales) ≡ asset turnover x profit margin
give 3 advantages of using ROI as a measure of divisional performance.
- relative measure which takes account of profit as well as all assets invested in the firm / division
- compatible with conventional financial reports
- enables comparison between firms / divisions
give 4 potential problems of using ROI as a measure of divisional performance.
- calculation of operating profit may be different as divisional revenue & expenses calculated diff
- determination of asset base (cost or NBV used?). if NBV is used, investment base will shrink overtime due to depreciation, making ROI increase even though it might actually need investment
- transfer pricing problem
- dysfunctional behaviour
what is RI?
residual income. income or profit that is generated by a division which exceeds the minimum acceptable level of income (amount necessary to cover cost of capital)
why are ROI and RI used?
divisional profit is inadequate measure of divisional performance - have to take account of investment in assets required to generate that profit.
give the equation for RI.
divisional profit - charge for capital invested = RI
what does a positive RI mean?
means the division is generating returns in excess of the minimum requirements of the business. higher the excess returns, better the performance of the division
what is EVA?
economic value added. measures amount of wealth that has been created for the shareholders
give the equation for EVA.
EVA = NOPAT - (R x C)
NOPAT - net operating profit after tax
R - required returns of investor (cost of financing)
C - capital invested (net assets)
what is transfer pricing?
setting prices for inter-divisional trading
what are the 5 objectives of transfer pricing?
- optimising of the profit of the business
- assessment of performance
- independence of divisions
- tax minimisation
- allocating divisional resources
what makes a good transfer price?
- maximises economic benefit of company as a whole
- facilitates localised decision making
- appeals to divisional managers - should be happy with the prices
- tax saving
what is the key point of transfer pricing?
transfer prices should motivate managers of individual divisions to act in the best interests of the firm as a whole
what are the three transfer pricing methods?
- market-based transfer prices
- cost-based prices (variable cost based & full cost based)
- negotiated prices
explain market-based transfer pricing.
applicable when external competitive market exists. price is an objective, verifiable amount which has real economic credibility. price may not always be appropriate for the division as may be spare capacity leading to lost sales.
explain cost-based transfer pricing.
variable cost based & full cost based.
using these pricing methods may lead to slack, wrong decisions being made. can also lead to negotiation which involves power play & interpersonal skills.
explain negotiated prices transfer pricing.
more practical, widely used. but pricing is artificial (not market behaviour based) and has all same disadvantages of cost-based pricing.
