Week 4| Financial Performance Metrics Flashcards
What are the attributes of performance metrics?
- information quality attributes are relevance, faithful representation (complete, neutral, free of bias)
- Enhancing characteristics are comparability, timeliness, verifiability, understandability, cost
- Reliability [revealing actual performance changes without new errors] and validity [capturing what is intended] of information is imperative to evaluate performance and inform strategic and operational decisions
What are some requirement of a suitable performance metric?
- reflect strategy and business drivers
- reflect managerial responsibility and accountability
- Faithfully represent what it purports
- Be comparable, timely verifiable and understandable
- Cost effective - benefit of measurement exceed associated cost of collecting data
What is another term for required rate of return?
hurdle rate
What type of profit is used when calculating ROI?
operating profit or controllable profit
What are the components of RI (what type of profit used in RI)
RI = operating profit - (hurdle rate * assets employed)
What does an increase in ROI mean?
An increase means an increase in revenue possibly
What happens when the required rate of return > ROI or ROI < required rate of return
When the rate of required return is bigger than ROI it means the company is generating positive RI
When the rate of required return is smaller than ROI then the company is generating negative income
How can goal congruence help with success of controls
The alignment of the goals of each individual, team or work-unit with the goals of the organisation as a whole
Does ROI or RI always give us same story on performance
No, they give different stories.
For example target ROI might be 10% for the company but the ROI of the project meets 9%. This means the manager shouldn’t invest in the project
But the residual income for the project is $10k and the manager’s RI for their division is $9k. Therefore, the decision from the RI side is to invest in the project.
Why does having more money not necessarily mean higher ROI
ROI measures the ratio of (operating profit)/(assets employed).
A divisional manager may forego an investment with a return in excess of what is required for the
firm simply because it has a lower projected ROI than the division’s projected ROI without the
investment.
What does RI measure?
income company generates after accounting for the cost of capital
What problem causes underinvestment
when divisional managers invest in projects with ROI above firm ROI but lower than divisional ROI
What does capital charge mean
Required rate of return
How does performance measure be used diagnostically and interactively
Diagnostically:
1. Facilitate more efficient use of management resources
- Acceptable standards are set
- Operational personnel monitor results and take corrective action as
and when required. Deviations form plan assumed a performance problem - The corrective action tends to be routine involving operational adjustments..
strategy assumed to be correct - Senior managers may be less extensively involved
- Diagnostic use is often referred to as “management by exception”
Interactively:
1. Require intensive use of management resources
- Results are analyzed in detail, additional information is gathered, assumptions and hypotheses are tested
- Corrective action may involve changes to business strategy, objective, management systems, the performance metrics used
- Senior managers are more extensively involved
