Performance Management

Question 1

Chapter 2 - Governance — Structure
What is Corporate Governace and its purpose?
The key players in a corporate governance structure are:
What is the Board of Directors?
What are Subcommittees?
What is the Audit Committee

Answer 1

What is Corporate Governace and its purpose?
Corporate governance is the connection between a company’s executive management, Board of Directors, shareholders, and stakeholders. It provides the framework by which the strategic objectives of the company are set and the monitoring and measurement of those objectives.
The purpose of governance is:
• to reduce ambiguity and confusion in the organization
• to enhance the effectiveness of strategy, risk management, resource allocation, monitoring, and overall organizational effectiveness
• to enhance relationships between management and principals (owners and other stakeholders, including communities and society)
• to reduce the risk of organizational failure

The key players in a corporate governance structure are:
• shareholders (and other relevant external stakeholders for instance regulators)
• the Board of Directors (and its various committees)
• executive management
Executive management are individuals at the highest level of organizational management who have the day-to-day responsibilities of managing a company or corporation; they hold specific executive powers conferred onto them with and by authority of the Board of Directors and/or the shareholders. They will carry out the directives of the board and are responsible for operating the business within the governance plans and policies established.

What is the Board of Directors?
In a publicly traded company, the members of the board are elected by the shareholders. In private corporations, the members can be chosen by the shareholder(s) or appointed by the other members of the Board of Directors. In an organization where there is voting membership (such as a professional body), the members choose the board.
The Board of Directors appoints executive management and establishes committees to deal with various aspects of governance in more detail.
Responsible for appointing Committees (Key ones are Compensation / Risk / Audit / Nominating
Role of a Board of Directors is to provide strategic direction to the organization and oversight of senior management’s activities.

In accordance with the Canadian Securities Administrator’s National Policy 58-201 — Corporate Governance Guidelines, the responsibilities for publicly traded companies are as follows:

• Adopt a strategic planning process and at least annually approve the strategic plan.
• Identify the principal risks impacting the organization and oversight of the company’s risk management activities.
• Monitor the organization’s controls and information systems.
• Develop the company’s corporate governance approach.
• Develop the roles and responsibilities for the chairperson, the board, subcommittees of the board, and the chief executive officer (CEO).
• Appointing the CEO and succession planning.
• Assess senior management’s performance and compensation.
• Assess senior management’s tone at the top to ensure that they create a culture of integrity.
• Adopt a written business code of conduct that is applicable to everyone in the organization and monitor compliance with the code.
• Adopt a communication policy for the organization.

Other best practices of board responsibilities include:

• overseeing the execution of the company’s strategic plan
• monitoring the company’s financial performance
• determining and monitoring a company’s resources, products, and services
• ensuring that new directors receive a comprehensive orientation

Some other best practices for an effective board include:
• assessing the board, its committees and each individual director’s performance on a regular basis
• ensuring that board composition consists of a majority of independent directors
• ensuring that the board chair is an independent director
• holding independent directors meetings regularly (excluding non-independent directors)

Board members must have certain qualities to effectively carry out their responsibilities. The first is that they should have experience in the industry of the organization. They should also understand their responsibilities within a system of corporate governance.

The second skill board members must possess is the willingness to challenge management’s decisions. If board members are complacent or are influenced, perhaps because there is a member of executive management on their board, they are not carrying out their responsibilities of oversight, allowing for poor decision making or mismanagement of organizational resources.

Board members must also have a duty of care, meaning they will exercise the same care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Board members are also expected to have a duty of loyalty, meaning they put the organization’s interests ahead of their own all the time.

There are no specific rules or regulatory requirements regarding the maximum number of board members a company should have. In practice, board membership ranges from 3 to 30 directors. The factors to consider in determining the number of directors is the objectives of the organization. A small private business might benefit from a having small number of board members to help executive management make better decisions. A non-profit organization might benefit from having a larger number of directors as having more directors facilitates fundraising initiatives.
In order for the board to run effectively, the directors should elect a chairperson, which is commonly referred to as the chair. The chair’s role is to provide leadership. The chair’s responsibilities include:

• calling meetings of the board and setting the agenda for the meeting
• ensuring that the board meetings are efficient
• ensuring that the board is following the bylaws or any other procedural regulations
• meeting regularly with the CEO to adjudicate matters that should be brought to the board for discussion

What are Subcommittees
The board will first determine which committees are required to efficiently and effectively meet the governance requirements of the organization. Various matters of discussion will be delegated to the committees for discussion and resolution. The chair will ask for a resolution appointing certain directors to serve on a committee. Each committee in turn will elect a committee chair to run the committee meetings. The committee chair will report back to the chairperson and/or the entire board on matters requiring board approval. Not all board members are required to be on a committee.

The following are some examples of common committees and their mandate (note that the list is neither restricted nor required):
• Nominating committee: This committee evaluates the board’s size and effectiveness. It will recommend new members for election and which members should be removed.
• Compensation committee: This committee evaluates the CEO’s performance and makes recommendations to the board regarding the CEO’s (and potentially senior management’s) compensation. They monitor the company’s share compensation plans.
• Risk committee: This committee oversees how risk is managed within the organization, sets the organization’s risk framework and risk appetite, and monitors management’s risk activities.
• Finance committee: This committee oversees the financial and budgeting functions for the organization. It can be combined with or separated from the audit committee, depending on the size and composition of an organization.

Sub-committees only review and recommend items for approval to the board.

What is the Audit Committee
• The audit committee is an additional sub-committee that oversees the quality and integrity of the organization’s financial and reporting function. As all publicly traded companies in Canada are required to have an audit committee, CPAs must be aware of this committee in greater depth:

• It deals directly with both the internal and external audit functions and is responsible for ensuring that appropriate systems of internal control have been established to prevent fraud.
• It is responsible for evaluating the external auditors’ qualifications and independence, and for monitoring their performance.
• It ensures that the financial reporting process complies with legal and regulatory requirements.
• It monitors new accounting standards and reviews current accounting policies for their appropriateness.
• It reviews an organization’s risk assessment.
• The composition should be as follows:
o All members must be independent of the organization, meaning that a member does not hold or has not held a position in the organization.
o Members must be financially literate.
o Every audit committee must have at least three members.

Question 2

Chapter 3 - Governance: Organizational Structure

1. Influences on organizational structure
2. What is a simple structure (pros/cons)
3. What is a functional structure (pros/cons)
4. What is a Divisional structure (pros/cons)
5. What is a Matrix structure (pros/cons)
6. What is a Network structure (pros/cons)
7. Centralized Vs Decentralized Structures

Answer 2

Influences on organizational structure
An organization’s structure is influenced by the following factors:

• Economic environment: Some organizations may be under pressure to be lean in a declining economy.
• Competition/industry: Some organizations will look to align themselves to address the characteristics of the industry and/or their competition.
• Products/services: Some products or services may require special alignment to support their offering, such as aftermarket service, financing, or highly reliable information systems.
• Regulatory environment: Regulators may dictate that certain departments or positions are required for a business to keep operating.

Simple structure

The owner, sole shareholder, or a small group of senior managers makes all decisions and then communicates them to everyone.

Advantages
The greatest advantage of a simple structure is that with decisions being centralized, they can be made quickly. This allows the organization to be very responsive and to adapt to changes in a timely manner. Additionally, when decisions are made by one person, usually the owner, they are likely to be consistent and in line with the strategic objectives.

Disadvantages
Employees who may otherwise feel engaged in their jobs often do not feel empowered in their roles, and this can lead to job dissatisfaction and increased employee turnover. As a company grows, this structure may not be able to adapt, and the company will run less efficiently as a result — which can lead to reduced profits and the potential for subsequent reorganization.

This is a common structure in small businesses, but as small organizations grow, they will usually need to transition into the more complicated structures discussed below.

1.2.2 Functional structure

In a functional structure, specialized departments are defined by their purpose and are staffed accordingly — for example, accounting, human resources, processing, and sales. This structure allows the functional managers to manage their area of responsibility, and the CEO to provide general direction and ensure integration of the organizational activities. Decision-making is still relatively centralized, but executives or senior managers in each department have some latitude.

Advantages
The advantage of this structure is that it promotes learning and facilitates economies of scale. It also allows for specialization within the sub-structure such that entry level staff can progress as they develop their skills and knowledge. This provides a clear path for individuals to advance their careers, which means there will be a logical progression for highly motivated individuals.

Disadvantages
The downside is that interdepartmental communication may become limited. This can be remedied in part by cross-functional work teams. As an organization grows, top management of each functional group will have difficulty controlling their group. Further delegation is required to help mitigate this loss of control.

1.2.3 Divisional structure
The divisional structure is where organizations are divided into divisions, and each division has its own resources and is managed as a separate business. Decision-making is more decentralized and each division operates autonomously. An organization may choose this structure if it has a variety of products or if it operates in different locations. With a divisional structure, the business-level strategies are the domain of the divisional managers, while the corporate strategy is managed by the executive team.

Advantages
Divisions allow employees to focus on one product / service and develop their own culture. A singular focus allows employees to buy into executing on the division’s strategy with higher probability of success. As well, a stronger internal culture will reduce the amount of employee turnover and, in turn, increase efficiencies and divisional profits.

Disadvantages
Multiple divisions can create a culture of competition, with a focus on outdoing other divisions instead of beating the competition. There may also be incompatibilities between the products and services of the different divisions because they were created without the consultation of the other divisions.

1.2.4 Matrix structure
The matrix structure is where functional and business unit structures are combined at the same level of the organization. That is, employees have two superiors to report to: a functional manager (for example, the finance manager) as well as a business line manager (the general manager of the business unit).

This type of structure combines the stability of the functional structure with the flexibility of a divisional structure. It’s best used when the external environment is complex and changing.

Advantages
This structure promotes input from multiple employees, regardless of their position or rank, which results in empowered employees and higher employee morale. Employees from various business disciplines can freely communicate with one another, which can result in a quicker response time when resolving problems and implementing solutions.

Disadvantages
The open exchange of information can create for multiple lines of communication and an unclear chain of command for leadership. Employees may be unclear as to who their direct supervisor is and, when faced with conflicting instructions, this can lead to poor employee morale. A typical matrix structure has more managers than the other organizational structures, which results in it being more expensive than the other options. Managers may also compete with one another over employees and waste company resources as a result.

1.2.5 Network structure

The network structure is a type of matrix structure that is based virtually, with no need for formal offices. Most of the activities are outsourced to strategic partners and the organizational structure is “virtual.” It’s best used when the environment is unstable and there are constantly changing conditions that require innovation and quick response times. This structure provides the organization with flexibility to cope with change and shifting patterns of trade and competition, while allowing it to concentrate on its distinctive competencies. This structure is becoming more common in the public sector as well. In addition to all the advantages and disadvantages of a matrix structure, the network structure has its own unique advantages and disadvantages.

Advantages
A lack of formal offices results in decreased overhead expenses for the company. Also, offering a flexible work arrangement is a recruiting technique that can attract top talent for the same — and sometimes less — money than competing organizations that do not use a network structure.

Disadvantages
This structure is reliant on technology, so any Internet connectivity disruptions or network issues can impede progress. If the workload is not managed appropriately, it could lead to an imbalance of work. This can result in some employees feeling frustrated and burnt out, while others feel underutilized, unmotivated, and dissatisfied. It is imperative that the organization has oversight related to information systems reliability in order to achieve its strategic objectives.

7 Centralized versus decentralized structures
Centralized structures

A centralized structure is most appropriate when there are few leaders (usually just one). A small business with one owner who is also the leader for business operations is an example of a centralized organization.

The impact of a centralized structure on management is that many managers can feel that their compensation is based on rather arbitrary metrics, as they are not empowered to make changes that can impact the future of the organization or their remuneration. Innovation is typically not rewarded and can lead to friction between the decision maker and employee, as there is no formal process for communicating and rewarding employee input.

Advantages
Decisions tend to be quick and efficient because there is only one layer of management to finalize the decision. This structure is typically cheaper to implement because there are fewer layers of management, which keeps the overall salary expense lower than if there were multiple layers of management.

Disadvantages
The centralized nature of an organization can lead to “group think,” which creates an environment of complacency, stunting the future growth and innovation of an organization. Employees who voice an opinion other than that of the leader’s may be negatively impacted, become frustrated, and eventually leave the organization.

2.2 Decentralized structures

A decentralized structure is used when there are several individuals responsible for a company’s decision-making. This typically results in team environments throughout the various levels of an organization, with each team having its own leader. Each group can react to environmental changes and implement a solution specific to that group’s problem without having to go through a formal decision-making process. A decentralized organization facilitates growth because when a group becomes too big, another sub-group can spin off and create a larger, decentralized organization. This is especially helpful when a company wishes to expand quickly and/or be geographically dispersed.

The impact on management of a decentralized structure is greater empowerment, as there is a formal structure in place to acknowledge and facilitate individual contribution. This creates an appropriate challenge for motivated employees and management, leading to greater job satisfaction and reduced employee turnover. Bonus structures can be created for each sub-group in order to motivate desired outcomes for each group.

Advantages
By empowering employees, a decentralized structure can result in greater job satisfaction and reduced turnover. It can also reduce the burden placed on senior management and owners, and allow them to focus their time on strategic (as opposed to operational) issues.

Disadvantages
Managers of individual groups can become competitive with one another, to the detriment of the company as a whole. Bonus metrics must be created to motivate each group’s leaders while maintaining the company’s objectives for the greatest profit.

Question 3

What is Corporate Social Responsibility?

Answer 3

Corporate social responsibility

Corporate social responsibility is a term used to describe the voluntary decisions made by businesses to actively apply high moral and ethical standards above and beyond those required by the law. Corporate social responsibility deals with the ethical regard of all stakeholders, namely people (consumers, employees, communities, and so on) and the environment.
For purposes of the CPA profession, corporate social responsibility can be grouped into three key areas:

1. Environmental accounting
   Meeting or exceeding environmental standards and regulations has become a key responsibility for senior managers, in view of the enormous financial and reputational risks that organizations harming the environment now face. Environmental accounting is the inclusion of key environmental information (mostly cost-related) in the information systems of the organization.

Environmental accounting involves setting goals, formulating policies, and assessing and reviewing performance as it relates to the environment (with changes being made as appropriate). This includes a means of assessing the organization’s current environmental performance and finding opportunities for improvement.

2. Environmental costing
   Environmental costing is the quantitative portion of environmental accounting. It involves the identification, appropriation, and application of environmental costs, falling into two main categories:
   A. Managerial (internal use): This includes environmental cost control and management, the correlation of business and environmental performance, and proper resource management.
   B. Financial (external use): This is governed by ASPE / IFRS and includes financial reports to stakeholders where appropriate.
3. Social ethics
   * *Good corporate citizenship requires meeting or exceeding certain standards of social performance that the organization builds into its business mode**l. Compliance is the minimum that is expected, and some organizations go beyond this to engage in actions that further social good, even when it does not directly benefit the company. This is the essence of social ethics.

The range of programs and initiatives that bring awareness and benefit to the environment and the community are vast and diverse. They include local and global matters. There are a variety of ways to establish and abide by social ethics, including the establishment of a set of moral principles about what is acceptable social behaviour and what is not.

Question 4

Chapter 7 Strategic Process - Vision, Mission, and Values

What is a Vision statement?
What is a Mission statement?
What is a Values statement?

Answer 4

What is a Vision statement - Where we do we see ourselves?

A vision statement includes a vivid description of where the organization is going. It is future-oriented, meant to inspire and give direction to an internal audience. It may describe an idealized future state for the organization.

To be most effective, the vision statement should be inspirational and memorable. It addresses questions such as the following:
• What would the world look like if we were successful?
• How do we add value?
• What are our ultimate goals?

The vision statement’s main purpose is to provide motivation and inspiration to an internal audience. As a result, it is important that employees believe the vision. While it can be catchy and should be memorable, it is not meant to be a marketing tool for external parties.

What is a Mission statement - Why are we here?
The mission statement is a written declaration of an entity’s primary reason for existence. It may define the entity’s high-level goals regarding customers, employees, and shareholders.

Mission statements are communicated to both internal and external audiences. As a result, corporations may spend considerable time and money to ensure the wording concisely conveys the appropriate message. The underlying reasons for existence do not change, although effort is necessary to refine and define that purpose.

What is a Values statement?
A values statement supports the mission and vision statements by identifying the core beliefs, principles, and philosophies that are intended to influence the organizational culture. A clear values statement encourages people throughout the organization to work together and tells customers, suppliers, and other external stakeholders what behaviour they can expect.

Question 5

Financial Ratios

Answer 5

Appendix: Common ratios

Liquidity ratios

Liquidity ratios provide information about the ability to meet short-term financial obligations. They are commonly used by short-term creditors.

Current ratio: Current assets / current liabilities

The current ratio (also known as working capital ratio) is used to measure liquidity by comparing the proportion of current assets to current liabilities. The purpose is to determine whether short-term assets (cash, cash equivalents, marketable securities, receivables, inventory, and so on) are sufficient to cover short-term liabilities (bank overdraft, notes payable, current portion of term debt, payables, accrued expenses, taxes, and so on).

In theory, the higher the current ratio, the better. However, this is not necessarily always the case, as it could indicate mismanagement of working capital. Conversely, a low current ratio is not necessarily bad. A company that operates on a cash basis with limited inventory, such as a restaurant, can do just fine with a nominal current ratio. So typical values for the current ratio can vary by organization and industry. Organizations in cyclical industries may strive for a higher current ratio to remain solvent during economic downturns.

The concept of the current ratio is based on the assumption that all current assets can be liquidated to meet current liabilities. Practically speaking, this is not likely to occur because certain assets, such as inventory, can be difficult to liquidate quickly and may have liquidation values other than their carrying values.

Quick ratio: (Current assets – prepaid expenses – inventory) / current liabilities

The quick ratio (also known as the acid test ratio) is a liquidity measure that refines the current ratio by comparing only the most liquid current assets (cash, accounts receivable, notes receivable, and so on) with current liabilities. The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which are more difficult to liquidate. Therefore, a higher ratio means a more liquid current position. As with the current ratio, however, a higher quick ratio is not always optimal. A high ratio might indicate that the organization maintains excessive amounts of liquid assets.

Asset turnover ratios

Asset turnover ratios measure a company’s efficiency in utilizing assets.

Receivables turnover: Credit sales / average accounts receivable

The receivables turnover ratio measures how quickly accounts receivable are collected. When it is not possible to use the average accounts receivable, ending accounts receivable for that period will be used instead. In general, the higher the receivables turnover rate, the more efficiently receivables are collected. Greater efficiency both reduces the risk of receivables becoming uncollectable (that is, bad debts) and converts this source of working capital into a more liquid asset, cash. A high receivables turnover is not always optimal. A high ratio may indicate that the organization has an excessively tight credit-granting policy, which has resulted in fewer sales.

Average collection period: Average accounts receivable / (credit sales / 365)

The average collection period is derived from the receivables turnover ratio and measures the average number of days that credit sales remain in accounts receivable before they are collected. When it is not possible to use the average accounts receivable, ending accounts receivable for that period will be used instead. It is often used to assess the efficiency of receivables collections and the effectiveness of collection policies. This ratio can also be used to assess the risk that overdue receivables will become uncollectable (that is, bad debts).

Inventory turnover: Cost of goods sold / average inventory

Similar to the receivables turnover ratio, the inventory turnover ratio measures how quickly inventory is sold. When it is not possible to use the average inventory, ending inventory for that period will be used instead. Generally speaking, the higher the inventory turnover rate, the more efficiently inventory is being managed. Higher turnover is of benefit because it reduces the risk of inventory obsolescence and converts this source of working capital more quickly into a liquid asset, cash. A high inventory turnover is not always optimal. A high ratio may indicate that the organization has a shortage of inventory on hand for sale, which has resulted in fewer sales.

Inventory period: Average inventory / (cost of goods sold / 365)

Similar to the average collection period, the inventory period measures the number of days that goods remain in inventory before they are sold. When it is not possible to use the average inventory, ending inventory for that period will be used instead. It is often used to assess how efficiently inventory is managed. In this way, it can also be used to assess the risk of inventory obsolescence.

Profitability ratios

Profitability ratios provide several ways to measure success in generating profits.

Gross margin percentage: (Sales – cost of goods sold) / sales

The gross profit margin percentage measures the percentage of each sales dollar that remains after recovering the cost of goods sold.

Profit margin: Net income / sales

The profit margin ratio measures overall profitability after all expenses, including cost of goods sold, operating and financing expenses, and taxes. It measures the so-called bottom line and is frequently mentioned when discussing a company’s profitability.

Return on assets: Net income / average total assets

Return on assets (ROA) measures how effectively assets are used to generate profits.

Return on equity: Net income / average equity

Return on equity (ROE) measures the profits earned for each dollar invested in equity.

Debt service ratios

Debt service ratios provide an indication of a company’s long-term solvency. Unlike liquidity ratios, which are concerned with short-term assets and liabilities, debt service ratios measure the overall use of debt. Debt service ratios are also often called leverage ratios or financial stability ratios.

Debt ratio: Total liabilities / total assets

The debt ratio compares a company’s total debt to its total assets. It is used to assess the amount of leverage being used to finance assets. A low debt ratio means that the organization is less dependent on leverage. A higher ratio means that the organization is more leveraged and is considered to be more financially risky.

Debt-to-equity: Total liabilities / equity

The debt-to-equity ratio compares total liabilities to total equity. It is a measurement of how much suppliers, lenders, and other creditors have committed to the organization versus what owners have committed.

Similar to the debt ratio, the debt-to-equity ratio measures the degree of leverage. Similar to the debt ratio, a lower percentage indicates less leverage and a stronger equity position.

Debt service coverage: Net operating income / (principal + interest payments)

The debt service coverage looks at net income as a multiple of the debt payments due within a year. This is a measure of how much cash, after expenses are covered, is available to pay debt.

Times-interest-earned ratio: EBIT / interest expense

The times-interest-earned ratio is used to measure the ability to pay interest expenses from income. The lower the ratio, the more income is burdened by debt expense.

Other ratios

Asset turnover: Sales / average total assets

Asset turnover ratios indicate how efficiently assets are utilized. Because of this, they are sometimes also referred to as efficiency ratios or asset utilization ratios.

Asset turnover in days: 365 / (sales / average total assets)

The asset turnover in days is derived from the asset turnover ratio and measures the average number of days that it takes for the company to earn sales equal to the amount of assets that it has.

Accounts payable turnover: Purchases / average accounts payable

The accounts payable turnover ratio measures how quickly accounts payable are paid. In general, the higher the accounts payable turnover rate, the more quickly payments are made. A company does not want the turnover to be too high, as this may indicate poor cash management. However, if it is too low, it may indicate difficulty making payments.

Days payable outstanding: Ending accounts payable / (cost of goods sold / 365)

Linked to the payables turnover ratio, this measure is used as an estimate of the number of days it takes a company to pay its suppliers. A higher number of days could be indicative of difficulty making payments.

Price earnings: Market price of shares / earnings per share

The price earnings ratio measures the current market price of a share relative to earnings per share. This provides an indication of how much an investor needs to invest in order to receive one dollar of the company’s earnings.

Dividend payout: Yearly dividend per share / earnings per share OR dividends / net income

The dividend payout ratio measures the amount of income that translates to dividends in a year. It is an indication of how much of an entity’s earnings are paid out to the shareholders. Generally speaking, a low ratio could indicate that the funds generated from operations are lacking, and that the company is in poor financial health. Conversely, a high ratio may indicate a return of capital in excess of funds generated from operations, which could indicate financial difficulties because capital should be invested in the business to earn future operating cash flows and not returned to investors.