Week 9 Performance measurement Flashcards
What is a responsilbiity centre?
e is a part, segment, or a sub-unit of an organisation whose manager is accountable for a specified set of activities.
What are 4 responisilbity centres in an organisation?
Cost centre
Revenue centre
Profit centre
Investment centre ( responsible for all the above)
What is a centralised structure?
Keeps all the decision making firmly at the top of the hierarchy ( amongst the senior management)
What is a decentralised structure?
is spread out to include more managers in the hierachy, as well as individual business units or trading locations.
What are advantages of decentralised organisations?
Helps with timely decisions
Specialist knowledge
Management motivation
The top management can just be focused on the strategic roles.
What are disadvantages of decentralised structure?
Dysfunctional decision making. Serving individual segment, but harming the organisation as a whole. E.g. service providing department compromising on quality to save costs and therefore the service receiving department does not get what it should
What does divisional performance measurement mean and what is performance management?
Performance measurement asks, “How do we track the progress of the strategy we’ve put in place?”,
Performance management asks ‘ “How do we manage the strategy we’ve put in place?
What are 3 key performance measurement systems?
Divisonal performance e.g ROI
Shareholder value e.g. RI, EVA
A company has three hotels to choose from for investing. All are going to be profitable and especially one with the highest contribution margin, but whats the problem?
Profit measures ignore differences in the size of the investments in each hotel.
What are the measures that include investment?
Return on investment (ROI)
Residual income (RI)
Economic value added (EVA®)
What is the return on investment?
Measure of the amount of return on an investment relative to the cost of that investment (assets employed).
What is the formula for return on investment
HOW CAN A COMPANY HAVE A HIGH RETURN ON INVESTMENT?
A division can achieve this through working on either strategy (High operating profit margin or high asset turnover).
OR it can be pre-tax profit / Net assets x 100
What are problems with ROI?
1) Percentage return or the size of investment What is better? A return of 10 per cent on £1m, or an 8 per cent return on £2m?
2) Different ROIs are for different businesses and industries: Traditional manufacturing organisations tend to have a large number of physical assets – tangible fixed assets.
What is RI ( residual income)?
What is left over after you have accounted for what investors want from business.
If it is bigger than 0, then you have done something to add to the shareholders wealth.
What is the formula for Residual income Its a dollar amount compared to ROI which is a percentage hence more commonly used?
RI = Income - required rate of return x investment
Required rate of return is also known ass cost of capital.
Why choose RI?
RI removes manager’s temptation to increase gearing through excess borrowing. Because the required rate of return will have to be adjusted upwards for the higher risk. Also interest would leave low profits.
Calculate ROI and RI?
We are going to see a problem with ROI using an example
Continuing from the flashcard 17: Div1 management of company X has a project under consideration. This new project requires an initial investment of £20,000 of assets and it can contribute to further profit of £4,100. How will this effect the ROI and RI of Div1?
Based on the 2 methods you would have 2 different answers.
RI went up by $100
As ROI and RI both have its disadvantages, what is another way we can do performance measurement fufiling the role of maxmising shareholder value( the utimate indicator)
Economic value added
What is EVA?
A varation of profit ( when you get money from someone, they except a return, cost of capital, which isnt measured by profit)
What is the formula for Economic added value?
NOPAT - ( WACC X NET ASSETS)
NOPAT = NET OPERATING PROFIT AFTER TAX
WACC : WEIGHTED AVERAGE COST OF CAPITAL
NET ASSETS = TOTAL ASSETS - TOTAL LIABILITIES
Calculate Economic value added?
So what is the difference between EVA AND RI?
in how each calculates the investment’s projected revenues. ( NOPAT IS DIFFERENT TO INVESTMENT)
What is an advantage of EVA and what is a disadvantage of EVA?
Focus on cost of capital ADV
DISADV Still purely fianancial
What are limits of financial accountign based measures ?
Failure to incorporate non-financial items, skills culure etc
There can easily be manipulation ( Earnings management)
What is transfer pricing?
The price charged by the selling division to the buying division for an intertemdiate producct
Give an example of transfer pricing and why do we care?
Lets say ABC has 2 divisions each with different output and division 1 produces batteries and division 2 produces cars,
Division one can sell batteries to division 2 but its still internal.
Both divisions may have performance measurement targets of maxmising profit, so we need a price that would be optimal for the company.
What are 3 main ways to determine a transfer price?
Market based transfer ( your sister sells you a laptop for the same price she brought it for)
Cost based transfer prices ( pays the cost to produce the goods that it purchased from another subsidary
Negoitated transfer prices ( between cost and market price )
What is one key objective for transfer pricing?
Tax minimisation ( firms can manipulate the price they sell to other divisions, transfer pricing can happen in different countries, so with countries with a lower tax rate, profit can be high visa versa)
What is a rational minimum pricr approach from the selling division to charge for a transfer
The sum of the selling division’s marginal cost and the opportunity cost of the resources used. Or a price at which it could sell outside
What is a rational maxmimum price approach from the selling division to charge for a transfer
The lowest market price at which the buying division could acquire the goods or services externally, less any internal costs in packaging and delivery (because if goods are internally transferred without packaging, the buying division will need to do itself.)
What are critical success factors?
) are activities that need to be done well in order for a business to achieve its strategic objectives such as productivity employee attitudes, public responsilbitily.
What is a key performance indicator?
KPI is used to measure performances. KPI should be used to measure CSF.
What would be some examples of KPI’s for a manfuacturing business?
Standard Costing Variances
Capacity utilisation
• Customer complaints
etc
What are examples of KPI’s for a fianancial sector?
Accouting ratios
What is a balance scorecard?
a series of cause and effect relationships that shows how a company intends to achieve its intended strategy. e.g fast food company might train employees better, to respond faster when a customer comes to the shop, when customers are happier they want to come back to store more to improve probability if that was the intended strategy.
What does a balance scorecard include?
Financiala and non financial measures to evaluate performance.
What are the 4 aspects of performance in a balance score card?
Financial ( how do we create value for our shareholders)
Customer ( what do customers value from us)
Internal ( what processes must we excel at, to achieve our financial and customer objectives
Innotative learning ( improvements in internal capacity)
What measures can we use for the 4 aspects of a balance scorecard?
1) customer measure ( market share, new customers)
2) Internal perspective measures( production time cycle)
Financial ( ROI, EVA)
Innovation and learning ( revenue per employee, time taken in developing new products)
Give an example of the balance scorecard cause and effect relationship?
What are 2 big critques of Balance score cards?
The cause and effect links e.g • Improving customer relations will improve financial performance. Will it?
Also its a top down model
What is benchmarking?
making meaningful comparisons to others and identifying opportunities to improve.
What is competitive and functional benchmarking?
Competitive benchmarking: with the best in the same industry or business type.
• Functional benchmarking : In case data is lacking, this type benchmarks certain business functions with the best, irrespective of differences in industry
What is internal benchmarking?
compare performance of one part of the business with another part of the business
What are pros of benchmarking?
Openness to change can be encouraged and therefore culture becomes less rigid; something that is a pre-requisite in the current business world
Assists with team working and cross-functional learning
What are cons of benchmarking?
Can take up a lot of time and money
ROI: Profit/invested capital x 100 %
Existing expected ROI: 9/50 x 100 = 18%
Revised ROI: (9+4)/(50+28-24) x 100 = 24% So, the manager would be inclined to undertake this transaction since the ROI now exceeds the target ROI of 20% but in selling these houses in a hurry, the company is likely to be losing a profit of £6 million and therefore his target ROI is motivating him to act in a non-goal congruent manner
