[8�3 The J!afa!

1,Ee_�- Scorecard' (B_SC) __ , __ _

A number of integrative frameworks for performance measurement have been proposed

in an attempt to remedy che perceived failings of traditional cost systems, of which
Kaplan and Norton's Balanced Scorecard is the best known. The Balanced Scorecard was
developed as a resulc of a research project in the early 1990s into advanced performance
measurement techniques carried out by Professor Robert Kaplan from the Harvard
Business School and David Norton (a management consultant). The research project
was conducted in conjunction with 12 US businesses regarded as being at the leading
edge of performance measurement. The actual title, the 'Balanced Scorecard', was a
variation on the title - Corporate Scorecard - developed by Arc Schneiderman, then VP
Quality and Productivity at Analog Devices. The resultant template, the Balanced
Scorecard (BSC), became an extension of Schneiderman's and was publicised in a pio-
neering article by Kaplan and Norton in the Harvard Business Review (jan/Feb 1992).
Since chat time, the concept of che 'Balanced Scorecard' has generated a great deal of
interest and practical application.
The essential thrust of che balanced scorecard is based on two fundamental propo-
sitions. First, as most people realise, 'what you measure is what you gee' and, secondly,
managers need a broad range of performance measures in order co manage their busi-
ness. By way of analogy, they refer co an airline pilot who has a variety of dials and
indicators in the cockpit for airspeed, altitude, direction, position, destination, fuel
and so on. All of these are needed for a successful flight and relying on a single perfor-
mance measure can be potentially fatal.
The Balanced Scorecard is, traditionally, divided into different perspectives as out-
lined in Exhibit 8.4 below and is intended co provide answers co four basic questions
as follows:
• How does the firm look to shareholders? (financial perspective)
• How do customers see the firm? (customer perspective)
 8. PERFORMANCE MANAGEMENT AND MEASUREMENT 301

• What must the firm excel at? (internal perspective)

• Can the firm continue to improve and create value? (learning and growth perspective)

EXHIBIT 8.4: THE BALANCED SCORECARD

Financial Perspective How do we look

to shareholders?
Goals Measures

Customer Perspective

Goals Measures Measures

Learning and Growth

Pers ective What must we
excel at?
Can we continue to Goals Measures
improve and create value? ���������

Source: Kaplan and Norton (1992) (adapted)

The BSC is 'balanced' in three ways. First, there is a balance between internal and
external measures. Secondly, it is balanced by the use of both financial and non-
financial measures. Finally, it is balanced in terms of time, i.e. it reflects the past, the
present and the future. The financial perspective reflects past decisions and represents
the historical, financial performance of the firm. The customer and internal process
perspectives represent current performance. The learning and growth perspective rep-
resents what muse be done in the future that will have a positive future impact on the
firm. Each of these four perspectives will now be discussed in turn.

FinanciaJ Perspective

The financial perspective highlights how the company appears to shareholders (actual
and porenriai) and concentrates on measures relating to financial performance. Whi!e
profitability as a performance measure has been criticised, it is important to remember
chat it is an important source of finance. Usually, profit is associated with operating
cash flow and offers greater flexibility in the source of finance for corporate invest-
ment. Easier access to finance facilitates greater investment, which boosts productivity,
competitiveness and employment. In a macro context, company profits reflect the
health of the economy. Financial measures can be identified along che following
themes:
• overall profitability such as return on funds invested;
• sales growth;
302 MANAGERIAL ACCOUNTING

• cost reduction;
• cash flow generated, especially from operating activities;
• asset utilisation; and
• financial position, including liquidity and gearing (leverage) .
The Balanced Scorecard (BSC) complements these financial measures with three other
perspectives chat are generally represented by non-financial measures of performance:
(a) the customer perspective;
(b) the internal perspective; and
(c) the learning and growth perspective.

Customer Perspective

The customer perspective is designed to highlight how customers perceive the busi-
ness and focus on specific measures chat reflect the factors chat really matter to
customers. One could argue that this perspective is at the heart of the BSC. Success
in any business depends on the ability to establish, maintain and build relationships
with customers. However, customer satisfaction does not necessarily mean that your
satisfied customers are committed or loyal. On average, a business loses as much as
20% of its customer base each year. To compound the problem, in today's competi-
tive environment, you cannot rely on acquiring new customers to take the place of
lost ones. Five generic areas across most kinds of organisations can be cited for the
customer perspective.

• Customer satisfaction - since this is considered to be the crucial performance

measure for predicting the future success of most companies.
• Customer profitability.
• Customer retention.
• Customer acquisition.
• Market share.

Internal Perspective

The internal business perspective is designed to focus on chose critical internal activi-
ties chat must be performed in order to satisfy the expectations of its customers and
stem from the entire value-chain, which is the sequence of business processes through
which value is added to goods and services. Analysis of the value chain leads to the
identification of processes chat are critical co the organisation's success. There are three
primary activities in the generic value chain, which are stated below:
• The Innovation Process Creating entirely new products and services to meet the
emerging needs of current and future customers.
• The Operations Process Producing and delivering existing products (or services)
to existing customers efficiently and reliably.
 8. PERFORMANCE MANAGEMENT AND MEASUREMENT 303

• The After-sale Service Process Satisfying customers after the sale has been
highlighted with prompt attention to their concerns and by providing field ser-
vice and technical support, as needed.
Thus, the internal perspective represents an analysis of the company's internal pro-
cesses. We focus on measures for these internal processes that will have the greatest
impact on enhancing customer relationships and, therefore, facilitating the achieve-
ment of the organisation's financial objectives. It is useful to remember that they
represent activities/processes that must be performed within the firm.

Learning and Growth Perspective

The financial, customer and internal business process objectives of the Balanced
Scorecard will typically reveal deficiencies in existing capabilities of employees and
internal systems. To close these gaps, businesses will have to invest in re-skilling its
employees, enhancing information technology and aligning organisational procedures
and routines. These objectives are articulated in the learning and growth perspective.
Organisational learning and growth come from three principal sources:
• employee capabilities;
• the information system and procedures; together with
• employee motivation.

At the heart of this perspective are the employees. The learning and growth perspec-
tive highlights the fact that, in the face of intense competition, firms must make
continual improvement to existing products and processes and have the ability to
introduce new products in the future. A generic balanced scorecard is shown in
Exhibit 8.5.

EXHJBIT 8.5: A GENERIC BALANCED SCORECARD

Critical success factor Performance measures and indicators

Financial perspective
Overall profitability Return on shareholders' funds
Sales growth Sales volume trend; sales of new products
Cost reduction Total cost as percentage of total revenue
Cash flow Operating cash flow as percentage of sales
Asset utilisation Fixed asset turnover; capacity utilisation
Financial position Liquidity and gearing (leverage) ratios
304 MANAGERIAL ACCOUNTING

Customer perspective
Customer satisfaction Customer survey index
Customer profitability Average profit per customer
Customer retention Number of repeat orders
Customer acquisition Number of new customers acquired & sales€
Markee share % of served market achieved

Internal business perspective

Innovation Percentage of sales from new products
Expenditure on research and development
Operations Labour and/or machine efficiency ratios
Defect races, including wastage
On-time deliveries
After-sales service Customer complaint response time
Number of visits to customer

Learning and growth perspective

Employee capability Days training
No. of graduates in workforce
Information systems & Spending on IT capability
procedures No. of meetings attended by employees
Employee motivation Employee turnover
Employee satisfaction

Advantages and Problems of the Balanced Scorecard

A number of advantages and problems of the balanced scorecard will now be dis-
cussed briefly. The BSC integrates traditional financial measures with operational,
customer and employee issues, which are vital to the long-term success of the firm.
Having understood what is important for the business, performance measures are
established to monitor performance and targets muse be sec for improvement.
These must then be clearly communicated to all levels of management and staff
within the business and appropriate training of all employees should be undertak-
en. This enables managers and individuals to understand how their own efforts can
contribute to the success of the enterprise and the BSC can then become an impor-
tant instrument in the regular reporting system of the company. However, a
scorecard should not be introduced unless it is clear what is to be achieved.
 8. PERFORMANCE MANAGEMENT AND MEASUREMENT 305

No organisation should allow itself to drift into implementing a scorecard unless it

has a very good idea of what it expects from it.
Furthermore, it cannot be emphasised enough that top management must be com-
mitted to the project. They must ensure that the task is given adequate priority. It is
also essential to involve as many opinion leaders as possible in the initial process, par-
ticularly for the purpose of recruiting a number of highly motivated 'missionaries' for
its subsequent implementation.
One should never underestimate the required managerial time in implementing
scorecards. The main implementation issue is to accept that it is not a one- or a two-
day project. The process of working down from a vision/mission statement, objectives
and strategy to the critical performance measures, standards and rewards takes much
time and effort. It may take as long as six months and, even then, the scorecard may
subsequently need co be revised.
The cost of acquiring some of this additional information for the various perfor-
mance measures must also be considered and viewed in the context of its value to
decision-makers. Also, it is important to decide 'who' shall have the responsibility to
coordinate the additional information. The importance of chis information to the
firm, coupled with the central role of the management accountant within the organi-
sation, suggests that s/he should become more involved with this information gather-
ing process. The management accountant's office could become the 'information
warehouse' of the organisation. Admittedly, there are important organisational and
behavioural issues relating to this proposition that should first be addressed.
In developing a range of performance measures, one should be aware of the pos-
sible dysfunctional consequences associated with any performance metric. For exam-
ple, if the measure is the percentage of orders delivered on time, then there is an
incentive for managers to sacrifice one late shipment for the sake of other orders that
can be delivered on time. Thus, on-time delivery performance looks better when
nine deliveries are made on time and one is 10 days late compared with 10 deliveries
being made one day lace.
In summary, the traditional role of management accountants as the recorders of
historical, internal and financial information is changing. Management accountants
should realise this and avail of the opportunity to become important facilitators of
change. Management accountants who grasp this opportunity will considerably
increase their own relevance in modern organisations and increase the capacity of their
organisations to prosper. The important issue for management accountants is to reflect
on what Albert Einstein once remarked:
"Not everything that counts can be counted, and not everything that can be
counted, counts."

.-' . - . ' ,,
88..4 Variations.on.the Balanced Scorecard
: • - •. •
. . -·
'II

After years of neglect, small and medium-sized enterprises (SMEs) have received addi-
tional scrutiny in recent years. This should not be surprising, as they are currently the
 306 MANAGERIAL ACCOUNTING

dominant form of business organisation in all countries, typically accounting for over
90% of all business entities and providing in excess of 60% of total employment.
Without their smaller counterparts, few large firms could sustain their sizeable contri-
bution to national and international economies.
However, there is a need to strengthen the managerial capabilities of SMEs. One way
to do this is to make small business managers aware of a variation of the BSC tool.
Most SMEs do not have sufficient scale to pursue only a strategy of cost leadership.
Therefore, they have co differentiate themselves from their competitors. However, while
a customer may be prepared to pay a premium for a differentiated produce, common
sense suggests chat there is an overall limit to the premium that can be charged.
Like any useful managerial tool, the one proposed here is based on the premise chat
businesses are created to satisfy a need, and SMEs are no exception. Successful SMEs
need to know their customers and anticipate their future needs; and they muse have a
solid understanding of their competitors. Logic suggests, and evidence confirms, that
SMEs, like most other firms, compete on the basis of:
• price competitiveness,
• quality of product, and
• cuscomer service
(concepts that apply as much to retail and service firms as to those in manufacturing).
Arguably, SMEs muse satisfy minimum thresholds in all three areas in order co be
successful in a competitive and changing market place. There is no fixed position in
the triangle in which the SME should ideally place itself in Exhibit 8.6 in relation to
these three variables. Much will depend on the individual SME and its competitive
environment - indeed, its position may shift over time, reflecting the changing needs
of existing customers or a new customer base. However, it is interesting to ask an
SME manager to identify within the triangle (Exhibit 8.6) the position he chinks
most appropriate for his firm, given its target customers.

EXHIBIT 8.6: SOURCES OF COMPETITIVE ADVANTAGE

There are two immediate advantages to chis simple exercise. First, it encourages
the manager to chink about two external groups: customers and competitors. SMEs
can only be successful if they focus on the potential future characteristics of their
 8. PERFORMANCE MANAGEMENT AND MEASUREMENT 307

customers and competitors. Secondly, the exercise forces managers to think in terms
of a cause-and-effect relationship and to reflect on two fundamental questions:
• What critical activities should the firm perform in order co deliver quality of product,
price competitiveness and customer service?
• How well is the firm currently performing in achieving these objectives?
Based on Kaplan and Norton's Balanced Scorecard, the variation below focuses on four
elements integrated in a cause-and-effect relationship (see Exhibit 8.7). The cause-
and-effect relationship begins with the various internal activities (i.e. 'doing the right
things'), moving to the customer perspective ('then our customers will be happy').
However, the internal activities can only be accomplished by employees, supported by
appropriate resources. This leads us to a consideration of 'Enablers' ('if we have the
right employees and technology'). Finally, on the right-hand side of Exhibit 8.7 we
can identify the financial implications ('we will generate financial rewards').

EXHIBIT 8.]: CAUSE-AND-EFFECT RELATIONSHIP

Enablers
If we have the right employees and
the right technology ...

l
Internal Activities
Cash outflows
Doing the right things ...
..-----·,
<:::-:_Quali ryj Financial Results
·-:::1'-<l ----J And the SME will generate
· -·-··-.�--..J
nee, . ------·-·1
financial returns for its
-c::::::.::=5ervicei stakeholders
--·-··----'
Customers' Reaction
Then our customers will 1--------��1 Cash inflows
be happy and loyal ...

Internal Activities
Internal activities refer to a relatively. small set of actions that have the greatest impact
on customer satisfaction and customer loyalty and these usually include aspects of price
competitiveness, quality of product and customer service. Such activities are critical to a
firm's long-term success and muse be monitored through appropriate performance
measures in order co ensure that they are carried out effectively and efficiently.
For example, co highlight the importance of quality of finished products, perfor-
mance measures relating to, say, the number of defects could be used. These defects
could be calculated either by internal inspection or on the basis of customer rejects.
Likewise, aspects of customer service should be measured, such as the number of on-
time deliveries (OTO) or the lead time (i.e. the number of days between receipt of
order and final delivery of goods).
 308 MANAGERIAL ACCOUNTING

One simple indicator of price competitiveness is Pc/Po (i.e. average price of com-
petitors [Pc] divided by our average price [Po]). Internal cost efficiency, which is the
relationship between a product's cost and its price, is similarly important. Internal cost
efficiency can be estimated by calculating total coses (TC) divided by total revenues
(TR). In the long run, the price an organisation receives for a product muse cover its
costs, or ic will go out of business. Since customers may purchase goods on rhe basis of
price only, keeping coses low relative co competitors provides an SME with a sustainable
. competitive advantage.
A small number of easy-to-gather performance measures, with related performance
targets for internal activities, are presented in Exhibit 8.8 for illustration purposes only.

EXHIBIT 8.8: PERFORMANCE MEASURES FOR INTERNAL ACTIVITIES

Objective Performance measures Target for period

Quality of product % (or number) of (say)« 2%
customer re3eccs
% (or number) of (say) < 10%
internal rejects
Customer service On-time delivery (OTD) (say) 90%
Lead time (days) (say) 15 days
Price competitiveness Price competitiveness (say) 1.2
(Pc/Po)
Internal cost efficiency (say) 90%
(TC/' fR) x 100

Customers' Reaction
If the SME fails to satisfy customers in terms of delivering the right product (or ser-
vice) at a competitive price, it is difficult co see how profits will be generated. Ac the
same time, however, customer satisfaction does not necessarily translate into customer
loyalty. le is generally accepted chat, on average, a business may lose up co 20% of its
existing customer base each year. To compound the problem, an increasingly com-
petitive environment means new customers do not aucomacically cake their place and
it coses about five times more co acquire new customers than co retain existing ones.
SMEs should focus on three customer-related objectives:
• Customer satisfaction (considered co be the crucial performance measure in
predicting future company success).
• Customer loyalty, i.e. co what extent do existing customers continue their business
association?
• Customer acquisition, i.e. how many new customers were acquired during a given
period?
 8. PERFORMANCE MANAGEMENT AND MEASUREMENT 309

Exhibit 8.9 presents objectives, performance measures and related targets for the cus-
tomer perspective. (These are for illustration purposes only.)

EXHIBIT 8.9: PERFORMANCE MEASURES FOR CUSTOMER PERSPECTIVE

Objective Performance measures Target for period

Customer satisfaction No. of complaints (say) 10 complaints
Customer loyalty Amount (€) of repeat (say) 80% of sales from
business existing customers (or€)
Customer acquisition Sales ( €) ro new (say) 10 new customers (or€)
customers

Enablers
The third dimension relates tO 'enablers' - factors that facilitate internal activities
and their improvement. Internal activities are achieved by employees, working with
the right technology. Well-trained and motivated employees, through their work
attitudes, ethics and behaviour, facilitate customer loyalty through low cost and
high-quality production, short lead-time for the production of products and delivery
of services. Typical objectives, performance measures and related targets for enablers
of internal activities are presented in Exhibit 8.10 (for illustration purposes only).

EXHIBIT 8.JO: PERFORMANCE MEASURES FOR ENABLING ACTIVITIES

Objective Performance measures Target for period

Staff development Staff training (say) 1 day per employee

Staff morale No. of suggestions per (say) 1 suggestion per
employee employee
Investment (in assets) € spent on new (say) € 10,000
I equipment

Financial Results
The final dimension highlights the financial results that accrue co SME owners. It is
important to highlight the use of the word 'results', because that is precisely how cash
flow and profit arise: they are the result (or residual) of previous activities. Profit is
often described as the 'bottom line' and a memorable quotation is:
"The bottom line is down there where it belongs - at the bottom. Far above it in
importance are the infinite number of events chat produce the profit or loss."
310 MANAGERJAL ACCOUNTING

Three financial objectives, performance measures and related targets for Financial
Results are shown in Exhibit 8.11 below, but they are for illustration purposes only.

EXHIBIT 8.rr: FINANCIAL R.EsuLTS PERFORMANCE MEASURES

Objective Performance measures Target for period

Profitability Return on Investment (say) 20%
(ROI)
Liquidity (cash flow) Cash increase during (say) €5,000
year(€)
Credit control Average credit days (say) 40 days
granted co accounts
receivable

Two final points should be made about the above presentation. First, an increased
emphasis on non-financial measures of performance is an important seep cowards
improving the management capability of SMEs. The above discussion focuses on the
'drivers' of financial success, i.e. che internal activities and those enablers that drive
customer satisfaction and loyalty. Secondly, these non-financial performance measures
are often much easier and quicker to generate than some of the more traditional finan-
cial metrics, which require the preparation of annual financial statements.

r' Conclusion
'
By way of summary and conclusion, we initially discussed in this chapter some of the
limitations of accounting numbers. One of these is that, traditionally, accounting
information reports the results of historical operations rather than details of how these
results were created. The argument, therefore, is that management accountants should
expand their traditional accounting system into a more appropriate performance mea-
surement system within their organisation. This performance measurement system
muse be aligned with corporate strategy and linked to critical success factors. One such
system was elegandy explained by Kaplan and Norton in the form of a Balanced
Scorecard. However, there are many improvisations of chis model, including the
'Cause-and-Effect Relationship', which may be suitable for SMEs.

SUMMARY OF LEARNING OBJECTIVES

Learning Objective 1: Discuss the general limitations of accounting informa-

tion.

It can be argued chat accounting numbers have the potential to suffer from a
number of limitations. Because they mostly reflect the internal operations of the