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Advanced Analysis and Appraisal of Performance: Financial and Nonfinancial

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Stephanie Bez Saludes

on 6 August 2013

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Transcript of Advanced Analysis and Appraisal of Performance: Financial and Nonfinancial

Advanced Analysis and Appraisal of Performance: Financial and Nonfinancial
Performance Measurement or Evaluation
It is the process by which managers at all levels gain information about the performance of tasks within the firm and judge that performance against preestablished criteria as set out in budgets, plans, and goals.

Financial and Nonfinancial Measures
Firms are increasingly presenting financial and nonfinancial performance measures for their subunits in a Balanced Scorecard, and it’s four perspectives:

Financial perspective
How do we look to shareholders?
Customer perspective
How do customers see us?
Internal Business Process
What must we excel at?
Learning and Growth
How can we continue to improve, create value and innovate?
Nonfinancial Performance Measures
Market share
Market share is a key indicator of market competitiveness—that is, how well a firm is doing against its competitors.
It includes customer satisfaction, delivery performance, product quality and service quality.
Customer Service
Nonfinancial Performance Measures
Nonfinancial Performance Measures
This includes new product development, manufacturing flexibility, technological capability, and innovation
A futuristic picture of the enterprise, described in words or the vision statement.
The basic purpose for being of the organization.
The enterprise translates the broad vision and mission statements to specific objectives.
KRA’s are qualitative manifestations or proofs that the objectives are being achieved or attained.
PI’s are nothing but exact quantifications of the KRA’s

It specifies the product or service to be rendered and also defines the market.
These are measurable end results.
Steps in designing accounting-based performance measures
Step 1: Choosing among different performance measures
Four commonly used measures to evaluate the economic performance of organization subunits:
Return on Investment
Residual Income
Economic Value-Added
Return on Sales
Investment turnover
return on sales
Residual Income
Income -
Economic- Value Added
After tax
Return on Sales
(Required rate of return x Investment)
Average cost
of Capital
Current Liabilities
Step 2: Choosing the Time Horizon of the Performance Means
Should performance measures be calculated for one year or for a multi-year time horizon?
Step 3: Choosing Alternative Definitions for Performance Measures
Total assets available
Step 4: Choosing Measurement Alternatives for Performance Measures
Operating Income
Multiple periods of evaluation are sometimes appropriate
Total assets employed
Total assets employed minus current liabilities
Shareholder's Equity
Two different ways to measure or value asset
Current cost- asset measure based on cost of purchasing asset today
Advantages of Net Book Value; Disadvantages of Gross Book Value
Net book value maintains consistency with the balance sheet for external reporting purposes, more meaningful comparisons of return on investment measure

Advantages of Net Book Value; Disadvantages of Gross Book Value
Net book value measure invested capital more consistent with definition of income (ROI numerator). In computing income current period depreciation on long term asset is deducted as expense.
Historical cost- aggregate price paid by the firm to acquire ownership
Advantages of Gross Book Value; Disadvantages of Net Book Value
The usual methods of computing depreciation are arbitrary. They should not allow affecting ROI or residual income.

Advantages of Gross Book Value; Disadvantages of Net Book Value
When long-term assets are depreciated, net book value declines over time. This result in misleading increase in ROI and residual income. Gross book value eliminates this problem.

A weakness of comparing operating incomes alone is ignoring differences in the size of the investments in each subunit.
Step 5: Choosing Target Level of Performance
Careful selection of benchmarks or target can help offset shortcomings with historical cost based ROI, RI or EVA measures.
Many problems of asset valuation and income measurement can be satisfactorily solved if top management gets everybody to focus on what is attainable in forthcoming budget period.
Step 6: Choosing the Timing of Feedback
Factors to be consider in timing the report:
-How critical is the information for the success of the organization
-The specific level of management that is receiving the feedback
-The sophistication of the organization’s information technology
Strategic feedback enables managers to test if strategy produces the expected result. If not, it is cause by:
Implementation problems
Invalid strategy

Feed forward control means making predictions of outputs expected at some future time and then quantifying those predictions, in management accounting terms.
Feedback control involves comparing outputs achieved against outputs desired and taking corrective action if necessary
Popular way to establish targets is to set a continuous improvement targets.
Timely reporting of actual results and identification of causes could help correct an action so that the plan an executed as intended.

These are companies that operate in several countries.
Timely reporting of actual results and identification of causes could help correct an action so that the plan an executed as intended.
International environmental conditions may be very different from and complex than, domestic conditions.
Environmental variables facing local managers of divisions:
Economic variables
Legal and political factors
Quality, efficiency and effectiveness of legal structure
Defense policy
Foreign policy
Degree of government control of business
Level of political unrest
Educational variables
Literary rate
Sophistication of accounting system
Degree of technical training
Management development programs
Economic variables
Currency restrictions
Transfer prices
Capital markets

Legal and Political factors
Educational variables
Sociological and cultural variables
Sociological and cultural variables
Cultural and social diversity
Social attitude toward material gain
Cultural attitude toward authority and persons in subordinate positions
Work ethics
Evaluation of performance of foreign units and their managers can create additional difficulties for the following reasons:
Complications brought about by legal, cultural, political, economic and social differences across countries that direct attention to special areas or restrict a local manager’s actions.
Multinationals must cope with changes in exchange rates. Issues of inflation and fluctuations in foreign currency exchange rates affect performance measures and over which the local manager has no control.
Availability of materials and skilled labor, as well as costs of materials, labor and infrastructure (power, communication, and transportation) may differ significantly across countries.
Companies may have problems in setting transfer prices considering the different tax structures and currency restrictions of the countries in which their divisions operate.
Import controls (e.g., tariffs and custom duties) and limiting selling prices of a company’s products may be imposed by government in some countries.
Distinguishing performance of managers from performance of organization units
Performance evaluation is performed at different levels in the firm: top management, mid-management, and the operating level of individual employees such as production and sales.
It is important though that the performance evaluation if a manager should be distinguished from the performance evaluation of the manager’s subunit, such as a division or subsidiary of a company.
Factors that should be considered in evaluating the performance of a manager:
The evaluation should recognize that factors inside and outside the firm influence the outcome of the manager’s efforts and abilities. The evaluator should separate the outcome of the manager’s activities from the effort and decision making skills employed by the managers.
The evaluation must include only factors that the manager controls.
Because of uncertainty and lack of observability, a risk-averse manager us improperly biased to avoid decisions with uncertain outcome. A performance report should consist of financial and nonfinancial measures of the outcomes of the manager’s decisions and effort.
Intensity of incentives; financial and nonfinancial incentives
Compensation of manager contains portion for salary and for incentive.

Management compensation frequently includes incentives tied to performance.
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