CA BUSINESS SCHOOL

POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE

SEMESTER 1 : FINANCIAL PLANNING AND CONTROL

Performance Measurement

M B G Wimalarathna
[FCA, FCMA, MCIM, FMAAT, MCPM][MBA–PIM/USJ]
 Introduction
Performance Measurement is a key tool used by an entity through
which achievement of goals/targets will be evaluated. To assess
whether goals have been achieved, an evaluation is conducted using
measures deemed appropriate for such an evaluation.

In measuring the performance, it (generally) compares with a

benchmark such as previous achievement, expectation and/or
competitors’ achievement.

Both people (employees) and organization (as a whole) will be

motivated by the achievement of goals. Generally, entity’s goals are
expressed through the mission.

Mission is a common path to achieve long term unique goal of every

corporation. (why do we exist?)
 Performance Measurement - internally
It is widely used practice to divide entire organization in to key business
units called Segments/Divisions. This helps to;

 Localize decision making. This improve timelines of and access to

information.
 Improve commitment and motivation of managers responsible for
each unit.
 Provide inputs to strategic long-term planning of whole organization.
 Assign responsibility & authority to divisional managers.

An entity’s performance reflects both inside and outside perspective at

a particular time. .
Outside - Restricted information and generally could find from the
company’s annual report.
Inside -Not restricted. Can be internal-external, accounting-non
accounting, financial-non financial.
 Balance Scorecard (BSC)
The balance scorecard is an internal performance measurement
module widely used by entities which provides a set of performance
measures that reflect achieving an entity’s goals & strategies. As
framework provided, it measures (from) four perspectives.

 Financial - How do we create value for our shareholders?

 Customer - What do new and existing customers value from us?
 Internal Operations - What processes must we excel as to achieve
our financial and customer objectives?
 Innovation & Improvement activities - How can we continue to
improve and create value?
Balance Scorecard (Contd.)
 Development of a BSC
 Use the scorecard as the basis for implementing strategic goals.
 Put in place the strategies before implementing the balance
scorecard. Ad-hoc development will re-enforce the wrong behaviour.
 Ensure that senior management (CEO) is committed to its success.
 Trial the scorecard to learn valuable lessons. Don’t be panic.
 Gradually introduced the scorecard to each business units to ensure
that the scorecard meets the business unit’s needs.
 Do not use the scorecard as an extra level of top down control. This
will lead to opposition of rather than collaboration.
 Do not adopt a standardized scorecard. It should be customised and
align with corporate strategy.
 Do not underestimate the need for training & communication.
 Do not over complicate the scorecard by striving for perfection, or
delay its introduction by always searching for better indicators.
 Do not underestimate the additional cost associated with recording/
administrating and reporting the scorecard.
 Criticism made against using BSC
 It focuses mainly on shareholders’ view point.
 It does not give proper attention to employees & suppliers.
 It does not address adequately the selection of specific measures
for the role of performance target.
 The casual relationship between some of the measures and their
economic impact has never been empirically tested and proven.

Divisional performance measurement

The Organization structure is the structure taken by an entity to help
direct and control its resources for the attainment of its mission. It also
helps to delineate the level of responsibility and authority of a division.
Divisional Performance Measurement (Contd.)
 Effective Performance Measurement
The Performance Measurement system of an entity generally aligns with
its structure. That is, each division, group or segment identifies its
contribution to the overall goal of the entity, and is evaluated on the basis
of this contribution.

Key Business Centres;

1. Cost Centre - Responsible for the production of goods/services at
minimum cost.
2. Revenue Centre - Solely responsible for generating target level of
revenue.
3. Profit Centre - Responsible for evaluate & control cost inputs and
outputs of revenue through which attain required level of profitability.
4. Investment Centre - Responsible for the Investment activities such as
investment in assets, deposits.

Notice any negative impact to the whole organization on above.

Effective Performance Measurement (Contd.)
The responsible manager’s performance is assessed on the division’s
overall contribution to the entity’s goal.

When evaluating the divisional performance, it should clearly identify

the controllable and non-controllable cost and revenue.

The preparation of divisional performance report designed to;

 Evaluate the performance of each division.
 Provide guidance for the pricing of goods & services.
 Evaluate the level of investment in each division.
 Evaluate the overall efficiency/effectiveness of each division.
 Performance Evaluation
The evaluation of performance with respect to the investment center is
based on the economic return relative to the invested resources.

Following key indicators used to evaluate the performance.

1. Return on Investment (ROI)
2. Residual Income (RI)
3. Economic Value Added (EVA)

Formulas; ROI = Profit

Investment
Du Pont ROI = Return on sales x Investment Turnover
= Profit x Sales
Sales Investment
 Performance Evaluation (Contd.)
RI = Profit before tax - (required rate of return x investment)

EVA = NOPAT - (Cost of capital x Capital)

Note: Adjustments require when calculating NOPAT.
– Add R & D Costs.
– Add marketing expenditures.
– Not consider the amortization (Goodwill)
 Individual Performance Measurement
“Companies don’t succeed, people do.”

The company itself brings owners, workers and resources together under a
legal structure. The people working within the companies perform
multiple tasks individually and in teams to help accomplish the
organization’s goals.

Performance measurement at the individual level should highlight to the

employees what tasks are important.

Another consideration of the performance measurement system is the

reward system which basically focused both respective individuals and
group of people/team work.

Note: Most of the instances, entity might link both performance

measurement and reward to the short - term and long - term perspectives.
 Non-financial Performance Evaluation
An entity must analyse and understand non - financial performance
indicators along with the financial performance indicators to establish
well effective performance measurement system.

The balance scorecard framework (identified earlier) considers both

financial and non - financial measures. Non - financial performance
measures are being (generally) more operational in nature.

Most of non -financial performance measurement equipped with

following benefits.
 They are more user friendly and relevant to non - management
employees.
 They are more likely to lead to longer - term performance gain, as
they tend to be linked more readily to the organization’s goals.
 They tend to diminish the likelihood of myopic management decision
making, as they usually promote more long - term thinking.
 Non-financial Performance Evaluation (Contd.)
 They can identify problems in a more timely fashion, and locate the
entity’s problems and benefits.
 They can be easily structured to suit an organization’s goals.
 They can be benchmarked easily.

Non - financial performance measures have following disadvantages.

 They are subjective in nature.
 Including too many measures can impede understanding and be
costly to collect, so there is a need to limit the number of measures.

Besides the above obstacles/disadvantages, more the qualitative

factors will be benefited.
 Non-financial Performance Evaluation (Contd.)
Quality - customer satisfaction
 Number of defective products shipped
 Customer response time
 Warranty claims
 Number of customer complaints
Quality - supplier
 Percentage of defects per delivery
 Frequency of defective supplies
 Number of late deliveries
Quality – internal measures
 Number of defects per product /product run
 Measure of scrap and rework in the production process
 Number of suggestions from employees
 Process downtime
Inventory
 Inventory turnover
 Warehouse space reduction
 Warehouse space utilization
 Non-financial Performance Evaluation (Contd.)
Equipment and maintenance
 Machine use and capacity
 Machine availability
 Maintenance hours
 Time between failure
Employees Performance Measures
 Employee morale: percentage of absenteeism, staff turnover
 Health and safety: injury rate, workers’ compensation claims
 Employee skill: age and experience statistics, percentage of trained
staff, staff educational qualifications
 Employee productivity: labor efficiency, output measures
Market Performance Measures
 Market share growth (percentage and volume)
 Market leadership
 Market vulnerability