FMA/MA – Management Accounting

Performance Measurement
Performance measurement is a vital part of control and aims to establish how well something or
somebody is doing in relation to a planned activity. Control is to compare actual results with the plan.
Strategic management must decide what they want the business to be and how to get there.

Mission
Mission should identify the purpose of the business and what is it trying to achieve and just as importantly
what the business does not do. The managers of the business will contribute their views of the desired
position of the business in the future. For this reason, the mission has also become known as the vision
due to the requirement of being able to look into the future.

Purpose of mission: It shows why the company exists

▪ To create wealth for shareholders
▪ To satisfy all stakeholders

Mission provides the commercial logic for the organisation like products or services it offers & its
competitive position. It also defines its competence by which it hopes to prosper.

Mission statement: A mission statement is a formal, short, written statement of the purpose of
a company or organization. The mission statement should guide the actions of the organization, spell out
its overall goal, provide a sense of direction, and guide decision-making. It provides "the framework or
context” within which the company's strategies are formulated. It should possess certain characteristics:
▪ Brevity Easy to understand and remember
▪ Flexibility To accommodate change
▪ Distinctiveness To make the firm stand out

Elements of mission

(a) Purpose. Why does the company exist?

(i) To create wealth for shareholders?
(ii) To satisfy the needs of all stakeholders?
(iii) To reach some higher goal, such as the advancement of society?

(b) Strategy. Mission provides the commercial logic for the organisation, and so defines two things.
(i) The products or services it offers and therefore its competitive position
(ii) The competences by which it hopes to prosper, and its way of competing

(c) Policies and standards of behaviour. The mission needs to be converted into everyday
performance. For example, a firm whose mission covers excellent customer service must deal
with simple matters, such as politeness to customers and speed at which phone calls are
answered.

(d) Values and culture. Values are the basic, perhaps unstated, beliefs of the people who work in the
organisation.

For there to be a strong, motivating sense of mission, the four elements above must be mutually
reinforcing.

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The following are the mission statements for some well-known companies.

Coca-Cola 'To refresh the world

To inspire moments of optimism and happiness
To create value and make a difference.'

Google 'To organise the world's information and make it universally accessible and useful.'

Starbucks 'Our mission: to inspire and nurture the human spirit – one person, one cup and
one neighbourhood at a time.'

eBay 'To provide a global trading platform where practically anyone can trade practically
anything.'

Mission statement can play an important role in the planning process.

▪ Plans should outline the fulfilment of the organization’s mission.
▪ Evaluate and screening (mission helps to ensure consistency in decisions)
▪ Implementation (mission also affects the implementations of a planned strategy, in the culture and
business practice of the firm)

Goals: The goals set for different parts of the organization should be consistent with each other (goal
congruence). There are two types of goals:
Operational goals: Can be expressed as objectives. It can be measurable. For example, cut
cost, objective reduce budget by 10%.

Non-operational goals: Not all the goals can be measured. For example, a university goal might
be to seek the truth, this goal cannot be measured.

Distinguish between goals and objectives

Goals:
▪ Goals will support the mission.
▪ This is primary long term objective of the organisation
▪ Goals are the main purpose of the organization.
▪ This is at overall organizational level.
▪ Goals are decided at corporate planning stage by strategic management.

Objectives:
▪ Objectives are sub-division of goals.
▪ Objectives are at departmental level.
▪ If the departments achieve their objectives, the organization will achieve its goal.

Objectives usually are smart

▪ Specific
▪ Measurable
▪ Attainable
▪ Result orientated
▪ Time bounded

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Some objectives are primary corporate objectives (goals) and some are secondary objectives. Both
should combine to ensure the achievement of the overall corporate objective. For example a company
sets its Primary objective as to maximize profit, for this it has Secondary objectives like cost reduction,
sales growth, customer satisfaction etc.

Objectives may be long term and short term. A company that suffering from losses in short term might
continue to have a long term primary objective of achieving a growth in profits, but in short term its
primary objective might be survival.

Strategic, tactical and operational objectives: Objectives can also be classified as strategic, tactical or
operational.
♦ Strategic objectives would include matters such as required level of company profitability.
♦ Tactical objectives would concern with efficient and effective use of organizational resources.
♦ Operation objectives would include guidelines for ensuring that specific tasks are carried out.

Trade-off between the objectives: When there is number of objective, some might be achieved on the
expense of others. For example, a company’s objective of achieving good profits and profit growth might
have adverse consequences for the cash flows of the business, of the quality of the firm’s products.

Short-termism is when there is a bias towards short-term rather than long-term performance. It is often
due to the fact that managers' performance is measured on short-term results.

Organizations often have to make a trade-off between short-term and long-term objectives. Decisions
which involve the sacrifice of longer-term objectives include the following.

▪ Postponing or abandoning capital expenditure projects, this would eventually contribute to growth and
profits, in order to protect short term cash flow and profits.
▪ Cutting R&D expenditure to save operating costs, and so reducing the prospects for future product
development.
▪ Reducing quality control, to save operating costs (but also adversely affecting reputation and
goodwill).
▪ Reducing the level of customer service, to save operating costs (but sacrificing goodwill).
▪ Cutting training costs or recruitment (so the company might be faced with skills shortages).

Managers may also manipulate results, especially if rewards are linked to performance. This can be
achieved by changing the timing of capital purchases, building up inventories and speeding up or
delaying payments and receipts.

Methods to encourage a long-term view: Steps that could be taken to encourage managers to take a
long-term view, so that the 'ideal' decisions are taken, include the following:
▪ Making short-term targets realistic. If budget targets are unrealistically tough, a manager will be
forced to make trade-offs between the short and long term.
▪ Providing sufficient management information to allow managers to see what trade-offs they are
making. Managers must be kept aware of long-term aims as well as shorter-term (budget) targets.
▪ Evaluating managers' performance in terms of contribution to long-term as well as short-term
objectives.
▪ Link managers' rewards to share price. This may encourage goal congruence.
▪ Set quality based targets as well as financial targets. Multiple targets can be used.

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The link between mission statements and key performance indicators

Strategic objectives concern the firm as a whole, for

example:
(a) Profitability (g) Customer satisfaction
(b) Market share (h) Quality
(c) Growth (i) Industrial relations
(d) Cash flow (j) Added value
(e) ROCE (k) Earnings per share
(f) Risk

Critical success factors and key performance

indicators

(a) Profitability (e) Personnel development

(b) Market share (f) Employee attitudes
(c) Productivity (g) Public responsibility
(d) Product leadership

A critical success factor is 'An element of the organisational activity which is central to its future success.
Critical success factors (CSFs) may change over time, and may include items such as product, quality,
employee attitudes, manufacturing flexibility and brand
awareness'.

Performance measure can be divided in two groups

1. Financial performance measures (used to measure the performance of Profit Seeking
Organizations)
It includes:
▪ Ratio analysis - Several profitability and liquidity measures can be applied to divisional
performance reports.
▪ Variance analysis - is a standard means of monitoring and controlling performance; care must
be taken in identifying the controllability of and responsibility for each variance. (already studied in
standard costing)
▪ Benchmarking (financial + non-financial)
▪ Balanced scorecard (financial + non-financial)

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2. Non-financial performance measure (used to measure the performance of Profit Seeking

Organizations and Not For Profit Organizations)
▪ Benchmarking (financial + non-financial)
▪ Balanced scorecard (financial + non-financial)

❖ FINANCIAL PERFORMANCE MEASURES

Ratio Analysis
Financial ratios quantify many aspects of a business and are an integral part of the financial statement
analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio
measures. Financial ratios allow for comparisons;
▪ Between companies
▪ Between industries
▪ Between different time periods for one company
▪ Between a single company and its industry average

➢ Profitability Ratios: measure the firm's use of its assets and control of its expenses to generate an
acceptable rate of return. Management is always keen to measure its operating efficiency. Owners /
shareholders invest their funds in the expectation of reasonable returns. The operating efficiency of a
firm and its ability to ensure ample returns to its owners / shareholders depends basically on the
profits earned by it.

✓ Operating profit margin: Operating profit is an income of the company that is generated from its
own operations. It excludes income from investment in other businesses. The ratio illustrates
what proportion of sales revenue was retained in the form of profit before the deduction of interest
and tax. The operating profit ratio measures the operating efficiency and pricing efficiency
through cost control. If profit margin unsatisfactory means excessive cost or low selling price.

Note: if no information about interest and tax is given then take NET PROFIT instead of Profit
before interest and tax

Investors can measure the quality of the company’s operations looking at the operating profit
margin ratio over the period of time and comparing it with other competitors in the industry.

✓ Gross profit margin: Gross profit margin ratio indicates how efficiently the material, labour and
expenses related to production are used by an organization in order to produce a product at a
lower cost. Higher percentage shows better control over the costs and reasonable profit on sales.

Comparison of the business ratios to those of similar businesses will reveal the relative strengths
or weaknesses in the business.

✓ Earnings per share (EPS)

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The earnings per share ratio are widely used to measure the profitability of the shareholders’
investment. EPS represents the amount of profits attributable to each ordinary share or, what
each share has generated in terms of profits. Investors compare the EPS of the company with the
industry average and with the EPS of other companies before taking investment decisions.

✓ Return on capital employed (ROCE): ROCE is probably the most popular ratio for measuring
general management performance in relation to the capital invested in the business. Also known
as Return on investment (ROI). ROI is normally used for divisional or investment centre
performance appraisal. This ratio expresses profits earned as a proportion of capital employed. It
illustrates how efficiently the company is using its capital to generate profits.
ROCE = Profit before interest and tax OR Net Profit x 100
Capital employed

Capital employed = Net Assets = Fixed Assets + Current Assets – Current liabilities

Average Capital employed should be used. This is because if the company has purchased
assets near the year end, they will be included in the capital employed figure increasing the value
of the capital employed figure but the profits will only show one or two months of the assets
contribution in generating profits. Comparisons of ROCE can be made between different years or
different companies.

✓ RESIDUAL INCOME (RI): It is the measure of the centre’s profits after deducting a notional
interest cost. It can be calculated as
Residual income = (profit before interest and tax + profit from any other investments) – (Total
capital employed x notional interest charge)

Notional interest is also called imputed interest.

Important: the amount of total capital employed is calculated by including the non-operational
investments as well.

Advantages and disadvantages of residual income

Advantages
It makes divisional managers aware of the cost of financing their divisions.
It is an absolute measure of performance and not subject to the problems of relative
measures such as return on investment.
In the long run it supports the net present value approach to investment appraisal (the
present value of a project’s residual income equals net present value of that project).

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Disadvantages
▪ Residual income gives the symptoms not the causes of problems. If residual income falls the
figures give little clue as to why.
▪ Problems exist in comparing the performance of different sized divisions (large divisions will
earn larger residual incomes simply due to their size).
▪ Residual income when applied on a short term basis is a short term measure of performance
and may lead managers to overlook projects whose payoffs are long term. This could well be
the case for the hotel chain.

✓ Asset turnover
Asset turnover = total sales _
Capital employed

This ratio indicates the efficiency with which company is able to use all its (net) assets to gearing
$1 sales. Generally, the higher a company’s total net asset turnover, the more efficiently its
assets have been used. The total net asset turnover is probably of greatest interest to
management, however, other parties, such as creditors and prospective and present shareholder,
will also be interested in the measure.

The return on investment is widely used by external analysts of company performance when the
primary ratio is broken down into its two secondary ratios:

ROI = Asset Turnover X Profit Margin

ROI = total sales _ x profit before interest and tax

Capital employed total sales

ROCE = Profit before interest and tax OR Net Profit x 100

Capital employed
➢ Liquidity Ratios: Liquidity refers the state of an asset’s nearness to cash. Nearness to cash has
been defined in terms of the time and effort needed to sell an asset. Liquidity is vital to the financial
health of any company too much liquidity is a misuse of money, and too little leads to severe cash
problems.

✓ Current ratio

Current ratio measures the short-term solvency of a firm. It shows the availability of current
assets for every one dollar of current liability. The higher the current ratio, the larger is the amount
of current assets in relation to current liabilities and the company’s ability to meet its current
obligations is greater too. If the current ratio is 2:1 or more, the company is generally considered
to have good short-term financial strength. If the current ratio is less than 1 (liabilities exceed
current assets), the company may face difficulties in meeting its short term obligations.

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✓ Quick ratio or acid test ratio

Quick ratio determines the relationship between liquid assets and current liabilities. Liquid assets
are the assets that can be easily and immediately converted into cash without loss of value. A
quick ratio of 1 to 1 or more represents a satisfactory current financial position of a firm.

Activity ratios: Activity ratios measure the effectiveness of the firm’s use of resources.

✓ Receivables collection period:

Receivables collection period = average debtors × 365
Sales

✓ Inventory turnover period:

Inventory turnover period = average inventory × 365
Cost of goods sold

✓ Payables payment period:

Payables payment period = average payables × 365
Purchases
➢ Gearing ratios: The debt position of a company indicates the amount of other people's money (other
than the owner’s money) that is being used by it in generating its profit. Typically, attention is placed
on long-term debts, since these commit the company to pay interest over the longest run and
eventually repay the sum borrowed. Since long term, debt has prior claims, present and prospective
shareholders pay close attention to the degree of indebtedness and ability to repay debts. In general,
the more debt (or financial leverage) a company uses the greater will be its risk and return.

✓ Gearing ratio (debt to equity ratio)

Prior charge capital (long term debt).

Prior charge capital + shareholders’ equity

The ratio is some time referred to as the debt–equity ratio indicates the relationship between the
long-term funds provided by the loan group and those provided by the company’s owner. The
figure is only meaningful in light of the company’s business and comparison with other
organizations within the industry is useful. The ratio can also be measured as the relationship
between prior-charge debt and the company’s assets. If this ratio is too high, lender will view the
business as high risk and owners may have trouble obtaining new finance and if this ratio is too
low usually indicates that the business is not using its cash and profits effectively to obtain
business assets. This may discourage investors because it means that less profit are distributed
to them.

✓ Interest cover ratio

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The interest cover ratio shows whether company is earning enough profit before interest to pay its
interest costs comfortable, or whether its interest costs are high in relation to the size of its profit,
so that a fall in profit before interest and tax would then have a significant effect on profits
available for ordinary shareholders. An interest cover of 2 times or less would be low, although
benchmarks are different industry by industry.

Possible limitations of financial ratio analysis:

However, this analysis approach must be used with circumspection and in circumspection with other
analytical tools and techniques as it have a number of limitations. These include:
1. That the approach is based on historical data and thus the ratio may not be a good guide to the
future
2. The quality of the analysis is determined by the quality of the accounting information upon which

it is based (considering the fact that here the distortion has taken place resulting from creative
accounting such as window dressing of financial statement to hide short term fluctuation)
3. Difference in accounting practices adopt by company over the treatment of fixed asset
depreciation and revaluation, stock valuation, research and development expenditure, goodwill
write off and profit recognition
4. The change in value of money and differences in trading enjoinments over time
5. The use of ratios to measure performance may encourage sub-optimal behaviours by managers
e.g. short-term manipulation of results
7. Ratios are normally based exclusively on finance, and reflect only financial indicators of
performance. There are of coursed non-financial implications associated with performance

TRACEABLE AND CONTROLLABLE COSTS

The main problem with measuring controllable performance is in deciding which costs are controllable
and which costs are traceable. The performance of the manager of the division is indicated by the
controllable profit (and it is on this that he is judged) and the success of the division as a whole is
judged on the traceable profit.

Consider, for example, depreciation on divisional machinery. Would this be included as a controllable
fixed cost or a traceable fixed cost? Because profit centre managers are only responsible for the costs
and revenues under their control, this means that they do not have control over the investment in
noncurrent assets. The depreciation on divisional machinery would therefore be a traceable fixed cost
judging the performance of the division, and not of the individual manager

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❖ NON FINANCIAL PERFORMANCE MEASURES

These are the qualitative measures which are not expressed in numeric. Due to Changes in cost
structure, more competitive environment and competitive manufacturing environment have led to an
increased use of non-financial indicators.
▪ In modern businesses, a major investment is required for new technology and product life cycle have
got shorten. Mostly costs are committed at planning stage so it is too late to control cost in further
stages
▪ Financial measures do not convey full picture of the company’s performance. In competitive
environment companies are competing in terms of customer satisfaction, quality, product features,
quality deliveries, after sales services etc.

▪ New competitive process of making a product focuses on reducing time of production, less machine
setups, more efficient labour and machine, increase in productivity etc.

Non-financial measures Key performance indicators

Competitiveness Sales growth by product or service.
Measures of customer base.
Relative market share and position.
Quality of service Quality measures in every unit.
Evaluate suppliers on the basis of quality.
Number of customer complaints received.
Number of new accounts lost or gained.
Rejections as a percentage of production or sales.
Customer satisfaction Speed of response to customer needs.
Informal listening by calling a certain number of customers each week.
Number of customer visits to the factory or workplace.
Number of factory and non-factory manager visits to customers.
Quality of working life Days absence
Labour turnover
Overtime
Measures of job satisfaction

✓ BALANCED SCORECARD
The balanced scorecard measures performance in four different perspectives. It employs a variety of
financial and non-financial indicators.
➢ Financial perspective (financial success)–how do we create value for our shareholders?
➢ Customer perspective (customer satisfaction)–how do existing and new customers value from
us?
➢ Internal business perspective (process efficiency)–what must process we excel at?
➢ Innovation and learning perspective (growth)–can we continue to improve and create future
value?

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In balanced scorecard these four perspectives are act as Critical Success Factors (CSF). A
critical success factor is a performance requirement that is fundamental (critical) to competitive
success. These critical success factors have number of Key Performance Indicators (KPI). These
are the indicators used to measure performance. There are two types of key performance indicators.
▪ Financial key performance indicators( in monetary terms)
▪ Non-Financial key performance indicators(in non-monetary terms)

➢ Financial perspective: This considers how the organisation can create value for its stakeholders.
Performance measures are likely to include traditional financial measures of profitability, cash flow
and sales growth. This focuses on satisfying shareholder value. Examples;
▪ Return on capital employed
▪ Profit margins
➢ Customer perspective: This looks at how existing and potential customers see the organisation.
Performance measures could include number of customer complaints, new customers acquired, on-
time deliveries etc. This is an attempt to measure customers’ view of the organization by measuring
customer satisfaction. Examples;
▪ Customer satisfaction with timeliness
▪ Customer loyalty.

➢ Internal business perspective: This considers the processes at which an organisation must excel if
it is to achieve customer satisfaction and financial success. Measures might include the speed of
innovation, the quality of after sales service or manufacturing time. This aims to measure the
organization’s output in terms of technical excellence and consumer needs. Examples;
▪ Unit cost
▪ Quality measurement

➢ Innovation and learning perspective: This looks at the organisation’s capacity to maintain its
competitive position through the acquisition of new skills and the development of new products and
services. This focus on the need for continual improvement of existing products and techniques and
developing new ones to meet customers’ changing needs. Examples;
▪ A measure would include % of turnover attributable to new products.

The following important features of this approach have been identified:

▪ It looks at both internal and external matters concerning the organization.
▪ It is related to the key elements of a company's strategy.
▪ Financial and non-financial measures are linked together.

The balanced scorecard approach may be particularly useful for performance measurement in
organizations which are unable to use simple profit as a performance measure. For example the
public sector has long been forced to use a wide range of performance indicators, which can be
formalized with a balanced scorecard approach.

Advantages
▪ All four perspectives considered by manager: Managers need to look at both internal and external
matters affecting the organization. They also need to link together financial and non-financial
measures. Therefore they can see how factors in one area affect all other areas.

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▪ Consistency between objectives, control systems and staff: It can be difficult to incorporate
objectives into control systems such as budgets. So targets set by a budget may conflict with
objectives. Moreover, staff may put their own interpretation on objectives against the actual intention
of the original objective. The balanced scorecard should improve communication between different
levels of the organization. The balanced scorecard strives to keep all of these factors in balance.

Disadvantages
▪ Conflicting measures: Some measures in the scorecard such as research funding and cost
reduction may naturally conflict. It is often difficult to determine the balance which will achieve the
best results.
▪ Selecting measures: Not only do appropriate measures have to be devised but the number of
measures used must be agreed. Care must be taken that the impact of the results is not lost in a sea
of information.
▪ Expertise: Measurement is only useful if it initiates appropriate action. Non-financial managers may
have difficulty with the usual profit measures. With more measure to consider this problem will be
compounded.

▪ Interpretation: Even a financially-trained manager may have difficulty in putting the figures into an
overall perspective.

➢ Application of Balance Scorecard for Electronic Circuits Inc.

Financial success
Goals Measures (KPI)
Survive Cash flows
Succeed Quarterly sales growth in income by division
Prosper Increased market share and ROCE.
Customer satisfaction
Goals Measures (KPI)
New products Percentage of sales from new products.
Percentage of sales from proprietary products.
Preferred supplier Share of key accounts purchased.
Customer partnership Number of cooperative engineers efforts.
Process efficiency
Goals Measures (KPI)
Technology compatibility Manufacturing geometry vs. competitors
Manufacturing Excellence Cycle time.
Design productivity Silicon and engineering efficiency
New products introduced Actual introduction schedule vs. planned
Growth
Goals Measures (KPI)
Technology leadership Time to develop next generation
Manufacturing learning Process time to maturity.
Time to market New product introduced vs. competition

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➢ Application of Balanced Scorecard for a Restaurant

Financial success
Goals Measures (KPI)
To grow and open new restaurants New restaurants opened
Profitable Net profit margins
Customer satisfaction
Goals Measures (KPI)
Great services Excellent results on customer survey
Repeat business Customers booking to come again
Innovative food New menus on a regular basis
Process efficiency
Goals Measures (KPI)
Timely food delivery Time from order to delivery
Efficient staff Processing of food order, few mistakes
Low food wastage Amount of food discarded
Growth
Goals Measures (KPI)
Trained staff Employees with relevant training
New menu choices Number of new dishes introduced

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Value for Money

Value for money means providing service in a way which is economical, efficient and effective.

Value for Money (VFM) is often referred to as the 3E's-Economy, Efficiency and Effectiveness.
▪ Economy: It implies that the least possible cost should be incurred for acquiring and using resources,
while maintaining the appropriate quality ('doing things at a low price') like more clean plates per
pound.
▪ Effectiveness: It focuses on the achievement of the desired objectives through the spending of
available funds. It is concerned with the relationship between the planned results and the actual
results of projects, programs and other activities ('doing the right things'). Like plates as clean as they
should be.
▪ Efficiency: It is attaining desired results at minimum cost. It implies the maximisation of output to
input ratio i.e. per unit of input the output should be the most. It is concerned with the relationship the
resources (input) and the output of goods, services and other results.
University

Area Economy Efficiency Effectiveness

Possible Minimizing cost Maximizing Quality of degrees
measure per student student/staff ratio awarded

It is clear that high effectiveness may conflict with economy and efficiency. Multiple and conflicting
objectives may exist due to the multiple stakeholders involved

Performance Measurement of Labour Using Standard Hour

It is not possible to measure output in terms of units produced for a department making several different
products. This problem can be overcome by ascertaining the standard hours produced,
✓ Activity ratio / production volume ratio
This ratio measures how the overall production compares to planned levels. It compares the number
of standard hours equivalent to the actual work produced and budgeted hours.
Standard hours for actual output x 100
Budgeted hours

✓ Capacity ratio: This ratio measures the extent of worker's capacity by their working hour has been
achieved in a period with the planned labour hours’ utilization.
Actual hours worked x 100
Budgeted hours

✓ Efficiency ratio: This ratio measures the efficiency of the labour force by comparing equivalent
standard hours for product produced and actual hours worked. The benchmark of efficiency is 100%.
Standard hours for actual output x 100
Actual hours worked

Activity ratio = Efficiency ratio x capacity ratio

Standards hours per unit = Budgeted hours ÷ Budgeted units produced
Standard hours for actual output = Standard hours per unit X Actual output.

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Performances measurement through cost per unit

In contract and process costing environment cost per unit is a useful performance measure.
Total cost
Cost per unit = Number of units produced in the period

Performance measure for Services

Characteristics of services: There are four particular characteristics of services, which affect both
performance and its measurement:

Simultaneity – production and consumption of the service at the same time

Perishability – the inability to store the service

Heterogeneity also called variability – provision of a non-standardized service

Intangibility– there is no physical product.

Performance measurement in service sectors: There are 6 key dimensions to performance in the
service sector
▪ Competitive Performance
▪ Financial Performance
▪ Quality
▪ Resource utilization
▪ Flexibility
▪ Innovation

Together these areas influence the competitiveness of the business and ultimately its profitability.
➢ Competitive performance
▪ Sales Growth
▪ Market Share
▪ Obtain New Business

➢ Financial performance
▪ Budgeted Expenditure Limit
▪ Standard Performance Measurement (Standard cost per unit; Productivity etc.)

➢ Quality
Quality cannot be measured physically so it is assessed by different means, this will be mo

Service quality factor Measure Mechanism

• Assess Walking distance Customer survey and internal
operational data
• Cleanness Cleanness of environment and Customer survey and management
equipment inspection
• Comfort Crowdedness of airport Customer survey and management
inspection

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• Friendliness Staff attitude and helpfulness Customer survey and management

inspection

➢ Resource utilisation
Resource utilization is measured in terms of productivity. The main output of accountancy firm is
chargeable hours. Productivity will therefore be measured as ratio some of the ratios are given below:
Business Input Output
Accountancy firms Man hours available Chargeable hours
Common wealth hotels Rooms available Rooms occupied

➢ Flexibility: It has three aspects.

Speed of delivery This is vital in some services industries. measure included factors such as
waiting time in queries
Ability to respond in This will depend on type of services professional service such as legal
customer’s advice must tailored exactly the customer’s needs
specification
Coping with demand This is measureable in quantity terms. E.g. train company can measure
exact overcrowding

➢ Innovation
How much cost it will take to develop new service and how effective this process is. In can be
summarized as follows:
▪ Amount of spending on research and development
▪ Proportion of new service to total service provided
▪ Time between the identification of customer need and for a new service and making it available.

MONITORING PERFORMANCE MEASUREMENT

Non-financial performance measure (used to measure the performance of Profit Seeking Organizations
and Not for Profit Organizations)
▪ Benchmarking (financial + non-financial)
▪ Balanced scorecard (financial + non-financial)

✓ BENCHMARKING
Benchmarking involves the establishment, through data gathering, of targets and comparators,
through whose use relative levels of performance (and particularly areas of underperformance) can
be identified. By the adoption of identified best practices the performance of the organisation should
be improved.

Types of benchmarking
▪ Internal benchmarking: This involves the comparison of different departments or divisions within
an organisation. Data for this is easy to obtain and conditions are often comparable. Learning
may be limited as comparisons are only being made within the same company.

▪ Competitive benchmarking: This involves comparing performance with that of direct

competitors. The potential for learning is improved but data may be difficult to obtain. For
commercial reasons firms are often unwilling to divulge information to direct competitors. The
growth of benchmarking clubs and trade associations has reduced the problems of competitive
benchmarking

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▪ Functional benchmarking: Various functions in the business are compared with those
recognised as the best external practitioners of the function. A manufacturing company could
compare its invoice preparation time with that of a credit card company, its delivery time with a
firm of couriers etc. The potential for learning how to improve performance is very high, but
comparability problems sometimes exist. (This is sometimes referred to as operational or generic
benchmarking)

▪ Strategic benchmarking: This involves comparison of performance with competitors at the

strategic level. Areas such as market share and return on capital employed could be considered.
Such comparisons are important in designing competitive strategy.

Reverse engineering: Buying a competitor’s product and dismantling it in order to understand its
content and configuration.

Why use benchmarking?

✓ For setting standards: Benchmarking allows attainable standards to be established following
the examination of both external and internal information. If these standards are regularly
reviewed in the light of information gained through benchmarking exercises, they can become
part of a program of continuous improvement by becoming increasingly demanding.
✓ Its flexibility means that it can be used in both the public and private sector and by people at
different levels of responsibility.
✓ Cross comparisons (as opposed to comparisons with similar organisations) are more likely to
expose radically different ways of doing things.
✓ It is an effective method of implementing change, people being involved in identifying and seeking
out different ways of doing things in their own areas.
✓ It identifies the processes to improve.
✓ It helps with cost reduction.
✓ It improves the effectiveness of operations.
✓ It delivers services to a defined standard.
✓ It provides a focus on planning.

'Most importantly benchmarking establishes a desire to achieve continuous improvement and helps
develop a culture in which it is easier to admit mistakes and make changes.' Stages involve,
1. Planning and organization e.g. setting up a steering group and setting out aims and objectives
2. Identification of key internal processes for analysis.
a. Practices. steps in a process
b. Metrics. measures of times and outcomes e.g. cost, quality
3. Researching potential partners. Collecting information and investigating metrics for comparison.
4. Making agreements and developing plans for exchange visits. Formulating a common program
for internal data collection
5. Partner site visits by benchmarking teams collect data
6. Analyzing data and developing plans for improvements
7. Implementation and monitoring.

Benefits of performance measurement systems

▪ Clarification and communication of organizational objectives e.g. profitability.
▪ Developing agreed measures of performance within the organization e.g. ROCE.
▪ Allowing comparison of different organizations e.g. ratio analysis.
▪ Promoting accountability of the organization to its stakeholders.
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Problems
▪ Tunnel vision – an obsession with maximizing measured performance at the expense of non-
measured performance e.g. staff welfare.
▪ Myopia (short sightedness) – maximizing short run performance at the expense of long run
success.
▪ Manipulation of data – “creative” reporting e.g. trying to classify all adverse variances as
planning variances.
▪ Gaming – e.g. building slack into budgets.

Solutions
▪ Participation – involve staff at all levels in the design and implementation of the system.
▪ Encourage a long-term view among staff e.g. through company share option scheme.
▪ Ensure the system of performance evaluation is “audited” by experts to identify problems.
▪ Review the system regularly.
▪ Audit data used in performance measurement to prevent/detect manipulation.

PERFORMANCE MEASUREMENT IN NON-PROFIT MAKING ORGANISATIONS (NFMOs) AND

PUBLIC SECTOR ORGANISATIONS

Performance measurement in Non-profit Making Organisations: Performance cannot be judged by

Profitability rather than it is judged in terms of inputs and outputs which ties in with the Value for Money
criteria.
▪ Economy
▪ Efficiency
▪ Effectiveness

Problems with Non-profit Making Organisations:

▪ NFMOs tend to have multiple objectives
▪ Outputs can seldom be measured

Performance can be measured by

▪ Input – Output Relation
▪ Judgments
▪ Comparisons
▪ Unit cost Measurement

Performance measurement in Public Sector Organisations: Large volume of information on

performance and value for money is produced. This information is for internal and external use.
Performance can be measured against;
▪ Financial Performance Targets
▪ Volume of Output Targets
▪ Quality of Service Targets
▪ Efficiency Targets

Management Performance Measures: It is necessary to consider a manager and measure performance

in relation to his or her area of responsibility. It is unreasonable to assess manager’s performance in
relation to matters that are beyond their control. Management performance measures should therefore
only include those items that are directly controllable by the manager. The way to control their
performance is to establish in advance a set of measures that will be used to evaluate their performance
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at the end of the period. It is of critical importance that the performance measures are designed well.
Below are the possible performance measures of the management

Measures Detail
Subjective Measures An example is performance on a scale of 1 to 5. This will measure
managerial performance rather than divisional performance. The
judgement should be made by somebody impartial.
Judgement of Outsiders Bonus attached with the share price for example manager will receive
bonus if share price out performs for three years. Increase in share
price may reflect the performance aspect.
Upward Appraisal This involves staff giving their opinions on the performance of their
managers. To be effective this requires health working relationships.
Accounting Measures These can be used, but must be tailored according to what or who is
being judged.

Practical problems involved in measuring the performance of manager: Difficult to devise

performance measures that relate specifically to a manager to judge his or her performance as a
manager. Statistics such as days absent, professional qualification, personality etc. can assess the
manager as an employee but cannot assess his managerial performance

Impact of External Considerations: The organisation is not sealed off from its environment, it is subject
to the conditions present in that environment and its performance is influenced by them. We must always
be aware when measuring performance of the influence of external conditions and changes in them.

Market Conditions: A business operates in a competitive environment and suppliers, customers and
competitors all influence one another’s operations. The entry of a new and dynamic competitor, for
example is certain to have an effect on budgeted sales.

General Economic Conditions: These influence businesses most obviously by increase and decrease
in Demand and Supply. The role of government is very important as government economic policy affects
the demand. For non-profit making organisations, economic conditions and government policy are still
important e.g. charity organisations depending on donations will be subject to general feelings of
prosperity. The general conclusion from these and similar conditions is that appropriate attention should
be paid to general and specific external conditions when measuring performance.

Impact of Sustainability on Performance Measurement

Sustainability is increasingly at the forefront of stakeholder concerns when evaluating company
performance.

Because of this, the company must design and implement performance measures that indicate how
sustainable the organisation is and what it is doing to improve its sustainability.

Defining Sustainability
Sustainability is defined as the ability to meet the current generation’s needs without compromising future
generations’ ability to meet their own needs.

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It usually encompasses three main areas:

• Environmental: Care and stewardship for the environment. Company activities should be
ecologically sustainable and minimise damage to the natural environment.
• Social: The company should care for the local communities and stakeholders and ensure human
rights and quality of life are upheld.
• Governance: The company should be accountable to its stakeholders and focus on sustainable
long-term value generation.

Incorporating Sustainability in Performance Measurement

To successfully incorporate sustainability, it needs to be given a sufficient level of priority in setting CSFs
and KPIs, and adequate reporting systems and accountability must be enforced.

Consider the following additional CSFs and their corresponding KPIs to Winston’s Football Factory:
Mission CSF KPI
aspect
Purpose To be at the forefront of • Ranking among
sustainable organisations in the sustainable organisations
sector. in the sector.
• Recognition by
independent sustainability
certification bodies.
• Measurement of public
perception regarding
sustainability.

Strategy To ensure that activities are • Compliance with

known to be sustainable, meeting sustainable reporting
international standards. standards.
• Implementation of
sustainability reporting and
measurement processes
in critical activities.

Policy To minimise damage to the • Measurement of pollutants

environment and uplift produced by company
communities. activities.
• Analysis of the supply
chain for pollutants and
human impact.

Value To be a force for sustainability. • Measurement of

contribution to overall
societal sustainability
development goals (such
as the United Nation’s
Sustainable Development
Goals)

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Cost Reduction
COST MANAGEMENT
Cost can be managed by:
▪ Reducing cost
▪ Controlling cost

Cost reduction
▪ Cost reduction is a planned and positive approach to reduce expenditure.
▪ Its aim is to reduce cost to below budget.
▪ By changing working method, cost can be reduced to below current budget or standards.

Cost control
▪ Cost control is concerned with regulating the costs of operating a business and keeping costs within
acceptable limits.
▪ Acceptable limits mean standards or budgets.
▪ If actual cost varies from budgeted cost then cost action will be required.
▪ It means actual cost should be below the budget.
▪ Cost control actions lead to reduction in excessive spending.

❖ APPROACHES OF COST REDUCTION

There are two approaches used to reduce cost.

➢ Crash programme to cut spending levels

▪ Immediate plan to reduce spending without any proper planning like:
✓ Some projects might be abandoned
✓ Deferred some expenses
✓ Stop new recruitments
✓ Redundant unnecessary employees.
▪ It might create a panic situation
▪ Poor planning may lead to poor efficiency
▪ May be cost reduced in short term but increase in long term.
▪ May be useful in time of crisis.

➢ Planned Programme to reduce cost

▪ It involves continual assessments of organization products, methods, services and so on
▪ It is a planned approach
▪ It reduces the cost for long term

Problems in introducing cost reduction programmes

▪ Resistance from employees
▪ To overcome this problem, proper communicate the programme through some campaign
▪ If the programme introduced in one area may lead extra cost in other area
▪ Not properly planned programme create panic situation

Managers’ responsibilities in reducing cost

▪ They should have a positive approach
▪ They should do cost benefit analysis
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▪ Investigate area of potential cost reduction and identify unnecessary costs

▪ Cost reduction should be planned, agreed, implemented and monitored by managers

Scope of cost reduction

▪ Cost reduction should be applied to whole organization through campaigns
▪ Cost reduction campaigns should have a long term aim as well as short term objectives
▪ In short term only variable cost can reduce easily. Fixed cost remains unchanged like rent
▪ Some fixed costs can be avoided in short term like advertising or sales promotions. These are
called discretionary fixed costs
▪ In long term variable and fixed costs both can be either avoided or reduced

METHODS OF COST REDUCTION

✓ Improving efficiency
✓ Improving efficiency includes:
▪ Improving efficiency of material usage
▪ Low level of wastage
▪ Better quality checks

✓ Improving labour productivity

▪ Pay incentives
▪ Change working methods
▪ Improving coordination between departments
▪ Give challenging standards
▪ Improving efficiency of equipment usage
▪ Better use of equipment resources
▪ Provide proper maintenance to avoid down time

✓ Material costs
▪ Avail bulk purchase discounts
▪ Introduce EOQ
▪ Use Cheap substitute material
▪ Improve store controls

✓ Labour cost
Work study is a mean of raising the productivity of an operating unit by reorganization of work.

There are two parts of work study:

▪ Method study: It is the systematic recording and critical examination of existing and proposed
ways of doing work in order to develop and apply easier and more effective methods and reduce
costs.
▪ Work measurement: It involves establishing the time for qualified workers to carry out a
specified job at a specified level of performance.
Methods of work study:
♦ Direct observation methods: It involves observing jobs in practice
♦ Synthetic methods: These are used to estimate work content of jobs without having to
observe them.

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✓ Organization and methods (O&M)

It is a term for techniques, including method study and work measurement that are used to examine
clerical, administrative and management procedures for improvements.

Critical examination of existing and proposed ways of doing work in order to improve it through
alternative cost reduction methods and establishing the time for a skilled worker to carry out a
specified job at specified level of performance

✓ Finance Cost
▪ Avail cash discounts from suppliers
▪ Reassessed cash discounts offered to credit customers
▪ Borrow at low interest rates
▪ Improve foreign exchange dealings

✓ Rationalization
When organizations grow, especially through mergers and takeovers, there is a tendency for work to
be duplicated in different parts of the organisation. The elimination of unnecessary duplication and
concentration of resources is a form of rationalisation.

✓ Expenses
▪ Authorised expenses
▪ Evaluate capital expenditure
▪ Continually questions about expense items

❖ ANOTHER APPROACH TO COST REDUCTION

Value analysis: It is a planned, scientific approach to cost reduction, which reviews the material
composition of a product and product’s design so that modifications and improvements can be made
which do not reduce the value of the product to the customer or user. This means the value of the
product remains same with reduced cost.

Value engineering: It is the application of similar technique on new products so that new products
are designed and developed to a given value at minimum cost.

STEPS OF VALUE ANALYSIS

▪ Reduce unit cost so cost value is the only value which we try to reduce
▪ Value analysis try to provide same or improved use value in a low cost
▪ Value analysis try to maintain or enhance the esteem value at low cost

ROLE OF SENIOR MANAGEMENT IN VALUE ANALYSIS

Value analysis programmes must have the full backing of senior management. Management must
therefore do the following:
▪ Provide support like acting as a member of Value analysis programs, attend training sessions
▪ Establish goals for Value analysis programs to be achieved
▪ Select the personnel for value analysis
▪ Provide sufficient budget
▪ Insist on continual audit
▪ Give reward

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