1. BPP LEARNING MEDIA CIMA P2 Advanced Management Accounting For exams in 2016 江西财经大学会计学院 吉伟莉 499159596@qq.com

2. BPP LEARNING MEDIA Chapter 6 Performance measurement —Financial Performance Indicators —ROI & RI —EVA ® —Non-financial Performance Indicators (NFPIs) —Balanced scorecard —Benchmarking

3. Financial performance indicators 1

4. BPP LEARNING MEDIA Financial performance indicators 2 Profitability —PBIT( 税息前利润） =operating profit before tax + interest charges on long-term loan —Sales margin( 毛利率） = gross profit/sales —Profit margin （利润率） =PBIT/Sales —EPS( 每股盈余） =(net profit after tax-preference dividend)/number of ordinary shares —ROCE( 资本报酬率） =PBIT/capital employed=PBIT/(total assets-current liabilities) —Asset turnover( 资产周转率） = sales/capital employed —profti margin *asset turnover =ROCE

5. BPP LEARNING MEDIA Financial performance indicators 3 Liquidity —Current ratio( 流动比率） =current assets/current liabilities —Quick ratio( 速动比率） =(current assets- inventories)/current liabilities —Accounts receivable payment period( 应收账款 周转天数） =Trade receivables/credit sales*365 days —Inventory turnover period( 存货周转率） =inventory/cost of sales —Accounts payable payment period( 应付账款周 转天数） =Trade payable/credit purchase or cost of sales

6. —FPIs allow comparison between similar companies in the same industry and —Between results for different years for the same company Financial performance indicators 4

7. Return on investment (ROI) —Also known as the return on capital employed (ROCE) —Shows how much profit has been made in relation to the amount of capital invested —Typically measured as (profit/capital employed) × 100% —ROI is generally regarded as the key performance measure —Ties in directly with the accounting process —Measures the performance of a division/company as a single entire unit ROI & RI 1

8. Residual income (RI) —This is calculated by deducting and imputed interest based on investment in the investment centre, from profit —It is typically measured as follows. £ Profit (after depreciation) X Imputed interest (capital employed × cost of capital) (X) Residual income X ROI & RI 2

9. —Both ROI and RI use the same basic figure for profit and investment —But RI produces an absolute measure whereas ROI is expressed as a percentage ROI & RI 3

10. Disadvantages of ROI / RI —Both methods suffer from disadvantages in measuring profit and investment —Investment can be based on net assets (most usually), gross assets or replacement cost —However none of these bases is ideal —Investment centres might use different bases to value inventory and to calculate depreciation —Charges made for the head office expenses/assets for investment centres are likely to be arbitrary ROI & RI 4

11. —There may be problems when bonuses are linked to ROI or RI —The measures can be massaged if the asset base of the ratio is altered by increasing/decreasing payables and receivables —If it is the performance of the manager (rather than the investment centre) being assessed, then the profit should be based on the revenues/costs controllable by the manager —Service and head office costs should be excluded (except those specifically attributable to the investment centre) ROI & RI 5

12. —The biggest problem in divisional performance measurement occurs if: —A division maintains the same annual profit, keeps the same assets without a policy of regular non-current asset replacement and values assets at net book value —ROI or RI will increase year by year as the assets get older, even though profits may be static —This can give a false impression of improving performance over time —It acts to discourage managers from undertaking new investments ROI & RI 6

13. Problems with RI in particular —It does not facilitate comparisons between investment centres —It does not relate the size of a centre's income to the size of the investment —In these respects ROI is a better measure ROI & RI 7

14. Problems with ROI in particular —Avoiding new investments whose initial returns are lower than required ROI —Encourages focus on short-term performance —RI can help to overcome this problem of sub-optimality and lack of goal congruence by highlighting projects which return more than the cost of capital ROI & RI 8

15. Problems with ROI in particular continued —It can be difficult to compare percentage ROI results of investment centres if their activities are very different —RI can overcome this problem through the use of different interest rates for different investment centres ROI & RI 9

16. Behavioural implications —Managers like to ensure that their performance/results of their decisions appear in the most favourable light —They may have no regard for the later life of their centre's projects or overall performance of the group —This could have the following results: —They will favour proposals that produce excellent results in the short term but may be unacceptable in the longer term —They will disregard proposals that are in the best interests of the group as a whole ROI & RI 10

17. Example 1 —A manager might decide to reduce investment and depreciation (and hence increase ROI) by scrapping some machinery not currently in use —When the machinery is eventually required, the manager would be obliged to buy new equipment ROI & RI 11

18. Example 2 —A manager might reject a project with an ROI of 30% if it causes the investment centre’s ROI to fall from 38% to 35% —Even if the return is above the organisation’s target of 25% and hence the project is beneficial for the group as a whole ROI & RI 12

19. —This type of performance measurement may therefore produce dysfunctional decision-making —Managers will consider their own performance —Not the longer-term interests of the investment centre or the interests of the group ROI & RI 13

20. Economic value added —EVA® is an absolute performance measure like RI —EVA® differs from RI because it is based on economic profit and not on accounting profit —It also takes into account a capital charge based on the entity’s weighted average cost of capital and the replacement cost of net assets —EVA® = net operating economic profit after tax (NOPAT) less capital charge —Where capital charge = weighted cost of capital x net assets at replacement cost EVA® 1

21. EVA® and RI compared —EVA® and RI are similar as they are both absolute performance measures —In both measures a deduction is made for the capital charge —EVA® and RI differ in that EVA® uses economic profit and not accounting profit —For the calculation of the capital charge, EVA® values the net assets at their replacement cost —EVA® is a registered trademark owned by Stern Stewart & Co. EVA® 2

22. (EVA®) continued —Economic profit —Costs which are normally treated as expenses may be added back to NOPAT —If these costs are considered as investments, building for the future Examples —Research and development, advertising, and goodwill —These are added back to accounting profit to reflect the economic reality of the expenditure —They are also included in net assets employed EVA® 3

23. Economic profit continued —Adjustments are sometimes made to economic depreciation to reflect the economic fall in asset value due to wear and tear or obsolescence —Interest is excluded from NOPAT as it is taken into account in the capital charge —Capital charge = replacement cost of net assets employed × weighted average cost of capital (WACC) EVA® 4

24. NOPAT is calculated from PAT Add back items that are non cash, such as: Accounting depreciation Provision of doubtful debts Non cash expenses Interest paid net of tax Add back items that add value, such as: Goodwill amortised R&D costs/Advertising costs Operating leases Take off Economic depreciation Any impairment in the value of goodwill =NOPAT in cash flow terms The calculation of EVA

25. Deduct charge for the cost of capital: Capital employed Add adjustment to allow for the net replacement cost of tangibal non-current assets =capital invested Multiply cost of capital =charge for the cost of capital The calculation of EVA