9 accouting based kpi

Financial Key Performance Indicators

Module 9 - Finance for Non-Finance

Accounting based Accounting based Performance Performance MeasurementMeasurement

1. Define responsibility accounting, and describe four types of responsibility centers.

2. Tell why firms choose to decentralize.3. Compute and explain return on investment

(ROI) and economic value added (EVA).4. Explain the role of balance scorecard in a

evaluating firm performance.

ObjectivesObjectivesObjectivesObjectives

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Responsibility accounting is a system that measures the results of each responsibility

center according to the information managers need to operate their centers.

Responsibility accounting is a system that measures the results of each responsibility

center according to the information managers need to operate their centers.

Types of Responsibility CentersTypes of Responsibility Centers

Cost center: A responsibility center in which a manager is responsible only for costs.

Revenue center: A responsibility center in which a manager is responsible only for sales.

ContinuedContinued

Types of Responsibility CentersTypes of Responsibility Centers

Profit center: A responsibility center in which a manager is responsible for both revenues and costs.

Investment center: A responsibility center in which a manager is responsible for revenues, costs, and investments.

ACCOUNTING INFORMATION USED TO MEASURE ACCOUNTING INFORMATION USED TO MEASURE PERFORMANCEPERFORMANCE

CapitalCapital Cost Sales Investment Other Cost Sales Investment Other

Cost center x

Revenue center Direct cost xonly

Profit center x x

Investment center x x x x

Return on InvestmentReturn on InvestmentReturn on InvestmentReturn on Investment

ROI = Operating income

Average operating assets

Beginning net book value + Ending net book value

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Comparison of ROIComparison of ROI

Electronics Medical SuppliesElectronics Medical Supplies Divisions DivisionsDivisions Divisions2003:

Sales $30,000,000 $117,00,000Operating income 1,800,000 3,510,000Average operating assets 10,000,000 19,500,000ROI 18 18% %

$1,800,000$10,000,000

Comparison of ROIComparison of ROI

Electronics Medical SuppliesElectronics Medical Supplies Divisions DivisionsDivisions Divisions2004:

Sales $40,000,000 $117,00,000Operating income 2,000,000 2,925,000Average operating assets 10,000,000 19,500,000ROI 20 15% %

$2,000,000$10,000,000

Margin and TurnoverMargin and TurnoverMargin and TurnoverMargin and Turnover

ROI = Margin x Turnover

Operating IncomeSales

SalesAverage operating assets

MARGIN AND TURNOVER COMPARISONSMARGIN AND TURNOVER COMPARISONS Electronics Medical SuppliesElectronics Medical Supplies

Division Division Division Division

Margin 6.0% 5.0% 3.0% 2.5%Turnover x 3.0 x 4.0 x 6.0 x 6.0ROI 18.0% 20.0% 18.0% 15.0%

2003 2004 2003 20042003 2004 2003 2004

1. It encourages managers to focus on the relationship among sales, expenses, and investments.

2. It encourages managers to focus on cost efficiency.

3. It encourages managers to focus on operating asset efficiency.

Advantages of ROIAdvantages of ROI

1) It can produce a narrow focus on divisional profitability at the expense of profitability for the overall firm.

2) It encourages managers to focus on the short run at the expense of the long run.

Disadvantages of ROIDisadvantages of ROI

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Economic value added (EVA) is after-tax operating profit minus the total annual cost of capital.

EVA = After-tax operating income – (Weighted average cost of capital x Total capital employed)

EVA = After-tax operating income – (Weighted average cost of capital x Total capital employed)

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There are two steps involved in computing cost of capital:

1. Determine the weighted average cost of capital (a percentage figure)

2. Determine the total dollar amount of capital employed

Weighted Average Cost of Capital

Suppose that a company has two sources of financing: $2 million of long-term bonds paying

9 percent interest and $6 million of common stock, which is considered to be of average risk. If the company’s tax rate is 40 percent and the rate of interest on long-term government bonds is 6 percent, the company’s weighted average

cost of capital is computed as follows:

Suppose that a company has two sources of financing: $2 million of long-term bonds paying

9 percent interest and $6 million of common stock, which is considered to be of average risk. If the company’s tax rate is 40 percent and the rate of interest on long-term government bonds is 6 percent, the company’s weighted average

cost of capital is computed as follows:


Amount Percent x After-Tax Cost = Weighted Cost

Bonds $2,000,000 0.25 0.009(1 –0.4) = .054 0.0135

Equity 6,000,000 0.75 0.06 + 0.06 = .120 0.0900

Total $8,000,000 0.1035

Thus, the company’s weighted average is

10.35 percent.

Thus, the company’s weighted average is

10.35 percent.

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Suppose that Mahalo, Inc., had after-tax operating income last year of $900,000. Three

sources of financing were used by the company: $2 million of mortgage bonds paying 8 percent interest, $3 million of unsecured bonds paying 10 percent interest, and $10 million in common stock, which was considered to be no more or less risky than other stocks. Mahalo, Inc. pays

a marginal tax rate of 40 percent.

EVA ExampleEVA ExampleEVA ExampleEVA Example


Weighted Amount Percent x After-Tax Cost = Cost

Mortgage bonds $ 2,000,000 0.133 0.048 0.006Unsecured bonds 3,000,000 0.200 0.060 0.012Common stock 10,000,000 0.667 0.120 0.080 Total $15,000,000Weighted average cost of capital 0.098

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Mahalo’s EVA is calculated as follows:

After tax operating income $900,000

Less: Cost of capital 784,000

EVA $116,000

EVA ExampleEVA ExampleEVA ExampleEVA Example

A number of companies have discovered that EVA helps to encourage the right kind of behavior from their divisions in a way that emphasis on operating income alone cannot. The underlying reason is EVA’s reliance on the true cost of capital.

Behavioral Aspects of EVA

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Behavioral Aspects of EVAIn many companies, the responsibility for investment decisions rests with corporate management. As a result, the cost of capital is considered a corporate expense. If a division builds inventories and investment, the cost of financing that investment is passed along to the overall income statement and does not show up as a reduction from the division’s operating income.

The Balanced Scorecard

The Balanced Scorecard translates an organization’s mission and strategy into operational objectives and performance measures for four different perspectives:

The financial perspective

The customer perspective

The internal business process perspective

The learning and growth perspective

Strategy, according to Robert Kaplan and David Norton, is defined as

“. . . choosing the market and customer segments the business unit intends to serve, identifying the critical internal and business

processes that the unit must excel at to deliver the value propositions to customers

in the targeted market segments, and selecting the individual and organizational

capabilities required for the internal, customer, and financial objectives.”

Vision and StrategyVision and Strategy

FinanciFinancialal

L and GL and GCustomerCustomer ProcessProcess

ObjectivesObjectives

MeasuresMeasures

TargetsTargets

InitiativesInitiatives

Strategy-Translation

Process

Testable Strategy Illustrated

Testable Strategy Illustrated

Quality Quality TrainingTraining

Infra-structure

Redesign Redesign ProductsProducts

ProcessReduce Reduce

Defective Defective UnitsUnits

Increase Increase Customer Customer

SatisfactionSatisfactionCustomer

Increase Increase Market Market ShareShare

Increase SalesIncrease SalesFinancial Increase ProfitsIncrease Profits

Summary of Objectives and Measures:Financial Perspective

Objectives MeasuresObjectives MeasuresRevenue Growth:

Increase the number of new Percentage of revenue products from new products

Create new applications Percentage of repeat customers

Develop new customers and Percentage of revenue from markets new sources

Adopt a new pricing strategy Product and customer profitability

Objectives MeasuresObjectives MeasuresCost Reduction:Reduce unit product cost Unit product cost

Reduce unit customer cost Unit customer cost

Reduce distribution channel cost Cost per distribution channel

Asset Utilization:Improve asset utilization Return on investment

Economic value added

Summary of Objectives and Measures:Customer Perspective

Objectives MeasuresObjectives MeasuresCore:Increase market share Market share (percentage of

market)Increase customer retention Percentage of repeat

customersIncrease customer acquisition Number of new customersIncrease customer satisfaction Ratings from customer

surveysIncrease customer profitability Customer profitability

Objectives MeasuresObjectives MeasuresPerformance Value:Decrease price PriceDecrease postpurchase costs Postpurchase costsImprove product functionality Ratings from customer

surveysImprove product quality Percentage of returnsIncrease delivery reliability On-time delivery percentage

Aging scheduleImprove product image and Ratings from customer

reputation surveys

Actual Conversion Cost per UnitActual Conversion Cost per Unit

Standard costs per minute = $1,600,000/400,000

= $4 per minute

Actual cycle time = 60 minutes/10 units

= 6 minutes per unit

Actual conversion costs = $4 x 6

= $24 per unit Theoretical Conversion Cost per UnitTheoretical Conversion Cost per Unit

Theoretical cycle time = 60 minutes/12 units= 5 minutes per unit

Theoretical conversion costs = $4 x 5

= $20 per unit

Summary of Objectives and Measures:Process Perspective

Objectives MeasuresObjectives MeasuresInnovation:Increase the number of new Number of new products vs.

products plannedIncrease proprietary products Percentage of revenue from

proprietary productsDecrease new product Time to market (from start

development time to finish)

Objectives MeasuresObjectives MeasuresOperations:Increase product quality Quality costs

Output yieldsPercentage of defective units

Increase process efficiency Unit cost trendsOutput/input(s)

Decrease process time Cycle time and velocityMCE

Postsales Service:Increase service quality First-pass yieldsIncrease service efficiency Cost trends

Output/input(s)Decrease service time Cycle time

Summary of Objectives and Measures:Learning and Growth Perspective

Objectives MeasuresObjectives MeasuresIncrease employee capabilities Employee satisfaction ratings

Employee turnover percentage

Employee productivity (revenue/employee)

Hours of trainingStrategic job coverage ratio

(percentage of critical jobrequirements filled)

Objectives MeasuresObjectives MeasuresIncrease motivation and Suggestions per employee

alignment Suggestions implemented peremployee

Increase information systems Percentage of processes withcapabilities real-time feedback

capabilitiesPercentage of customer-

facingemployees with on-line access to customer andproduct information

Examples of Key Performance Indicators

Examples of Key Performance IndicatorsKey Results Areas Key Performance Indicators

Return/profit Return on investmentPercentage of return on sales

Net profit before taxes (dollars)Percentage of gross margin (by product

line)

Productivity Dollars of sales per employeeUnits per month (by product line)

Output per work-hourOutput per employee

Overtime as percentage of payroolDowntime

Turnaround time

Examples of Key Performance Indicators (2)

Examples of Key Performance Indicators (continued)

Key Results Areas Key Performance Indicators

Employee development Training investment as percentage of salesNumber of employees on degree plan

Cross-training planNumber of backups per position

Number of employees with implementeddevelopment plan




Quality assurance Percentage of first-time acceptance

YieldCost of rework, scrap

Percentage of error-free completions (per

shift, per employee)Percentage of recidivism (in law

enforcement)

Cross-functional Percentage of on-time completions

Integration Number of unresolved conflicts

Average lead time on support requestsSpecific joint project agreements




Research and Number of new product ideas approved for

development developmentProjected dollar value of

approved product ideasNumber of new applications

for current products/services

Cost of R&D investment: ratio to total budget




Organizational Favorable mentions in mediaImage Public information programs

Involvement in communityInterorganizational cooperative efforts

Legislative relations Response time to legislatorsInquiries handled favorably

Funding approvedMajor programs approved

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Past performance trends per historical data.

Performance levels of similar organizational units at a comparable level that facilitates benchmarking.

Best practices across the agency, the public sector or the private sector. Must be at a pre-existing high level of performance before you use this approach.

For newly launched services, may have to establish a baseline per a prototype test and extend out from this point forward.

For major strategic shifts, may have to set directly per the plan itself without regard for hard data.

How to Set Targets How to Set Targets

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Targets match up with measurements, one to one. Targets require improving current levels of performance. Targets are a stretch, but achievable: they may require

improvements to existing processes. Targets are quantifiable so that the target communicates if

the expected performance was met. Long-term targets are established before short-term

targets. Financial/Budget related targets are established before

non-financial targets.

Checklist for Setting TargetsChecklist for Setting Targets

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Initiatives Goals or ObjectivesValue Mapping Project Improve identification and delivery of all

agency services across the full stakeholder spectrum

Employee Rotation Program Improve the employee turnover and satisfaction scores

Web Self Service Portal Reduce agency costs and streamline our services for more direct service delivery

Common Knowledge Center Expand the overall knowledge base so that inter-functions can learn from one another

Customer Survey and Analysis Tool Program

Develop a more systematic process across the entire agency to better connect to our customers

Shared Service Center Tracking System

Reduce reworks and overlaps between our seven shared service centers

Initiatives should enable strategic executionInitiatives should enable strategic execution

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When you first launch your Initiative, you probably want to use an Output Measurement. Once the Initiative is up and running, change your measurement to an Outcome to see if the Initiative is

really having strategic impact.

Initiative Output Measurement

Outcome Measurement

Lean Process / Six Sigma

Number of Projects Defined by Region

Overall reductions in errors, reworks, and cycle times

Activity Based Costing / Management (ABC/M)

% of Service Center Outlets with ABC Models in place for Allocation Costs

Reductions in identified re-activities per process study

Employee Competency Models

% of Employees who have a Competency Model in place

Higher skill levels of employees using the models

Going from Output to OutcomeGoing from Output to Outcome

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What is KPI in graphic?

Input KPI

KPI2

After

Before

Before After Output

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Sale per ringgit Advertising

Advertising Sales/advertising

KPI2

After

Before

Before After Sales

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Thank you

Question please

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9 accouting based kpi

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