week 4 - Financial performance measures Flashcards
Financial performance measures are a central component of management control systems.
What role do performance measures play in an organisation?
Encourage good planning and control decisions by providing info re sub-unit performance
- Aligns the owner / agent relationship
- Aligns the manager / e’ee relationship
- ROI / RI gauges & rewards performance & drives business decisions.
Define responsibility accounting
Authority delegated to sub unit managers where it is measures & monitored
Beware suboptimal decision making where mgers act in own best interests instead of overall companys.
Where responsibility sits is determined by the following factors. Discuss
Structure - hierarchical or flat
Centralised vs decentralised decision making. Ie decisions made top down or throughout the org.
Type of knowledge -general (centralised) or specialised (decentralised)
Technology supports global communications & multinational operations
Responsibility centres are subunits in which managers are accountable for specific types of operating activities.
Define cost & revenue centres.
Responsibility centres - subunits in which managers are accountable for specific types of operating activities.
Cost – responsbille for cost only, expected to min costs or max output eg production lines
Revenue – revenues only, max sales • Eg Travel agencies
Responsibility centres are subunits in which managers are accountable for specific types of operating activities.
Define investment & profit centres.
Investment – revenues, costs & investment eg corporate divisions
Profit – revenues & costs, determine price/sales mix & determine inputs eg Retail outlets
- Engineered cost centres = easy measure inputs/outputs
- Discretionary cost centres difficult = measure variance
Return on Investment (ROI) is the ratio or percentage of operating income to investment and can be used to make comparisons between investment options.
Define the formulae, list pros & cons.
Operating income / investment
Where:
• Op income = earnings before interest & taxes (EBIT) (after costs)
• Investment receivable, inventory, property & equipment used in producing revenue
Adv
• Holds mgers responsible
• Motivates increasing sales, decreasing costs & minimise investment
Disadv
• Discourages investment under current ROI
• Fails to acknowledge risk
• Encourages short term thinking
Determines that ROI can be improved in 3 ways:
• Increasing sales
• Decreasing costs
• Decreasing investment in operating assets
RI residual income
Measures the dollar amount of profits above a minimum required rate of return and can be used to see if an investment is viable.
Define formulae, list pros & cons
Residual income = Op income – (expected rate of return * investment)
Where:
• Op income = earnings before interest & taxes (EBIT) (after costs)
• Expected rate of returne = minimum return that is expected on operations and new investments
• Investment = total of cash, accounts receivable, inventory, property & equipment used in producing revenue
Advantages
• Reduces the role of investment in the measure of effectiveness.
Disadvantages
• Larger subunits more likely to have larger RI’s
• Encourages cost cutting for short term benefit at expense of long term gain.
Define transfer price
The amount of revenue & cost allocated when good / services are transferred between responsibility centres
What is the ideal way to set a trasnfer price
Setting a transfer price.
• Ideally – opportunity cost of selling the good elsewhere.
Rarely used as it would vary too much.
There are other methods of setting transfer prices.
Define cost based & dual rate transfer.
• Cost based – cost of good (calculate using various methods).
Can see fixed costs palmed off.
• Dual rate transfer – selling dept gets market rate, buying dept gets variable.
Can overstate profit
There are other methods of setting transfer prices.
Define market based & activity based
• Market based – value based on competitor price or market forces.
Can hide underlying costs
• Activity based – purchaser charge fro batch production.
Incentive for purchaser to be accurate.
There are other methods of setting transfer prices.
Define negotiated trasnfer prices.
• Negotiated – Agreement between buyier / seller.
Takes time.
Neg skills become a factor
