Performance Measures and Management Techniques CPA review BEC Module 45 Performance Measures and Management Techniques

Organization of Module 45 2 Organization of Module 45 Financial and Nonfinancial Performance Balanced Scorecard and Performance Measures Value Based Management Choosing Among Different Performance Measures Traditional Financial Statement Analysis Benchmarking and Best Practices Quality Control Principles Cost of Quality Business Process Management Project Management

Concept of Performance Measures and Management Techniques 3 Concept of Performance Measures and Management Techniques Financial and nonfinancial measures are used for a variety of purposes including: resource allocation, incentive compensation, divisional and business unit evaluation, budgeting and planning.

The Balanced Scorecard 11-4 The Balanced Scorecard Management translates its strategy into performance measures that employees understand and influence. Financial Customers Performance measures Learning and growth Internal business processes

The Balanced Scorecard: From Strategy to Performance Measures 11-5 The Balanced Scorecard: From Strategy to Performance Measures Financial Has our financial performance improved? What are our financial goals? What customers do we want to serve and how are we going to win and retain them? Vision and Strategy Customer Do customers recognize that we are delivering more value? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? What internal busi- ness processes are critical to providing value to customers? Learning and Growth Are we maintaining our ability to change and improve?

The Balanced Scorecard: Non-Financial Measures 11-6 The Balanced Scorecard: Non-Financial Measures The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.

Understanding Return On Investment 11-7 Understanding Return On Investment ROI = Net operating income Average operating assets Margin = Net operating income Sales Turnover = Sales Average operating assets ROI = Margin  Turnover

Increasing ROI – An Example 11-8 Increasing ROI – An Example Regal Company reports the following: Net operating income $ 30,000 Average operating assets $ 200,000 Sales $ 500,000 Operating expenses $ 470,000

Increasing ROI – An Example 11-9 Increasing ROI – An Example ROI = Margin  Turnover Net operating income Sales Average operating assets × ROI = $30,000 $500,000 × $200,000 ROI = 6%  2.5 = 15% ROI =

Investing in Operating Assets to Increase Sales 11-10 Investing in Operating Assets to Increase Sales Assume that Regal's manager invests in a $30,000 piece of equipment that increases sales by $35,000, while increasing operating expenses by $15,000. Regal Company reports the following: Net operating income $ 50,000 Average operating assets $ 230,000 Sales $ 535,000 Operating expenses $ 485,000

Investing in Operating Assets to Increase Sales 11-11 Investing in Operating Assets to Increase Sales ROI = Margin  Turnover Net operating income Sales Average operating assets × ROI = $50,000 $535,000 × $230,000 ROI = 9.35%  2.33 = 21.8% ROI = ROI increased from 15% to 21.8%.

11-12 Criticisms of ROI Telling managers to increase ROI may not be enough. A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. A manager who is evaluated based on ROI may reject investment opportunities…

Calculating Residual Income 11-13 Calculating Residual Income ( ) This computation differs from ROI. ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets.

Residual Income – An Example 11-14 Residual Income – An Example Division A Division B Average operating assets $1,000,000 $3,000,000 Net operating income $  200,000 $  450,000 Minimum required return: 12% × average operating assets    120,000    360,000 Residual income $   80,000 $   90,000

Residual Income – An Example 11-15 Residual Income – An Example Present New Project Overall Average operating assets (a) $1,000,000 $250,000 $1,250,000 Net operating income (b) $200,000 $40,000 $240,000 ROI (b) ÷ (a) 20.0% 16.0% 19.2% Average operating assets (a) $1,000,000 $250,000 $1,250,000 Net operating income (b) $  200,000 $ 40,000 $  240,000 Minimum required return: 12% × (a)    120,000   30,000    150,000 Residual income $   80,000 $ 10,000 $   90,000

GPM = Gross Profit/Net Sales Gross (Profit) Margin GPM = Gross Profit/Net Sales GPM = $986,000/$3,074,000 = 32.1%

Operating Profit Margin OPM = EBIT/Net Sales Your book has OPM = operating income/Net Sales OPM = $418,000/$3,074,000 = 13.6%

Return on Total Assets (ROA) ROA = Earnings Available to Common Stockholders Total Assets You book has ROA = Net income after interest and taxes average total sales ROA = $221,000/$3,597,000 = 6.1%

ROE = Earnings Available to Common Stockholders Total Equity Return on Equity (ROE) ROE = Earnings Available to Common Stockholders Total Equity You book has ROE = Net income after interest and taxes average common stockholders equity ROE = $221,000/$1,754,000 = 12.6%

Current Ratio Current ratio = total current assets total current liabilities Current ratio = $2,447,830 = 1.24 $1,968,662

Quick Ratio Quick ratio = Total Current Assets - Inventory total current liabilities Quick ratio = $2,447,830 - $300,459 = 1.09 $620,000

Cash Ratio Cash ratio = Cash total current liabilities $1,968,662

Debt to Total Assets Ratio Total Liabilities/Total Assets Debt Ratio = $1,643,000/$3,597,000 = 45.7%

Times Interest Earned Ratio Times Interest Earned = EBIT/Interest Times Interest Earned = $418,000/$93,000 = 4.5

Theory of Constraints A constraint (also called a bottleneck) is anything that prevents you from getting more of what you want. The Theory of Constraints is based on the observation that effectively managing the constraint is the key to success. The constraint in a system is determined by the step that has the smallest capacity.

Theory of Constraints 2. Allow the weakest link to set the tempo. Only actions that strengthen the weakest link in the “chain” improve the process. 3. Focus on improving the weakest link. 1. Identify the weakest link. 4. Recognize that the weakest link is no longer so.

Sometimes associated with the term zero defects. Six Sigma A process improvement method relying on customer feedback and fact-based data gathering and analysis techniques to drive process improvement. Refers to a process that generates no more than 3.4 defects per million opportunities. Sometimes associated with the term zero defects.

Six Sigma