1. CIMA P2 Advanced Management Accounting
First Intro slide – change details to your own
For exams in 2016
江西财经大学会计学院 吉伟莉

2. Chapter 6 Performance measurement
Financial Performance Indicators
ROI & RI
EVA ®
Non-financial Performance Indicators (NFPIs)
Balanced scorecard
Benchmarking
First Intro slide – change details to your own

3. Financial performance indicators 1
Financial performance indicators (FPIs)
Liquidity
Current ratio
Quick ratio
Accounts receivable days
Accounts payable days
Inventory days

4. Financial performance indicators 2
Financial performance indicators (FPIs) continued
Profitability
Sales margin
ROCE
Profit margin
Asset turnover
FPIs allow comparison between similar companies in the same industry
and
Between results for different years for the same company

5. ROI & RI 1 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

6. ROI & RI 2 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

7. ROI & RI 3
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

8. ROI & RI 4 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

9. ROI & RI 5 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)

10. ROI & RI 6
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

11. ROI & RI 7 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

12. ROI & RI 8 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

13. ROI & RI 9 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

14. ROI & RI 10 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

15. ROI & RI 11
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

16. ROI & RI 12
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

17. ROI & RI 13
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

18. EVA® 1 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

19. EVA® 2 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.

20. EVA® 3 (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

21. EVA® 4 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)

22. Non-financial performance indicators 1
Non-financial performance indicators (NFPIs)
Value of NFPIs
Can be provided quickly
Easy to understand
Tailored to circumstances
NFPIs for employees
Labour turnover
Absenteeism
Skills levels

23. Non-financial performance indicators 2
NFPIs for quality
Quality of incoming supplies
Quality of work done as it proceeds
Measure of customer satisfaction

24. Balanced scorecard 1 Balanced scorecard
A way of measuring performance which integrates traditional financial measures with operational, customer and staff issues
It is ‘balanced’ in the sense that managers are required to think in terms of all four perspectives
This is to prevent improvements being made in one area at the expense of another

25. Balanced scorecard 2 Customer perspective
Measures relating to what actually matters to customers
For example time, quality, performance of product
Examples
Customer complaints
On-time deliveries

26. Balanced scorecard 3 Internal business perspective
Measures relating to the business processes that have the greatest impact on customer satisfaction
For example quality, employee skills
Examples
Average set-up time
Quality control rejects

27. Balanced scorecard 4 Innovation and learning perspective
Measures to assess the organisation’s capacity to maintain its competitive position through the acquisition of new skills/development of new products
Examples
Labour turnover rate
% of revenue generated by new products

28. Balanced scorecard 5 Financial perspective
Measures that consider the organisation from the shareholder’s point of view
Examples
ROCE
EPS

29. Benchmarking 1 Benchmarking
A comparison exercise through which an organisation attempts to improve performance
The idea is to seek the best available performance against which the organisation can monitor its own performance

30. Benchmarking 2 Types of benchmarking Metric benchmarking
Comparing appropriate metrics to identify possible areas for improvement
Process benchmarking
Comparing processes with a partner company as part of an improvement process
Diagnostic benchmarking
Reviewing the processes of a business to identify those which indicate a problem and offer a potential for improvement