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CHAPTER – 6
Measuring Organizational Performance

CONTENTS
• Organizational roles of Performance measures
• Designing a system of performance measures
• Traditional Short-term Financial Performance measures
• Non-Financial Performance Measures
• Balanced Score card, Quality Time and Theory of Constraints

1. Organizational roles of Performance measures

Introduction

1. Performance measurement serves as a source of information about financial outcomes and the
internal operations shown in an organization’s financial statements.

2. Effective performance measurement is key in ensuring that an organization’s strategy is

successfully implemented. It is about monitoring its own predetermined goals or stakeholders
requirements. Performance measurement is a very important aspect of business activities.

3. The purpose of measuring performance is not only to know how a business is performing but
also to enable that business perform better.

4. It helps to improve the performance of an organization so that it may better serve its
customers, employees, owners and stakeholders.

5. A performance measurement system enables an enterprise to plan, measure, and control its
performance according to a pre-defined strategy.

6. Performance measurement system plays a catalytic role and has many dynamic benefits crucial
for business growth.

7. It involves the use of different measures to collect and report information regarding the
performance of an individual, groups or organization.

8. Performance measurement can be financial or non-financial. Horngren, Datar and Foster (2006)
note that many organizations are increasingly presenting financial and non-financial
performance measures for their subunits in a single report called Balance Scorecard. Different
Organizations stress different measures in their Balanced Scorecards, but the measures are
always derived from a company’s strategy.
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Different Organizations stressed that the balance scorecard measures an organization’s performance
from four perspectives:-

1. Financial perspective

2. Customer perspective

3. Internal–business process perspective and

4. Learning and growth perspective.

2. Designing a system of performance measures (Financial Measures)

STEP- 1: Choosing Performance Measures that Align with Top Managements Financial Goal: the first
step in performance measurement is choosing among different performance measures for example,
operating income, net income, return on assets, or the best measure of a subunit’s financial
performance. The following are mostly used measures.

1. Operating income (OI)

2. ROI

3. Net income (NI)

4. Return on assets (ROA)

5. Revenues

6. Residual income(RI)

7. Economic Value Added(EVA)

8. Return on sales (ROS)

Step-2: choosing the time horizon of each performance measure:the ROI, RI, EVA, and ROS calculations
represent the result for a single period, say one year. Managers could take actions that cause short run
increase in these measures but conflict with the long run interest of the company. For example
managers may curtail R&D and plant maintenance in the last three months of a fiscal year to achieve a
target level of annual operating income. For this reason, many companies evaluate sub units on the
basis of ROI, RI, EVA and ROS over multiple years.

1. return on assets – be calculated for one year

Step-3: choosing alternative definitions for performance measures:

Companies that use ROI, or RI generally define investment as the total assets available. When top
management directs a sub unit manager to carry extra or idle assets, total assets employed can be more
informative than total assets available. Companies that adopt EVA define investment as total assets
employed minus current liabilities. The most common rational for using total assets employed minus
current liabilities of the subunit. We consider four alternative definitions of investment that companies
use.
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1. Total assets available

2. Total assets employed
3. Total assets employed – current liability
4. Stock holder’s equity
Step- 4: choosing measurement alternatives for performance measure: To design accounting based
performance measures, we need to consider different ways to measure assets included in investment
calculations. Should assets be measured at historical cost or current cost? Should gross book value
(that’s original cost), net book value (original cost minus accumulated depreciation) be used for
depreciable assets.So choosing measurement alternatives for performance measure are

1. Current cost

2. Historical cost

Step-5: choosing target levels of performance measures: wenext consider setting target for an
accounting based measure of performance against which to compare actual performance. Historical-
cost- based accounting measure are usually inadequate for evaluation economic return on new
investments, and in some case, they create disincentive for expansion. Despite these problems,
historical –cost- ROIs can be used to evaluate current performance by establishing target ROIs. For
Hospitality inns, we need to recognize that the Hotels were built in different years, which means they
were built at different levels of construction cost index. Top management could adjust the target
Historical – cost – based ROIs accordingly, say by setting san Francisco ROI at 26%, Chicago’s at 18% and
New Orleans at 19%

1. Target such as - rate of return on assets

Step-6: choosing the time of feedback - It depends upon largely: the final step in designing accounting –
based – performance measure is the timing of feedback. Timing of feedback depends largely on

(a) How the critical the information is for the success of the organization,
(b) The specific level of the management receiving the feedback, and
(c) The sophistication of the organizations’ information technology.

For example, hotel manager responsible for room sales want informationon the number of rooms sold
on daily or weekly basis. That’s because a large percentage of hotel costs are fixed costs, so achieving
high room sales and taking quick action to reveres any declined sales trends are critical to the financial
success of each hotel. Supplying manager with daily information about room sales is much easier if
Hospitality inns has a computerized room reservation and check in system. Top management, however,
may at look information about daily room sales only on a monthly basis.

1. How critical the information is for the success of the organization.

2. The specific level of management receiving the feedback.
3. The sophistication of the organization’s information technology.
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3. Traditional Short-term Financial Performance measures

I. Internal financial measures

1. Operating income
2. ROI
3. Net income
4. Return on assets
5. Revenues
6. Residual income
7. Economic Value Added(EVA)
8. Return on sales
II. External financial measures

1. Stock prices

4. Non - financial measures

I. Internal non-financial measures

1. Defects rates
2. Manufacturing lead time
3. Number of new patents
II. External non-financial measures

1. Customer satisfaction ratings

2. Market share

5. Balanced scorecard

1. Some organist ions present financial and non financial performance measures for their subunits
in a single report called the balanced scorecard.

2. Different organizations stress different elements in their scorecard. The balanced scorecard
allows managers to look at the business from four important perspectives. It provides answers
to four basic questions:

1. Financial Perspectives (profitability measures)

2. Customer Perspectives (customer satisfaction measures)
3. Internal Business Perspectives (Efficiency, Quality and time)
4. Innovation Perspectives (Innovation measures)
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