Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

Performance Management
About the Paper

This is one of the Most Interesting and tough Courses in Skills Level, as Some of Us Might Have Known This Before
and One of The Difficult paper To Do In An Online Platform Like this because of the Calculative Nature of It and It's
Technicality. Even in Physical Classes, IT used to Be Confusing, talk less of Mere Online Class, which Is Not Audio
Visual. But, In Shaaa Allah.... We are Gonna Try Our Best To Give You The Best. May Allah Crown Our Efforts with
Success.

The Syllabus at a glance

➢ Section A - Cost planning 20% of the Syllabus

This Contains Chapter 1 - 5.

And the Major Topics we have here are:

▪ Modern Mgt Accounting Techniques (ABC, Target Costing, Life Cycle Costing, Through Put Accounting,

▪
Backflush Accounting, Environmental Accounting, Kaizen Accounting)

▪
Learning Curve Theory
Quality Cost

➢ Section B - Planning and Control 20% of the Syllabus

This comprises of Chapters 6 - 8 of the Pack.

Where we have 2 Major Topics

▪
▪
Budgetary and Budg. Control, and
Variance Analysis

➢ Section C - Performance Mgt and Control 20% of the Syllabus.

This Covers Chapter 9 - 12

▪
▪
Performance Analysis (Written)

▪
Transfer Pricing (One of the Most Confusing Topics in PM, If not The Most)
Divisional Performance.

➢ Section D - Decision Making 30% of the Syllabus

This Covers from Chapter 13 - 27.

The Bulk of the Topics in the Course are from here:

▪
▪
Relevant Costing Techniques

▪
Short Term Decision Making Techniques.

▪
Linear Programming

▪
Pricing Techniques

▪
Risk and Uncertainties

▪
Working Capital Management
Capital Budgeting Decision

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

➢ Section E - Strategic Models This covers 5% of the Syllabus

This comprises of chapter 28 only

All the models covered in CSME. This Part is Purely Written.

➢ Section F - Mgt Info. Systems and Project Mgt This covers 5% of the Syllabus

Chapters 29 &30. This is Purely written as well.

That Analysis is Very important and Needful. As a Student, you should know what you are going into and how you
should Capture it. As a Facilitator, That's the 1st thing I do for all Courses and it worked for me as a Student. So, if it
worked for me, it will definitely work for you as well. It makes students flow better in study since each of the topics
links to one another. And I will urge you guys to study in this Format as well. It Will Help You A Lot.

Course Outline

1. Introduction to strategic planning and control 3

2. Overview of cost planning and control 5
3. Modern Management Accounting Techniques 7
4. Learning and experience Curve Theory
5. Quality and quality costs 12
6. Budgetary control systems 14
7. Variance Analysis 19
8. Advanced Variances 21
9. Performance Analysis 23
10. Other aspects of performance measurement 29
11. Transfer Pricing 30
12. Divisional Performance 36
13. Relevant Costs 38
14. Cost-Volume-Profit (CVP)Analysis 39
15. Limiting Factor 40
16. Linear Programming 41
17. Further Aspects of Linear Programming 44
18. Other Decisions 45
19. Pricing Decision 48
20. Risk and decision making 51
21. Working Capital Management 53
22. Management of Trade Receivables and Payables 54
23. Inventory Management 55
24. Cash Management 53
25. Introduction to Capital Budgeting 54
26. The Discounted Cashflows Techniques 55
27. Replacement Theory 58
28. Strategic Models and Performance Management 59
29. Information systems and performance management 72
30. Implementing performance management systems 81

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

Chapter 1

Introduction to strategic planning and control

Management Accounting

The overall purpose of management accounting is to provide relevant and reliable information so that managers can
make well-informed decisions. The Value of management accounting depends on the quality of information provided
and whether it helps managers make better decisions or not.

In other words, the purpose of management accounting is to provide information for:

▪
▪
Planning

▪
Control, and
Decision Making.

Those are the 3 concepts in which performance management is drawn on. Let's take them one after another.

️ Planning - This includes setting objectives for the organisation and making plans to achieve those objectives. In
order to make sensible plans, information is needed. Example of plans includes budgets, sales plans, weekly production
schedules, capital expenditure plans, etc.

️ Control - Controlling the performance of an organisation involves monitoring actual performance to compare with
plans, then where appropriate, taking control action. Example of control exercise is that of variance analysis.

️ Decision Making - The end result of planning and controlling is for managers to make informed decisions.

Levels of strategic planning

Planning is a hierarchical activity, linking strategic planning at the top with detailed operational planning at the bottom.
According to R. N. Anthony (1965), there are 3 levels of planning in an organisation:

1. Strategic Planning
2. Tactical Planning, and
3. Operational Planning
The main focus of this chapter is strategic planning.

Process of strategic planning

1. Setting of objectives
2. Strategic Analysis
3. Strategic Choice
4. Evaluating strategies
5. Implementing strategies
6. Review and control

A brief explanation of each of them

️ A Clear objective needs to be set and this may be in form of mission statement.

️ Strategic Analysis - This has to do with both:

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

• External Analysis which is threats and opportunities.

• Internal analysis which is strength and weaknesses in terms of organisation's products, resources, customers,
management and technical knowhow.

️ Strategic Choice - Which of the strategies the organisation is adopting. It involves how they want to:

• Take advantage of the opportunities they have

• Protect against threats
• Make full use of strengths
• Eliminate weaknesses.

️ Evaluation of Strategies - Before an entity will chose a strategy, an evaluation should be done as to its suitability,
feasibility and acceptability.

️ Implementation of strategy - After the company must have evaluated the one they opt for, how to put into action is
the next question. In a way that stakeholders will not be affected.

️ Review and control - After the strategy must have been implemented, should any variance occur between what we
expect and actual result, appropriate control measure should be taken.

Levels of management

In a well structured organisation, there are hierarchy of managers, from senior management down to junior managers
then to supervisors. The responsibilities of Managers vary according to their position in the management hierarchy. The
levels are same as decision making processes.

1. Strategic Management
2. Tactical Management
3. Operational Management.

1. Strategic Management - They are concerned with setting objectives for the organisation and develop plans to
achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level managers. They
monitor actual performance to assess whether planning targets deceleration by strategic management are achieved.
Their main function is usually associated with budgets and Budgetary control.
3. Operational Management - This is the management of day-to-day operations and activities. The planning horizon is
usually short and requires immediate decision. This is usually saddled with supervisors and Frontline managers who
monitors daily efficiency level.

Potential Conflict between strategic plans and short term decisions

In practice, problems occur with a large number of managers when local managers take decisions which are inconsistent
with long term strategies of the senior management. The following are some of the reasons why thus may happen:

▪ When Local Managers are rewarded for achieving short term objectives, whereas organisation sees beyond that.
▪ When local managers feel strategic plans are unfair to them.
▪ When Local Managers are unaware of the strategic Plans due to poor communication within the society.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

Chapter 2

Overview of cost planning and control

Business Information

Information is a processed data and management could not make decisions without information. However, information
can vary in quality and managers can only make better decisions when they have better quality information.

Levels of management

1. Strategic management - They are concerned with setting objectives for the organisation and develop plans to
achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level managers. They
monitor actual performance to assess whether planning targets deceleration by strategic management are achieved.
Their main function is usually associated with budgets and Budgetary control.
3. Operational Management - This is the management of day-to-day operations and activities. The planning horizon is
usually short and requires immediate decision. This is usually saddled with supervisors and Frontline managers who
monitors daily efficiency level.

Each of those management levels require different information need. Strategic management need strategic information.
Tactical management needs tactical information while operational management needs operational information. For
example:

️ Strategic Information which is needed by strategic managers has the following characteristics:

▪
▪
It is usually Summarised and not detailed.

▪
Longer term in nature

▪
Often forward looking

▪
Sourced from both internal and external source.

▪
Usually contain qualitative information rather than quantitative.

▪
It captures overall objectives of the organisation as a whole.

▪
Prepared on an adhoc basis, rather than regular.
There is a high degree of uncertainty in the information, because of its futuristic nature.

️ Tactical Information - This are information used to decide how the resources of the organisation should be used.
They are information relating Budget where plans are expressed in financial terms. Tactical information has the
following characteristics:

▪
▪
It is often about individual departments and functions not overall as strategic.

▪
Also Summarised form of information but a bit level of detail than strategic information.

▪
Generally Relevant to short and medium term.

▪
Often concerned with performance measurement.

▪
Data sourced from both internal and external sources but more from with in the organisation.

▪
Often prepared on routine or regular basis. For example, monthly, or weekly performance reports.

▪
Consists of mainly quantitative information rather than qualitative.
Though, there is a degree of uncertainty but much less than strategic.

️ Operational Information - This is that one needed by Frontline managers or supervisors to enable them organise
and monitor operations, make on the spot decisions whenever operational issues arise. They have the following
characteristics:

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

▪
▪
Usually task specific, about specific transactions, specific job, daily workloads, etc.
Usually detailed in nature.
▪
▪
Relevant to very short term

▪
Relates to daily transactions

▪
Data comes exclusively from within the organisation.

▪
Often prepared frequently

▪
Consists mainly of quantitative information
Information are usually factual and with less uncertainty.

Sources of information

There are 2 Major sources of information

1. Internal Sources - A Control system such as a management accounting system must obtain data from within the
organisation for planning and control purpose. Potential internal sources include:

▪ Financial accounting records

▪ Human resources records maintained to support payroll systems.
▪ Production information
▪ Sales Information
▪ Minutes of meetings
2. External Sources - Managers also need information about customers, competitors and other elements in their business
environment. This is needed for strategic planning and control. Examples are information needed about customers,
competitors, suppliers, regulatory environment, economic or financial environment. Potential sources include:

▪
▪
Market Research

▪
Trade journals

▪
Suppliers Price list

▪
Newspapers and other media
Government reports and statistics

Limitations of external information

1. It might not be accurate

2. It might be incomplete
3. It might not be detailed enough
4. It might not be available when required
5. It might be misinterpreted.

Cost of information

For information to be Useful, it should be captured and processed. Capturing and processing data costs some money.
Costs associated with hardware, software, analysis, interpretation and procuring modern computing equipment can
amass huge amounts.

Methods of gathering information

1. Observation - This method involves looking into the process being executed by others and understanding how a
program or system actually operates.
2. Interview - By asking questions verbally and documenting them in a paper. This could be useful when there is a
need to understand the interviewee's response in more depth.
3. Questionnaire - This can be used to gather information in a structured way from a large number of people.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

Chapter 3

Modern Management Accounting Techniques

Introduction

Traditionally, management accounting systems provides accounting information obtained from accounting records and
other data within the organization. Commonly management accounting techniques includes absorption costing, marginal
costing and CVP Analysis, pricing techniques, budgeting, standard costing, Budgetary control and variance analysis.

For various reasons, questions have been raised about the relevance of traditional management accounting techniques
that they do not serve the needs of management in the modern business environment.

▪ Traditional management accounting techniques do not provide all the information needed by managers in
manufacturing companies where total quality management (TQM) or Just in time (JIT) techniques are used.
▪ Traditional techniques like absorption Costing is probably of limited value in a manufacturing environment
where production processes are highly automated and production overhead costs is a much more significant
element of cost than direct labour.
▪ Traditional methods focus on manufacturing costs, whereas many modern companies operates in service
industry rather than manufacturing.
▪ Traditional techniques focus on cost control and cost reduction techniques which indicates lower production
costs and higher profits. Whereas modern organizations now focus on customers satisfaction and how to meet
customers need in terms of quality, reliability and speed of delivery.
▪ Traditional management accounting techniques do not provide managers with strategic decisions as they focus
on short term decisions. However, modern managers need information about competitors, customers,
development in technology and other external factors to make strategic decisions.

In a nutshell, for a management accounting Information system to be Useful in an organization, it must be able to
provide variety of information - Financial and non financial, long-term and short term. In an increasingly competitive
global market environment, business organizations must be able to deliver the customer's need more successfully than
their competitors. Many businesses compete with each other on the basis of product quality, delivery, reliability,
customer satisfaction, after sales services.

Problem with standard costing and variance analysis

Kaplan and Johnson have argued that standard costing and variances should not be used in a modern manufacturing
environment for either cost control or performance measurement. They argued that standard costing technique ignores
quality costs and innovation which are key factors in a modern successful operations.

However, standard costing systems are still relevant due to the following reasons:

1. Standard costs can be useful for budgeting even in a total quality management environment.
2. Managers need short term (real time) feedback on costs. They need to know whether costs are under control and
variance analysis provides thus.
3. Standard Costs for existing products can provide a useful starting point for planning cost for a new product.
4. Standard costs can be useful for target costing techniques, so far the difference between standard cost and target cost
is cost gap. Manager then focus on this gap and how it's to be closed.
New Trends in Management Accounting

The following are new techniques developed in management accounting.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

1. Target costing
2. Life Cycle Costing
3. Throughput accounting
4. Backflush accounting
5. Activity Based Costing
6. Product Profitability Analysis
7. Segment Profitability Analysis

Some of these techniques have been developed in response to changes in manufacturing methods and systems.

Activity Based Costing (ABC)

Activity based costing is modern method of costing developed as a remedy to the weaknesses embedded in the
traditional absorption Costing method. In modern manufacturing environment, activities are more complex and
automated that apportioning costs needs to be much looked into.

Criticism of absorption Costing

The aim is to calculate full cost of production per unit. No serious issue with direct cost of material and labour as there
is a link between the cost and its activities driven by it. Where major issue lies is in the production overhead costs, they
are highly relative and cannot be traced directly to a particular production process. So, there is a need for apportionment
and traditionally, time spent in production (direct labour hour or machine hour) are used to apportion them. This has
been criticised in the modern manufacturing set up due to the following reasons:

• The basis is arbitrary and not justifiable.

• Difficulty to use for budgeting, pricing and other forms of decision making.
• Inaccurate product costs

Activity Based Costing Method

A better method for calculating full cost per unit. This links costs more accurately and avoids arbitrary apportionment or
guess work. There is no difference as to how direct material cost and labour costs are allocated, those are direct. The
major difference is how production overhead costs are apportioned. Instead of using direct labour hour or machine hour,
we make use of activities to apportion overhead costs.

Identifying Activities

One of the major problem with ABC method is deciding which activities create or drive costs. There are many
Activities within a manufacturing firm and it is not always clear which activity to use. Examples of activities are:

• Material handling and storage

• Quality control and inspection
• Customer order processing
• Repairs and maintenance
• Purchasing
• Machines

Although, ABC is often concerned with production costs but can also be applied to activities outside production such as
sales and distribution.

Cost drivers and cost pools

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For each activity, there should be a cost driver, a factor which determines the cost of activity. For example, material
purchasing is an activity, while number of customer orders is a cost driver. Cost pool is simply the overhead expenditure
allocated and apportioned to an activity.

Justification of ABC

1. Modern manufacturing processes are becoming more complex, so arbitrary appointment is not appropriate.
2. In a multiproduct environment, ABC method is more relevant.
3. Because of mechanisation, overhead is no more an insignificant part of organisation total cost.

Limitations of ABC

1. ABC method could be very expensive to apply.

2. It's difficult to apply in practice.
3. It focuses on rearranging costs rather than reducing it.
4. There is no difference in profit reportable.

Target Costing
Origin of target costing

Target costing originated in Japan in the 70s. This began as a result of customers demanding more diversity in products
that they bought, and the life cycle of products were getting shorter. This means that new products had to be designed
more frequently to meet customers need. Companies then became aware that large proportion of costs of making a
product are committed at the design stage, before the product goes into manufacture.

Purpose of target costing

This is a method of strategic management of costs and profits where target is set for maximum cost of a product or
service then work out on how to achieve this target. It is used for business strategy by companies that operate in a
competitive market where new products are continually introduced into the market in order to compete successfully.

Closing the target cost gap

As said earlier, the major rationale here not just to determine the estimated cost and the target cost, rather to close the
cost gap that exists between the 2. This can be achieved with the following methods:

1. Re-designing the product - By using more cost efficient component to design the product.
2. Reducing Material cost - Target costing involves the entire value chain of a product. Costs should be managed from
the point of purchase of raw materials from the supplier up until when it reaches the final consumer.
3. Eliminating non value additive features or activities of the product design - Something is non value additive if costs
the organisation but fails to add anything of value to the customer.
4. Train staff in more efficient techniques and working methods - Improvement in efficiency will reduce cost.
5. Achieving economies of scale - By producing in larger quantities and Also purchasing larger quantities of materials.

Life cycle costing

This is a modern management technique which considers the total costs associated with a product or asset over its
estimated useful life or life span. The principle here is that not only the initial acquisition cost is considered here, some
annual running costs needs to be considered as well. For example, in acquiring a printer, initial cost of Printer A may be
less than Printer B. But printer B costs more in changing cartridges than A. So, all those needs to be put into
consideration at initial stage.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

This applies to:

• Asset acquisition, and

• Introduction of new products to the market.

Categories of life cycle costs

1. Acquisition and set up costs (Market entry cost for products) - These are usually one off capital expenditure.
2. Operational or running costs - These are recurring costs and may be annual or quarterly or monthly as the Case May
be.
3. End of life cost - These are costs incurred to withdraw a product from the market or demolish an asset at the end of
its life.

Life cycle costing involves proper cost identification, estimation and discounting techniques, which takes into account
time value of money.

Benefits of LCC

✓ Improved evaluation of options

✓ Improved forecasting
✓ Improved understanding of the tradeoff between performance of an asset and its cost.
✓ Improved management awareness about the consequences of decisions.

Problems of LCC

✓ Availability of data
✓ Difficult and time consuming
✓ In practice, organizations are structured in a way that different managers are responsible for the purchase
decision of an asset. So, there is a potential integration issue.

Life cycle costing and product life cycle

Most products made in large quantities go through a life cycle which consists of several stages. They include:

They have 4 Major Stages:

▪ ➖Introduction Phase
▪ ➖Growth Phase
▪ ➖Maturity Phase
▪ ➖Decline Phase.

But, some added:

▪ ➖ Research and Development Phase (Before Introduction Phase)

▪ ➖Withdrawal Phase (After Decline Phase)

But, the Most important and widely acceptable Stages are the 1st 4.

Let me Now take them one after another

1. ➖ Introduction Phase: The Stage the product of a Company is freshly introduced to the Market. Everyone will be
talking about it and willing to Buy it. At this stage, sales and profit will be Low Because no Much recognition is
Derived yet. The Product is just gaining ground. We can relate this to A Man as well That Stage of life we pass
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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

through that we were small in age and size. Our thinking is Childish Because we were children. No one is thinking
about making money as we are now. All what we are after is how to eat, play, sleep and Watch Cartoons.
2. ➖Growth Stage: This Stage, the product is getting well known and more Patronisers come in. The profit grows
Because the sales grew already.
3. ➖Maturity Stage: This is when the Recognition, Sales of the Product gets to its Peak. Then, the profit derived from
the product gets to its pinnacle. At this Point, no increase in the Profit derived from the Product again.
4. ➖Decline Stage: The Product starts fading out of the Market and Sales Drop. So do Profit. At this point, the
Company has 2 Options, either they Withdraw it from the Market or they repackage it.

Each Stage of the Product or asset has its own Peculiar Costs, Sales and Profit. And That’s what Constitute the Diagram
of the Model.

Computation of life cost per unit

Life Cost = Total life cycle cost/Total expected life unit

Throughout accounting
This is a traditional costing technique which is associated with theory of constraints. A theory that postulates that an
entity always has a constraint that sets a limit on the achievement of its goals. Management are therefore required to
identify what the constraint is, then eliminate this constraint so that performance can be improved.

Through put Accounting has some similarity with limiting factor analysis. However, where traditional limiting factor
technique make use of marginal costing method, throughput differs in that sense with the assumption that Labour Costs
are not variable costs, rather they are fixed.

Assumptions in throughput accounting

1. Where traditional marginal Costing methods assumes labor cost to be variable, throughput accounting assumes that
labour are paid fixed monthly or weekly wages or salaries and are thereby fixed, not variable.
2. Only material and component cost are variable in throughput accounting because they are from external source.
3. Business makes real profit by adding value and value is only added by selling goods to customers.

Throughput, Inventory and operating expenses

• Throughput - This can be said to be 'Contribution' in traditional marginal costing technique. Throughput = Sales
Less variable costs (which is raw material and component cost).
• Operating costs - These are other expenditure aside from material and component costs, which are not assumed
to be variable. This includes Labour Costs.
• Inventory - Inventory are investments tied up in the business. These earn nothing until finished goods are sold,
then throughput is a created.

Performance Measurement Ratios in throughput accounting

1. Throughput accounting ratio = Throughput per hour of bottleneck resources/Operating expenses per hour of
bottleneck resources
2. Throughput productivity = Throughput/Operating Expenses x 100

The higher this ratio, the better for the organisation. An objective is to increase this ratio by increasing the throughput or
reducing operating expenses.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

Backflush Accounting
This goes in line with JIT system. As the name implies, costs are calculated after production has been completed. They
are allocated between cost of goods sold and inventory in retrospective manner. Costs are not built up as work
progresses through production process. The aim is to eliminate detailed accounting transactions that is carried out in a
cost accounting system environment. It focuses on the output of the organisation and then work it back in the allocation
of costs rather than tracking the movement of materials through the production process.

Backflush accounting and traditional cost accounting

Under the traditional systems, manufacturing costs are segmentally tracked down through the process. Ie. From raw
materials, to work in process, to finished goods. However, in modern manufacturing world, where most manufacturing
processes are just in time and inventory is smaller, an alternative method which fits in is Backflush accounting.

Environmental Management Accounting

Traditional management accounting technique often ignores environmental related costs in arriving at their decision. In
modern organizations, environmental issues are significant in terms of both strategy and cost because:

• Poor environmental behaviour behaviour can result in significant costs or losses such as fines for excessive
pollution, cost of law suits, environmental taxes.
• Environmental behaviour can affect the perception of customers, and their attitudes to a company and their
products.

Environmental management accounting provides managers with financial and non financial information to support their
environmental decision making.

Chapter 5

Quality and quality costs

Introduction

Success in business depends on satisfying the needs and requirements of customers. An essential part of meeting
customers' needs is to provide the quality that customers require. Quality is therefore an important aspect of product
Design and marketing. Poor quality in production will result in losses due to rejected items and wastage rates, sales
returns by customers and loss of reputation.

An entity should then seek to minimise quality-related costs. In order to do this, quality related costs should be
measured, analyzed and controlled. However, many organisations do not capture this in their management accounting
system.

Quality-related Costs

This are expenses incurred to prevent defects and losses due to internal and external failure of a product or service,
through failure to meet agreed specification.

An organisation must incur costs to deal with quality in the sense that:

➖ Required quality are maintained in production - Cost of conformance

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➖ When poor quality occurs, they are corrected - Cost of non - conformance

Dr Armand Feigenbaum is considered a 'quality guru', he developed the concept of total quality control (TQC) in the
1950s. He has got the following analysis and categorisation.

Formula for Quality Costs

Total Quality Costs = Cost of conformance + Cost of non-conformance

(Cost of control) (Costs of failure)

Where,

Cost of conformance = Prevention Costs + Appraisal Costs

Cost of non-comformance = Internal Failure Costs + External Failure Costs

Costs of conformance

Appraisal Costs

No matter how much money is spent to prevent quality failure, some failures will certainly occur. So, some inspection
checks are needed to test whether quality standards are being maintained, and if possible to identify defective items that
do occur.

Appraisal costs are the cost incurred to detect defective items before being delivered to customers. Quality inspections
are conducted on goods supplied before subjected to production and defective materials are returned back to suppliers.
Also, during production process, quality check are carried out on finished products. Any defective items are either
reworked or scrapped.

In large organisations, where items are bought in large quantities, inspecting 100% of items would be impossible. For
this reason, it is usual for quality inspection to be carried out in sample basis.

Prevention Costs

These are costs of action to prevent quality problem from arising, by preventing or reducing the number of defects. The
following are example of measures that might be taken to reduce quality failures:

✓ Quality planning - by paying closer attention to getting specifications right particularly in product design.
✓ Investing in systems and equipment to achieve the required quality.
✓ Training staff to recognise the importance of quality and getting things right.
✓ Choosing the best suppliers that can deliver quality.

Costs of non-conformance

Internal Failure Costs

These are failures that occur when products are defective because they do not meet specific requirements and are
discovered before being delivered to customers. They would have been detected by customers if delivered like that and
lead to external failure. They are usually found at inspection process and when discovered, they are either reworked to
meet required quality standards or rejected totally and thrown out.

Costs associated with internal failure include:

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• Variable cost of items that are scrapped.

• Incremental cost of reworking them
• Cost of production time lost due to defective products.

External Failure Costs

These are failure costs arising after the product must have been delivered to the customers. They include the costs of:

• Dealing with customers complaints

• Carrying out repair work under a guarantee or warranty.
• Transport costs when recovering faulty items from customers.
• Transport costs of returning them back to customers.
• Legal costs, when a customer takes the organisation to court.
• Cost of reputation lost when customers stop buying from the organisation.

Total Quality Management

TQM is a philosophy of quality management which originated from Japan in the 1950s. According to CIMA, its an
integrated and comprehensive system of planning and controlling all business functions so that products or services are
produced which meet or exceed customer's expectations.

TQM as against traditional view, is of the view that it is impossible to identify or measure all quality costs especially
cost of lost reputation. The aim should therefore be to work towards zero defects and to achieve this, it will be necessary
to spend more money on prevention costs. The TQM approach to quality costs is to get things right in the 1st time.

Chapter 6

Budgetary control systems

Introduction

A budget is a financial or quantitative statement prepared and approved ahead of a defined period of time for the
purpose of attaining certain objectives.

Purpose of Budget

1. A means of Accountability.
2. Its an Economic and Financial Document.
3. Allocation of Available Resources.
4. A Means of Assessing Executive's Performance.

Uses of Budgets to Govt:

1. As a Guide for Present And Future.

2. As Performance Evaluator.
3. As Planning Tool.
4. Motivational Tool.
5. Communication Tool to the Citizens.
6. Cost Reduction Techniques.
7. To Distribute Economic Resources.
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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

The Master Budget

This is the final approved budget, presented in the form of financial statements - a budgeted income statement and
statement of financial position for the end of the financial year. However, the master budget is a result of a large number
of detailed plans, many of them prepared at a departmental or functional level.

Functional budgets

This vary for a particular aspect of the entity's operations. The functional budgets that are prepared vary with the type of
business and industry. In a manufacturing company, they include:

• A sales budget
• A production budget
• Materials Purchase Budget
• Conversion costs budget

Principal Budget Factor

This is the factor that sets a limit to the volume and scale of operations. The most important factor is sales demand or
expected sales volume. That will determine the volume of production.

Stages of Preparing Budget

For a manufacturing company, the process of preparing budget is more complex than other types of organisations:

▪
▪
Stage 1 - Provision and communication of budget guidelines to relevant managers.
Stage 2 - Identify the Principal Budget Factor. Mostly sales volume.
▪
▪
Stage 3 - Prepare the functional budget for the principal budget factor. Ie. Sales budget.
Stage 4 - Prepare other functional budgets, like inventory, production budget, labour usage, material usage and

▪
purchases budget.
Stage 5 - Submit the functional budgets to the budget committee for review and approval.
▪ Stage 6 - Prepare the Master Budget which summarises the plans for the budget period. The master budget might be
presented in form of a budgeted income statement, budgeted statement of financial position, and budgeted

▪
Cashflows statement for the next financial year.
Stage 7 - The master budget and the supporting functional budgets should be submitted to the board of directors for

▪
approval.

▪
Stage 8 - Upon approval, it should be communicated to the managers responsible for their implementation.
Stage 9 - Control Processes start. After the budget has been approved, actual performance should be monitored by
comparing it with the budget, then any significant differences (variances) should be investigated.

Budgeted Systems

✓ Top-down Budgeting vs bottom up budgeting

✓ Periodic Budgeting vs rolling or continuous budgets
✓ Incremental Budgeting vs zero based budgeting
✓ Activity based budgeting
✓ Feed forward control
• Top-down Budgeting - A system where by the targets are set at senior management level, perhaps by the board of
directors or by the budget committee. This will be imposed on the low level divisions who are required to prepare a
budget for their own operations that is consistent with the budget imposed on them from above.

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• Bottom-up budgeting - This is a situation where budgeting starts at the lowest level in the management hierarchy
where budgets are prepared. This may be at departmental level, then submitted to the next level of management in
the hierarchy, say the following divisional level, which will be combined and coordinated into a divisional budget.
Eventually, budgets from each division will be submitted up to the budget committee or the Board of directors.
In a system like this, lower level management are likely to have more inputs to the budget decision making than
that of Top-down system. This is applicable in a largely decentralised organisation.
• Periodic Budgets - This is a budget for a particular period of time, typically the financial year. The budget is not
revised during the year, and fixed for the period. Traditional budgeting systems are periodic systems.
• Rolling budgets - Also called continuous budget because it is continuously updated say every quarter of the year
for a 12 months period. Rolling budgets might be particularly useful for cash budgeting because an organisation
must have sufficient cash to meet its requirements. The main advantage of this is that its continuous review
makes it responsive to changes in the business conditions.

Traditional/Incremental System

Under this Method, Next Year's Figures are derived by adding a percentage to the current year own. Based on Factors
Like Inflation, Trends of Economic Events, Available Funds.

Advantages

1. Simple to Understand.
2. Cheaper to produce.
3. Suits our country's Level of Devt.
4. Past projects can be continued.

Disadvantages

1. Past Errors can be Carried forward.

2. It does not fund new programmes.

Zero-Based Budgeting (ZBB)

A method introduced by Peter Phyrr of Texas, Popularized by the former president of the USA Jimmy Carter in 1976.
Under this technique, resources are not allocated based on previous figures. All Govt expenditures are assumed to kick-
start from the Beginning, From Zero. It is usually Used by the Executive, legislative members, Govt Ministries and
Parastatals.

Advantages of ZBB

1. Allows Optimum Allocation of Resources.

2. Good For Profit Oriented Projects.
3. Measures Performance.
4. Reduces Wastages.
5. Change is Allowed.
6. Important Projects can continue to be funded.

Disadvantages of ZBB

1. Its not Good for Recurrent Expenditure, Therefore, its not being successful in the Public Sector.
2. Sometimes, lack of unreliable Data.
3. Bureaucrats do not Like it.

Activity based budgeting

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This is a planning system under which costs are associated with activities and Budgeted expenditures are then compiled
based on the expected activity level. ABB is an extension of ABC which is an alternative to traditional absorption
costing system. ABC system assumes that overhead costs are caused by activities and the cost of activities are driven by
factors other than production volume. For each activity, there should be a cost driver which is the factor that determines
the cost of activity. In a situation where an organisation uses ABC system, budgets are prepared based on that.

Behavioural aspects of budgeting

The effectiveness of budgeting and budgetary control depends largely on the behaviour and attitudes of managers and
possibly other employees. Budgets provides performance targets for individual managers if they are rewarded for
achieving targets, budget could provide them with an incentive and motivation to perform well. When budgeting creates
motivation in individuals, the human aspect of budgeting is positive and good for the organisation. Unfortunately,
human behavior in the budgeting process often has a negative effect due to the following reasons:

• Misunderstanding and worries about cost cutting

• Opposition to unfair targets set by senior management
• Sub-optimisation
• Budget slack or budget bias

1. Misunderstanding and worries about cost cutting

Budgeting is often considered by managers involved to be an excuse to cut their costs, and because of that, they resent
having to reduce their spending and pose a hostile attitude to the entire budget process. The fear and hostility can exist
even when senior management do not have a cost cutting strategy.

2. Opposition to unfair targets set by senior management

When senior managers use budgeting process to set unfair and unrealistic targets for the year, their subordinates may
unite in opposition to what the senior managers are trying to achieve. Senior managers should communicate and consult
with individuals affected by setting reasonable targets and try to win them.

3. Suboptimization

When their is lack of coordination amongst different managers in the organisation which is not in the best interest of the
organisation as a whole. One may be trying to achieve something that is not in line with the overall goal of the
organization.

4. Budget Slack

This has been identified as the international overestimation of expenses or underestimation of revenue in the budget
process. Managers who prepare budgets may try to overestimate costs so that it will be much easier to keep actual
spending with in the budget limit or underestimate revenue in their budget so that it will be easier for them achieve their
revenue targets As a result budget slack, budget targets are lower than they should be.

Participation in budget setting

Individuals should be allowed to participate meaningfully in the budget setting so that they can be motivated to improve
performance and be more committed to their work.

Advantages of such are:

• Better planning decisions

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• Better communication of goals

• Better understanding of the target setting process
• Stronger motivation to achieve targets

Disadvantages are:

• It might be Difficult for junior managers to understand the overall objectives of the organisation which Budget
is designed to meet.
• Participation may not be effective when individuals lack experience.
• Participation should be real. Because in practice, senior managers might be pretend to be encouraging
participation, but disregard the ideas of their subordinates.
• When not properly managed, participation disrupt optimum decisions.

Factor affecting participation

a) Nature of the task - The Effectiveness of participation depends on the nature of the work, and the extent to
which employees have control over the way it is being done.

b) Organisation Structure - Participation is like to be more effective in a decentralised organisation, where local
managers have more influence over their own budgets.

c) Personality of the employees - Some types of individual are more likely to be motivated than others.

Beyond Budgeting
Beyond Budgeting Round Table (BBRT) is a European-wide research project set up in 1998 investigating whether
entities would benefit from the abolition of budgeting. They claim that several successful European companies have
stopped preparing budgets. Instead, they use a 'responsibility model' for decision making and performance measurement.
The ideas are associated with the writing of Jeremy Hope and Robin Fraser.

Weaknesses in traditional budgeting

Hope and Fraser argued that traditional budgeting system is inefficient and inadequate for the needs of modern
businesses. In a continually changing business environment, traditional budgeting budgeting system find it difficult to
adapt to rapid changing world.

According to Beyond Budgeting Round Table, there are 10 problems with the traditional budgeting control systems:

• Budgets can be time consuming and expensive - In spite of computer technology and the use of budget models,
it still take four to five months in a large company to prepare annual budgets for next year. Budgets has been
observed to take 20% of the time of senior managers and financial controllers.
• Traditional budgeting adds little value to the entity upon using valuable management times that could be used
better in other ways.
• Traditional budgeting tails to consider shareholders value because it focuses on internal matters and not enough
on external business environment.
• Rigidity and inflexibility - Managers concentrate on achieving agreed budget targets, which may not be in the
best interest of organisation as a whole.
• Budgets protect spending but fails to I reduce costs - In real life, managers are expected to spend their entire
budget allowance or else money will be taken away from their budget allowance next year.

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• Traditional budgeting discourages innovation since managers are expected to achieve a fixed target and fixed
budget does not encourage continuous improvement. Managers will be reluctant to exceed their spending limits
even if extra spending is necessary, because this will put their bonus as risk.
• Traditional budgeting focuses on sales targets and not customers satisfaction. Meeting sales target is short term
in nature. If customers are not satisfied, sales will be affected in the long run.

Beyond Budgeting Model

The model is an alternative to traditional budgeting system which is based on dependency model of management and
organisation culture. An alternative to that is 'responsibility model' where decision making and performance
measurement are delegated to line managers. Instead of having fixed, these managers agree performance targets which
are reviewed regularly and amended as necessary in response to changing circumstances and unexpected events.

The idea here is that responsibility should be delegated to operational managers who should be empowered to take
decisions in response to changing circumstances and a good solution to that is continuous rolling forecasting budget.

Principles of Beyond Budgeting Model

• Governance
• Responsibility for performance
• Delegation
• Structure
• Coordination
• Leadership
• Setting goals
• Formulating strategy
• Anticipatory management
• Resource Management
• Measurement and control
• Motivation and rewards

Chapter 7

Variance Analysis
Introduction

A standard costing system is a system of control which enables deviation from budgets to be analysed in detailed in
which cost can be effectively controlled.

Types of standard

1. Ideal standard - A standard that is established on perfect working condition. This type of standard gives no room for
breakdown, spoilage, or idle time. It is not attainable in practice.

2. Attainable standard - This is a standard that is established on a normal operating condition. A standard where
allowances would be provided for losses, inefficiencies, fatigue, etc. It is known as practical standard.

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3. Current Standard - This is a type of standard that is established for use over a short period of time. It is based on the
current working condition of the entity.

4. Basic Standard - This is the type that is used for a long period of time, and used to show trend trends.

Analysis of Variances

Variance is the difference between the standard cost/price and actual cost/price for a given period. A given variance
may be favourable or adverse. Variance is analysed into production costs variances and sales variances.

Production Cost Variances

• Direct Material Cost Variance

i) Material Price Variance = (SP - AP) AQ (Act Qty Purchased)
ii) Material Usage Variance = (SQ – AQ Used) SP

Note: Some questions may give both actual quantity of materials purchased different from actual quantity used.
Material purchases should be used for Price Variance while Material used should be used for usage. In the
reconciliation statement, adjustment should be made for us to have a reconciled actual profit. Material unused
constitute closing stock and should be taken way from the material purchased valued at standard cost.
• Direct Labour cost Variance
i) Labor Rate Variance = (SR - AR) AH
ii) Labor Efficiency Variance = (SH - AH) SR
iii) Idle Time Variance = (AH Paid for - AH Worked For) SR

• Variable Overhead Variances

i) Variable Overhead Expenditure Variance = (SR - AR) AH
ii) Variable Overhead Efficiency Variance = (SH - AH) SR

• Fixed Overhead Variances

i) Fixed Overhead Expenditure Variance = (BH x SR) - (AH x AR)
ii) Fixed Overhead Volume Variance = (SH - BH) SR
That is analysed into 2:
a) Fixed Overhead Efficiency Variance = (SH - AH) SR
b) Fixed Overhead Capacity Variance = (AH - BH) SR

Sales Variances

• Sales Price Variance = (Budgeted Profit - Actual Profit) Actual Qty Sold
In Some Questions, students may be required to make use of Contribution Margin instead of Profit Margin,
depending on the costing method used, whether Absorption or Marginal Costing Method.
• Sales Volume Variance = (Budgeted Sales Qty - Actual Sales Qty) Budgeted Profit or Margin

Note that the in determining whether Favourable or adverse, sales variances results will be the exact opposite of Cost
Variances.

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Reconciliation of Budgeted Profit with Actual Profit

Budgeted Profit (Budgeted Units x Std Profit) Xx

Add/Less

o Sales Price Variance x / (x)

o Sales Volume Variance x / (x) Xx

Standard Profit Xx

Adjustment For Cost Variances

o Material Price Variance x/(x)

o Material Usage Variance x/(x)
o Labor Rate Variance x/(x)
o Labor Efficiency Variance x/(x)
o Voh Efficiency Variance x/(x)
o Voh Expenditure Variance x/(x)
o Foh Expenditure Variance x/(x)
o Foh Efficiency Variance x/(x)
o Foh Capacity Variance x/(x) Xx

Actual Profit Xx

The Actual profit to be derived must be the same with that in the question.

Chapter 8

Advanced Variances
Outline

▪ Material Mix & Yield Variance - An Extension to Material Usage Variance

▪ Sales Mix & Quantity Variance - An Extension to Sales Volume Variance
▪ Planning & Operational Variances
▪ Market Share & Market Size Variances

Material Mix and Yield Variances

This is an advancement of the material usage variance, and it is applicable when there are 2 or more input materials in
production of an item.

a) Material Mix - This measure the effect on costs of changing the combination (mix) of 2 or more inputs in
production process. Variance is calculated when the actual mix of materials is higher than the standard mix.
b) Material Yield - This is the difference between the actual Yield from a given input and standard Yield. It
indicates the effect on costs of material inputs yielding more or less output than expected.

Note that in calculating Material Mix and yield variance, there is a need to determine the revised quantity (revising the
actual quantity using the proportion of the standard quantity). It is also known as standard mix of actual quantity. At
times, the question may give this, or else students may be required to determine this themselves.
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Formula

a) Material Yield = (SQ - RQ) SP

b) Material Mix = (RQ - AQ) SP

Sales Mix & Quantity Variances

This is also applicable when a company sells more than one product, then the volume variance can be splitted into mix
and quantity variance.

a) Sales Mix = (BQ - RQ) SPM

b) Sales Qty = (RQ - AQ) SPM

Planning and Operational Variances

These are advanced variances for Direct Materials and Direct Labour Cost Variances. This arises as a result of the
difference between what was set as standard at the beginning of the year and what the standard turned out to be due to
some occurrences during the year before being compared to the actual result at the end of the year.

This can be analysed below:

Original Standard (Ex Ante) - Revised Standard (Ex Poste) - Actual Standard

Planning Variance Operational Variance

The Major Issue is that the original standards might be out of date due to the time they are prepared. So their may be a
need to revise it to reflect the change.

Features of Planning Variance

• It occurs due to Planning Error

• It arises as a result of changes over time
• It's occurrence is uncontrollable because it could be a general reason affecting the general economy like
inflation, recession, outbreak of disease, minimum wage for labour.

Features of Operational Variance

• It occurs due to operational Factors

• It arises as a result of Management Action
• It is Controllable because it is internal.

So, planning variances can be analysed as thus

1. Material Price Variance can be split into:

a) Planning Price Variance = (SP - RP) AQ

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b) Operational Price Variance = (RP - AP) AQ

2. Material Usage Variance Can be Split into:

a) Planning Usage Variance = (SQ - RQ) SP

b) Operational Usage Variance = (RP - AQ) SP

Same thing can be replicated for Direct Labour Variance

1. Labour Rate Variance

a) Planning Labour Rate Variance =

b) Operational Labour Rate Variance =

2. Labour Efficiency Variance

a) Planning Efficiency Variance =

b) Operational Efficiency Variance =

Benefits of Planning and Operational Variances

Market Size and Market Share Variance

This is a further analysis of the Sales Volume Variance. Some scholars have argued that:

1. Market Size is a Planning Variance because it goes beyond the control of the management. While
2. Market Share Variance is an Operational Variance because it is controllable by the management.

Market Size Variance is the effect on sales volume, if the Actual total size of the market is larger than expected
(Favourable Market Size Variance) or smaller than expected (adverse market size Variance).

Market share Variance is calculated by taking the actual total market size and comparing the expected sales volume, if
the Budgeted market share had been achieved, and actual sales.

Chapter 9

Performance Analysis
Introduction

In practice, business organizations need to measure performance at overall level or segmental level, in order to ascertain
whether they have done well compared to what they expect to do. Performance can be measured both financial and non-
financial.

Financial Performance
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This is concerned with the extent to which the financial objectives of an organisation are being met. This has to do with
measurement in monetary terms.

✓ For businesses - Their main financial objective is to make profit.

✓ For non profit organisations - Their own financial objective is not to make profit, rather to keep spending within
limits.

Non-financial performance

This is a performance that is not measured in monetary terms. Most of them are the contributing factors to overall
financial performance. Examples of non financial performance in business are customer satisfaction, innovation, labour
productivity, output capacity, etc. All these can be measured as well.

Financial Performance indicators (FPIs)

Performance indicator is a tool to measure or evaluate the success of an organisation in relation to a particular activity.
Therefore a financial performance indicator is used to measure a quantitative aspect of an organisation. Financial
performance indicators include:

� Financial Ratios

� Variance Analysis

� Absolute measures of sales, costs and profits.

Ratio Analysis

This is a measure of entity's performance and it is a relationship between two or more items to present financial
information in a more understandable form.

Ways of comparing Ratios

• ➖ Comparison with different company

• ➖ Comparing with previous years (Trend)
• ➖ Comparison with industry average

Categories of financial ratios

1. Probability Ratios

✓ ROCE
✓ ROA
✓ ROE
✓ Gross Profit Margin
✓ Net Profit Margin
✓ Overhead percentage
✓ Net cost plus

2. Short term Liquidity

✓ Current ratio
✓ Quick or acid test ratio
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3. Efficiency Ratios

• Inventory Turnover or Average Inventory Days

• Receivables Turnover or receivables days
• Payable turnover or payable days
• Asset turnover

4. Long term solvency

• Gearing ratio
• Interest Cover

5. Investors ratio

✓ EPS
✓ DPS
✓ P/E Ratio
✓ Dividend Cover
✓ Earnings Yeild
✓ Dividend Yeild
✓ Dividend payout ratio.

Limitation of interpretation techniques

1. Differences in accounting policies

2. Ratios are calculated from historical costs and can be misleading.
3. Differences in calculation of Ratios.
4. Difference in industry of operation.
5. Use of creative accounting

Non-financial performance indicators (NFPIs)

Financial performance alone does not give a complete picture of the performance of an entity. Financial performance is
the result of other factors such as market Share and customer satisfaction. The following areas are where non financial
indicators are identified:

• Human resources
• Customer satisfaction
• Quality

️ Human Resources

A well motivated and trained workforce is vital to an organisation in achieving its objectives. For that, possible NFPIs
include:

1. Labour Turnover
2. Labour Productivity
3. Absenteeism rate
4. Average hours worked.
5. Idle time

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️ Customer Satisfaction

Customers are so important because they ultimately determine the level of profits for an organisation. Their satisfaction
can be measured using the following:

1. Percentage new subscribers

2. Number of complaints
3. Results of customer's satisfaction surveys
4. Speed of complaint resolution

️ Quality

Quality is linked to customer's satisfaction. As treated in earlier chapter, resolving quality issues has a direct cost (e.g.
the cost of replacing an item) and indirect costs (e.g. lost of goodwill leading to future lost sales). Possible quality
measures include:

1. Proportion of returns
2. Proportion of sales
3. Number of successful inspections
4. Proportion of re-worked items during production.

NFPIs for different departments

For different departments in an entity, performance targets can be set, which includes:

� Sales and customer service

• Calls per hour

• Average waiting time
• Proportion of returning customers
• Proportion of satisfied customers

� Online Sales

• Number of visits to website

• Website down time
• Delivery times

� Inventory Control

• Proportion of wastage
• Number of stockouts
• Average Inventory holding

� Sustainability/Environmental measures

• Proportion of recycling
• Annual percentage reduction in CO2 emissions
• Proportion of components sourced from green materials

Performance and sustainability

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Balanced Score Card

A Concept developed by Kaplan & Norton in the 90s, for measuring performance relating to both Financial & Non
financial Objectives, Long & Short Terms Objectives.

The Rationale behind BSC is that there are several perspectives to Performance and targets should be set for each of
them.

They are:

 Customer Perspective
 Internal Perspective
 Innovation & Learning Perspective
 Financial Perspective

Explanation

 Costumer Perspective: This has to do with What Customers Value and their Needs, Satisfaction, Convenience

 Internal Perspective: Internal Perspective deals with Strengths of the Entity and their Resources, Competencies
& Quality.

 Innovation & Learning: This is saying for an organisation to survive in this Present Economy, it must not be
and Capability.

Stagnant. How to maintain that Competitive Position by Developing New Products or new ways of doing

 Financial Perspective: How the Organisation creates value for its Shareholders enhancing their wealth and make
Services.

more Profit.

Performance measurement in service industry

Service industries are increasingly rampant in this Modern Day Economy. Eg. Hotels, Entertainment, Holiday & Travel
Industry, Professional Services, Banking, Recruitment Services, Cleaning Services, etc.

Measuring Performances in the Service Industry differs from that of Manufacturing due to the following Reasons:

Study this acronym - SHIP

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1. Simultaneity: Unlike manufacturing companies, where goods have to be produced before being sold to customers.
In Service industry, providing the service and receiving the service by the Consumer happens at the Same Time. Ie.
Both are Simultaneous in Nature.
2. Heterogeneity: Unlike Production of Products in a Manufacturing Company, where Products are specifically the
Same. In Service Industry, its not the Same. Service Companies attend to Customers in different ways. Eg. If you
Call MTN Customer Care, they will attend to u based on Your Peculiar Problem.
3. Intangibility: Their Products can not be seen, nor Hold. But if valuable, we can notice.
4. Perishability: It's impossible to store a Service For Future Consumption. Unlike manufacturing & retailing
companies, there is no stock of Unused Services. The services must be provided when the Customer Wants it.

Fitzgerald & Moon Building Block Model

Those 2 Guys Propounded a Model to measure Performance in Service Industry. They gave 3 Building Blocks to
measure performance in a Service Industry

▪
▪
Dimensions

▪
Rewards
Standards

Let's Take them one after another

❖ Rewards: How we give back Sth to the person that achieved the Performance Targets. There are 3 Aspects here:

▪ ▶ Motivation: If they achieve performance targets, they may be Paid Bonus.

▪ ▶ Awareness of the Motivation Metric: If Employees knew Bonus exists, they perform well.
▪ ▶ Individuals should only be responsible for aspects of financial performance they can control.

❖ Standard: This has to do with how we Measure the Performance. Setting Standards for measuring performance.
This can be analysed in 3 Aspects:

▪ ▶Whether the Standard is Fair or equitable to all Managers.

▪ ▶ Whether they are Achievable.
▪ ▶ Whether Consumers accept it as their Own.

❖ Dimensions of Performance: There are 6 Elements here, namely:

▪ ▶Profit, Measuring Financial Performance

▪ ▶Competitiveness, measuring Sales or Company's Share.
▪ ▶ Quality of Service, Measured by Customer Satisfaction and Number of Complaints from Customers.
▪ ▶Flexibility: No Rigidity In delivering Work. Since its Based on Customer's Request.
▪ ▶ Innovation: Possibility of new services introduced.
▪ ▶ Resources Utilisation: How well a Company Utilised its Resources.

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The Model

Chapter 10

Other aspects of performance measurement

Measuring performance in non-profit organisations

NFPOs objective is not to make profit, rather it is provision of service to the society of which the service will have to be
provided within the constraint of the resources at disposal. Example of NFPOs are Charity, clubs and societies or
publicly owned organisations.

Value for money

This originated in the public sector organisations as a way of assessing financial performance. In public sectors,
conventional profit based measures are not appropriate because the objectives is not to make profit. The concept of
VFM has now been widely adopted by commercial organisations as a means of assessing performance on a broader
basis than just profit.

The concept simply means an organisation should get good value from the money spent. Example :

1. Economy - Not Spending more than what is necessary to obtain the required resources. This will make the entity to
avoid spending on unnecessary items.
2. Efficiency - Getting high volume of output from the resources used. Efficiency of employees is often referred to
productivity. It can also be achieved by making better use of machines and equipment.
3. Effectiveness - Achieving objectives of the entity with the available resources used. Using resources efficiently has
no value if the resources are not used in a way to achieve objectives. For example, a manufacturing company may
improve efficiency and produce a larger quantity with its available machines. However, if the extra output can not
be sold, the organisation has not achieved its objectives of maximising profit.

In Summary,

• Economy means doing it cheaply - Comparing Money spent with inputs acquired.

• Efficiency means doing it well - Comparing inputs used with outputs achieved.

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• Effectiveness mean doing the right thing - Comparing output achieved with objectives.

Four (4) things; Money inputs outputs and resources.

Problems with VFM in practice

1. Measurement difficulties - It is not always possible to measure efficiency and effectiveness. Even if it is relatively
easy to measure the output of a manufacturing company, it is not so easy to measure that of a service department like
human resources. Some functions in the organisation, their objective is not quantifiable.

2. Over emphasis on cost savings - VFM often focus on ways to reduce costs without considering the impact on quality
of goods or services rendered. If quality not up to standard, customers may stop buying.

3. Calculating VFM measures - There are no regulations about the measurement of the 3Es in VFM. This makes it
difficult to undertake meaningful performance comparisons between organisations and possibly between units of
organisations.

Chapter 11

Transfer Pricing
Introduction

In a group of companies, one company may supply goods and services to another. Or in large company, which has
divisionalised structure, one division might sell to another in the same company. This will form a cost for the buying
division and a profit for the selling division. For Accounting purposes, these internal transfers of goods or services are
given a value. Transfers could be recorded at cost and not at usual external selling price.

Transfer Price

This is the price at which goods or services are sold by one division within a company to another division in the same
company. The overall profit of the group or the company is not affected.

Methods of Transfer Price

•
•
Marginal cost

•
Full Cost

•
Cost plus
Market Price

Objective of transfer pricing

Transfer prices are set to make it possible for divisionalisation to operate successfully within a company, and:

• Give autonomy to divisional managers to make decisions.

• Enable the company to measure the performance of each division in a fair manner.

Factors that should be considered when setting the transfer pricing policy are:

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• The policy should lead to transfer prices that are fair to both the internal supplier and the internal customer and
should provide them both with an incentive to carry out the internal transaction where it is worthwhile from the
Group’s viewpoint to do so.
• The policy should reflect the capacity constraints and market demand for the item being transferred. Therefore,
the transfer price should take account of the supplier’s opportunity cost.
• The policy should provide autonomy to both the internal supplier and the internal customer to make their own
decisions concerning internal transactions.
• There must be divisional structure.
• Each division must be a profit or investment centre.
• One of the divisions must be willing to transact business with the others.
• The transfer pricing policy must be tax efficient by reducing the overall tax burden of the company.

The bulk of what of what Transfer Pricing entails is Practicals and enough questions could be practiced in the past
questions.
Chapter 12

Divisional Performance
Introduction
In a large organisation, the degree of authority delegated by top management to lower level operating managers can be
viewed as a continuum. There are 2 possible practices:

1. Centralisation - Where all decisions are made from the head office and no power is delegated to division heads or
branch managers.

2. Decentralisation - A Situation where responsibilities are delegated to divisional managers or unit heads. Each
operating unit has its own management team which reports to the head office. Divisions in this regard, refers to either a
geographical area or a product line.

Advantages of a decentralised setting

✓ It increases motivation of the divisional managers.

✓ It reduces time of decision making
✓ It allows better decision since they have local knowledge.
✓ It's a form a training to them should they rise up to strategic position.

Disadvantages of decentralised setting

• Lack of goal congruence (ie. where divisional managers work towards achieving their own goal rather than
overall goal of the head office.
• There is sub optimality in the system.
• Management may lose control
• Lack of economies of scale

Responsibility Centers

In a decentralised organisation, performance of each managers can be categorised into 4:

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• Cost Centres - This is a department or a unit for which costs are established. Organisations only spend on the
department. In a cost center, managers only has control over controllable cost and performance is measured
using Variance analysis, because they are responsible for keeping cost under control.
• Revenue Centres - This is a unit within an organisation for which revenue is established. No measurement of
cost or profit here. Managers are only accountable for revenue streams coming in through that unit or division.
• Profit Centres - This is a Department or division within an organisation where both cost and revenue are
established. Profit is then determined by deducting costs generated from that division from its own costs. Here,
managers have control over oontrollable costs and sales prices, and performance is measured by their profit.
• Investment Centres - This is a department where managers is not only responsible for costs and revenues from
the division only, but also responsible for decision relating to investments in assets of that division. A manager
here usually has authority to Purchase new assets, like plant and equipment, furnitures and fittings, etc. So, at
the end of each year, his performance is not only measured by profit, but profit in relation to the investment
employed. His performance is measured by Return on investment, residual income, and other Ratios.

Evaluation of divisional performance

In order to carry out proper evaluation of performance in an organization, we need to understand within an organisation,
profits that are controllable and traceable to a particular division.

✓ There are costs controllable by the divisional manager

✓ There are also costs traceable to his division, and
✓ There are costs not traceable to or controlled by him. Example is share of overhead costs allocated from head office.

Tools/Methods for assessing divisional performance

•
•
Return on Investment or ROCE

•
Residual Income
Economic Value Added

Return on Investment (ROI)

This is calculated for an investment center to ascertain whether it has succeeded in achieving a target ROI for the
financial year, or whethet ROI has improved between one year and another. Some organisations do give bonus to
divisional managers on the basis of ROI achieved by its division. This may push them towards improving the ROI of
their division and to avoid anything that will reduce it. Then, this becomes a serious problem especially when
investment decision is involved. The problem is that investment decisions are meant for longer term, and a new
investment that reduces ROI in the 1st year may increase it in subsequent year. Whereas, an investment center may
therefore reject an investment because of its short term effect on ROI, without giving proper consideration to the longer
term.

Formula for ROI = EBIT/CE x 100

Advantages of ROI

1. It relates the profit of the division to the capital employed, and the divisional manager is responsible for both profit
and capitalemployed;
2. ROI is a percentage measure and can be used to compare the performance of divisions of different sizes;
3. ROI as a measure of financial performance is easy to understand;
4. It focuses attention on capital as well as profit, and encourages managers to sell off unused assets and avoid
excessive working capital (inventory and receivables);
5. ROI ensures goal congruence between different divisions and the firm; and
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6. It measures profitability better than other measures of investment.

Disadvantages of ROI

There are also disadvantages in using ROI as a measure of the performance of an investment centre. These includes:

• Investment decisions might be affected by the effect they would have on the division‟s ROI in the short term, and

•
this is inappropriate for making investment decisions;
There are different ways of measuring capital employed. ROI might be based on the net book value (carrying value)
of the division at the beginning of the year, or at the end of the year, or the average for the year. Comparison of

•
performance between different organisations is therefore difficult;
When assets are depreciated, ROI will increase each year provided that annual profits are constant. The division‟s
manager might not want to get rid of ageing assets, because ROI will fall if new (replacement) assets are purchased;

•
and
ROI is an accounting measure of performance. An alternative system of performance measurement that includes
non-financial performance indicators, such as a balanced scorecard approach, might be more appropriate.

Residual Income

An an alternative to using a percentage form of measurement, residual income measures the performance of an
investment centre in absolute value. As the name implies, this is the profit remaining for an investment centre after
deducting interest paid on investment of such division.

Residual Income is calculated as

•
•
Controllable Profit xx

•
Less notional interest on average controllable investment xx
Residual income

Advantages of Residual Income

There are several advantages in using residual income as a measure of the performance of an investment centre. These
include:

• It relates the profit of the division to the capital employed, by charging an amount of notional interest on capital

• Residual income is a flexible measure of performance, because a different cost of capital can be applied to
employed, and the division manager is responsible for both profit and capital employed;

• Residual income concept takes a long term view of divisional performance; and
investments with different risk characteristics;

• Residual income performance measures are reconcilable to planning decisions using techniques such as NPV and
IRR.
Disadvantages of residual income

There are also disadvantages in using residual income as a measure of the performance of an investment centre. These
are:

• Residual income is an accounting-based measure, and suffers from the same problem as ROI in defining capital

•
employed and profit;
Its main weakness is that it is difficult to compare the performance of different divisions using residual income.

•
Larger divisions should earn a bigger residual income than smaller divisions; and
Residual income is not easily understood by management, especially managers with little accounting knowledge.

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Economic Value Added

This is method devised by stern stewart (a management consultancy firm) in measuring economic profit. The method is
a trademark to the firm. It is argued that using residual income (accounting profit) to measure performance of a division
is not appropriate enough. Economic profit is better because it reveals the value of the business during the year. One of
the important reason for criticizing accounting profit is because account profit is determined using accounting concepts
an conventions so can not represent the real economic value of an organization.
Peter Drucker opined that “until a business returns a profit that is greater than its cost of capital, it operates at a loss”.
Therefore, experts have challenged accounting profit as a good measure of increase in the value of a business and have
proposed a measure of real economic profit. In their view, this will lead to better measurement of the increase in value
of a business during a given period of time. O
Benefits of EVA over RI

1. It measures creation of value by a company.

2. It focuses on longterm profitability
3. It is simple to apply and operational managers can understand
4. Reward based on EVA aligns with interests of the management or shareholders rather than bonus system based
on accounting profit.
5. Can be used in investment appraisal.
6. Can be used in goodwill and share valuation.

Formula for EVA

NOPAT – (Capital employed x WACC)

Chapter 13

Relevant Costs
Introduction

Section C is The Largest Section in the Syllabus and this Particular Topic is Very Important as far as The Syllabus is
concerned as a Whole. Because any topic treated afterwards, still draws Back to your Sound Understanding of this
Particular Topic. Also, ICAN Says Question 1, 40 Marks will usually be tested from the Core Areas of the Syllabus,
and this Section C tends to be the Area, considering the Weight of Percentage it carries, and the length of Chapters in it.
From Chapter 13 - Chapter 27.

What is a Relevant Cost?

A Relevant Cost is used to assess The Consequences of any Mgt Decision. Management Make Decisions about The
Future and not the Past or Present. Therefore, You as A Management Accountant, needs to provide them with A
Quantitative Or Computational Analysis of Only those Costs that are Relevant, any time a Decision is to be Made. In a
Nutshell, a relevant cost is a Future Cashflows.

In A Decision Making Technique, For you to determine whether a cost is Relevant or not, U Must Consider the
following:

A Relevant Cost should be:

•
•
Cash Based: ie. Not dealing with Non-cash items, like Depreciation.

•
Futuristic Cost: Not Past/Sunk Cost.
Incremental/Differential Costs: As addition to the usual Costs.
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•
•
Variable/Direct in Nature.

•
Specific Fixed Cost. Not General.
Opportunity Costs.

Irrelevant Costs are:

•
•
Non Cash Costs like Depreciation, Internal Job Done which The Company did not pay Cash, Use of Spare time.

•
Past or Sunk Cost

•
General /Apportioned Fixed Costs.
Committed Cost: Costs which Makes no difference Whether Something is done or not. You will Definitely Pay
it, because u have entered into an Agreement to Pay It.

Terminologies in Relevant Costing

a) Incremental Costs: Those Additional Costs arising as a result of Taking A Decision. Ie. What led to them is the fact
that a Decision is made. If not, they will not come to Exist. This is usually Useful Under Further Processing
Decision.
b) Avoidable Costs: They can be avoided if a Particular Decision is not Made. While Unavoidable, whether u make the
Decision, or not, U still incur them. Eg. Variable Cost. This is usually common in Shut Down Decision.
c) Committed Costs: Costs already agreed upon by the Organisation. Whether U enter into a new decision or not, U
Will Pay it.
d) Sunk Costs: They are Past Costs, and has nothing to do with the Future.
e) Opportunity Costs: Benefit Lost by Chosing an alternative course of Action.

Uses of Relevant Costing Techniques

1) To Calculate Minimum Price to charge for A Product.

2) Accept or Reject Situation (Chapter 18)
3) Make or Buy Decision (Chapter 18)
4) Continue or Discontinue(Shutdown) Situation (Chapter 18)
5) Further Processing Decision. (Chapter 18)
6) Capital Budgeting Decision (Chapter 25 - 27).

Can you see the Important of this Particular Topic to all the other Topics in this Section. Very Very Important.

Each of all those terminologies has Separate Examples in The Pack.

You Can Study Them on your Own. Because we still have Enough things to Look At.

Identification of Relevant Costs

This is one of the most Important Aspects of Relevant Costing. In a Big Scenario Question, How do we Identify the
Relevant Costs of:

• ✔ Material
• ✔ Labour, and
• ✔ Overhead.

Relevant Cost of Material

1. If non of the Materials is currently held in Stock, then Relevant Cost of Material is the Purchase Cost.

2. If the Required Materials are Currently held as Stock, the Following Rules Apply:

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➖ If The Material is in Regular Use, then Replacement Cost is Relevant.

➖ If not in Regular Use, then Opportunity Cost is the Relevant Cost.

Note: Opportunity Cost Higher of :

•
•
Net Disposal Value, or
Net Benefit from Alternative Use.

Relevant Cost Of Labour

1. If Labour is Temporary, Relevant Cost is Hourly Rate.

2. If Labour is Permanent, then, the Following Rules Apply:

➖ Not Fully Utilised, Relevant Cost is Zero Value.

➖ Fully Utilised, but:
There is Overtime, Relevant Cost is Overtime Rate.
No Overtime, Relevant Cost is Opportunity Cost.

Relevant Cost of Overhead

Only Variable Costs are relevant. Fixed Cost is not Relevant, except Specific or Incremental.

Chapter 14

Cost-Volume-Profit (CVP)Analysis
Introduction

This Stands for the relationship between costs and profits and how they change with changes in the volume of activities.
CVP analysis is an application of marginal costing concepts. This topic is very important as any principle learnt here
will be applicable throughout the course.

Assumptions of CVP Analysis

1) Costs are either fixed or variable.

2) Variable cost per unit is the same at all level of activity (output/sales).
3) Total fixed costs are normally assumed constant at all levels of output.
4) Contribution per unit is constant for each unit sold.
5) The selling price is constant for every unit sold.

Contribution

This is measured as sales revenue less variable costs. While profit is measured as contribution less fixed cost.
Contribution per unit is sales price minus variable cost per unit.

Contribution to sales ratio

•
•
Contribution per unit/Selling Price per unit
Or Total Contribution/Total Sales

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Break-even Point

This is the volume of sales required in a period to break even. Ie. to me neither profit not loss. At break even point,
profit is zero. What it then indicates is that such volume of sales must be sufficient enough to earn a total contribution
that covers the fixed cost alone without making profit.

Calculating BEP

➖ BEP as a number of units to be sold

= Total fixed cost/Contribution per unit.

➖ BEP expressed in Sales Revenue Value

= Total Fixed Costs/Contribution to sales ratio

Margin of Safety
This is the difference between the budgeted sales (in unit or in Naira) and the BEP Sales (in units or in Naira). It is
usually measured as a percentage of the budgeted sales, but can also be in units or in volume. It is called margin of
safety because it is the maximum amount by which actual sales can be less lower than budgeted sales without incurring
a loss. A high margin of safety indicates a low risk of making loss.

Formula

Margin of Safety = Budgeted sales - BEP Sales

Margin of safety ratio = Budgeted Sales - BEP Sales/Budgeted Sales

Target Profit
Management might decide to ascertain what volume to sell in order to make a target profit. What it then indicates is that
such volume of sales must be sufficient enough to earn a total contribution that covers the fixed costs and then makes a
target amount of profit.

Units sales to ascertain target profit = Total Fixed Cost + Target profit/Contr. Per unit

Sales revenue to ascertain target profit = Total FC + Target Profit/Contr to Sales ratio.

Break Even Chart

Another method to do breakeven analysis is by plotting it on a graph. The graph will show all volumes of output and
sales.

Multiproduct CVP Analysis

All the analysis up there, we have assumed that the company is only making and selling single product. The technique
can be extended to a Multiproduct situation. In order to tackle this, we need to make further assumptions which might
seem unrealistic. Assumption that products are sold in a set ratio which does not change with volume.

This allows us to tackle similar problems in two ways: We either use

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• Weighted Average Contribution per unit and weighted average C/so ratio per unit.
• Contribution per batch and weighted average C/S ratio for the batch (assuming that goods are sold in the
budgeted sales mix).

Questions under Multiproduct CVP analysis can be so technical and confusing. Students should practice questions in the
Pack and past questions.

Importance of CVP Analysis

▪ It provides a valuable insight into the relationship between costs, revenue and profits.
▪ It allows managers to understand profit impact on decisions under consideration.
▪ CVP analysis can provide important information about sales strategies, cost control, and decision making.
▪ It allows managers to understand the minimum number of items needed to be sold in order to generate a target
profit. This can be very useful when launching new product.

Weaknesses of CVP analysis

This rests on the series of underlying assumptions which may not hold true in reality.

Chapter 15

Limiting Factor
Introduction

In practice, there could be a shortage of key production resources such as items of direct materials, labor or machine
capacity. In these circumstances, those factors setting a limit to the volume of products to be produced or sales and
profits in a particular period are called limiting factors or constraints or bottle neck (Through put Accounting). The
difference between this topic and throughput accounting is that this uses marginal accounting and contribution
technique, while TA uses through put by not considering labour cost as variable cost.

Identifying the limiting Factor

In examination questions, the examiner might not be explicit with that particular factor that is limited in an organisation.
Students must identify it by calculating the resources needed to meet particular production or sales then compare it with
the available ones. In most cases, it used to be machine or labour hours, but it could be any other as well.

In this chapter, techniques to tackle a single limiting factor is looked into. In a situation where there are more than one
limiting factors, we make use of Linear Programming technique.

Steps to calculate optimum profit

1) Calculate the contribution per unit
2) Identify the scarce resource
3) Determine the contribution per unit by dividing the contribution per unit with the limiting factor.
4) Rank the products using the results in 3 above
5) Prepare a production plan by allocating outputs or sales based on ranking, until it reaches the scarce resource where
the remaining will be allocated to it.

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Chapter 16

Linear Programming
Introduction

This is useful when there are 2 or more limiting factors or constraints. Ranking based on contribution per limiting factor
could not be used. To decide the mix of products to make or sold in order to maximise profits, a linear programing
problem has to be formulated.

Linear programming is a mathematical method for determining a way to achieve the best outcome (such as maximum
profit or lowest cost) subject to a number of limiting factors or constraints.

What constitutes the best outcome depends on the objective (whether to minimise cost or maximise profit). The
equation constructed to represent the best outcome is known as the objective function.

Overall approach (For 2 Products Situation)

• Formulate the problem

a) Define the variables

b) Formulate the objective function
c) Formulate the constraints

• Solve the problem (Graphical Method)

a) Plot the constraints on graph

b) Identify the feasible region
c) Identify the values of the 2 products that lead to optimum value of the objective function.

Simultaneous Equation

Instead of reading the optimum values on the graph, this can be determined using simultaneous equation. The exact
values of x and y will be determined.

Usefulness of Linear Programming Model

i. It is used to solve limiting factor decision when there are at least two limiting factors;
ii.It can be used to calculate “shadow price” of a limiting factor;
iii.
It can be used to determine additional unit of the limiting factor which can give extra contribution;
iv.It helps management to identify slack that might be used by management to identity the amount of constraint
that is not used in the optimal solution; and
v. It is used in solving operational problems.
Limitations of Linear Programming Model*

i. It cannot be used to solve limiting factor situation when there is a single limiting factor;
ii. Uncertainty is not taken care of;
iii. Parameters are assumed to be consistent;
iv. It is only useful when solving allocation problems involving more than one limiting factor;
v. For non-financial Managers, it could be complex;
vi. It assumes complete linearity. In practice however, the liner relationship may not hold because of quantity
discount of raw material, the presence of learning curve, etc.
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vii. It assumes divisibility of products. In practice, fractions of products cannot be produced and sold.
viii. It assumes profit maximization. In practice, organizations may have other objectives

Chapter 17

Further Aspects of Linear Programming

Dual Prices

In a linear programming function, every constraint has a dual price which is also known as shadow price. This is the
change in the objective function that is brought about if a constraint is changed by a unit.

Dual prices of limiting resources always have a value. This may be positive or negative depending on whether it is
calculated by reducing or increasing availability of a resource and whether a problem is maximising or minimising.

Steps to calculate Dual Prices

1. Increase the limit of the 1st constraint by 1

2. Recalculate values for the Variables.
3. Recalculate the value of the objective function then compare the new figure to the value of the objective function in
the original solution.

The difference is the dual price of the constraint. The same process is then repeated for the other constraint.

Simplex Method

As against using the graphical method, which is flawed with its limitation to 2 products only. Simplex method can be
used for more than 2 products and more than one constraint. It requires introduction of slack variables and formulation
of tableau until the optimum values are determined.

Chapter 18

Other Decisions
Introduction
In chapter 13, we were able to Launch one of the Important Concept in Performance Management; Relevant Costing.
We Learnt the Principles in Chapter 13. Today, we are moving to Chapter 18, Where we will learn the Application of
those Principles learnt earlier. Decisions that are based on Relevant Costing Techniques.

To start with, Relevant Costing is Useful for both:

✔ Short Term Decisions: Decisions that Result into Immediate increase in Cashflows or Profit.

✔ Longterm Decisions: Capital Investment Decisions, that takes several years before you recover your Outlay.

Example of Management Decisions where Relevant Costing is used are:

•
•
One off contract Decisions

•
Make or Buy Decisions
Shut down Decision

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• Joint Product Or Further Processing Decision.

Make or Buy Decision

This is a decision whether to:

✔ Make An Item Internally or to buy it from External Supplier.

Or
✔ Do Some Works With Internal Resources, or to Outsource it to another Contractor.

In A Situation Like this, both Financial & Non-Financial Factors need to be Considered.

• Financial Consideration is based on which Alternative Produces the Highest Profits, lowest Cost.
• While,
• Non Financial Considerations, in the Case of Outsourcing Include:
� Loss of Control over the Work Outsourced.
� It Can Cause some employees to be redundant.
� Sensitive Information may be lost to Competitors.

Scarcity of Resources: This is a Scenario that use to arise before a Company will decide to Outsource his Operations, or
some part of its Operations instead of doing it inwardly. When the Company is already in Full Capacity, and they can
only carry out some parts of the Company's Activities and Let Out Others.

Chapter 19

Pricing Decision
Introduction

The selling price of a company charges on its product and services is very important because it affects the volume of
sales demand and profit margin per unit. Though the ability of companies to decide what price to charge differs from
one to another. It is determined according to the size of the company and the market it operates in.

On that note, there are:

• Price Makers - These are companies that dominate the market they operate in. They can charge lower prices to
maintain the market.
• Price Takers - These are companies who do not dominate the market and have to take the prices determined by
other entities. They are able to charge lower prices in order not to run at loss, at the same time afraid of charging
higher prices so that customers will not switch to rival.

Factors affecting pricing decision

• Quality of product
• Product mix
• Income of the customers
• Cost incurred on product
• Price and demand relationship
• Price of substitute goods
• Price of complementary goods
• Inflation
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• Product life cycle

• Consumer taste and fashion
• Advert and marketing

Pricing Strategies

➖ For New Market - Monopoly Position

1. Market skimming pricing - When an entity introduces a new product to the market, they charge high prices and sell
small units to a small part of the market in the early period in order to generate maximum return per unit. It might be
based on the attitude of the buyers who might decide to gain prestige from buying new product at first. But as time goes
on, the price gradually reduces slowly because competitors will set into the market with their new product. This pricing
strategy is normally effective for new “high technology” products such as flat screen television sets, laptops, etc.

However, it is usually a shortterm pricing strategy that cannot usually be sustained for a long period of time. It can also
be used with a differentiated product of high quality, e.g. cars.

Features

▪ Low volume, high prices

▪ For short term strategy
▪ There is a barrier to enter the market in form of brand, patent and technology iinnovation.

2. Market Penetration Pricing - It is an alternative pricing strategy to market skimming pricing strategy when a new
product is introduced to the market. Under market penetration pricing strategy, the aim is to introduce the product into
the market with a low selling price in order to create a high sales demand as quickly as possible. This can help the
company to capture the market before competitors can introduce rival products.

This pricing strategy can be used when a company is using a cost leadership strategy, because low price will help a
company to obtain a large market share which can further lead to economies of scales and lower costs.

Features

• Low price, mass sales

• Substantial initial investment
• High risk since it might be at competitors advantage

Forms of Pricing

1. Cost-based Pricing
2. Demand-based pricing
3. Market-based Pricing

Cost Based (Cost-Plus) Approach

▪ Full Cost Plus Pricing

This involves calculating the full cost of a product and adding a profit margin toarrive at a selling price. Profit is
expressed as either:

- a percentage of the full cost (a profit mark-up) or;

- a percentage of the sales price ( a profit margin)
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It is useful when operating on historical basis; for planning purposes, appraisal of divisional performance and stabilising
product prices.

▪ Marginal Cost Plus Pricing

Under this pricing strategy, the marginal cost of the product is calculated and a mark up or profit margin is added to the
marginal cost to arrive at the selling price. This is useful in preparing marginal costing statements.

Advantages of cost based pricing

1. It is easy to apply
2. Cost is covered and there will be a profit.
3. It's used for profit making.

Disadvantages of cost based pricing

1. Its purely internal and requires judgemental figures

2. It ignores market condition
3. Choice of margin or markup is arbitrary

The difference between marginal cost and full cost pricing is that Fixed overhead is added to the total costs before apply
profit percentage.

Demand-based Pricing

This is a research based pricing determined by looking at the economic forces of demand and supply like:

✓ Competition
✓ Nature of product
✓ Location

One of the major advantages of this approach is that, not only does it generates prpfit rather it maximises it.

Demand Curve Equation

P = a - bq

Where a = Price, b = Change in price/Change in quantity

Steps in maximising profit

1. Calculate demand equation (a, b). P = a - bq

2. Derive the marginal equation MR = MC, in order to derive Q.
Where MR is a - 2bq
3. Substitute the q (Units) you got in step 2 above into the demand equation to get P.
That's the Optimal Price, which will produce the maximum profit for the organisation.

Return on investment (ROI) Pricing

This method of pricing strategy is used in a decentralised environment where an investment centre within a company is
required to meet a target return on capital employed. Prices are set to achieve a target percentage return on the capital
invested. This is needed in divisional performance appraisal.

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Formula to derive this pricing method is

Budgeted total cost of division + Target ROI% on Capital Employed / Budgeted Volume x 100

Chapter 20

Risk and decision making

Introduction

In the real world, a lot of business decisions involves some risks or uncertainty. The decision maker might base his
decision on what he thinks will happen, but there is some possibility that the actual outcome will be different possibly
better or worse than expected.

✓ Risk - This occurs when the future outcome from a decision could be any of several possibilities.
✓ Uncertainty - This occurs when there is insufficient information about what will happen in the future. It is
therefore likely that future figures are not accurate because they are estimates.

Risk Preference

This terminology describes the attitudes of a decision maker towards risk. Decision makers might be seen as:

• Risk Averse - This person, in making a decision, tries not to select a course of action that is more risky unless
the expected return is higher enough to justify the extra risk.
• Risk Neutral - This one ignores risk entirely in making decision by selecting the course of action with the
highest expected return regardless of risk.
• Risk takers / Risk Seeker - This one takes extra risks in the hope of earning a higher return.

Methods of Risk

1. Expected Values
2. Decision Tree
3. Value of perfect & Imperfect information
4. Simulation
5. Sensitivity Analysis
6. 3 Model Assessment - Maximax, Maximin, and Minimax Regret

Expected Value

This is weighted average value calculated using probability estimates of possible outcomes.

Sensitivity Analysis (What if)

The purpose of this is to assess how NPV of a project will be affected if cash flows estimates are worse than expected.
That means to establish a sensitivity margin, we first need to calculate NPV, then start changing the variables. The
Variables are:

• ️ Selling Price - Revenue

• ️ Sales Volumes - Contribution
• ️ Variable Cost
• ️ Fixed Cost
• ️ Discount Factor or Cost of Capital

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• ️ Initial Investment

❖ ️ Year of the Project

Calculation of Sensitivity Margin (SM)

•
•
S.M to Cashflows = Npv/PV of the Cashflows

•
S.M to Number of Years = Discounted PBP
S.M to Discounting Factor = IRR

Interpretation

Depending on whether it is cost or revenue. At what percentage will the variable rise or fall before NPV becomes Zero.
It can be calculated on percentage or absolute value.

Chapter 21

Working Capital Management

Introduction

Working Capital is an Integral part of Investment Decision Making which an Entity needs to run its Day - to - Day
Operations. It is simply represented with (Current Assets - Current Liabilities).

This is a Bundle of Topic on its own which is broken down into several packages like:

•
•
Cash Operating Cycle

•
Overtrading

•
Funding Principles

•
Receivables & Payables Mgt.

•
Inventory Management
Cash Management.

What Constitutes Working Capital itself?

• Current Assets: Inventory +Receivables + Cash/Cash Equivalent + Prepayments.

•
Minus
Current Liabilities: Payables + Overdraft

The Need for W. C Management

In order for an entity to run a Business Successfully, the following must be Managed Properly:

� Invest in Inventory to avoid Stock out.

� Sell Goods/Services to Customers on Credit.
� Obtain Credit Sales from Suppliers.
� Manage Cash and Short Term Investment to avoid Liquidity Problem.
� Obtain Overdraft from Bank.

Although, an entity should maintain a Balance concerning Working Capital. Ie.

 They should Avoid Excess of it because it reduces Profit.

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 Avoid Shortage of it at the Same time because it causes Liquidity Issue.

Factors Determining the Level of W.C an entity should Hold

The Question now is how can an Organisation determine the Quantity or Amount of Working Capital they should?

The Following Factors Influence that:

•
•
Type of the Industry: In Practice, manufacturing setups hold more inventories than Retailers.

•
Length of W. C Cycle: Big Coys Have More Longer Days than another...
Level of Activities: Big Companies have more Inventories, more Debtors, more creditors dealing with than Small

• Management Attitude to Risk: It depends on whether the Mgt of the Coy are Risk Seekers or Risk Averse.
Ones.

Funding of Working Capital

1. Aggressive Funding Policy/Short Term Funding:

2. Conservative Funding Policy/Long Term Funding.

What we are Saying is that what Kind of Finance should we use to Buy Inventories?

Before we will be able to answer that Question, we need to highlight the Classes of Working Capital we have:

Classes of Working Capital

1. Permanent Working Capital: This is the minimum level of Working Capital Which is Required that the Company
should old all the Time. Ie. Minimum Level of Inventories, Minimum Level of Receivables, Minimum they can Buy
from Payables (Trade Creditors).

This can be Funded using Long-term Funding.

2. Fluctuating Working Capital: They are those that may be required for a particular period of time. Eg. For Seasonal
Period, some manufacturing companies may want to sell in Bulk to Customers to take advantage of that period. In such
a situation, they need a short term Funding because its for temporary Reason.

Note:

• Short Terms means is to Use Payables and Overdraft to buy a bulk of Inventory and Sell to Customers.

While

• Long Term is to make use of Equity and Long Term Debt.

Note: Each has advantages and Disadvantages. In a Nutshell, a question might just come that. What is the Best Way a
company can fund its Working Capital? It's a Subjective Question The Answer depends on what Class of Working
Capital The Management want to Invest in.

Cash Operating Cycle

This is also known as Working Capital Cycle and its the Average length of time it takes a Company to Buy
Goods/Services from Supplier, Converting those Goods to Finish Goods, then selling it to Customers, then receiving
Payments from them to settle Suppliers.

It's a Cycle. Ie.

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Performance Management By: Yusuff Kabiru Aremu ACA, 08169069670 @ Apex Professional Associates

From

SUPPLIERS (Raw Materials) ➡ WIP ➡ FINISHED GOODS ➡ CUSTOMERS ➡ CASH ➡SUPPLIERS.

In Simple Terms, the length of Days that it takes us to convert our Goods/Services to Cash. It is usually Measured by
Number of Days/ Week/Month... Depending on What you Multiply with.

And the Interpretation is that the Longer the Cash Operating Cycle, the more the investment in W. C. But, the shorter
the better.

The Formula is Simply:

Receivables Days + Inventory Days - Payable Days = Cash Operating Cycle.

If you are Familiar with Your Ratio Analysis Very Well, this should not be difficult at all.....

Pls. Kindly go to Chapter 21 of your Pack and Solve that Simple Question on Cash Operating Cycle...

Computation of Working Capital Cycle

It's By Dividing Balance Sheet Figure with Profit/loss Figure.

Ie.

✔ Receivables Days = (Average Receivables/Credit Sales) x 365Days.

(If no Credit Sales Specified, Assume all sales are on Credit)

✔ Payable Days = (Av. Payables/Cos) x 365

Or (Av. Payables/Purchases) x 365.

✔ Inventory Days: We have 3 Kinds of Inventory. Raw Materials, Work in Progress and Finished Goods.
➖ RM Days = RM/Purchases) x 365
➖ WIP Days = WIP/Cos) x 365
➖FG Days = FG/COS)x 365

Example:

Pls. Kindly go to Chapter 21 of your Pack and Solve that Simple Question on Cash Operating Cycle.

Page 671 of the Pack

Overtrading (Undercapitalization)

This means carrying on an Excessive Volume of trading in relation to the Amount of Long term Capital Invested in the
Business. Ie. When a Business is doing beyond its Capacity, growing beyond what it can control, we said the business is
Overtrading.

Symptoms of Overtrading.

How do you detect an organisation Is Overtrading?

The Following Symptoms Help���

1. High Growth Rate.

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2. Large increase in Inventory & Trade Receivables.

3. Inability to Pay Creditors as they fall due.
4. Large increase in Bad Overdraft.
5. Low Profitability as a result of high Administrative Expenses.
6. Lack of Permanent Funding.

We can then deduce that too much of Short term Funding is Tantamount to Overtrading.

Measures of Overtrading

If You hold a Financial Statement of a particular Company, how do you detect whether they are Overtrading or not? As
a Professional Accountant, these are the things you check:

•
•
Liquidity Ratios; Current & Quick.

•
Check the Change in Cash Balance (Previous Vs. Current)

•
Check Overdraft.

•
Check Payable Days.

•
Check Sales Revenue.
Permanent Funding. (Share Capital + Debt).

Consequences of Overtrading.

1. Eventual Insolvency, the business can die at anytime.

2. Suppliers will refuse to sell on Credit.
3. Bank will refuse to allow more Overdraft.

Remedial Action

1. Increase Longterm Capital (Share + Long term Debt)

2. Reduce Operating Cost to increase Profit.

Practical Exercise, Page 681.

There is A Question on Overtrading that is in the Pack and the Solution is just after it.

Chapter 22

Management of Trade Receivables and Payables

Introduction

Trade Receivables are otherwise known are Debtors. Every successful company cannot do away without selling on
credit. All they just need to do is to manage it.

Benefits of Giving Credit.

� To sell at high Volume.

� To Retain Customers.

Cost of Giving Credit

Because there are benefits, the following costs are attached:

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1. Finance Costs: Trade Receivables are finance with Long-term Capital. So, it attracts Cost of Capital.
2. Bad Debts: The More you sell to your Customers on Credit, the more the risk of Bad Debt.
3. Administrative Expenses: Some Debtors can be stupid, so you will need to chase them before they pay.

This will cost you some Admin expenses like Transport, Phone Calls, or at the extreme, litigation.
A Company should be able to match the Cost Against the Benefits. (Cost/Benefits Analysis)

Giving Credit to Customers

Before any company will decide to give credit to Customers or not, there should be some checks and procedures which
defers between a New Customer or an Existing Customer.

✅ Existing Customer: It depends on Past experience with him whether he's being paying promptly before or not.

✅ New Customer: The Following Credit Checks are Important:

 Asking for trade reference from other Suppliers he has being dealing with.
 Asking for a reference from his banker.
 Carrying out Ratio Analysis on his Most Recent FS.

Content of a Credit Term

If we are saying a company should design a Credit Terms, what does it mean? Its the Combination of the Following:

 Credit Period: Commonly within 30 - 60Days.

 Credit Limit: Maximum Amount a Coy can give out.
 Interest Charges on Overdue Payments (Though, this one is not practicable because the person self is finding it

 Discount for Early Payment.

difficult to pay the Main Money)

Note: All these are usually found on Invoice.

Efficient Collection of Debts

When a credit is given then, there should be an efficient procedure in ensuring that customers pay on time.

They include:

1. Sending Invoice on time.

2. Sending Reminders regularly.
3. Ensure that Credit terms are not exceeded.

Exercises on This.

Let's Check Question on Page 714 & 718 of the Pack.

Debt Factoring

Debt Factors are specialist organisations that assist Companies with the management of Receivables and financing of
Debts. This is usually common with Small and Medium Sized Organisations that have large number of Debtors turning
to bad debts and does not have an efficient debt collection procedures.

Services offered by them

1. Trade Receivables Administration.

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2. Credit Insurance
3. Debt Financing.

Explanation

1. Trade Receivables Administration: A Factor will take over the Administration of trade Receivables on behalf of
the Company, though you will pay them for this. What they do is by:

 Sending out invoices on behalf of the Client.

 Payment collected by the Factor.
 Chase Customers with Late Payments.

Example on Factoring.

Check Page 721 of your Pack.

2. Credit Insurance: Additionally, aside from trade Receivables administration, they also agree to provide insurance
against Bad Debts.

This is Known as Non-Recourse Factoring Or Factoring Without Recourse. The agreement is that if a customer of the
Company refuses to pay an Invoice that was issued by the Factor, the factor bears that bad debt and pay the Company in
Full. They also offer "With Recourse Factoring" which is the opposite of this.

3. Debt Finance: With this service, the factor provides Advances of Trade Receivables to The Company without
collecting it yet. Let's say May be 80% of the Debt is given to the Company in advance at an agreed interest Rate. Then,
after the factor is able to collect the Full Money, he remits the Remaining 20%.

Benefits of using a Factor

1. It saves administration costs.

2. With Non-Recourse Factoring, Bad debt is reduced.
3. It’s a source of Finance.

Each of them is attached to a Cost. For example:

 Service Charge is for Collection & Administration of Trade Receivables.

 Commission Charge for Credit Insurance.
 Interest Charges for Debt Financing.

Discount Policy

A company might adopt a policy for reducing trade Receivables by offering a Cash Discount for Early Payment. This
has both advantages and Disadvantages.

� The Advantage is that it reduces cost of Capital.

� While the Disadvantage is that it reduces Annual Profits.

Invoice Discounting

This is the same thing with Debt Factoring only that an Invoice Discounter only provides one of the 3 Services provided
by a Factor, which is Debt Financing on a small number of Selected Invoices. He does not provide other 2,
administration of Receivables, or provision of credit insurance against Bad Debt.

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Chapter 23

Inventory Management
This is a Package of Topic on its own. So, under it we will study:

� EOQ
�Reorder Level
�Just in Time

Costs Associated with Inventory

1. Purchase Costs
2. Ordering Cost
a. ➖ Delivery Cost
b. ➖ Telephone Cost
c. ➖ Checking Cost.
3. Holding Costs: This Entails
a. ➖ Insurance Costs
b. ➖ Warehousing
c. ➖ Obsolescence, deterioration and theft.
d. ➖ Cost of Capital tied down
4. Stock out cost

The Economic Ordered Quantity (EOQ)

This is a Mathematical Model used to Calculate the Optimal(Best) Quantity of Inventory to order from a supplier each
time an order is made.

It's Limiting Assumptions

 � Annual Demand is constant.

 �Purchase price is constant, no discount.
 � Lead time is constant and known.
 � There is no stockout in the System.
 � The only relevant costs are Annual Holding Costs and annual ordering costs.

Practical Aspects of EOQ.

It's usually represented with the Letter Q. And it has its has some Relevant Formulas as we might have known from
previous Studies.

Lets check the pack for possible examples.

1. Example 1 is a straight forward Question..

2. Example 2 is a little bit advanced because it introduced Price Discount
3. Same thing with Example 3. Where we have to compare 3 Different Scenarios.

If we actually Sit down and study those things on our own, we will get to understand them well.

Reorder Level
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This is Another Technique of managing inventory. This is asking the question that at what point should an Inventory of
a company reach before they order for new stock.

We should not have 2 Much Inventory to avoid Wastage or Spoilage. At the same time, we should not go out of stock so
that we can meet up Customers Demand.

This is Best tackled by the following Formulas:

✅ Reorder Level = Max. Demand x Max. L. T

✅ Minimum Level/Buffer Stock = ROL - (Av. Dem x Av. LT)
✅ Maximum Stock = ROL + ROQ - (Min. Dem x Min. LT)
✅ Average Level = Min Level + Max. Level.

Just in Time (JIT)

This is a System which originated from Japan in the 70s. A radically different approach to inventory management
compared to the traditional methods of EOQ and ROL.

It follows the following principles:

 Holding too much of Inventory is not necessary, because it increases holding costs.
 If there is no immediate demand for Finished Goods, the production department should not produce.
 Similarly, Raw Materials should be obtained only when they are actually needed for Production.

There is a Problem Associated with this in the Real World.

There are 2 Systems:

1. JIT Production
2. JIT Purchasing.

JIT Production: This says don't Produce Finished Goods and keep in store without having ready to sell them to the
Market. In order for this to work:

� Production Times must be very Fast.

�Production must be reliable, No Stoppage or bottle neck.
� Suppliers must deliver to us on time.

JIT Purchases: This is Saying that don't Buy Raw Materials except you are in need of them for Production Purpose.

Kindly Read up your Pack for The Remaining Stuff under Inventory Management.

We are done with Inventory Management.

JIT Problem in Practice

1. Zero Inventory is not possible in some industries.

2. Difficulty in arranging a reliable supplies with some suppliers.

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Chapter 24

Cash Management

Cash Models

Those Models are useful in Determining:

� How Much Cash to hold & How much to invest in short terms investment.
�Then, when a company is a dire need of Immediate Cash, how much investment should they sell to obtain Cash?
They are 2:
1. Baumol Model
2. Miller Orr Model

Baumol Model

This is based on similar principles to that of the EOQ Model used for Inventory Control. It assumes that a company
spends cash regularly on expenses and that to obtain the cash, it has to sell short term investments. The purpose of this
model is to calculate the optimal amount of cash that should be obtained each time that short term investments are sold.

Assumptions



The Company uses constant Rate of Cash Through out the Year.


The Company can replenish its Cash immediately as soon as it runs out of cash.


Cash is replenished by selling Short Term Investments.
Holding Cash has a Cost. That's Opportunity Cost of not investing it to earn interest. (Similar to Holding Cost

 Selling Short term Securities to obtain cash also has a Transaction Cost. (Similar to Ordering Cost in EOQ 'Co').
of EOQ 'Ch').

However, we need to know a bit about the Statistical Details of the Model Anyway. �

Cash is usually represented with X as against Q in Inventory Management. And it takes the Formula Method of that of
EOQ. Only that terminologies are different.

Miller Orr Model

The Baumol Model Assumes that Cash payments are evenly spread over time and are constant each period. In reality,
this is unlikely to happen. There are more Uncertainties over the timing of cash payments and Receipts. So, the Miller
Orr model recognises this uncertainty in Cash flows which is measured statistically. However, we do not need to know
the Statistical Details of the Model Anyway. Please master the formula in the pack. Though, the examiner will give us
this in the examination hall.

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Chapter 25

Introduction to Capital Budgeting

Introduction

Capital Expenditure refers to a spending on a non current asset, or investing in a new line of business, or purchase of a
new business. As a result of capital expenditure, a new fixed asset appears on the financial statement, in the statement of
financial position.

Appraising Investments

Before an entity undertake a capital expenditure, they should assess whether the project is viable or not. As a general
rule, projects are not undertaken unless:

They are expected to provide a suitable financial RETURN

The RISK attached to the investment is acceptable.

Features of Investment Projects



They usually involve an asset or a business acquisition.


They usually involve several useful life.


Returns on investment consists largely on net income.


The asset might have a disposal value at the end of the useful life
They might also need an investment in working capital which is usually recouped at the end of the project.

Methods of Investment Appraisal

 Traditional Method - ARR & PBP

 Modern Method - NPV & IRR

️ Account Rate of Return (ARR)

ARR measures the impact of investment on accounting profit term. It is similar to ROCE except that ROCE is a
measure of financial returns for a company or business as a whole, but ARR measures the financial returns from a
specific capital project.

Differences between ARR and ROCE/ROI

• Objective - The objective of ROCE is to measure performance of the business as a whole, while ARR is

•
appraise investment in a capital project.

•
Time Period - ROCE is just for a year, but ARR is for the whole life of the project.
When Necessary - ROCE is carried out on historical information, so it relates to the past. While ARR is for

•
future prospects.

•
Use - ROCE is only for appraisal remarks, while ARR is for decision making.
Scope - ROCE is on a whole business, while ARR is on individual asset.

Formula

ARR = Estimated average annual accounting profit/Average investment

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Where, Accounting Profit = Total Profit - Total Depreciation

Average Investment = Initial Cost + Residual Value/2 + Working Capital (If any)

️ Payback Period (PBP)

This is a measure of cash flow, not profits like ARR. It is the length of time it takes a capital project to recover its cash
outflows.

• Formula - For Equal Annual Cash flows

Investment /Cash flows per annum

If the cash flows are not the same on annual basis, cash flows will be cumulated and removed from initial outlay until
the project becomes positive, that becomes the the PBP.

Chapter 26

The Discounted Cashflows Techniques

Introduction

This is the modern technique in investment appraisal which considers time value of money. Time value of money
explains between time and money. A sum of money today is far more better than the value tomorrow. The Reasons for
that are inflation, risk of what tomorrow may hold and opportunity cost.

The Concept leads to hypothetical terms of:

• Compounding - Future Value of Present Amount

Ie. FV = PV(1 + r)n

• Discounting - Deriving present value of future cash flows

Ie. PV = FV/(1 + r)n

️ Net Present Value (NPV)

This is the value of cash flows that will maximise shareholder's wealth. It is theoretically most sound method to use and
it represents value of the business in absolute terms.

️ Internal Rate of return

A method which is estimated rather than calculated. It is the point at which NPV becomes Zero. There is an inverse
relationship between the Net Present Value and the Discounting Factor. As the DF goes up, the NPV reduces, closer to
zero until it gets to zero point. This point can be plotted on graph but there is formula which is represented through
linear interpolation.

Specific things to know in DCF technique

• Annuity - A Series of equal cash flows every year.

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Formula = 1-(1+r)-n/r

• Perpetuity - A series of equal cash flows which runs each and every year till eternity.

Formula =

Advanced Application of DCF

Under the advanced application, the following will be considered:

•
•
Relevant Costs

•
Inflation

•
Taxation
Risk and uncertainties
️ Relevant Costs

Investment is a form of decision making, so it used the theory of relevant costing. We should note that ARR Method of
appraisal uses accounting profits, so it ignores the concept of relevant costing while PBP, NPV and IRR use cash flows,
so relevant costing theory is useful for them.

Rules are:

1. Only Future costs are relevant. Past costs are not.

2. Only Cash costs are relevant, non cash costs are not. Eg. Depreciation.

3. Only Variable Cost and incremental fixed costs are relevant. Fixed costs and allocated costs are not relevant.

4. Ignore any financing cash flows like interest. It has been taken care of by the Discounting Factor.

Relevant Costing

• ➖ Relevant Cost of material

• ➖ Relevant cost of labour
• ➖ Relevant cost of existing equipment
• ➖ Relevant cost of investment in working capital
• ➖ Opportunity cost

Relevant Costing of existing equipment

When new capital equipment is to be purchased for a project, the relevant cost is the purchase cost of the equipment
which is part of the initial capital expenditure. However, in a situation where a project is going to make use of an
equipment which the business already owns, the relevant cost of such is its

️ Inflation
In investment appraisal, we have 2 cash flows:

• Money Cash flows - This already includes inflation, and the discounting factor to use here is Money Rate of
return/Money Cost of Capital

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• Real Cash flows - This does not reflect inflation, and the discount rate to use is real rate of return or Real Cost
of capital.

For examination purpose, we should always assume that all cost of capital is in money terms or money rate of return,
that is every cost of capital given reflects inflation, except otherwise stated.

Also, we should assume that all the cash flows given are in real terms. They do not reflect inflation, so inflation rate will
be given to make them reflect it. Care should be taken as to when to start inflating the cashflows, whether it will start
from year 1 or year 2.

Students should read the question very well to ascertain whether the Costs (Selling Price, Variable costs, incremental
fixed costs) are stated in Year Zero terms or year 1 terms. That will give a clear guidance as to when to start inflating
them.

� If the question states that they are in year zero term - Then we start inflating them by year 1.

� If the question states that the cash flows are in year 1 - They inflating them will start from year 2.

When to use MRR or RRR

️ Money Analysis - This is used when there are more than one inflation rates, whether the question states so or not.

In that case, inflate all the cash flows with their appropriate inflation percentage because they are all in real terms (of
course that's why they gave you many inflation rates).

Then, use money rate of return.

️ Real Analysis - This is applicable when there is a single inflation rate given in the Exam question. Knowing fully
well that all cash flows are already stated in real terms, we can't make used of that inflation rate to inflation the different
cash flows given because it won't be specific for one. Except if the question gave one cash flow.

So, what we need to do is restate the money cost of capital to real cost of capital using fisher's formula or effect.

(1 + m) = (1 + r) (1 + i)

Where, m = Money Cost of capital given

r = Real cost of capital unknown

i = General Inflation Rate given.

Note, using the 2 analysis, NPV should be the same.

️ Taxation in Capital Budgeting

There are 2 major considerations as to tax in investment appraisal.

• Tax Payable/relief on estimated profits or Loss.

• Tax relief on Capital Allowance.

We need to take them one after another.

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Tax Payable on Profits

 ️ Tax Base is the incremental profit.

 ️ Timing of the tax can either be actual year basis or preceding year basis. Students should look out for this in
the Question. But, if the question is silent assume PYB and state your assumption.

Capital Allowance or Tax Depreciation

 ️ The Method to use should be determined from the question. Whether straight line basis or reducing balance
method.

 ️ When to claim capital allowance is also very important and can be played upon by the examiner. Always
know what the examiner states. Capital allowance can be claimed either in:

In Advance (From Year 0), or

In Arrears - From Year 1.

If the question is silent, always make use of the 2nd technique. Also, when to claim capital allowance is different from
when tax is paid. Take Note!

 ️ The relevance of ascertaining the capital allowance of the asset is not for the sake of capital allowance itself,
but Tax relief on it.

 ️ When the asset is finally scrapped, we should ascertain whether it is sold at profit or loss, because there could
be balancing allowance or balancing charge. This can lead to additional tax relief (Balancing Allowance) or tax
payable (Balancing Charge).

Chapter 27

Replacement Theory
Replacement of an asset

This is considering how long an asset should be used before being replaced. What year will it be optimal for them to
replace an asset. This is not a decision of whether to buy an asset to not.

The following cost considerations relate to that:

•
•
Purchase Cost of the asset

•
Running cost - Because the more we use the asset, running cost keep increasing as the asset gets older.

•
Tax Relief on running cost - This is an allowable expense for tax purpose.

•
Tax relief on capital allowance - This will affect tax savings.
Scrap or residual Value at the end of the useful life - This may reduce as the year increase and the asset gets older.

•
An entity can not sell an asset the same amount when selling it at the end of year 2 or at the end year 3.
Revenue is not usually relevant here expecially when it is same every year. That's why it's called replacement COST.

Decision Rule

The frequency of replacement that gives the minimum present value of cost.

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If Every 2 Years, that means they will replace in at the end of Year 2, then in the 4th Year, another time will be in year
6th.

If Every 3 Years, that Means they will replace in Year 3, then in year 6 then in year 9.

Methods of Asset Replacement

✓ If dealing with 2 or more Machines - We determine which one provides lesser cost.

✓ If dealing with one machine - We determine the frequency of years.

In this case, NPV might not be a best method to use because we are either dealing with different machines with different
years or a machine where NPV is derived for different years. So, NPV will not produce a Good Comparison.

The Method to use is known as Equivalent annual cost or equivalent annual value by dividing the NPV or PV with
Cumulative Discounting Factor or annuity factor.

Formula

EAC = NPV/AF

That's the method to use when dealing with projects with unequal lives and we are to chose one of them. Ie they are
mutually exclusive (Choosing one will not make you to choose the other).

Chapter 28

Strategic Models and Performance Management

Introduction

Modern business environment is dynamic and do not only require manipulation of numbers to succeed. There is a need
for use of some management tools and strategic models to analyse the problem an organization is encountering and
profer necessary solution. We are going to be looking at some strategic models in this chapter.

PESTEL Analysis
•
•
P - Political Factors

•
E - Economic Factors

•
S - Socio-Cultural Factors

•
T - Technological Factors

•
E - Ecological Factors
L - Legal Factors

The Model is Widely used most especially when the Scenario is More of External Environment of the Company than
Internal. Each Major Factor has other Sub-Factors Under Them.

Once You read the question, the Understanding of what to bring under each Factor will Flow in.

Also, its part of Analysis as well that u Criticise the Model...

For Example, PESTEL Has the Following Limitations:

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➖ No Quantitative Approach to its Application. Managers only use their Descretion in Classifying them.
➖ No Way to rate them whether one has more influence than another.
➖ Its Limited to Macro Economic Environment Only.

PORTER'S DIAMOND
A Model propounded by Michael Porter, dealing with International, National and Regional Competitive Advantages.

Michael Porter came into conclusion that Industries in one particular Country or Region of a country perform better than
others due to some Advantages that are present in the Country/Region.

He Gave Four Major Factors and placed them in form of Diamond where each of them connects to one another from
sides and within.

The 4 Factors are:

➖ Favourable Factors Condition

➖Related and Supporting Industries

➖Demand Conditions in the Home Market

➖Firm's Strategy, Structure And Rivalry.

Study this Acronym.

FFC

RSI

DC

FSS

Let me Explain them in the Most Short and Concise Way.

1. FFC: As the Name Implies, those factors of production that are Favorable for Organisations Operating in those
Areas.

Such Factors Could either be:

Basic, or

Advanced.

✔Basic Factors are the Natural Resources. Eg. Land, Mineral Resources, Water, Good Weather, Etc..

✔Advanced factors are man made like Labour Skills, Technology and Social Infrastructure that The Govt of that
Country or Region put in Place.

What Porter is trying to make us know is that Some Companies enjoying these factors will definitely perform well than
companies that their own Factors of Production is not Favourable. And In some countries, their Government has
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assisted Companies Operating there with Stable Social Infrastructure like Uninterrupted Power Supply, Good Road, etc.
Weather is not as Favourable as it is in some Regions Or Country.

2. RSI: By their name, u shall understand what they stand for. Industries that are Related and not only that they
Support One Another. With that, they will be able to explore more advantages and pull more opportunities than
their counterparts.

3. FSSR: The Strategy that a company employs, their Organisation Structure and the way they compete with other
companies will assist them a lot.

4. DC in Home Market: Charity, they say, begins at home.... Michael Porter is making us to understand that when
Home Customers demand a lot of the products, it will serve as a bedrock to move Internationally. A Very Good
Example is the Chinese Economy.

Limitations of the Model.

It is not applicable to Multinational Coys.

It does not take Note of developing countries.

Its only applicable to Macro Environment.

When is the Model Applicable.???

It's applied in a scenario where One Company is Compared to its Counterparts in another Country or Region. If you are
lucky, the Question will specify. But, if the Question wanna be Tough a little, they might not specify.

Porter's 5 Forces
Another Beautiful Work of Michael Porter. This one is used to analyse certain industries might become and remain
profitable than another.

In other words, The Forces that drives a particular industry to make more profit or hinder them from making profits.

There are 5 Forces:

� Threats from Potential Entrants

� Threats from Close Substitute

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� Bargaining Power of the Customers.

�Bargaining Power Of Supplier.
�Competitive Rivalry

1. Threats from Potential Entrants: Michael Porter propounded that if an industry Is Profitable, more Companies will
want to Come in. In the process, the industry will become more competitive and competitive. And then, Profit will
reduce.

To avoid this, the company can set Barriers to Entry which are:

� Economies of Scale
� Technological Know How
� Govt Regulations
� Access to Distribution Channel

2. Bargaining Power of the Customers: When Customers demand for Lower Price or improved quality. It will affect
Profitability.

3. Bargaining Power of the Supplier: When Suppliers can charge high prices. This will affect the Profits of companies in
that Industry.

4. Threats from Close Substitute: The Threat posed as a result that Consumers can go for another Product instead of
their own.

5. Competitive Rivalry: When the Coys in the Industry are also Competing with one another.

They Might Reduce their Profitability, because they can result into Reduction of Price or reduction of Quality.

See the Diagram below:

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Life Cycle Model

A Model designed for Product's Life Cycle or Asset's Life Cycle. It can be used to analyse:

• ️A Product, or
• ️An Asset.

The Rationale behind this model is that every product/asset as the case may be has its own Life Cycle.

Just like we Men as well.

We Move from one stage of life to another. These stages form our Life Cycle. Infancy ➡Childhood
➡Adolescence➡ Youthfulness ➡Adulthood➡Oldage

This is applicable to an asset/product.

They have 4 Major Stages:

• ➖Introduction Phase
• ➖Growth Phase
• ➖Maturity Phase
• ➖Decline Phase.

But, some added:

• ➖ Research and Development Phase (Before Introduction Phase)

• ➖Withdrawal Phase (After Decline Phase)
But, the Most important and widely acceptable Stages are the 1st 4.

Let me Now take them one after another

➖ Introduction Phase: The Stage the product of a Company is freshly introduced to the Market. Everyone will be
talking about it and willing to Buy it. At this stage, sales and profit will be Low Because no Much recognition is
Derived yet. The Product is just gaining ground. We can relate this to A Man as well That Stage of life we pass through
that we were small in age and size. Our thinking is Childish Because we were children. No one is thinking about making
money as we are now. All what we are after is how to eat, play, sleep and Watch Cartoons.

➖Growth Stage: This Stage, the product is getting well known and more Patronisers come in. The profit grows
Because the sales grew already.

➖Maturity Stage: This is when the Recognition, Sales of the Product gets to its Peak. Then, the profit derived from the
product gets to its pinnacle. At this Point, no increase in the Profit derived from the Product again.

➖Decline Stage: The Product starts fading out of the Market and Sales Drop. So do Profit. At this point, the Company
has 2 Options, either they Withdraw it from the Market or they repackage it.

Each Stage of the Product or asset has its own Peculiar Costs, Sales and Profit. And That’s what Constitute the Diagram
of the Model.

Pls. Kindly Study It from your Pack

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Application of the Model

The Model is applicable where you are dealing with Selecting Pricing Strategy for a Product... And Whether a Product
should still stay in the Market or not. The Stage it is will determine that.

One of the Limitations of the Model is that One might not easily distinguish the Stages from one another.

Boston Consulting Group (BCG) Matrix

This is an empirical research conducted by a management consulting company known as BCG. They based their
analysis on 3 Key Areas:

• ➖ Market Growth
• ➖ Market Share
• ➖ Cash Flows (arising from the Combination of the 2).
They presented a 2 by 2 Matrix where Left Vertical Side Represents Market Growth and Top Horizontally represents
Market Share.

The Question is what's the Understanding of the 2 Concepts in respect to Company's Performance and Activity?

➖Market Growth: This is the Probability that People will buy the Product of the Product.

For example, in 2015, the Coy sells 30, then, in 2016, the sales increase to 40 then, in 2017, it increases to 50. We say
the Company has a High Growth Rate.

In A Nutshell, Growth is Measured Horizontally. On a Straight Line

➖Market Share: As the Name Implies, this is percentage that the Company sells out the Total Market Sales.

For Example, it we have 10 Companies selling Car in Nigeria and all of them sold 1000 Cars during the year, but our
company alone sold 200 Cars. That means, our company have gained (200/1000) 20% of the Total Market Share.

Note: Market Share is Measured Vertically.

Application of the Model.

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The Model is applicable to:

➖Portfolio of Products: In a Situation where you wish to select which Product is performing well or which one is
Under performing.

➖Strategic Business Units or Subsidiaries of a Group Company: This Model can also be used to analyse a Big
Company with different business units. For instance, Dangote Group of Companies now. They Have Dangote Sugar,
Dangote Cement, Dangote Salt, etc. Each of them is a Business Unit. U can use it to Analyse which of the units is
performing well or not. Also, in the Case of a Group Company with Many Subsidiaries selling different Products. U
can use this same model to analyse which subsidiary is Performing well or not, and decide whether to Dispose off the
subsidiary or not.

The Model Itself

There are 4 Quadrants namely:

1. Star (High Growth + High Share): These are the Market leaders products. Products like these generate Net cash
flows but at reasonable Low amount, because the company will be spending more cash to maintain the High Position of
Growth it has in the Market, than what they earn from it.

The Strategy the Company should employ with them is to use money gained from Cash Cows to continue financing it.

2. Cash Cow (Low Growth + High Shares): As the Name Implies Cash Cow, The Product has highest percentage of
Customers buying it while the product itself is no more growing in the market. This makes the Product to generate more
Cash than what the Company Invests in it. This is the Point where the Company reap what they sow In a Product.

The Strategy is that they should no more spend to develop the product, rather use the Bundle of Cash generated
from it to Develop other Products like Stars and Problem Child.

3. Question Mark/Problem Child (High Growth + Low Share): The Company still spend a huge amount of money to
Develop the Product, but yet, no reasonable market share in Compensation for the Money spent on it. It raises a
Question Mark ? What should we Do?

Whether they should continue to invest on it Ní o or Withdraw it from the Market. The Simple Strategy Here is that the
Company Increase the Product Life or increase its investment.

4. Dog: This product is Tantamount to a Decline State of Product Life Cycle. The Company should not even bother to
invest more on it because there's no certainty that they will recoup their investment at all.

If it still bring in little Cashflows, the company can decide to enjoy it for a few Moment and then decide to Withdraw it
(in the case of Product) or Close the Unit down or Dispose off the Subsidiary, as the Case may be.

Limitations of the Model

It is limited to only 2 Factors in analysing competitiveness of a Product while there are other Factors as well. E.g.
Quality, Branding, Pricing Etc...

The Definition of Market itself might not be easily determinable in Real Life.

How to Determine whether the Market is Growing or not is Another Problem.

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What's Remaining in that Chapter is Opportunity & Threats. But, we are gonna do it Together Under SWOT
Analysis In Chapter 4.

Study the Diagram below:

✔ Strategic Capability:

Ability of a firm to Outperform its Competitors through effective use of their Resources & Competencies. 2 Key words
are important there.

Resources, What we have &

Competencies, how we use them.

That is looking at the market from an internal point of View, building our areas of core Competencies instead of
looking outward to competitors. By the time we get outside to the market, it becomes a problem to the Competitors.

✔ Customers Need:

Since market can also be defined as customers as earlier said, we look at our products from the Point of View of our
customers, who they are and what do they Need.

Customers' Need are the reason why They Buy Goods. Eg:

1. -Price
2. -Quality
3. -Better Design
4. -Convenience of Product
5. -Advert or Sales Promo.

Categories of Customers

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1. Individual Customers
2. Industrial Customers
3. Government Organisations

Those are self Explanatory.

Critical Success Factors (CSFs)

The Idea behind this is that for a product or service to be Successful, it must have Value. Therefore, CSFs are factors or
features or components Our products must possess for them to be Successful in the Market and Outperform Competitors
Products.

Several Success Factors could be Shortlisted, out of which might be:

•
•
-Charging Low Prices,

•
-Locating Office at a Favourable Environment.

•
-Employing Skilled Labour.
-Etc.

However, not all of them might be Critical to the Success of the Organisation. Therefore, we need to look at them from
a Scale of Preference Point. Which comes first after another. This Leads Us To Another Important Concept Key
Performance Indicators KPIs.

Key Performance Indicators(KPIs)

These are Quantitative Measures to evaluate monitor and control the Attainment of CSFs.

6 Step Approach to Using CSFs

According to Johnson Etal, they are :

1. Identify the Success Factors for Profitability.

2. Identify The Critical Competence.
3. Develop The Level of Critical Competence.
4. Identify Appropriate KPIs for each Critical Competence.
5. Give Emphasis to developing Critical Competence.
6. Monitor the Firm's Achievement of it's KPIs.

Benchmarking
This is a Competitive Analysis by comparing the performance of an Organisation with that of another organisation
which is performing better in the industry. Then, that organisation becomes the "Benchmark".

The Rationale behind this is not just to compare, but to identify our own area of Weaknesses that they are performing
well in it and adopt it(If Possible).

Types/Methods of Benchmarking.

Note, there is no widely acceptable types for Benchmarking. So, just stick to one.

➖ Internal Benchmarking: This is within the Organisation itself. Comparing a particular Biz unit/branch with another
in the Same Organisation.

1. Customer Benchmarking: Comparing our Products with what the Customer Expects.
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2. Operational Benchmarking: Comparing our own operation or process with that of another company.
3. Competitive Benchmarking: This is the most Widely used. Comparing our overall performances with that of the
Most Successful Competitor.

Benefits of Benchmarking.

1. It makes the Company better performing.

2. It makes the Company to continue improving.

Problems with Benchmarking include:

1. Difficulty to get some confidential information.
2. The Process might be hectic.

There is usually a Process to adopt, depending on what the Organisation wants.

Porter's Value Chain

This is Another Work of Michael Porter. The Guy Actually Tried a lot in the Field of Strategic Management.
Propounding a Quite number of Management theories and Formulating a reasonable number of Models. If You are
actually familiar with this Paper very well, you will understand what I mean. His name comes out every 2 2 Pages.

Meaning: A Value Chain is set of Activities that a product or Service of an organisation will pass through before
reaching the Final Consumers. What Porter is saying is that Each Activity should add Value to the product. If not, they
are regarded as Non Value Additive...

He Now Gave 2 Categories of Activities:

� Primary Activities, and

�Secondary Activities

Primary Activities are:

1. Inbound Logistics
2. Operations
3. Outbound Logistics
4. Marketing & Sales
5. Services (After Sales)

Primary Activities include:

✔Inbound Logistics: This is Dealing with Buying of Raw Materials and keeping save for Production Purpose. The
Major Players here are the Suppliers.

✔Operation: Those Raw Materials bought are to be transformed into Finished Goods that are for the usage of the Final
Consumers. But, they will pass through production processes which is Work in Process... This One is Dealing with
Factory and Factory Workers in the Case of Manufacturing Company and its very important and should be Managed
Well...

✔Outbound Logistics: This has to do with Keeping of Finished Goods Save until they are readily sold to Customers.
Some Companies used to Keep them in Warehouses...

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✔After Sales Services: Some products do not end with just Buying. Installation, Fitting, Maintenance at intervals and
other After sales Services should be rendered as well....

It makes the Company More Competitive than Other...

✔Marketing and Sales: One of the Most Important Chain as well. Its dealing with Channel of Distribution and
Advertising. Our Products should be known to the Consumers and even if they know, how do we get it across to them.

Secondary Activities include:

1. Procurement
2. Technology Devt
3. Human Resources Management
4. Corporate Infrastructure

✔Procurement: This has to do with Purchasing of Assets.. Its a procedure that a company embarks on that makes them
to be able to get the best and efficient Assets and Inventory.

✔Corporate Infrastructure: This is referring to the Organisation Structure. How the company is managed. Those in
charge of Governance. Those giving policies... Any Policy they adopt can either make or Mar the Organisation.

✔Technology Development: As the Name Implies, present day companies should not be left out In the Advent of
Technology and technological Development. They make life easier.

✔Human Resources: Even with the Advent of Technology, machines can still do some things. Infact, it's Man that will
operate the machines. Human Beings could be very difficult to manage. A successful organisation should understand
that without the staff, the organisation will not be able to move forward. Manage them well and treat them like Humans,
not animals. Even if you pay them for the Job

The Model is Very useful but has some limitations. One of it is that It does not consider the External Factor in the
Organisation.

Diagram below:

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Resources and Competencies➖

A Resource is an asset, item, material, skill and knowledge that an entity has control over. This is a Strength of
organisation and it could be useful under SWOT analysis.

While Competency is the ability to put the Resources together to achieve the Best. Both of them work hand in hand.
It's one thing to have something, but another thing is to be able to make good use of it. We have Threshold Resources
and Unique Resources.

We also have Threshold Competencies and Core Competencies.

✔ Threshold Resources /Competencies are those ones an Organization Need as a Minimum Requirement, to be able to
Succeed in A Given Industry.

✔ While Unique Resources/ Core Competencies are those ones that Only the firm possesses it in That Industry. This is
what will make them Competitively Different from Others, and it will make them Perform Better.

Categories of Resources:

• ✅Human Resources: Managers and Employees.

• ✅ Physical Resources: Assets and Raw Materials.
• ✅ Financial Resources: Cash in hand and at bank.
• ✅ Intellectual Resources: Intangible Assets like Patents, copyright and brands. Ability to innovate and R&D.

Ansoff's Growth Matrix

Another Guy like me and you as well propounded a 2x2 Matrix as well in 1957. He argued that there should be a
link between a Company's Current Product, its future product and the market at which he wishes to operate.

The Matrix placed Market on the Horizontal Left Side and Product on the Vertical Top side in relation to Existing
Market and New Market.

The Model Itself

The Four Strategies include:

✅ Market Penetration Strategy: As seen in the Matrix, this relates to existing product and existing market. I.e. An
entity seeks to sell more of its existing products in its existing market. This is a sensible choice to make when People
still demand for the Product. Ie, the market is growing rapidly.

✅ Market Development Strategy: Still on Existing Products, but probably its Fading away in the Market that people
are no more interested in it anymore. The Company takes it to a new Place (Market) or look for new buyers, it will be
new to them.

✅ Product Development Strategy: This is an innovation strategy, where we see that our Customers are loyal to us
and they still wish to continue buying from us. We Development New products with the help of our Research and
Development department. A Very Good Example of this is Mobile Phones in Nigeria. Eg. Infinix, Tecno, Huawei,
Apple, etc..

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✅ Diversification: Where Company moves from what they sell to a totally different something by acquisition of
another company. This can be Concentric or Conglomerate Diversification.

Application of this Model:

This model is applicable in A Situation where a company is faced with the Marketing Strategy to make use of for their
products. Whether they should Differentiate the Product ni ó or Change the Market. It depends on how the Question
Comes Anyway.

Gap Analysis Model

This is Subscript Model to Ansoff Growth Matrix. And It's saying that there may be a Gap Between:

✔ The Position A Business Entity wants to be by the end of the Planning Period, and

The Position it is likely to be if it does not have a Change of Strategy.

This Model is used to close this Strategic Gap. In a Nutshell, looking at the Gap Covered By An Organisation if these
Strategies are applied in terms of Profitability.

Withdrawal of Strategy

A Strategy adopted by a company in relation to A Product, may be withdrawn totally if the company deems fit.

Ie. A Company may decide to:

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1. Reduce the range of Products offered to the Market.

2. Pull Out from One Market for another.
3. No longer operate in a Market at all.

Reasons behind this are:

1. Inability to compete more effectively.

2. Poor Financial Results.
3. A Decline in the Sale of The Product.
4. A Decline in the size of the Market.

If the Company decides the Product is not a Core Product.

Chapter 29

Information systems and performance management

Introduction
When a raw data is processed into a meaningful form, it becomes information. Managers need information to make
different decisions, depending on the level of management it is. Aside from making decisions Information can also be
used to coordinate activities and measures performance and improve business processes.

Levels of management
1. Strategic management - They are concerned with setting objectives for the organisation and develop plans to
achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level managers. They
monitor actual performance to assess whether planning targets deceleration by strategic management are achieved.
Their main function is usually associated with budgets and Budgetary control.
3. Operational Management - This is the management of day-to-day operations and activities. The planning horizon is
usually short and requires immediate decision. This is usually saddled with supervisors and Frontline managers who
monitors daily efficiency level.

Each of those management levels require different information need. Strategic management need strategic information.
Tactical management needs tactical information while operational management needs operational information. For
example:

️ Strategic Information which is needed by strategic managers has the following characteristics:

• It is usually Summarised and not detailed.

• Longer term in nature
• Often forward looking
• Sourced from both internal and external source.
• Usually contain qualitative information rather than quantitative.
• It captures overall objectives of the organisation as a whole.
• Prepared on an adhoc basis, rather than regular.
• There is a high degree of uncertainty in the information, because of its futuristic nature.

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️ Tactical Information - This are information used to decide how the resources of the organisation should be used.
They are information relating Budget where plans are expressed in financial terms. Tactical information has the
following characteristics:

• It is often about individual departments and functions not overall as strategic.

• Also Summarised form of information but a bit level of detail than strategic information.
• Generally Relevant to short and medium term.
• Often concerned with performance measurement.
• Data sourced from both internal and external sources but more from with in the organisation.
• Often prepared on routine or regular basis. For example, monthly, or weekly performance reports.
• Consists of mainly quantitative information rather than qualitative.
• Though, there is a degree of uncertainty but much less than strategic.

️ Operational Information - This is that one needed by Frontline managers or supervisors to enable them organise
and monitor operations, make on the spot decisions whenever operational issues arise. They have the following
characteristics:

• Usually task specific, about specific transactions, specific job, daily workloads, etc.
• Usually detailed in nature.
• Relevant to very short term
• Relates to daily transactions
• Data comes exclusively from within the organisation.
• Often prepared frequently
• Consists mainly of quantitative information
• Information are usually factual and with less uncertainty.

Qualities of Good Information

1. Relevance - A Good information must be relevant for its intended users.
2. Reliability - Information must be accurate and complete enough for its intended purpose.
3. Timeliness - Information must be available in time to its users and not when no more needed.
4. User confidence - Information must be realistic that users should have confidence in it.
5. Value more than cost - The benefits of that information must be more than its cost.

Accessibility of information
Business information in performance management systems should be readily accessible so that the user of it can be able
to find it when he or she needs it. In modern IT adapted organisations, information can be obtained immediately on
demand. In particular, data base can make large amounts of information immediately available through the use of
internet and computer database.

Security of information
Although, as we said above, information should be accessible to authorised users, but should also be secured from
unauthorised access. The following methods can be used to secure data:

1. Physical Security - Places where computers are kept should only be accessible to authorised staff.
2. Software Security - By the use of passwords and encrypted data, soft files should be safe.
3. Anti-virus software - To avoid destruction or corruption of data by hackers and crackers, anti virus should be
installed on systems and updated on regular basis.
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4. Use of backup files - No matter what, circumstances beyond control may warrant that data are totally corrupt or lost.
To avoid that, files should be duplicated and kept somewhere else for retrieval purpose. The best backup device is
the cloud.

Sources of information
There are 2 Major sources of information

1. Internal Sources - A Control system such as a management accounting system must obtain data from within the
organisation for planning and control purpose. Potential internal sources include:

▪ Financial accounting records

▪ Human resources records maintained to support payroll systems.
▪ Production information
▪ Sales Information
▪ Minutes of meetings

2. External Sources - Managers also need information about customers, competitors and other elements in their business
environment. This is needed for strategic planning and control. Examples are information needed about customers,
competitors, suppliers, regulatory environment, economic or financial environment. Potential sources include:

• Market Research
• Trade journals
• Suppliers Price list
• Newspapers and other media
• Government reports and statistics

Limitations of external information

•
•
It might not be accurate

•
It might be incomplete

•
It might not be detailed enough

•
It might not be available when required
It might be misinterpreted.

Cost of information
For information to be Useful, it should be captured and processed. Capturing and processing data costs some money.
Costs associated with hardware, software, analysis, interpretation and procuring modern computing equipment can
amass huge amounts.

Big Data
The term refers to huge volume of data available to a business on daily basis. Big data can be analysed for insights that
leads to better strategic decisions. An American IT by the name Doug Laney described big data as having the following
characteristics:

✓ Voluminous - This is a large volume of data available more than what a single customer can handle.
✓ Velocity - This refers to the speed in which the data becomes available to the user. Data streams in at an
unprecedented speed and must be dealt with in a timely manner.
✓ Variety - Data comes in all types of format. From structured, numeric, ununstructur, and etc.
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Recording Data
There are many different ways of capturing data and recording it in an information system. Recording data depends on
circumstances, and also on the nature of the data required. For example:

✓ Record of labour hour spent on particular tasks - This can be recorded on time or job sheet.
✓ Records of material used - Material requisition notes.
✓ Data about customer satisfaction - Customer feedback surveys.

The system of recording data should be made as convenient as possible for the one inputing it to the information system.

Methods of data collection or gathering information

(i) Observation Method: Observation method is a method during which data from the field are collected through
monitoring or systematic viewing. It could be either participatory or not.

Advantages:

•
•
Subjectivity and bias are eliminated;

•
Method is reliable and dependable;

•
System analyst gets current data and
Observation results are independent of respondent‟s variable.
Disadvantage

•
•
It is an expensive method (more time is required).

•
Limited data.

•
Unforeseen factors may interfere with observational task.
Respondents‟ opinion cannot be recorded on certain subjects.
• Consciousness of being monitored may affect respondents and this performance may be susceptible to
observers‟ bias.
(ii) Interview Method: This is a method of collecting data which involves presentation or oral /verbal stimuli and reply
in terms of oral/verbal responses. Most times, it is regarded as a face-to-face survey process. It could also be personal,
group or telephone interviews.

Advantage

•
•
Data are gathered in greater depth.

•
Flexibility in restructuring the questionnaire.

•
Interviewer, by his skill, can overcome resistance.
Interviewer can collect supplementary information about respondent’s personal characteristics and environment

•
which has value in interpreting results.

•
Fast to obtain information.
Eliminates ambiguity.
Disadvantages

•
•
Little time is given to respondents.

•
Survey is restricted to respondents who have telephones.
Not suitable for intensive survey where comprehensive responses are required.

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•
•
Biased data may be obtained.

•
Time consuming.

•
Can be costly.
Very difficult to develop interview questionnaire because it should be short, simple, less ambiguous, relevant,
non-offensive or non-irritating, and concise.

(iii) Questionnaire Method: This method of data collection is quite popular, particularly in the case of big enquiries.
The questionnaire is mailed to respondents who are expected to read and understand the questions and write down the
reply in the space meant for the purpose in the questionnaire itself. It could be structured or unstructured questionnaire
type.

Advantages

•
•
It can be achieved at lower costs even when the geographical area covered is large.
Respondent‟s claims are free from bias.
•
•
Adequate time to think of responses.

•
Non-reachable respondents may be conveniently contacted.

•
Large samples can be used, so results are more reliable.

•
Reduces chance of evaluation bias because same questions are asked of all respondents.

•
Popular method.
Can be subjected to mathematical or statistical analysis to make the results scientific.
Disadvantages

•
•
Low rate of return of duly filled questionnaire.

•
Can be used only when respondents are educated and cooperative.

•
It is inflexible.

•
Omission of some questions.

•
Difficult to know if the expected respondents have filled the form or it is filled by someone else.

•
Slowest method of data collection and therefore may not be timely.

•
Items may not have same meaning to all respondents.
Good survey questions are difficult to develop.

iv) Case Study Method: It is essentially an intensive investigation of the particular phenomenon/event under
consideration. Important characteristics are as follows:

•
•
The researcher can study one single variable or more of such variables for his purpose; and
The selected variable is studied intensively.
Advantages of Case Study Method

•
•
An opportunity for an in-depth and detailed examination of the entity.
More relevant and reliable data is gathered.
Disadvantages of Case Study Method

• Data gathered is restricted to the situation under study and at that particular time, and this may not be relevant to

•
future applications.
Usually, it is time consuming to collect, organise and analyse data.

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(v) Panel Method: In this method, data are collected from the same sample respondents at the same interval either by
mail or by personal interview. This is used for studies on:

•
•
Expenditure Pattern;

•
Consumer Behaviour;

•
Effectiveness of Advertising; and
Voting Behaviour and so on.
Advantages

•
•
Useful in aerodynamics and highly technical cases.
Extremely versatile tool for creative modeling.
Disadvantages

•
•
Too technical.

•
Costly.
Limited application.
(vi) Experiment Method: An experiment is a controlled study in which the researcher attempts to understand cause-
and-effect relationships. The study is "controlled" in the sense that the researcher controls:

•
•
How subjects are assigned to groups; and
Which treatments each group receives.
Advantages

•
•
It is scientific.

•
Reliable.
Eliminates bias.
Disadvantages

•
•
Expensive.
Time consuming.
(vii) Focus Group: Gathering information through a small demographically diverse group of people in guided or open
discussion about a subject matter with a view to determining reactions that can be expected from a larger population.

Advantages

• Information is obtained from a diverse group of people and therefore could be more reliable and real to life.
Disadvantages

• Result can be influenced by the researcher based on his/her reading of the group discussions. So, it could be
biased.
(viii) Tally/Counting: This involves gathering data by recording actual performance through physical counting.

Advantages

•
•
Scientific.

•
Accurate.
Reliable.
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•
•
Disadvantages

•
Could be cumbersome.

•
Time- Consuming.
Useful only for small population.
(ix) Literature Review Documentations and Records: This involves searching for available written data from past
records, documents, statistical details and other records.

Advantages

• Involves the use of verifiable empirical documented data sources which can be referred to subsequently.
Disadvantages

•
•
Because it is historical, it therefore may not be suitable for current or future situation.
Basis of compilation may be flawed

Effect of IT on performance management

Information technology has improved the quality of service providers with the provision of instant access to to
customer's files and prompt action to their request. Through the use of telephone, email, internet services, businesses
can be done easily online.

IT assists in the following areas

1. Collection of data
2. Storage of data
3. Access to data
4. Communication of information

Significance of modern IT Systems

1. Instant access to data - Information can be quickly gotten from the database by all authorised personnel through a
network connection.

2. Remote input - In a traditional performance management systems, data was input to the computer by specialist staff.
There was often a high rate of input errors. In order to reduce errors of input into the computer system by specialist staff,
modern IT systems have developed an automated input of data by a non finance operating staff at the point of sale.

3. Instant access to external sources of data - With the use of modern IT systems, managers now have access to external
information from the internet. Either free of charge or through subscription. An effective management and use of IT
system gives competitive advantage to companies.

e-business and performance management

E-business is the exchange of business information using electronic networks. Transactions with customers and
suppliers might involve transfer of information not necessarily transfer of money. This has changed the nature of market
place in which goods and services are bought or sold. It also changes the nature of the relationships between Customers
and suppliers.

Globalisation and advent of e-commerce

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Globalisation refers to the process of denationalization of clusters of political, economical and social activities. It is an
evolution which is systematically restructuring interactive phase among nations, by breaking down barriers in the area
of culture, commerce, communication and several other fields of endeavour. Globalisation is a growing worldwide
interdependence of people and countries made possible as a result of huge advances in technology. Barriers in trade are
broken down and the world major financial markets are integrating as a result of globalisation. It is a world without
frontiers where business, products, people and their ideas are freely disseminated and diffused. It makes global
exchange of knowledge, commerce and culture to freely interact. With the aid of satellite communications, internets,
fibre optics cable, digital information transactions, and highspeed computers, management of any organization can
safely monitor the activities and trend of their company’s performance. It ensures strong economic integration.

Globalisation makes possible the wide spread of materials, wealth, knowledge and culture. Corporate work places can
be effectively managed online. It has equally made it easier to open up other countries market, thereby leading to
expansion of trade. Internet technology has revolutionized communication. It enhances easy, cheap and quick access to
people and information worldwide. Globalisation has given rise to global market value system, global marketing, access
to international financial market and it has effectively removed the world trade barriers. Hence, with the attendant
benefits that come with globalization, managers of organizations can increase their entities productivity from any
remote area of the world and receive information as and whenever required.

Management Information System (MIS) is the effective use of information to aid the activities of managers. The
activities of managers include:

➢ Presentation of materials which is enhanced by the use of word processing equipment such as word processors.
The use of spreadsheets also aid the presentation and preparation of accounting information.

➢ Teleconferencing, which involves conferencing of managers in different locations also aid the effectiveness of
managers. Electronic Commerce (e-Commerce) is another area of MIS where wide varieties of goods and
services are made available to enhance the activities of the managers.

The production of good information also enables the company to gain more competitive advantage over rivals of the
same line of business and it encourages specialization by managers. Globalisation enables companies to gain more
competitive advantage over rivals in the same line of business. Wide varieties of goods and services are made available.
Specialization is enhanced as excess products have markets.

The criticisms against globalization

Despite the numerous benefits of globalization, it is not without criticisms. It has been argued that globalization has
widened the gap between the rich and the poor. Though global wealth has increased, it is held in fewer hands,
organizations and countries.

1. Globalisation brought about environmental degradation. The quest for growth and profitability by orgasniations has
made many of the companies to abandon or ignore environmental protection and sustenance. Environmental
pollution is rampant and environmental offenders are daily increasing. Though globalization has enriched the world
scientifically, economically, politically and socio-culturally, there appears to be no global government to regulate
globalization.
2. Globalisation has made different countries and cities of the world to be under one roof, but democracy is literarily
eroded and seeds of stability eroded in most countries. This has negative effect on organizations performance.
3. Human animal and plant diseases can spread more quickly through globalization. Economic depression in one
country can trigger adverse reaction across the globe. It can lead to capital flight where funds are moved from
country where interest on return on investment is low to a country where the interest is high.

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4. Companies are faced with greater competition. This can put smaller organisations at a disadvantage as they do not
have resources to compete on global scale. Globalizations do not maximize sustainable economic growth. With
globalisation comes the activities of fraudsters, hackers etc.
The major barriers to e-business include:
▪ (i) Set-up costs: It can be fairly expensive for a small company to establish a website for selling its products
and taking payment by credit card, debit card, Inter-switch or PayPal. For example, it will be expensive for a
small company to set up a website showing an online catalogue with photograph, keeping records of inventory
balances, and with a facility to debit customer credit cards.

▪ (ii) Type of business: Some products and services are easier to sell on the internet than others. For example,
computer firms sell products very successfully over the internet as their products can be perfectly specified in
writing. However, it is much more difficult to sell items of clothing. No matter how much detail about clothing
items that is provided on the website or how many photographs that are provided, there are difficulties with
selling such goods ‘by catalogue’. Companies that do sell clothing by internet have to budget for large amount
of sales returns.

▪ (iii) On-going operating cost: A website has to be updated frequently to keep it interesting (and accurate), and
it might be necessary to keep making special offers to encourage customers to keep revisit the site.

▪ (iv) Time to establish the system: It takes time to establish a website that customers know about and wants to
visit.

▪ (v) No in-house skills: A company might not employ individuals with the knowledge or skills to maintain a
website. However, this should not be a serious barrier to ebusiness, especially if the employer is prepared to
give suitable training to staff.

Virus
Viruses are computer softwares that are designed to deliberately corrupt computer systems. Virus can be introduced into
a system on a file containing the virus. A virus may contain:

•
•
In a file attachment to an e-mail; or
On backing storage device such as a CD.

Types of virus

The following are the commonest viruses:

•
•
Trojan horses: This is a type of virus that disguises itself, often hidden with other software or files;

•
Worms: This is a corrupt data that replicates itself within the system, moving from one file or programme to another;
Logic bombs: This is a virus that is designed to start working (corrupting the files or data processing) when a certain

•
event occurs;
Time bombs: This is a virus that is designed to start working (corrupting the files or data processing) on a certain

•
date;

•
Denial of service: This virus renders the system unusable by legitimate users; and
Trap doors.

The following steps can be taken to guide against virus attack:

•
•
Installation of anti-virus software which must be updated yearly;
Restriction on the use of floppy disks, re-writeable CDs and USB storage medias;

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•
•
Firewall software and hardware should be used to prevent unauthorized access from the internet;

•
Staff should be encouraged to delete suspicious e-mails without opening any attachments; and
There should be procedures, communicated to all staff, for reporting suspicion of any virus as soon as they appear.

Preventing Company’s Data from Activities of Hackers And Virus

Various measures might help to prevent hacking into a system, or to detect when a hacker has gained unauthorized
access. The following controls can be used to prevent or detect hacking:

• Physical security measures to prevent unauthorized access to the computer terminals of the Company;
• The use of passwords;
• The encryption of products that are sent via internet;
• Uses of audit trails, so that transactions can be traced through the system when hacking is suspected;
• Network logs, whereby network servers record attempts to gain access to the system;
• Use of firewalls;
• Data masking; and
• Data scrambling.

Chapter 30

Implementing performance management systems

Accessibility to Information

An important factor in the design of a performance management system is the way in which the information is made
available to intended users. Management with performance responsibilities should have information to do their work. IT
systems make this possible sometimes, but there is a risk of information overload which makes users to lose track of the
most important and relevant of them and in turn, not make the best use of the information they are given.

Employer/Employee Relationship

The advent of IT based system, the relationship between employer and employee is enhanced because information need
not going through hierarchical structure before it gets to the top managers. A junior employee can send message to the
CEO through the use of Email directly without any intermediary.

Home working

IT has also made it easier for individuals to work from home without a physical office.

Advantages

✓ Reduction in Cost since there is no need for office accommodation.

✓ Lack of disruption to work. For example, transportation.
✓ Attractive working conditions.

Disadvantages

✓ Management control problem

✓ Isolation
✓ Dissociation from the work team

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Email and work practices

With emails, individuals have immediate access to information and responses to queries. It makes communication more
faster.

Limitations of using email

1. Large amounts of junk mails

2. Exposure to viruses
3. Security problems
4. Gossiping with others
5. Delay from feedback
6. Errors of typing and attaching wrong documents
7. Other Technical Problems

Socio-technological System design

This is an approach to system design of IT systems that recognises social factors in the operation of the system together
with technical functions. The most efficient IT system is that which satisfy the need of the users in terms of social
interaction, so that as they carry out their work, they also interact with one another.

1. Technical aspect - This has to with running or operating the system.

2. Social Aspect - Satisfying the social needs of the operator as well. Example of social needs include:
o Communicating with others outside the organization.
o Interacting with other employees.
o Need for creativity in the work.

The potential risk with working in a computerised environment is that computers isolate individuals, even when
physically working together. Employees spend too much time looking at the computer screen more than having to
conversate with one another.

However, current working environment should be Socio-technological in nature so that individuals can interact socially,
distract away from work sometimes through chatting, visual communication, and then come back.

Challenges in the development of Management Information System (MIS)

The MIS development team is faced with various challenges from the requirement gathering phase to the
implementation phase due to technological and human challenges and the type of data and information required. Some

• Lack of internet connectivity: The lack of understanding about passwords and security policies caused
of the challenges are listed below:

• A major problem of introducing an MIS in an organization is the nature of the company, structure, product,
situations where passwords were even written on sticky notes and pasted on monitors, etc.

personnel, etc. These will always pose a challenge. When the system is introduced to the staff, some of them
may be reluctant to use the system because of lack of trust in computer systems. In addition to that, the

• Another challenge is the shortage of human resources within the MIS team. The problem associated with
infrastructure and security policy implementation are difficult tasks.

• Bad Communication: Lack of understanding/planning for customer, organization and other stakeholders‟
data gathering, analysis, training, and documentation activities, are all human resource problems.

• Unclear Requirements: Unclear requirements will lead to changes in the course of the project, which will
requirements/needs for the project.

increase delivery time and bring about customers‟ resentments.

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• Increasing Cost: This will lead to added labour and project cost. Thus making the project less profitable and

•
takes away interest from stakeholders.
Delayed Project Delivery: The impact of operational challenges and the introduction of software with less

•
functionality will result in delayed project delivery.
Market Pressure: Another important aspect is the rapid development of software to meet the ever-changing

•
market demands.
Knowing the Technical needs: This is about understanding programming languages, the frameworks, the

•
systems and the algorithms needed for a particular information system to be successful.
Design Patterns: Identifying the right design patterns for your information system software and establishing an
actual design review, quality evaluation criteria and design management is something highly neglected today

•
because of the time and effort it takes.

•
Quality Control: Building quality and maintaining same to serve multitude of customers.
Security: Security of data/information is highly important especially with today’s cyber warfare and attacks.

•
Use of Password, Physical security and limited access to a system is imperative.
Debugging challenges: Dealing with bugs through debugging as a process of locating and fixing a software or
hardware-related error or problem is critical to the successful Management of an information system.
Problems areas with implementing an Information System

When an Information system is designed, developed and implemented, several problem areas must be managed
carefully. The potential problems are:

• The new system should contribute to the economic, financial or operational performance of the organisation.
• The new system is likely to have an impact on organisational and social matters, and this may call for resistance
from them.

Experience shows that the Last one is the major problem affecting new systems due to significant impact on
organization's culture, structure and working practices.

Organisation Impact Analysis

This is the analysis on the likely impact that a new system would have on an organisation. The contribution to economic,
cultural, structural and social aspects of work. All of these should be considered at an early stage of the project
development, up to the implementation of the new system, as well as post implementation review.

The following should be considered:

• Economic Benefit - Whether the expected benefit from the system meets the expected cost.
• Human Related Issues - This has to do with training of staff, health and safety issues, Motivating them to be
user compliant and assessing their work condition. If all these human related issues are not considered properly,
there could be a resistance.
• System Implementation - This is another important area of organisational impact analysis. The period of
transition from the old system to new one. Management should consider any likely disruption the
implementation of the new system could cause on the organisation and how long it might last.
• Organisation Structure, culture and power - There should be an assessment of how the system will impact
those important 3 areas:
� Structure - This has to do with their organization structure and flow of authority. How the new
system might impact this, probably some staff are transferred to other aspects of work, or some relieved.
� Culture - This are sets of important assumptions and practices, often unstated or documented, but
which members of an organisation share in common.
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� Balance of power within the organisation is also required. Information and knowledge gives power
to whosoever possess and control them, and this may alter the balance of power in an organisation with
the introduction of new systems.

Organisation Impact Analysis is inevitable because it helps management to identify potential problems that new systems
might create and something can be done to resolve it before hand.

Success and failure of information systems

The aim of the management is to ensure as much as possible that each new information system is a success. The
following factors determine success for a new IS :

• Achieving the objectives of the system

• Financial Benefits
• User satisfaction
• System availability
• Level of usage
• Difficulty in using the system

Key success factors of developing systems project

1. Aims - Aim of the project should be clearly defined.

2. Organisation-

✓ The project should have sufficient resources

✓ It should have support of the top management
✓ It should also have employees support
✓ Communication channels should be adequate
✓ Control Mechanisms should be in place and in use.
✓ Contractors should be responsive to their clients.

3. People

✓ The project manager should be competent.

✓ The project team should also be competent.

Why IT projects fail

Failure is the opposite of success, and therefore any factor that determines success of a project can also determine its
failure. Though, success and failure are both relative measures. Some systems are more successful than others, while
some are much of a failure than others.

A new system may be described as a failure if any of the following outcomes arise:

• If it functions inefficiently
• If it is implemented, but fails to meet user's requirements
• If it is implemented but meets strong resistance from users.
• If it costs more than expected.

There could be economic factors, political factors, social or technological factors to why a project may fail. PESTEL

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Reasons for user resistance

Users are often resistant to change, they are reluctant to use a new system and could criticise it strongly. There are 3
general theories about the nature of user resistance. These are:

• People-oriented theory
• System-oriented theory
• Interaction theory

️ People-oriented Theory - This theory concentrates on resistance to a new system because it is seen by individuals
or groups of individuals as a threat to their social relationships at work. For example, resistance to a new system may
arise when it causes more shifting at work or make staff to work from home.

️ System oriented theory - This theory concentrates on resistance to a new system because of dissatisfisfaction with
the system design. May be the system is difficult to understand and the user could not cope.

️ Interaction Theory - This concentrates on the interaction between the system and its users. A new system may be
seen as a threat to person's job or status.

Lewin's Change Process

Force Field Analysis

This is a model for managing Change. An organisation may decide to dump one strategy for another, therefore, calling
for a Change. A Strategic Change needs to be Managed Well otherwise the objective that's to be derived from such
strategy will not be achieved.

A Guy Called Lewin, some years ago suggested that there are 2 Categories of Forces in a Situation of Change:

▪ The Driving Forces, and

▪ The Restraining Forces.

✅Driving Forces: They are those Supporting the Change, While

✅Restraining Forces: Those ones Opposing the Change.

He argued that the change might not work if the Restraining Forces are stronger than the Driving Forces, because
Human Beings by nature does not like Change.

The Following Factors can either be Driving or Restraining Forces:

1. People involved themselves.

2. Attitudes of Employees.
3. Policies of the Entity.
4. Organisation Structure
5. Resources Available.

Another Model of Change is 3 Level Model.

"Unfreeze, Change & Referee".

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1. Unfreeze: People are used to their old ways of Activities and its not easy to just change them like that. It takes a
serious persuasion of the employees that the change is necessary.We persuade them by making them see the lapses
in the Current System and show them how the Future of the change will look like.

2. Movement (Change itself) : Then, after you have decoupled them, you introduce the new system successfully.

3. Refreeze (Consistency): As Argued by Lewin that once change is done, an organisation should put some monitoring
tactics in place so that people do not turn back to their old ways of life.

Nine key elements of project management

The responsibilities of the project manager will be to manage each of these nine elements.

1) Scope - At the outset of the project, the project manager will define the scope of the project and set objectives.
These will then need to be agreed with the Board of Directors before the project begins and form the basis for the
overall project direction.

2) Risk management - The project manager will be responsible for identifying any major risk associated with the
project (e.g. a supplier delivering late), and managing these risks through transferring risks to other parties, avoiding
risks or accepting them and managing the consequences as they happen.

3) Integration - The project manager will need to develop plans for the development and implementation of the new
systems. This will ensure that the process happens quickly and easily and uses the resources in the best way. To
integrate the new system into the organisation, these plans will need to consider change in management issues.
People have been using the old system for a while and will need to adapt to the change in approach. It may also
mean changing job roles and working practices which could cause conflict and staff dissatisfaction if not effectively
managed.

4) Time - Each of the activities will need to be defined and their duration estimated. They can then be sequenced and
time schedules made, using techniques such as Gantt Charts or Network Analysis. This will help to ensure that the
project is well organised and co-ordinated.

5) Cost - A budget for the project must be defined. This might be done through cost estimates from suppliers or by
costing each specific element of the project individually. Throughout the course of the project, the project manager
will need to monitor costs and take control action if costs are not in line with budget.

6) Quality - It is project manager‟s responsibility to develop the Project Quality Plan which outlines expected quality
of the new information and systems. They will need to monitor progress against this plan and ensure that the quality
objectives are met. This will mean ensuring that the systems are developed by experienced suppliers and adequate
testing is undertaken prior to the system going live.

7) Resources - This will involve the acquisition and effective management of staff, materials, buildings and equipment,
and ensuring that each of these resources is adequately co-ordinated and managed.

8) Communication - Communication to all stakeholders will need to be undertaken on a regular basis. This will
include reporting to the Board of Directors on progress, and agreeing with any major changes in the scope. It will
also involve good team communication and management to ensure team members remain motivated and committed
to the project.

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9) Procurement - The project manager will be responsible for procuring goods and services from external suppliers.
This is likely to include the design and development of the new information system since ABC Limited has little in-
house expertise.

10) Motivation - Motivation is a key role in managing people for productivity, hence every team member should be
given the opportunity to own the tasks assigned to him/her. The project manager is expected to provide the required
enabling environment for team members to excel.

The skills required by the project manager are as follows:

1. Change management skills: He/She will have to be skilled in understanding the people aspects of the change
and helping to overcome resistance to change. This may involve knowledge of change management tools;

2. IT skills: Since the project is IT-based, some IT knowledge and ability will help the project manager to
understand the key issues and negotiate effectively with suppliers;

3. Leadership: Leadership involves obtaining results through personal direction and influence. The project
manager will need to be able to create a vision for the team, be assertive, inspire and motivate staff;

4. People skills: The project manager will need to understand the concerns and motivations of team members and
to effectively manage them. This may involve the use of a suitable management style and understanding of
approaches to motivation of staff. The aim will be to create a motivated and happy team that works well to
achieve the project‟s goals;

5. Communication skills: A key role of the project manager is communication with staff, suppliers or the Board
of Directors. He/She will therefore have to be able to use a variety of communication methods (i.e.
presentations, meetings, reports, e-mails) and know when to use these appropriately and be skilled at using each;

6. Problem-solving and decision-making skills: There will inevitably be many decisions to be taken during the
course of the project and problems to be overcome. The project manager needs to be an analytical thinker who
will be able to solve problems as they arise and who is firm and decisive so that the project is not delayed;

7. Negotiation skills: Negotiation with suppliers and internal departments is an inevitable part of the process. The
project manager will need to understand the basis of negotiation in order to ensure the best outcomes are
achieved for the organisation. This may involve being able to understand leverage points over potential
suppliers, to see the other parties‟ perspective being firm and willing to walk away when the deal is not right;
and

8. Planning skills: The project manager will need project planning skills, and need to be able to use project
management software to make and monitor plans. Knowledge of techniques such as Gantt Chart and Network
Analysis will facilitate this process. Some basic financial knowledge or expertise would be an asset to help with
the budgeting and cost monitoring process.

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