Financial Key Performance

Indicators
Module 9 - Finance for Non-Finance

Accounting based
Performance
Measurement

Objectives
Objectives
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.

Responsibility
Responsibility accounting
accounting isis aa system
systemthat
that
measures
measures the
the results
results of
ofeach
each responsibility
responsibility
center
center according
according to
to the
the information
information managers
managers
need
need to
to operate
operate their
their centers.
centers.

Types
Types of
of Responsibility
Responsibility Centers
Centers
Cost 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.
Continued
Continued

Types
Types of
of Responsibility
Responsibility Centers
Centers
Profit 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
Cost

Cost center

Sales

Capital
Investment

Other

Revenue center Direct cost

only

Profit center

Investment center

Return
Return on
on Investment
Investment
Operating income
ROI =
Average operating assets
Beginning net book value +
Ending net book value
2

Comparison of ROI
Electronics
Divisions

Medical Supplies
Divisions

2003:
Sales
$30,000,000
Operating income
1,800,000
Average operating assets 10,000,000
ROI
18 %

$1,800,000
$10,000,000

$117,00,000
3,510,000
19,500,000
18 %

Comparison of ROI
Electronics
Divisions

Medical Supplies
Divisions

2004:
Sales
$40,000,000
Operating income
2,000,000
Average operating assets 10,000,000
ROI
20 %

$2,000,000
$10,000,000

$117,00,000
2,925,000
19,500,000
15 %

Margin
Margin and
and Turnover
Turnover
ROI = Margin x Turnover
Operating Income Sales
Sales
Average operating assets

MARGIN AND TURNOVER COMPARISONS

Electronics
Division
2003

Margin
Turnover
ROI

6.0%
x 3.0
18.0%

Medical Supplies
Division

2004

2003

2004

5.0%
x 4.0
20.0%

3.0%
x 6.0
18.0%

2.5%
x 6.0
15.0%

Advantages
Advantages of
of ROI
ROI
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.

Disadvantages
Disadvantages of
of ROI
ROI
1) It can produce a narrow focus on

divisional profitability at the expense

of profitability for the overall firm.

2) It encourages managers to focus on

the short run at the expense of the

long run.

Economic value added (EVA) is after-tax operating

profit minus the total annual cost of capital.

EVA
EVA== After-tax
After-tax operating
operating income
income (Weighted
(Weighted
average
average cost
cost of
of capital
capital xx Total
Total capital
capital
employed)
employed)

15

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
16

Weighted Average Cost of Capital

Suppose
Suppose that
that aa company
company has
has two
two sources
sources of
of
financing:
financing: $2
$2 million
million of
of long-term
long-term bonds
bonds paying
paying
99 percent
percent interest
interest and
and $6
$6 million
million of
of common
common
stock,
stock, which
which isis considered
considered to
to be
be of
of average
average risk.
risk.
IfIf the
the companys
companys tax
tax rate
rate isis 40
40 percent
percent and
and the
the
rate
rate of
of interest
interest on
on long-term
long-term government
government bonds
bonds
isis 66 percent,
percent, the
the companys
companys weighted
weighted average
average
cost
cost of
of capital
capital isis computed
computed as
as follows:
follows:

Weighted Average Cost of Capital

Amount

Percent x After-Tax Cost = Weighted Cost

Bonds $2,000,000

0.25

0.009(1 0.4) = .054

0.0135

Equity 6,000,000

0.75

0.06 + 0.06 = .120

0.0900

Total $8,000,000

0.1035

Thus,
Thus, the
the companys
companys
weighted
weighted average
average isis
10.35
10.35 percent.
percent.

EVA
EVAExample
Example
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.

19

Weighted Average Cost of Capital

Amount

Weighted
Percent x After-Tax Cost = Cost

Mortgage
bonds $ 2,000,000
0.133
Unsecured
bonds
3,000,000
0.200
Common
stock
10,000,000
0.667
Total
$15,000,000
Weighted average cost of capital

0.048

0.006

0.060

0.012

0.120

0.080
0.098

EVA
EVAExample
Example
Mahalos EVA is calculated as follows:
After tax operating income
Less: Cost of capital
EVA

$900,000
784,000
$116,000

21

Behavioral Aspects of EVA

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

In 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.

23

The Balanced Scorecard translates

an organizations mission and
strategy into operational objectives
and performance measures for four
different perspectives:
The financial perspective
The customer perspective
The
Balanced
Scorecard

The internal business

process perspective
The 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

Financi
al

Customer

Process

L and G

Objectives
Measures
Targets
Initiatives

StrategyTranslation
Process

Financial

Increase Sales

Increase Profits

Customer

Increase
Market
Share

Increase
Customer
Satisfaction

Process

Redesign
Products

Reduce
Defective
Units

Infrastructure

Quality
Training

Testable
Testable Strategy
Strategy
Illustrated
Illustrated

Summary of Objectives and Measures:

Financial Perspective
Objectives
Revenue Growth:
Increase the number of new
products
Create new applications
Develop new customers and
markets
Adopt a new pricing strategy

Measures
Percentage of revenue
from new products
Percentage of repeat
customers
Percentage of revenue from
new sources
Product and customer
profitability

Objectives

Measures

Cost Reduction:
Reduce unit product cost

Unit product cost

Reduce unit customer cost

Unit customer cost

Reduce distribution channel cost

Cost per distribution channel

Asset Utilization:
Improve asset utilization

Return on investment
Economic value added

Summary of Objectives and Measures:

Customer Perspective
Objectives
Core:
Increase market share
Increase customer retention
Increase customer acquisition
Increase customer satisfaction
Increase customer profitability

Measures
Market share (percentage of
market)
Percentage of repeat
customers
Number of new customers
Ratings from customer
surveys
Customer profitability

Objectives
Performance Value:
Decrease price
Decrease postpurchase costs
Improve product functionality
Improve product quality
Increase delivery reliability
Improve product image and
reputation

Measures
Price
Postpurchase costs
Ratings from customer
surveys
Percentage of returns
On-time delivery percentage
Aging schedule
Ratings from customer
surveys

Actual Conversion Cost per Unit

Standard costs per minute = $1,600,000/400,000

= $4 per minute
Actual cycle time
= 60 minutes/10 units
= 6 minutes per unit
Actual conversion costs = $4 x 6
= $24 per unit
Theoretical Conversion Cost per Unit

Theoretical cycle time

Theoretical conversion
costs

= 60 minutes/12 units
= 5 minutes per unit
= $4 x 5
= $20 per unit

Summary of Objectives and Measures:

Process Perspective
Objectives
Innovation:
Increase the number of new
products
Increase proprietary products
Decrease new product
development time

Measures
Number of new products vs.
planned
Percentage of revenue from
proprietary products
Time to market (from start
to finish)

Objectives
Operations:
Increase product quality
Increase process efficiency
Decrease process time
Postsales Service:
Increase service quality
Increase service efficiency
Decrease service time

Measures
Quality costs
Output yields
Percentage of defective units
Unit cost trends
Output/input(s)
Cycle time and velocity
MCE
First-pass yields
Cost trends
Output/input(s)
Cycle time

Summary of Objectives and Measures:

Learning and Growth Perspective
Objectives
Increase employee capabilities

Measures
Employee satisfaction ratings
Employee turnover percentage
Employee productivity
(revenue/employee)
Hours of training
Strategic job coverage ratio
(percentage of critical job
requirements filled)

Objectives
Increase motivation and
alignment
Increase information systems
capabilities

Measures
Suggestions per employee
Suggestions implemented per
employee
Percentage of processes with
real-time feedback
capabilities
Percentage of customer-facing
employees with on-line
access to customer and
product information

Examples of Key Performance Indicators

Examples of Key Performance Indicators
Key Results Areas
Return/profit

Productivity

Key Performance Indicators

Return on investment
Percentage of return on sales
Net profit before taxes (dollars)
Percentage of gross margin (by product
line)
Dollars of sales per employee
Units per month (by product line)
Output per work-hour
Output per employee
Overtime as percentage of payrool
Downtime
Turnaround time

Examples of Key Performance Indicators (2)

Examples of Key Performance Indicators
(continued)
Key Results Areas

Key Performance Indicators

Employee development Training investment as percentage of sales

Number of employees on degree plan
Cross-training plan
Number of backups per position
Number of employees with implemented
development plan

Examples of Key Performance Indicators (3)

Examples of Key Performance
Indicators (continued)
Key Results Areas
Quality assurance

Key Performance Indicators

Percentage of first-time
acceptance
Yield
Cost of rework, scrap
Percentage of error-free
completions (per
shift, per employee)
Percentage of recidivism (in law
enforcement)

Cross-functional
Integration

Percentage of on-time
completions
Number of unresolved

Examples of Key Performance Indicators (4)

Examples of Key Performance
Indicators (continued)
Key Results Areas
Key Performance
Indicators
Research and
Number of new product ideas
approved for
development
development
Projected dollar value of
approved product
ideas
Number of new applications
for current
products/services
Cost of R&D investment:
ratio to total
budget

Examples of Key Performance Indicators (5)

Examples of Key Performance
Indicators (continued)
Key Results Areas
Organizational
Image

Legislative relations

Key Performance Indicators

Favorable mentions in media
Public information programs
Involvement in community
Interorganizational cooperative
efforts
Response time to legislators
Inquiries handled favorably
Funding approved
Major programs approved

How to Set Targets

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.

42

Checklist for Setting Targets

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.

43

Initiatives should enable strategic execution

Initiatives

Goals or Objectives

Value Mapping Project

Improve identification and delivery of all

agency services across the full stakeholder
spectrum

Employee Rotation Program

Improve the employee turnover and

satisfaction scores

Web Self Service Portal

Reduce agency costs and streamline our

services for more direct service delivery

Common Knowledge Center

Expand the overall knowledge base so that

inter-functions can learn from one another

Customer Survey and

Analysis Tool Program

Develop a more systematic process across

the entire agency to better connect to our
customers

Shared Service Center

Tracking System

Reduce reworks and overlaps between our

seven shared service centers

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Going from Output to Outcome

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.

Initiative

Output
Measurement

Outcome
Measurement

Lean Process / Six

Sigma

Number of Projects
Defined by Region

Overall reductions in errors,

reworks, and cycle times

Activity Based Costing

/ Management
(ABC/M)

% of Service Center
Outlets with ABC Models
in place for Allocation
Costs

Reductions in identified reactivities per process study

Employee
Competency Models

% of Employees who
have a Competency
Model in place

Higher skill levels of

employees using the models

45

What is KPI in graphic?

Input

KPI
KPI2

After
Before

Before

After

Output

46

46

Sale per ringgit Advertising

Advertising

Sales/advertising
KPI2

After
Before

Before

After

Sales

47

47

Thank you
Question please

48