PERFORMANCE MEASUREMENT

Key Concepts
 Vision statement

 Mission statement

 Goals and objectives

 Critical success factor

 Sources of critical success factor

 Key performance indicator

 Types of key performance indicator

Mission Statement:
The mission statement is an expression of the overall purpose and scope of the organization,

which is in line with the values and expectations of the stakeholders. It includes:

• General goals

• Key customers and key products

• Culture

• Values and beliefs

• Stakeholders
Mission Statement:
Characteristics of mission statement

• Brevity

• Flexibility

• Distinctiveness

Coca cola mission: To refresh the world, To create value and make difference, To inspire

moments of optimism and happiness.

 Mission statement : What’s wrong with the world and how you intend to fix it.

 Vision statement : What the world will look like after you’ve finished changing it.
Goals:
The goals set for different parts of the organization should be consistent with each other (goal

congruence). There are two types of goals:

Operational goals: Can be expressed as objectives. It can be measurable. For example,

cut cost, objective reduce budget by 10%.

Non-operational goals: Not all the goals can be measured. For example, a university

goal is might be to seek truth; this goal cannot be measured.

Goals:
Distinguish between goals and objectives

Goals:

• Goals will support the mission.

• This is primary long term objective of the organisation

• Goals are the main purpose of the organization.

• This is at overall organizational level.

• Goals are decided at corporate planning stage by strategic management.

Objectives:
• Objectives are sub-division of goals.

• Objectives are at departmental level.

• If the departments achieve their objectives, the organization will achieve its goal.

Objectives usually are smart

• Specific

• Measurable

• Attainable

• Result orientated

• Time bounded
Objectives:
Primary Objectives: are the main objectives, like profit maximization.

Secondary Objectives: are objectives that helps in achieving the primary ones, like cost

reduction and revenue maximization.

Strategic, tactical and operational objectives:

Strategic objectives: would include matters such as required level of company profitability.

Tactical objectives: would concern with efficient and effective use of organizational

resources.

Operation objectives: would include guidelines for ensuring that specific tasks are carried

out.
Objectives:
Trade-off between the objectives: It relates, when some objectives might be achieved on the

expense of others. For example, a company’s objective of achieving good profits and

profit growth might have adverse consequences for the cash flows of the business, of the

quality of the firm’s products.

Short-termism: is when there is a bias towards short-term rather than long-term performance.

It is often due to the fact that managers' performance is measured on short-term results.
Objectives:
Methods to encourage a long-term view:

• Making short-term targets realistic.

• Providing sufficient management information.

• Evaluating managers' performance in short term as well as long term.

• Link managers' rewards to share price. (encourage goal congruence).

• Set quality based targets (Multiple targets can be used)

The link between mission statements and key performance indicators

Performance measure can be divided in two groups:

1. Financial performance measures.

2. Non-financial performance measure.
1. Financial Performance Measures:
used to measure the performance of Profit Seeking Organizations. It includes,

• Ratio analysis.

• Variance analysis

• Benchmarking (financial + non-financial)

• Balanced scorecard (financial + non-financial)

RATIO ANALYSIS: Several profitability and liquidity measures can be applied to divisional

performance reports.
1. Financial Performance Measures:
Profitability Ratios: The operating efficiency of a firm and its ability to ensure ample returns to

its owners / shareholders depends basically on the profits earned by it.

 Gross profit margin: Gross profit margin ratio indicates how efficiently the material, labour

and expenses related to production are used by an organization in order to produce a

product at a lower cost.

100
1. Financial Performance Measures:
 Operating profit margin: Operating profit is an income of the company that is generated

from its own operations. It excludes income from investment in other businesses. The

operating profit ratio measures the operating efficiency and pricing efficiency through

cost control. If profit margin unsatisfactory means excessive cost or low selling price.

100

 Net Profit margin: It is calculated as

100
1. Financial Performance Measures:
 Return on capital employed (ROCE): This ratio expresses profits earned as a
proportion of capital employed. It illustrates how efficiently the company is using its
capital to generate profits.

100

Advantages:
• Easy to Calculate
• Easy to Understand
• Uses easily available data
• Measures how well a business is utilizing the funds invested in it.
Disadvantages of ROCE:
• Manager feels reluctant to invest in P & M

• ROCE increases on yearly basis because of depreciation of Non Current Assets

• Unfair to compare ROCE of two different departments with Assets of two different age

• Short-termism

• Can be distorted by accounting policies

• Research show poor correlation with shareholder value.

• Not useful for companies with less tangible asset base.

 RESIDUAL INCOME (RI): It is the measure of the centre’s profits after deducting a notional

interest cost. It can be calculated as

Residual income = Profit before interest and tax + Profit from any other investments –

(Total capital employed x notional interest)

 Notional interest is also called imputed interest.

 Asset turnover: This ratio indicates the efficiency with which company is able to use all its

(net) assets to gearing $1 sales. Generally, the higher a company’s total net asset

turnover, the more efficiently its assets have been used. The total net asset turnover is

probably of greatest interest to management, however, other parties, such as creditors

and prospective and present shareholder, will also be interested in the measure. It is

calculated as,

 ROI = Asset Turnover X Profit Margin

 Earnings per share (EPS): The earnings per share ratio are widely used to measure the

profitability of the shareholders’ investment. EPS represents the amount of profits

attributable to each ordinary share or, what each share has generated in terms of

profits. Investors compare the EPS of the company with the industry average and with

the EPS of other companies before taking investment decisions.

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 Price earnings ratio (P/E ratio) : Price earnings ratio compares current market price of

each share with the per share earnings in order to assess the company’s performance. A

high P/E ratio indicates that investors are expecting higher growth in future compared to

companies with low P/E ratio. It is more useful to compare one company’s P/E ratio with

that of the other companies in the same industry or the market in general and with the

company’s own P/E ratio of preceding years.

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Liquidity Ratios: Liquidity refers the state of an asset’s nearness to cash. Liquidity is vital to the

financial health of any company too much liquidity is a misuse of money, and too little leads

to severe cash problems.

 Current ratio: Current ratio measures the short-term solvency of a firm. The higher the

current ratio, the larger is the amount of current assets in relation to current liabilities and

the company’s ability to meet its current obligations is greater too. If the current ratio is

2:1 or more, the company is generally considered to have good short-term financial

strength. If the current ratio is less than 1 (liabilities exceed current assets), the company

may face difficulties in meeting its short term obligations.

%
 Quick ratio or acid test ratio: Quick ratio determines the relationship between liquid

assets and current liabilities. Liquid assets are the assets that can be easily and

immediately converted into cash without loss of value. A quick ratio of 1 to 1 or more

represents a satisfactory current financial position of a firm.

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& "$
%
 Receivables collection period:

Receivables collection period = Average Debtors × 365

Credit Sales

 Inventory turnover period:

Inventory turnover period = average inventory × 365

Cost of goods sold

 Payables payment period:

Payables payment period = average payables × 365

Credit Purchases
Gearing Ratios: The debt position of a company indicates the amount of other people money

(other than the owner’s money) that is being used by it in generating its profit. Typically,

attention is placed on long-term debts, since these commit the company to pay interest over

the longest run and eventually repay the sum borrowed.

 Gearing ratio (debt to equity ratio): The ratio indicates the relationship between the long-
term funds provided by the loan group and those provided by the company’s owner. The
figure is only meaningful in light of the company’s business and comparison with other
organizations within the industry is useful.

Gearing Ratio = Prior charge capital (long term debt).

Prior charge capital + shareholders’ equity
 Interest cover ratio: The interest cover ratio shows whether company is earning enough
profit before interest to pay its interest costs comfortable, or whether its interest costs are
high in relation to the size of its profit.

Profit before Interest and Tax

Interest Cover 
Interest

 Dividend cover: A high dividend covers means that a high proportion of profit is being

retuned, which might indicates that the company is investing to achieve earning growth

in the future.

Profit before Interest and Tax

Dividend Cover 
Dividend
Example 1: You are given summarized results of an electrical engineering business as follows:
Profit and Loss Account
Sales $50,000
Cost of Sales ($32,000)
Gross Profit $18,000
Operating Expenses ($8,000)
Net profit $10,000
Statement of Financial Position
$ $
Non Current Assets 12,500
Current Assets:
Inventory 14,000
Receivables 16,000
Cash 500
30,500
Creditors (24,000)
Net Current Assets 6,500
Total Net Assets 19,000
Capital and Reserves 19,000
Required:
Calculate the following ratio, clearly showing the figures used in the calculations:
a. Gross Profit Margin
b. Net Profit Margin
c. ROCE
d. Asset Turnover
e. Current ratio
f. Quick/acid test ratio
g. Stock turnover period
h. Debtor turnover period
i. Creditor turnover period
Possible Limitation Of Financial Ratio Analysis

• Based on historical data and thus the ratio may not be a good guide to the future.
• Quality of the analysis is determined by the quality of the accounting information.
• Difference in accounting practices adopt by company over the treatment of fixed asset
depreciation and revaluation , stock valuation, research and development expenditure,
good will write off and profit recognition
• The change value of money and differences in trading enjoinments over time
• A difficulty in deciding on a suitable yardstick and the interpretation of change.
• The use of ratios to measure performance may encourage sub-optimal behaviours by
managers e.g. short term manipulation of results
• Ratios are normally based exclusively on finance, and reflect only financial indicators of
performance. There are of coursed non financial implications associated with performance
Traceable And Controllable Costs
The main problem with measuring controllable performance is in deciding which costs

are controllable and which costs are traceable. The performance of the manager of the

division is indicated by the controllable profit (and it is on this that he is judged) and the

success of the division as a whole is judged on the traceable profit.

2. Non-Financial Performance Measures

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

Organizations and Not For Profit Organizations)

 Benchmarking (financial + non-financial)

 Balanced scorecard (financial + non-financial)

Non financial measures Key performance indicators
 sales growth by product or service
Competitiveness  measures of customer base
 relative market share and position
 quality measures in every unit
 evaluate suppliers on the basis of quality
Quality of service  number of customer complaints received
 number of new accounts lost or gained
 rejections as a percentage of production or sales
 speed of response to customer needs
 informal listening by calling a certain number of customers each week
Customer satisfaction
 number of customer visits to the factory or workplace
 number of factory and non-factory manager visits to customers
 days absence
 labour turnover
Quality of working life
 overtime
 measures of job satisfaction
Balanced Scorecard
The balanced scorecard measures performance in four different perspectives. It employs

a variety of financial and non-financial indicators.

1. Financial perspective (financial success) – “how do we create value for our

shareholders?

2. Customer perspective (customer satisfaction) – “how do existing and new customers

value from us?”

3. Internal business perspective (process efficiency) – “what must process we excel at?”

4. Innovation and learning perspective (growth) – “can we continue to improve and

create future value?”

Balanced Scorecard

1. Financial perspective: This considers how the organisation can create value for its
stakeholders. Performance measures are likely to include traditional financial measures of
profitability, cash flow and sales growth. This focuses on satisfying shareholder value.
Appropriate performance measures are ROCE and Profit Margins.

2. Customer perspective: This is an attempt to measure customers’ view of the organization by

measuring customer satisfaction. Performance measures could include number of
customer complaints, new customers acquired, on-time deliveries etc.
Appropriate performance measures are:
 Customer satisfaction with timeliness
 Customer loyalty.
Balanced Scorecard
3. Internal business perspective: This considers the processes at which an organisation must

excel if it is to achieve customer satisfaction and financial success. Measures might include

the speed of innovation, the quality of after sales service or manufacturing time. This aims to

measure the organization’s output in terms of technical excellence and consumer needs.

Appropriate performance measures are

 Unit cost

 Quality measurement
Balanced Scorecard
4. Innovation and learning perspective: This looks at the organisation’s capacity to maintain

its competitive position through the acquisition of new skills and the development of new

products and services. This focus on the need for continual improvement of existing

products and techniques and developing new ones to meet customers’ changing

needs.

Appropriate performance measures are:

 A measure would include % of turnover attributable to new products.

Advantages And Disadvantages Of Balance Scorecard

Advantages Explanation
Managers need to look at both internal and external matters affecting
All four perspectives
the organization. They also need to link together financial and non-
considered by
financial measures. Therefore they can see how factors in one area
managers
affect all other areas.
It can be difficult to incorporate objectives into control systems such as
Consistency budgets. So targets set by a budget, say, may conflict with objectives.
between Moreover, staff may put their own interpretation on objectives against the
objectives, control actual intention of the original objective. The balanced scorecard should
systems and staff improve communication between different levels of the organisation. The
balanced scorecard strives to keep all these factors in balance.
Advantages And Disadvantages Of Balance Scorecard

Disadvantages Explanation
Some measures in the scorecard, such as research funding and cost
Conflicting measures reduction, may naturally conflict. It is often difficult to determine the
balance that will achieve the best results.
Not only do appropriate measures have to be devised but the number
Selecting measures of measures used must also be agreed. Care must be taken that the
impact of the results is not lost in a sea of information.
Measurement is only useful if it initiates appropriate action. Non-
Expertise financial managers may have difficulty with the usual profit measures.
With more measures to consider this problem will be compounded.
Even a financially trained manager may have difficulty in putting the
Interpretation
figures into an overall perspective.
Application Of Balanced Scorecard
Balanced Scorecard For A Restaurant
Goals Measures (KPI)
Financial success
To grow and open new restaurants New restaurants opened
Profitable Net profit margins
Customer Satisfaction
Great services Excellent results on customer survey
Repeat business Customers booking to come again
Innovative food New menus on a regular basis
Process Efficiency
Timely food delivery Time from order to delivery
Efficient staff Processing of food order, few mistakes
Low food wastage Amount of food discarded
Growth
Trained staff Employees with relevant training
New menu choices Number of new dishes introduced
Value For Money (Economy, Efficiency and Effectiveness)
Value for money means providing a service in a way which is economical, efficient and
effective. It is often referred to as the 3E's - Economy, Efficiency and Effectiveness.
• Economy: It implies that the least possible cost should be incurred for acquiring and using
resources, while maintaining the appropriate quality ('doing things at a low price') like more
clean plates per pound.
• Effectiveness: It focuses on the achievement of the desired objectives through the spending
of available funds. It is concerned with the relationship between the planned results and the
actual results of projects, programs and other activities ('doing the right things'). Like plates
as clean as they should be
• Efficiency: It is attaining desired results at minimum cost. It implies the maximizing of output
input ratio i.e. per unit of input the output should be the most. It is concerned with the
relationship the resources (input) and the output of goods, services and other results. Ideally,
maximum output should be achieved for a given input.
Performance Measurement In Service Sectors:
There are 6 key dimensions to performance in the service sector:

1. Competitive Performance

2. Financial Performance

3. Quality

4. Resource utilization

5. Flexibility

6. Innovation

Together these areas influence the competitiveness of the business and ultimately its

profitability.
Performance Measurement In Service Sectors:

3. Quality: Quality cannot be measured physically so it is assessed by different means, this

will be more understandable by following table:

Service quality factor Measure Mechanism

Customer survey and internal

Assess Walking distance
operational data
Cleanness of environment and Customer survey and
Cleanness
equipment management inspection
Customer survey and
Comfort Crowdedness of airport
management inspection
Customer survey and
Friendliness Staff attitude and helpfulness
management inspection
Performance Measurement In Service Sectors:
4. Resource utilisation: Resource utilization is measured in terms of productivity. The main

output of accountancy firm is chargeable hours. Productivity will therefore be measured

as ratio some of the ratios are given below:

Business Input Output

Accountancy firms Man hours available Chargeable hours

Common wealth hotels Rooms available Rooms occupied

 Performance Measurement In Service Sectors:

5. Flexibility: It has three aspects.

This is vital in some services industries. measure included factors such as

Speed of delivery
waiting time in queries.

Ability to respond in This will depend on type of services professional service such as legal
advice must tailored exactly the customer’s needs
customer’s specification
This is measureable in quantity terms. E.g. train company can measure
Coping with demand
exact overcrowding
Performance Measurement In Service Sectors:

6. Innovation: How much cost it will take to develop new service and how effective this

process is. In can be summarized as follows:

• Amount of spending on research and development.

• Proportion of new service to total service provided.

• Time between the identification of customer need and for a new service and making

it available.
Benchmarking

Benchmarking involves the establishment, through data gathering, of targets and

comparators, through whose use relative levels of performance (and particularly areas of

underperformance) can be identified. By the adoption of identified best practices the

performance of the organisation should be improved.

Types of benchmarking

1. Internal benchmarking: This involves the comparison of different departments or divisions

within an organisation. Data for this is easy to obtain and conditions are often comparable.

Learning may be limited as comparisons are only being made within the same company.
Benchmarking
2. Competitive benchmarking: This involves comparing performance with that of direct
competitors. The potential for learning is improved but data may be difficult to obtain. For
commercial reasons firms are often unwilling to divulge information to direct competitors.
The growth of benchmarking clubs and trade associations has reduced the problems of
competitive benchmarking.

3. Functional benchmarking: Various functions in the business are compared with those
recognised as the best external practitioners of the function. A manufacturing company
could compare its invoice preparation time with that of a credit card company, its delivery
time with a firm of couriers etc. The potential for learning how to improve performance is
very high, but comparability problems sometimes exist. (This is sometimes referred to as
operational or generic benchmarking)
Benchmarking
4. Strategic benchmarking: This involves comparison of performance with competitors at the
strategic level. Areas such as market share and return on capital employed could be
considered. Such comparisons are important in designing competitive strategy.
Reverse engineering: Buying a competitor’s product and dismantling it in order to understand its
content and configuration.

Why use Benchmarking?

• For setting standards.
• It identifies the processes to improve.
• It helps with cost reduction.
• It improves the effectiveness of operations.
• It delivers services to a defined standard.
• It provides a focus on planning.
• Establishes a desire to achieve continuous improvement.
Benefits Of Performance Measurement Systems
• Clarification and communication of organizational objectives e.g. profitability.

• Developing agreed measures of performance within the organization e.g, ROCE.

• Allowing comparison of different organizations e.g. ratio analysis.

• Promoting accountability of the organization to its stakeholders.

PROBLEMS:
• Tunnel vision: an obsession with maximizing measured performance at the expense of non-
measured performance e.g. staff welfare.
• Myopia (shortsightedness): maximizing short run performance at the expense of long run
success.
• Manipulation of data: “creative” reporting e.g. trying to classify all adverse variances as
planning variances.
• Gaming: e.g. building slack into budgets.
Solutions:
• Participation: involve staff at all levels in the design and implementation of the system.

• Encourage a long-term view among staff e.g. through company share option scheme.

• Ensure the system of performance evaluation is “audited” by experts to identify problems.

• Review the system regularly.

• Audit data used in performance measurement to prevent/detect manipulation.

Performance Measurement in Non-Profit Making
Organisations (NPMOS) And Public Sector Organisations
Organisations: Performance cannot be judged by Profitability rather than it is judged in

terms of inputs and outputs which ties in with the Value for Money criteria.

• Economy

• Efficiency

• Effectiveness

Problems with Non-profit Making Organisations:

• NPMOs tend to have multiple objectives.

• Outputs can seldom be measured.

Performance Measurement in Non-Profit Making
Organisations (NPMOS) And Public Sector Organisations

Performance can be measured by

• Input – Output Relation.

• Judgments.

• Comparisons.

• Unit cost Measurement.