Accounting and performance management

Performance management measures goal achievement of the firm

Goals of a firm long term

What you measure is what you get

PM influence individual’s behavior and it is important to choose goal congruent measurement

Variants of measures:

Financial performance measures

 Internal profit, ROI, residual income

 External stock price

Non-financial performance measures

 Internal product quality, deliveries in time
 External customers satisfaction

Financial measures represent past performance, non-financial measures could be the base for future
performances

Steps of performance measurement:

1. Finding the goal congruent measure

2. Definition and calculation of performance measures
3. Fixing of a target performance
4. Feedback on actual performance

ROI (accounting rate of return)

ROI=Income/Investment

ROI (DuPont method) = (Revenues/Investment) * (Income/Revenues) = Sales turn over* Return on sales
(ROS)

Sales turnover= Revenue/Investment

ROS= Income(Profit)/ Revenue

How to reach the target ROI? Options:

 Improve sales turnover by reducing assets

 Improve return on sale by reducing costs of production
 Or combination of both activities

Valuation of assets influences the ROI

 At current cost
 At gross book value (historical costs of buying an asset)
 At net book value (historical costs less depreciation)

Using net book value leads to increasing ROI in course of time

Residual income (RI)

Residual income is an accounting measure of income less an interest charge on an accounting measure
of investment.

RI = Income – Interest rate*Investment

The interest charge is also called imputed costs (opportunity costs of invested capital, cost of capital)

 Costs of forgone investment alternative

 Cannot be found in records

EVA is specific form of RI

Choice of performance measurement:

Functions of performance measures:

The performance measure has to highlight the contribution (вклад) of a center to firm goal
achievement
The performance measure has to motivate managers to make firm goal congruent decisions

Differing aspects:

Reflection of invested capital?

Managers do not care about invested capital

Is the performance measured as an absolute amount of money or as a percentage?

Investment based on ratio could be not optimal

 If ROI used than benchmark (целевой ориентир) for investment opportunity is ROI earned
 If RI used – benchmark is cost of capital
 Profitable opportunity could be missed if ROI is larger than costs of capital

Is performance measure is linked with long term goal of a company?

Ri is only one that is used to measure a company’s value

There is not a measure that fitting in all situations

Advantages and disadvantages of

Operating profit
+ Simple and fast calculation
-Neglects (пренебрегает) investment used to generate profit
(difficult to compare different centers)
-If OP is used to measure the performance of investment center, managers have incentive
(стимул) to overinvest as long as investment makes no loss
ROI
+Reflects also invested capital and is more suitable for comparison of different centers with
different sizes.
-If ROI is used to measure a performance of investment center, managers have incentive to
underinvest
(ROI of a possible investment should be higher than actual ROI of a company that is higher than
costs of capital)
-Risk of investment is not reflected in ROI

Residual income
+Considers costs of capital and creates incentives to use a capital efficiently
+/-Risk is reflected by costs of capital but it is hard to measure for each center or project
separately
-Difficult to compare centers with a different size, because RI is an absolute number (the larger
the center the larger the RI)
-Short run measure yearly based, but may be linked to the long run firm value

Target level of performance

 Fixing of a target level in budgeting process

Different types of participation

Widespread practice

Target should be challenging but achievable

 Timing (временные рамки) of feedback

Measurement of actual results
Feedback not only for evaluation also for information for controlling future activities
Timing depends on the importance of the information for the success of the firm
Degree of aggregation depends on hierarchy level (for center managers detailed information, for
headquarters aggregated info)

Distinction between individual and organizational evaluation

Simple comparison is misleading

Relative performance evaluation (takes performance of peers into account/ not only internal
comparison because of risk of rat race/ filters out uncontrollable factors, that makes evaluation of
management performance clearer)

It is difficult to reflect all aspects of performance in the performance measure

(challenge between quality and quantity)
The balanced scorecard
Is an attempt (попытка) to link accounting with strategic management and to combine financial and
non-financial measures of performance

BS highlights that to achieve financial goals non-financial objectives should be met

Covers at least 4 perspectives

Key perspectives:
1. Financial perspective

Gives information on financial goal achievement (ROI, RI, firm value)

Measures: EVA, ROI,

2. Customer perspective
Provides financial and non-financial information about success in targeted market (customer
satisfaction, number of complaints)
Measures: Market share, customers satisfaction, customer retention percentage
3. Internal business process perspective
Provides financial and non-financial information on process of production, administration and
delivery of products within the firm
Measures:
Innovation process number of new patents, new product development times, number of new
products
Operations process yield, defect rate, delivery time
After sales process time taken to replace defective products, customers training to use time
4. Learning and growth perspective
Provides information on capabilities to innovate process (financial and non-financial
information)
Special focus on human capital
Measures:
Employee satisfaction rate, skills rate, turnover
Information system availability

Aims of scorecard:
Providing a mix of performance measures providing information on current financial results and
factors driving future financial results.
Links short run and long run aspects of goal achievement also accounting management with strategic
management.

Challenges:
Difficult to link measures and show cause and effect relation
Improving a measure is not always beneficial
Some measures are difficult to verify
Complex and expensive to set up