Week 4 - Financial Performance Measures and Measurement Flashcards
Six step design process for accounting-based performance measures:
- Choose performance measures that align with top managements financial goals
- choose time horizon of each performance measurement
- choose a definition of each of the components within each measurement
- choose an alternative measurement for each performance measure
- choose a target level of performance
- choose timing of feedback
How to calculate ROI?
Benefits of ROI as a financial performance metric?
ROI is an accounting measure of divisional profits divided by assets employed in the division
ROI = divisional profit + assets employed
Benefits:
- objective measure
- facilitates comparison
- strategically alligned
- focuses attention on efficient use of asset base
- approximates past investment success (ARR)
Return on sales?
Investment turnover?
ROI?
- ROS = Profit / Revenue
- Investment turnover = Revenues / Investment
- ROI = ROS x Investment turnover
What is residual income?
how to calculate residual income?
when used?
but…
- It’s an accounting measure of profit minus a required monetary return on an accounting measure of investment. Defined as income a division/manager generates in excess of the minimum desired rate of return
- RI = Profit - (Required rate of return x investment)
- used to incorporate risk by adjusting cost of capital
- but is an absolute measure so difficult to make comparisons unless you set a target
What is economic value added?
how to calculate EVA ?
EVA = conventional divisional profit +- accounting adjustments - capital charge
EVA = after-tax operating profit - [WACC x (total assets - current liabilities)]
Total assets - current liabilities: Long-term assets + working capital
Benefits of financial measures of performance?
- simple to calculate and easy to understand
- objective
- comparable throughout organisation
- comparable with market measures
- provides an aggregate view of organisational performance
- easy to align with strategic goals
- based on readily available accounting data
Limitations of financial measures of performance
- short-term orientation
- focus only on managing those things you can measure in monetary terms
- tells you about the past not the future (lagging indicator)
- potential for incongruent decisions
- possibility for dysfunctional behaviour
- ignores importance of intangibles
What is a management control system?
- a means of gathering and using information to aid and coordinate the process of making planning and control decisions throughout the organisation
- guides behaviour of employees and managers
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Management control system refers to both:
- formal control systems - MAS, HR
- Informal control systems - shared values, culture, etc.
management control systems collect?
- financial data - net profit, materials, storage costs
- non-financial - time taken to respond to customer requests, absenteeism rates, etc.
Why have performance measures?
- making good planning and control decisions requires information about the different subunits of the organisation and how they performed
- feedback control
- monitorring progress
- assessing efficiency of managers/divisions
- guides decision making/goal congruence
- improvement
Characteristics of effective performance measures?
- integration with organisation’s strategy
- comprehensiveness
- timely feedback and review
- owned and supported through the organisation
- simple clear and understandable
- fair and achievable
What is centralisation vs decentralisation in organisational structure
centralisation - maximum constraints and minimum freedom for managers, vice versa for decentralised
Benefits and costs of decentralisation in performance management?
Benefits:
- local knowledge
- quicker decision making
- increases motivation
- aids management development
costs:
- suboptimal decision making
- focus on subunit
- costs of information
- duplication of activities
Measuring divisional profitability:
- controllable contribution
- divisional contribution
controllable cont. = divisional revenue - controllable divisional costs
divisional cont. = divisional revenue - divisional costs
