F5 Performance Management

2 Section E: Performance measurement and control Designed to give you knowledge and application of: E1. The scope of performance measurement E2. Divisional performance and transfer pricing E3. Performance analysis in not-for-profit organisations and the public sector E4. External considerations and behavioural aspects E1. The scope of performance measurement E2. Divisional performance and transfer pricing E3. Performance analysis in not-for-profit organisations and the public sector E4. External considerations and behavioural aspects

3 E1: The scope of performance measurement Learning outcomes  Describe, calculate and interpret financial performance indicators (FPI) for profitability, liquidity and risk in both manufacturing and service industries. Suggest methods to improve these measures. [2]  Describe, calculate and interpret non-financial performance indicators (NFPI) and suggest methods to improve the performance indicated. [2]  Explain the causes and problems created by short term-ism and financial manipulation of results, and suggest methods to encourage a long term view. [2]  Explain and interpret the balanced scorecard, and the Building Block model proposed by Fitzgerald and Moon. [2]  Discuss the difficulties of target setting in qualitative areas. [2]

4 Financial performance indicators Used by financial analysts for making decisions regarding credit & investment Utilises data from financial statements to determine company’s standing Facilitates inter- company as well as intra-company comparisons Different Financial performance indicators Profitability ratios – indicates operating efficiency, ability to generate returns Financial risk indicators (leverage ratios) – long term solvency of firm Liquidity ratios – ability to meet short- term obligations, financial strength / solvency Continued…

5 Profitability indicators Residual income Price earning ratio GP margin ratio EPS Operating profits (EBIT) ratio Returns on shareholder’s equity Return on capital employed Expenses ratio Continued…

6 Networking capitalCurrent ratio Acid-test ratioOperating cash-flow ratio Turn over ratio Liquidity indicators Debt-equity ratioDebt to total capital ratio Financial leverage Operating leverage Debt-service coverage ratio Financial risk indicators Continued…

7 The strategic and operational performance dimensions and the performance measures for each of them are enumerated as follows: Performance dimensions Performance hierarchy Appropriate performance measures CompetitivenessStrategic Relative market share, sales growth, measures of customer base FlexibilityOperational Flexibility towards volume of production/sales or service, specification, speed of delivery, etc. Quality of serviceOperational Responsiveness, competence, easy access, reliability, etc. Resource utilization OperationalProductivity, efficiency, etc. InnovationOperational Performance of the innovation process, performance of individual innovations, etc.

8 Method to improve performance indicators  The initial focus of an organisation is to improve upon a few key goals that are critical to the success of the business and to ensure that they are ‘SMART’ goals.  Develop performance measurement frameworks to define the outcomes to be measured  Develop matrices to understand performance  Identify current performance and GAP w. r. t. desired performance  Take steps to improve the performance S M A R T goals SSpecific MMeasurable AAchievable RRelevant TTimely

9 Non Financial Performance Indicators may measure performance in the fundamental areas Efficiency = Resource actually used x 100% / Resources planned to be used. Productivity = Output / Input. Effectiveness = Actual output x 100% / Expected output.

10  Tendency to focus on short term, ignoring long term consequences  Over emphasis on short term performance evaluation of managers & immediate profitability  Organisation’s health depends on initiatives & investment strategies which are long term  Short term focus is induced by a reward system  No focus on long term sustainability Issues in short term-ism / manipulation of results

11  Robert S Kaplan and D.P. Norton (1994) through their study of twelve corporations found that traditional measures of company performance fail to provide guidance to management operating in a competitive environment.  Realising the need for a balanced measurement system, they had developed a new measurement system called the Balanced Scorecard. It links the short-term operational goals of an organisation to its long- term objectives and strategy by forcing it to control and monitor day to day operations.  It defines the entire road map of lead indicators for achieving the goals, and constantly reveals what is happening in an organisation. Balanced Scorecard

12 Balanced Scorecard Continued…

13 Balanced scorecard Links short-term operational goals of an organisation to its long-term objective and strategy Defines entire road map of lead indicators for achieving goals Starts with defining the mission, outlining the strategies to achieve the mission Key performance by balanced scorecard Financial performance Customer satisfaction Internal business performance Learning and growth Continued…

14 Building block model proposed by Fitzgerald and Moon The performance measures as suggested for service industries are: Financial performance (e.g. profitability, capital structure etc) Competitiveness (e.g. growth in sales, capturing market share, etc) Quality of service (e.g. reliability, competence, customer relation) Flexibility (ability to synchronise supply with demand) Resource utilisation (how efficiently the resources are utilised - service rendered per labour-hour) Innovation (both innovation in the process of providing service and innovation in the service content). The first 2 indicate success /failure as outcome of decisions & actions. The others show competitive performance.

15 Building blocks for performance measurement systems

16 Difficulties in setting targets for qualitative factors  Major qualitative factors like flexibility towards volume of production, specification, speed of delivery, responsiveness to customer order etc.  Work measurement is difficult.  Attaching money value will only give approximate results.  Cost of quality could be analysed into – prevention, appraisal costs, failure costs.

17 RECAP  Describe, calculate and interpret financial performance indicators (FPI) for profitability, liquidity and risk in both manufacturing and service industries. Suggest methods to improve these measures. [2]  Describe, calculate and interpret non-financial performance indicators (NFPI) and suggest methods to improve the performance indicated. [2]  Explain the causes and problems created by short term-ism and financial manipulation of results, and suggest methods to encourage a long term view. [2]  Explain and interpret the balanced scorecard, and the Building Block model proposed by Fitzgerald and Moon. [2]  Discuss the difficulties of target setting in qualitative areas. [2]