accounting based kpi

Financial Key Performance IndicatorsModule 9 - Finance for Non-Finance

Accounting based Performance Measurement

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.ObjectivesAfter studying this chapter, you should be able to:

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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.

Types of Responsibility CentersCost 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.

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Types of Responsibility CentersProfit 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 PERFORMANCE

Capital Cost Sales Investment Other Cost centerxRevenue centerDirect costxonlyProfit centerxxInvestment centerxxxx

Return on InvestmentROI =

Comparison of ROI Electronics Medical Supplies Divisions Divisions2003:Sales$30,000,000$117,00,000Operating income1,800,0003,510,000Average operating assets10,000,00019,500,000ROI1818%%

Comparison of ROI Electronics Medical Supplies Divisions Divisions2004:Sales$40,000,000$117,00,000Operating income2,000,0002,925,000Average operating assets10,000,00019,500,000ROI2015%%

Margin and TurnoverROI = Margin x Turnover

MARGIN AND TURNOVER COMPARISONS Electronics Medical Supplies Division Division

Margin 6.0%5.0%3.0%2.5%Turnoverx 3.0 x 4.0 x 6.0 x 6.0ROI 18.0% 20.0% 18.0% 15.0% 2003 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 ROI

It can produce a narrow focus on divisional profitability at the expense of profitability for the overall firm.It encourages managers to focus on the short run at the expense of the long run.Disadvantages 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)

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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 CapitalSuppose 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 companys tax rate is 40 percent and the rate of interest on long-term government bonds is 6 percent, the companys weighted average cost of capital is computed as follows:

Weighted Average Cost of Capital Amount Percent x After-Tax Cost = Weighted CostBonds $2,000,0000.250.009(1 0.4) = .0540.0135Equity 6,000,0000.750.06 + 0.06 = .1200.0900 Total$8,000,0000.1035

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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 Example

Weighted Average Cost of Capital Weighted Amount Percent x After-Tax Cost = CostMortgage bonds $ 2,000,0000.1330.0480.006Unsecured bonds3,000,0000.2000.0600.012Common stock 10,000,0000.6670.1200.080 Total$15,000,000Weighted average cost of capital0.098

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Mahalos EVA is calculated as follows:After tax operating income$900,000Less: Cost of capital 784,000EVA$116,000

EVA 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 EVAs 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 divisions operating income.

The Balanced Scorecard translates an organizations mission and strategy into operational objectives and performance measures for four different perspectives:The financial perspectiveThe customer perspectiveThe internal business process perspectiveThe 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 Strategy

Testable Strategy IllustratedProcessCustomerFinancial

Summary of Objectives and Measures:Financial Perspective Objectives MeasuresRevenue Growth:Increase the number of new Percentage of revenue products from new productsCreate new applicationsPercentage of repeat customersDevelop new customers and Percentage of revenue from markets new sourcesAdopt a new pricing strategyProduct and customer profitability

Objectives MeasuresCost Reduction:Reduce unit product costUnit product cost

Reduce unit customer costUnit customer cost

Reduce distribution channel costCost per distribution channel

Asset Utilization:Improve asset utilizationReturn on investmentEconomic value added

Summary of Objectives and Measures: Customer Perspective Objectives MeasuresCore:Increase market shareMarket share (percentage ofmarket)Increase customer retentionPercentage of repeat customersIncrease customer acquisitionNumber of new customersIncrease customer satisfactionRatings from customer surveysIncrease customer profitabilityCustomer profitability

Objectives MeasuresPerformance Value:Decrease pricePriceDecrease postpurchase costsPostpurchase costsImprove product functionalityRatings from customer surveysImprove product qualityPercentage of returnsIncrease delivery reliabilityOn-time delivery percentageAging scheduleImprove product image and Ratings from customer reputationsurveys

Summary of Objectives and Measures: Process Perspective Objectives MeasuresInnovation:Increase the number of newNumber of new products vs.productsplannedIncrease proprietary productsPercentage of revenue fromproprietary productsDecrease new product Time to market (from startdevelopment timeto finish)

Objectives MeasuresOperations:Increase product qualityQuality costsOutput yieldsPercentage of defective unitsIncrease process efficiencyUnit cost trendsOutput/input(s)Decrease process timeCycle time and velocityMCEPostsales Service:Increase service qualityFirst-pass yieldsIncrease service efficiencyCost trendsOutput/input(s)Decrease service timeCycle time

Summary of Objectives and Measures: Learning and Growth Perspective Objectives MeasuresIncrease employee capabilitiesEmployee satisfaction ratingsEmployee turnover percentageEmployee productivity (revenue/employee)Hours of trainingStrategic job coverage ratio(percentage of critical jobrequirements filled)

Objectives MeasuresIncrease motivation and Suggestions per employeealignmentSuggestions implemented peremployee Increase information systemsPercentage of processes withcapabilitiesreal-time feedback capabilitiesPercentage of customer-facingemployees with on-line access to customer andproduct information

*Examples of Key Performance IndicatorsExamples of Key Performance Indicators

Key Results AreasKey Performance Indicators

Return/profitReturn on investmentPercentage of return on salesNet profit before taxes (dollars)Percentage of gross margin (by product line)

ProductivityDollars of sales per employeeUnits per month (by product line)Output per work-hourOutput per employeeOvertime as percentage of payroolDowntimeTurnaround time

*Examples of Key Performance Indicators (2)Examples of Key Performance Indicators (continued)


Employee developmentTraining investment as percentage of salesNumber of employees on degree planCross-training planNumber of backups per positionNumber of employees with implementeddevelopment plan



Quality assurancePercentage of first-time acceptanceYieldCost of rework, scrapPercentage of error-free completions (pershift, per employee)Percentage of recidivism (in law enforcement)

Cross-functionalPercentage of on-time completionsIntegrationNumber of unresolved conflictsAverage lead time on support requestsSpecific joint project agreements



Research and Number of new product ideas approved fordevelopmentdevelopmentProjected dollar value of approved product ideasNumber of new applications for current products/servicesCost of R&D investment: ratio to total budget



OrganizationalFavorable mentions in mediaImagePublic information programsInvolvement in communityInterorganizational cooperative efforts

Legislative relationsResponse time to legislatorsInquiries handled favorablyFunding 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

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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 Targets

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Initiatives should enable strategic execution

InitiativesGoals or ObjectivesValue Mapping ProjectImprove identification and delivery of all agency services across the full stakeholder spectrumEmployee Rotation ProgramImprove the employee turnover and satisfaction scoresWeb Self Service PortalReduce agency costs and streamline our services for more direct service deliveryCommon Knowledge CenterExpand the overall knowledge base so that inter-functions can learn from one anotherCustomer Survey and Analysis Tool ProgramDevelop a more systematic process across the entire agency to better connect to our customersShared Service Center Tracking SystemReduce reworks and overlaps between our seven shared service centers

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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. Going from Output to Outcome

InitiativeOutput MeasurementOutcome MeasurementLean Process / Six SigmaNumber of Projects Defined by RegionOverall reductions in errors, reworks, and cycle timesActivity Based Costing / Management (ABC/M)% of Service Center Outlets with ABC Models in place for Allocation CostsReductions in identified re-activities per process studyEmployee Competency Models% of Employees who have a Competency Model in placeHigher skill levels of employees using the models

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What is KPI in graphic?*

InputKPI

KPI2AfterBefore

BeforeAfterOutput

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Sale per ringgit Advertising *

AdvertisingSales/advertising

KPI2AfterBefore

BeforeAfterSales

Thank youQuestion please*

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accounting based kpi

Documents

computing cost of capital

cost efficiency

responsibility accounting

percent x aftertax cost

average operating assets10

total annual cost of

average risk

operating income1