Download - w12-Financial and Non Financial Measures
Financial and Non Financial Measures
SEMESTER 1 SESSION 2011/2012UKM GSB
ZCZA6103 ACCOUNTING FOR DECISION MAKING
What are Financial Controls?
Financial control involves the use of financial measures to assess organization and management performance The focus of attention could be a product, a product line, an
organization department, a division, or the entire organization
Financial control provides a counterpoint to the balanced scorecard view that links financial results to its presumed drivers Focuses only on financial results
Managers use and consider both: Internal financial controls
Information used internally and not distributed to outsiders External financial controls
Developed by outside analysts to assess organization performance
Responsibility Accounting Responsibility accounting is an underlying concept of
accounting performance measurement systems. Under responsibility accounting, managers’ performances
are evaluated on matters directly under managers’ control.
A responsibility center is an organization unit for which a manager is made responsible for specific financial results.
Underlying the accounting classifications of responsibility centers is the concept of controllability
The controllability principle states that the manager of a responsibility center should be held responsible only for the revenues, costs, or investment that responsibility center personnel control
Types of Responsibility Centers Cost center Revenue center Profit center Investment center
Cost Center
A responsibility center in which employees control costs but do not control revenues or investment level
Organizations evaluate the performance of cost center employees by comparing the center’s actual costs with target or standard cost levels for the amount and type of work done
Using variance analysis i.e. flexible budgets and standard costing.
Revenue Center A responsibility center is a responsibility
center where managers are responsible mainly on generating revenue with relatively little costs.
Performance measures of profit centers are mainly on sales volume, sales price variances and sales mix variances.
Profit Center
A responsibility center where managers and other employees control both the revenues and the costs of the product or service they deliver
A profit center is like an independent business, except that senior management, not the responsibility center manager, controls the level of investment in the responsibility center
Most units of chain operations are treated as profit centers
Profit Centre
Assessed by using segmented income statement which shows the profit and loss made for period under reviewed
Example: Bersatu Sdn Bhd
Total Business Products
Consumer Products
Sales RM1,000,000
RM600,000 RM400,000
Less: Variable costs 400,000 240,000 160,000Contribution margin RM 600,000 RM 360,000 RM240,000Less: Traceable fixed expenses 200,000 125,000 75,000Segment margin RM 400,000 RM 235,000 RM165,000Less: Common fixed expenses 200,000 Net income RM 200,000
Profit Center Segment margin is an performance indicator
use to measure profit center. Contribution approach is more appropriate in
distinguish costs that are controllable and uncontrollable
Costs are divide into: Traceable costs including variable costs and
traceable fixed costs Common costs is a fixed costs that support the
operations of more than one segment and cannot be directly traceable to a particular segment.
Investment Center A responsibility center in which the manager and
other employees control revenues, costs, and the level of investment in the responsibility center
Performance measures Return on investment (ROI) Residual Income Economic value added
Measuring Return on Investment
Dupont, as a multiproduct firm, pioneered the systematic use of return on investment (ROI) to evaluate the profitability of its different lines of business
ROI = Income/ Investment The following slide presents Dupont’s approach
to financial control in summary form
The Dupont ROI Control System
The Dupont System
The Dupont system of financial control focuses on ROI and breaks that measure into two components: A return measure that assesses efficiency A turnover measure that assesses productivity
It is possible to compare these individual and group efficiency measures with those of similar organization units or competitors
The Dupont System
The productivity ratio of sales to investment allows development of separate turnover measures for the key items of investment The elements of working capital
Inventories, accounts receivable, cash The elements of permanent investment
Equipment and buildings
Comparisons of these turnover ratios with those of similar units or those of competitors suggest where improvements are required
Questioning The ROI Approach
Despite its popularity, ROI has been criticized as a means of financial control: too narrow for effective control profit-seeking organizations should make
investments in order of declining profitability until the marginal cost of capital of the last dollar invested equals the marginal return generated by that dollar
Using Economic Value Added
Economic value added (EVA—previously called residual income) equals income less the economic cost of the investment used to generate that income If a division’s income is $13.5 million and the
division uses $100 million of capital, which has an average cost of 10%:Economic value added = Income – Cost of capital=$13,500,000 – ($100,000,000 x 10%)=$3,500,000
Using Economic Value Added
Like ROI, EVA evaluates income relative to the level of investment required to earn that income
Unlike ROI, EVA does not motivate managers to turn down investments that are expected to earn more than their cost of capital
Recently, EVA has been extended to adjust GAAP income for the conservative approach that GAAP uses to determine income and value assets
Using Economic Value Added
Organizations now use economic value added to identify products or product lines that are not contributing their share to organization return, given the level of investment they require These organizations have used activity-
based costing analysis to assign assets and costs to individual products, services, or customers
This allows them to calculate the EVA by product, product line, or customer
Organizations can also use economic value added to evaluate operating strategies
Critics of Financial Control
Financial information is delayed—and highly aggregated—information about how well the organization is doing in meeting its commitments to its shareowners
This information measures neither the drivers of the financial results nor how well the organization is doing in meeting its other stakeholders’ requirements
Financial control may be an ineffective control scorecard for three reasons: Focuses on financial measures that do not measure the
organization’s other important attributes Measures the financial effect of the overall level of performance
achieved on the critical success factors, and it ignores the performance achieved on the individual critical success factors
Oriented to short-term profit performance, seldom focusing on long-term improvement or trend analysis, instead considering how well the organization or one of its responsibility centers has performed this quarter or this year
The Efficacy ofFinancial Control
If used properly, financial results provide crucial help in assessing the organization’s long-term viability and in identifying processes that need improvement
Financial control should be supported by other tools since it is only a summary of performance
Financial control does not try to measure other facets of performance that may be critical to the organization’s stakeholders and vital to the organization’s long-term success
Financial control can provide an overall assessment of whether the organization’s strategies and decisions are providing acceptable financial returns
Organizations can also use financial control to compare one unit’s results against another
Integration of Financial and Non Financial Performance Measures
The impact of intense competition in business environment resulted changes in the business activities and structure.
Most of the activities required non financial information. Maskell (1989) suggested that day to day control of
manufacturing and distribution are better handle with non financial measures
Continuous use of financial measures in nowadays environment affected on the behaviors of individual such as myopic behaviour. Kaplan & Norton (1992), by focusing only on financial
performance, it can give misleading signals for continuous improvement and innovation activities of customer focused manufacturing strategy.
Contemporary Performance Measurement Systems Changing evolution from cybernetic to holistic
view A cybernetics model of control includes stated
objectives or goals, a predictive model and a tool to facilitate the choice of alternative actions
In a cybernetic view, control systems is primarily based on financial measures and consider as a component of planning and control cycle
Holistic view is based on multiple non financial measures where performance measurement acts a an independent process integrated in a broader set of activities.
Contemporary Performance Measurement Systems
Performance pyramid (Lynn & Cross, 1991).
Determinants and results matrix (Fitzgerald et. al, 1991)
Performance prism (Neely et al, 2002)
Balanced scored card (Kaplan & Norton, 1992)
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1992 1996 2000
Balanced Scorecard historyBalanced Scorecard history
Measurement and Reporting
Alignment and Communication
Enterprise-wide Strategic Management
Articles in Harvard Business Review:
“The Balanced Scorecard — Measures that Drive Performance” January - February 1992
“Putting the Balanced Scorecard to Work” September - October 1993
“Using the Balanced Scorecard asa Strategic Management System” January - February 1996
1996 2000
Acceptance and Acclaim:
“The Balanced Scorecard” is translated into 18 languages
Selected by Harvard Business Review as one of the “most important management practices of the past 75 years.“
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2004
Strategy-mapping
Strategy linkages
Intellectual Capital Model – Intellectual Capital Model – Converting INTANGIBLE ASSETSConverting INTANGIBLE ASSETSinto TANGIBLE OUTCOMESinto TANGIBLE OUTCOMES
Balanced Scorecard historyBalanced Scorecard history
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MISSIONMISSIONWhy We ExistWhy We ExistMISSIONMISSION
Why We ExistWhy We Exist
VALUESVALUESWhat’s Important to UsWhat’s Important to Us
VALUESVALUESWhat’s Important to UsWhat’s Important to Us
VISIONVISIONWhat We Want To BeWhat We Want To Be
VISIONVISIONWhat We Want To BeWhat We Want To Be
STRATEGYSTRATEGYWhat Our Game PlanWhat Our Game Plan
STRATEGYSTRATEGYWhat Our Game PlanWhat Our Game Plan
STRATEGY MAPSTRATEGY MAPTranslate the StrategyTranslate the Strategy
STRATEGY MAPSTRATEGY MAPTranslate the StrategyTranslate the Strategy
BALANCED SCORECARDBALANCED SCORECARDMeasure and FocusMeasure and Focus
BALANCED SCORECARDBALANCED SCORECARDMeasure and FocusMeasure and Focus
TARGET and INITIATIVESTARGET and INITIATIVESWhat We Need to Do What We Need to Do
TARGET and INITIATIVESTARGET and INITIATIVESWhat We Need to Do What We Need to Do
PERSONAL OBJECTIVESPERSONAL OBJECTIVESWhat I Need to DoWhat I Need to Do
PERSONAL OBJECTIVESPERSONAL OBJECTIVESWhat I Need to DoWhat I Need to Do
Linking Strategy toLinking Strategy toPerformancePerformanceManagementManagementS
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Financial Perspective Customer Perspective Internal Perspective Innovation and Learning
Perspective
The most commonly used key performance indicators found in a survey are--
Balanced Scorecard Linked to Balanced Scorecard Linked to Organizational PerformanceOrganizational PerformanceBalanced Scorecard Linked to Balanced Scorecard Linked to Organizational PerformanceOrganizational Performance
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Principle of the Strategy Focused Organization: TRANSLATE THE STRATEGY TO OPERATIONAL TERMS
The Strategy
Financial Perspective
“If we succeed, how will we look to our shareholders?”
Customer Perspective
“To achieve my vision, how must I look to my customers?”
Internal Perspective
“To satisfy my customer, at which processes must I excel?”
Organization Learning
“To achieve my vision, how must my organization learn and improve?”
@Measurement is the language that gives clarity to vague concepts.
@ Measurement is used to communicate, not to control.
@Strategy can be described as a series of cause and effect relationship
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Objectives
• Fast ground turnaround
Statement of what strategy must achieve and what’s critical to its success
Target
• 30 Minutes• 90%
The level of performance or rate of improvement needed
• Cycle time optimization
Key action programs required to achieve objectives
InitiativeMeasurement
• On Ground Time• On-Time
Departure
How success in achieving the strategy will be measured and tracked
Strategic Theme: Operating Efficiency
ProfitabilityFinancial
Learning
Morecustomers
Ground crew alignment
Lowest prices
Fewer planes
Customer
Internal
Fast ground turnaround
Strategy Map: Diagram of the cause-and-effect relationships between strategic objectives
Flight Is on time
Balanced ScorecardBalanced Scorecard
CLASS CASE DISCUSSION
Atkinson et al. 6th Edition. Case 2-53 pg. 79, Chadwick Incorporation. Read this case before class and do necessary
preparation. A group work of 4 students Time given: 1 hour 15 minutes One group will be selected to present.