INTRODUCTION

A management control system (MCS) is a system which gathers and uses

information to evaluate the performance of different organizational resources
like human, physical, financial and also the organization as a whole in light of
the organizational strategies pursued.

Management control system influences the behavior of organizational resources

to implement organizational strategies. Management control system might be
formal or informal.

Performance measurement is one of the critical factors that determine how

individuals in an organization behave. It includes subjective as well as objective
assessments of the performance of both individuals and subunits of an
organization such as divisions or departments.

Despite the importance of having good management control systems (MCSs),

management critics have argued that adding controls does not always lead to
better control and that the MCSs in common use cause managers to be
excessively short-term oriented or are prone to stifle creativity and initiative.

An old narrow view of a MCS is that of a simple cybernetic (regulating) system,

involving a single feedback loop (thermostat). This book takes a broader view
and recognizes that some management controls are proactive rather than
reactive. Proactive means that the controls are designed to prevent problems
before the organization suffers any adverse effects on performance. The benefit
of management control is that the probability that the firm’s goals will be
achieved increases.
 Divisional Performance Measurement
Performance measurement is the performance-based management
process which is flowing from the organizational mission and the strategic
planning process. Divisional performance measurement includes the objective
and subjective assessments of the performance sub-units of an organization such
as divisions or departments. Divisional performance measurement are effective
in ensure that a strategy of organisation is successfully implemented by monitor
a divisions effectiveness in satisfying its own predetermined goals or
stakeholder desires. Divisional performance measures may be based on non-
financial as well as on financial information.

Divisional Performance Measurement – Financial Measures

1. The Return on Investment (ROI)

Nowadays, most of companies concentrate on the return on investment (ROI) of

a division that is profit as a percentage in direct relation to investment of
division which instead of focusing on the size of a division’s profits. ROI
addressed divisional profit as a percentage of the assets employed in the
division. Assets employed can be defined as total divisional assets, assets
controllable by the divisional manager, or net assets.

The main advantage of using ROI is provides a valuable information about the
overall approximation on the success of a firm’s past investment policy by
providing a abstract of the ex post return on capital invested. When ROI is used
as a managerial performance measure, Measuring returns on invested capital
also focuses managers’ attention on the impact of levels of working capital (in
particular, stocks and debtors) on the ROI. It can lead to decisions making that
are optimal for individual divisions but sub-optimal for the company. ROI
focuses on short-term profitability, looking only at the last quarter or last year
for performance evaluation. This time horizon may not be long enough for
many projects to be evaluated. ROI is also a useful medium to communicate the
ROI to those who have varying degrees of financial knowledge. The ROI
concept allows managers to speak the same language when handle project goals
in financial terms across several departments in a corporation as well
Information Technology (IT) vendors use ROI as a sales tool to easily convey
the economic value of their products.

2. The Residual Income (RI)

Residual income overcomes the dysfunctional aspect of ROI. It is because the

use of ROI as a performance measurement can lead to under-investment. For
example a manager currently achieving a high rate of return ( 30 %) may not
wish to pursue a project yielding a lower rate of return (say 20 percent) even
thought such as a project may be desirable to a company which can raise
capital at an even lower rate (say 15 percent). Thus, used RI is better than ROI.

The purpose of evaluating the performance of divisional managers, RI is

defined as controllable contribution less a cost of capital charge on the
investment controllable by the divisional manager. For evaluating the economic
performance of the division RI can be defined as divisional contribution less a
cost of capital charge on the total investment in assets employed by the division.

Besides, RI is favour than ROI and it more flexible because different cost of
capital percentage rates can be applied to investments that have different levels
of risk. There is not only will the cost of capital of divisions that have different
levels of risk differ so may the risk and cost of capital of assets within the same
division. The RI measure enables to calculate the different risk-adjusted in
capital cost while ROI cannot incorporate these differences.
3. The Economic Value Added (EVA)

ROI and RI cannot stand alone as a financial measure of divisional

performance. One of the factors contribute to a company’s long-run objectives
is short-run profit ability. ROI and RI are short-run concepts that deal only with
the current reporting period whereas managerial performance measures should
focus on future results that can be expected because of present actions.

RI has been refined and re-named as economic value added (EVA) by the Stern
Stewart & Co. EVA is a financial performance measure based on operating
income after taxes, the investment in assets required to generate that income and
the cost of the investment in assets (or, weighted average cost of capital). The
objective of EVA is to develop a performance measure that find the ways in
which company value can be added or lost. The EVA concept extends the
traditional residual income measure by incorporating adjustments to the
divisional financial performance measure for distortions introduced by GAAP.
Thus, by linking divisional performance to EVA, managers are motivated to
focus on increasing shareholder value.

The apparent success of EVA is that many companies had derived from using
EVA to motivate and evaluate corporate and divisional managers. In fact,
companies which have adopted EVA as the basis of management performance
measurement have experienced a significant increase in their shareholders’
wealth.

Limitations of Financial Performance Measures

Financial performance measures are generally based on short-term measurement

periods and this can encourage managers to become short-term oriented. For
example, relying on short-term measurement periods may encourage managers
to reject positive NPV investments that have an initial adverse impact on the
divisional performance measure but have high payoffs in later periods.
Financial performance measures are limited to current reporting period only and
it needs to be supplemented by non financial information such as customer
satisfaction and quality while Managerial performance measures focus and
expect what will be the future result.

The major problem is obtaining profit measures are based on the historical cost
concept and thus tend to be poor estimates of economic performance.
Companies tend to rely on financial accounting-based information for internal
performance measurement. This information may be appropriate for external
reporting but it is doubtful for internal performance measurement and
evaluation. In particular, using GAAP requires that discretionary expenses are
treated as period costs, resulting in managers having to bear the full cost in the
period in which they are incurred.

Many traditional measurement and evaluation methods such as ROI, EVA,

ROCE and so on have failed to yield an appropriate estimate of the ‘pay back’
from these complex systems. Some claim these performance indicators have a
high reliance on financial perspectives and thus portrait only one facet of the
organisation.

Divisional Performance Measurement – Non-Financial Measures

1. Balanced Scorecard (BSC)

Balanced Scorecard was introduced by Kaplan and Norton to overcome the

shortcomings of traditional management accounting and control which fails to
signal changes in the company’s economic value as an organization makes
substantial investments or depletes past investments in intangible assets. The
scorecard contains four different perspective which is financial performance,
customers, internal business processes, and learning and growth. These
perspectives reflect the interests of the key stakeholders of companies involving
shareholders, customers and employees.

There are several benefits of adoption the balanced scorecard highlight by

Kaplan and Norton. One of the benefits is focusing the entire company on the
few key things needed to create breakthrough performance. A balanced
scorecard might show that an organisation is only weak in a couple of areas but
that these areas are impeding its overall success. By focusing everyone in the
organisation on improving those areas, overall performance gets better.

Next, it assists to integrate different company activities such as quality and

customer service. By looking at different organisational programmes or units
from different perspectives can be a way of getting everyone singing from the
same song sheet. If the balanced scorecard shows customer service to be weak,
focusing on everybody’s customer service performance behaviors will lead to
small improvements in each department or unit; the overall effect will be a
bigger improvement in the organization’s customer service performance across
the board.

Lastly, managers and employees both know what is required to achieve

excellent overall performance by breaking down strategic measures to lower
levels of the organisation. For example, an organisation might have overall
goals to increase productivity by 5 per cent. By breaking down its productivity
measures to granular levels of the organisation as part of a balanced scorecard,
every member of the organisation will have clear targets that achieve their
overall goals.

2. Performance Prism

The Performance Prism takes a drastically different look at performance

measurement and sets out clearly to recognize how managers can use
measurement data to improve business performance. It has a much more
comprehensive view of different stakeholders for example investors, customers,
employees, regulators and suppliers than other frameworks. It must be
considering the wants and needs of stakeholders first before the strategies can
be formulated. Thus, the stakeholders and their needs have been clearly
identified, if not, it is impossible to form a proper strategy for company. Now
lots of measurement frameworks for example like the balanced scorecard tends
to take a fairly narrow view of stakeholders which refer to shareholders and
customers. However, it ignores employees, suppliers, regulators and in today’s
society organizations can’t afford to ignore those different pressure groups.
Those different groups of stakeholders that might be interested in the business.

The strength of this conceptual framework is that it first questions the

company’s existing strategy before the process of selecting measures is started.
In this way, the framework ensures that the performance measures have a strong
foundation. The performance prism also considers new stakeholders (such as
employees, suppliers, alliance partners or intermediaries) who are usually
neglected when forming performance measures.

It is structured to throw light on the complexity of an organization’s

relationships with its multiple stakeholders within the context of its particular
operating environment. It provides an innovative and holistic framework that
directs management attention to what is important for long term success and
viability and helps organizations to design, build, operate and refresh
their performance measurement systems in a way that is relevant to the specific
conditions of their operating environment.