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nirmal shrestha Performance Measurement & Control

CHAPTER 10

PERFORMANCE MEASUREMENT & CONTROL

1. Performance Measurement
Performance measurement is a vital part of control and aims to establish how well something or
somebody is doing in relation to a planned activity.

2. Reasons for measuring performance

The purpose of measuring performance is to:
 Determine whether the planning targets or standards are being met.
 Determine the performance of each of function/ department.
 Indicate the risk that targets will not be met, so that action to correct the situation can be
considered.
 Indicate poor performance, so that corrective action can be taken.
 Reward the successful achievement of targets or standards.

3. Responsibility and controllability

Two essential features of an effective performance reporting system are:
Responsibility: Performance reports should be provided to the individuals (and their managers) who are
actually responsible for the performance. Performance reports are irrelevant if they are sent to individuals
with no responsibility.
Controllability: Performance reports should distinguish between aspects of performance that should be
controllable by the individual who is made responsible and accountable. There is no sensible purpose in
judging the performance of an individual by looking at factors that are outside the individual's control.

4. Performance measures over Time

Performance measurement should cover the long-term, medium-term and short- term.

4.1 Long-term performance: Measures should be linked to the long-term objectives and the strategies of
the organisation. The most significant long-term objectives might be called critical success factors or
CSFs. In order to achieve its long-term and strategic objectives, the critical success factors must be
achieved. CSFs may be:
 Strategic Focus (Leadership, Management, Planning)
 People (Personnel, Staff, Learning, Development)
 Operations (Processes, Work)
 Marketing (Customer Relations, Sales, Responsiveness)
 Finances (Assets, Facilities, Equipment)
For each critical success factor, there should be a way of measuring performance, in order to check
whether the CSF targets are being met.
Performance measurements for CSFs might be called key performance indicators (KPIs) or
possibly key risk indicators (KRIs). Few KPIs are:
– Lead Response Time; Lead Conversion %; Cost per Lead ; Cross-Sell %
– New Customers ; Cost per Acquisition;
– Employee Turnover Rate; Employee Absence Rate; Employee Training Rate
– Number of Issues (By Type); First Response Time (FRT)

4.2 Medium term performance: Medium-term performance measurement is perhaps most easily
associated with the annual budget, and meeting budget targets. Targets, whether financial or nonfinancial,
can be set for a planning period such as the financial year, and actual results should be compared against
the planning targets.

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4.3 Short-term performance: Short-term performance should be monitored by means of operational

performance measures.

Financial Performance Indicators (FPI)

Financial performance of a company is crucial to the interests of shareholders,
senior management, lenders, potential investors and many other stakeholder
groups.
Financial statements provide the basis for much of the information but need
interpretation in order to assess performance in a meaningful way.
The result of ratios usually have little meaning when viewed in isolation, They only
really take on significance when used as a comparative measure.
Depending on the information available, ratios provide more relevant insight when
compared to:
๏ Previous years ratios (same company)
๏ Ratios from other similar companies
๏ Target ratio figures
๏ Industry averages

Percentage annual growth in sales = (Current Year Sales / Previous Year Sales-1) x 100%

Profitability Indicators
Profitability ratios are good indicators of the operating efficiency of an organisation.
Profit margin ratio
Gross Profit Margin = (Gross Profit / Sales) x 100%
Net Profit Margin = (Net Profit / Sales) x 100%
Profit Margin = (Operating Profit(PBIT)/Sales)x 100%

Cost/sales ratios
Profitability may also be measured by cost/sales ratios, such as: Ratio of cost of sales : sales; Ratio of
administration costs : sales; Ratio of sales and distribution costs : sales; Ratio of total labour costs:
sales
Asset Turnover = (Total Sales / Capital Employed) x 100%
Earnings per share (EPS) = Profits available to ordinary shareholder / Number of ordinary shares
Return on capital employed (ROCE) = (Profit Before Interest & Tax /Capital Employed ) x 100%
A comparison of the ROCE with current market borrowing rates
We may analyse the ROCE, to find out why it is high or low, or better or worse than last year. There
are two factors that contribute towards a return on capital employed, both related to turnover.
Profit margin. A company might make a high or a low profit margin on its sales.
Asset turnover. Asset turnover is a measure of how well the assets of a business are being used to
generate sales.
Profit Margin x Asset Turnover = ROCE

Financial Risk
Debt ratios
Gearing ratio (leverage) = (Long term debt/ Share capital and reserves) x 100%
Or (Long term debt/ Share capital and reserves plus long term debts) x 100%
Interest cover ratio = Profit before interest and tax / Interest charges in the year
Liquidity Ratios
Current Ratio = Current Assets / Current Liabilities [Ideal 2 times]
Quick Ratio = Current Assets excluding inventory / Current Liabilities [Ideal 1 times]
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Receivable Turnover Ratio (RTR) = Credit Turnover or Turnover/Avg. Receivables

Receivable Collection Period: (Avg. Receivables/Turnover) x Period or Period/RTR

Inventory Turnover Ratio (ITR) = (Cost of Sales/ Avg. Inventory) x Period

Inventory Turnover Period = (Inventory / Cost of Sales) x Period
Payable Turnover Ratio (PTR): (Credit Purchases/ Avg. Trade Payables) x Period
Payable Payment Period: (Trade Payables/ Credit Purchases) x Period or Period/ PTR
Period means:
365 or 360 if days are given; 12 if months are given

Practice Problems:
a) The current ratio of BM Ltd. Is 2:1. While quick ratio is 1.80:1. If the current liabilities are $40,000,
what will be the value of Inventory?
Hints: $ 8,000

b) The average period of credit allowed by a company which has an annual credit sales of $120 million
is one month. By reducing the period of credit to half-a-month, sales fall to $ 108 million. Find the fall
in average amount of debtors.
Hints: $550,000

c) The budgeted annual sales of a firm is $ 80 million and 25% of the same is cash sales. If the average
amount of debtors of the firm is $ 5 million, find the average collection period of credit sales.
Hints: Collection period = 5 / 60 year or 1 month.

d) The average period of credit allowed by a company to its customers last year was one month and the
average amount of debtors was $ 10 million. To increase sales and profitability the company doubled
the period of credit during the current year. As a result the average amount of debtors increased to $ 25
million. If the company has a contribution / sales ratio of 40%; what additional contribution has been
earned by the company during the current year?
Hints: Increase in contribution = $12 million

e) The following information are furnished by a company in regard to its working as on 31.03.2003:
Capital & Reserves Rs. 28 mi
Net working capital Rs. 2.8 mi
Current Ratio 2.4
Quick Ratio 1.6
Inventory Turnover Ratio (based on cost of sales) 8
Gross Profit 20%
Credit Allowed 1.5 month
Reserve amount to 40% of share capital. All sales are credit sales.
Current assets consist of, inventory, debtors and cash only.
Prepare balance sheet of the company as on 31.03.03.
Hints: PPE 25.2; Cash 1.2; Payables 2; Inventory 1.6; Receivables 2; PPE 25.2; BS Total 30

1. f) A company’s sales and cost of sales figures have remained unchanged for the last two years. The
following information has been noted: [from: June 2015, ACCA]
Year ended 31 May 2015 31 May 2014
Inventory turnover period 45 days 38 days
Payables payment period 40 days 35 days
Receivables payment period 60 days 68 days
Current ratio 1·3 1·4
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Quick ratio 1·1 1·3

The following statements have been made about the company’s performance for the most recent year:
(i) Customers are taking longer to pay and this may have contributed to the decline in the company’s
current ratio
(ii) Inventory levels have decreased and this may have contributed to the decline in the company’s
quick ratio
Which of the above statements is/are true?
A. (i) only B. (ii) only
C. Both (i) and (ii) D. Neither (i) nor (ii)
Answer: D.

g) The summarized balance sheet of R.K. Enterprises as on 31.3.2002 is given below:

Liabilitie
s Rs. Assets Rs.
Equity Capital 40,00,000 Fixed assets net 28,00,000
Reserve and Surpluses 6,00,000 Cash 2,40,000
Sundry Creditors 14,00,000 Debtors 18,60,000
Inventory 11,00,000
60,00,000 60,00,000
Other Information:
Rs.
Sales 52,00,000
Less: Cost of production of goods sold 36,00,000
Less: Cost of selling and administration 12,50,000
Net Profit 3,50,000
The current industry average of important ratios is given below:
Current ratio 2.1
Liquid ratio 1.4
Inventory turnover (Sales /
Inventory ) 10.2
Net profit / Sales 9.0
Debtors turnover 8.0
Sales / Total assets 2.0
Calculate the above ratio for R.K. Enterprise, compare the same with the inventory average and
comment.
Hints:
Industry R.K. Enterprises Comments
Current ratio 2.1 2.3 Satisfactory
Liquid
ratio 1.4 1.5 Satisfactory
Far below the standard. Debtors be
Debtors turnover 8 2.8 reduced.
Inventory turnover Far below the standard. Inventory be
ratio 10.2 4.7 reduced.
Net profit / Sales 9 6.7 Poor profitability
Sales / Total Assets 2 0.86 Poor utilisation of assets.

h) A company has following information:

2003 2004
$ mi $ mi

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Sales 180 185

EBIT 18 16.5
Interest Expenses 3.2 4.7
Tax Expenses 4.4 3.5
Profit 10.4 8.3
Capital 25 25
Reserves 45.6 48.2
8% Debenture 35 50
Payables 8.4 9.2
Total 114 132.4
Calculate following ratios and comment on the performance of the company for 2 periods:
i) Profit Margin; ii) Assets Turnover Ratio; iii) Return on Capital Employed
Hints: (i) 10%, 8.9% (ii) 1.7 times, 1.5 times (iii) 17%, 13.4%
i) Well-heeled ("WH") is a children's shoe shop located in a suburb of a major capital city. The shop
was started in 20X7, and quickly established a reputation for high quality children's shoes. There are no
other shoe shops in this particular suburb, but there is a large shopping centre in the next suburb 5
kilometers from WH with several children's shoe shops.
The retail space next door to WH became vacant at the start of 20Y0. Since this was also owned by the
same landlord, WH decided to rent this space too, expanding the area of the shop from 40 square
meters to 60.
The company employs one full-time shop assistant, and starting in 20Y0 employed an additional
assistant to work on Saturdays. The owner of WH also works in the shop, but does not take a salary for
her time.
The country in which WH is located was hit badly by an economic downturn in the first half of 20Y0,
but started to recover in the second half of 20Y0. Inflation in 20X9 and 20Y0 was 2%.
The income statements for the years 20X9 and 20Y0 are presented below:
2009 2010
$ $ $ $
Sales 180,000 240,000
Less: Cost of Sales 120,000 168,000
Gross Profit 60,000 72,000
Less: Expenses
Staff Costs 20,000 30,000
Rent 7,200 10,800
Marketing 5,000 6,000
Light and Heat 1,000 33,200 1,200 48,000
Net Profit 26,800 24,000
Required:
Assess the financial performance of the shop using the information above.

Performance Measurements – Benchmarking & TQM

Benchmarking is a process of measuring organisational performance against that
of best-in-class companies or other standards of excellence.
TQM environments use benchmarking to identify problems and improve,
develop and measure their performance in key areas. By selecting ‘standards of
excellence’ to compare against – rather than say simply an average for the industry,
the TQM principle of continuous improvement can be fulfilled.
There are many different types of benchmark - some of the main ones are
given below:

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 Competitive Benchmarking - involves comparison with competitors – this

data may be hard to obtain.
 Internal Benchmarking – comparing performance in one part of the
organisation to another part.
 Functional Benchmarking - comparing a function or area of the organisation
with the results of another organisation who are successful in that area.
 Product Benchmarking –comparing a product or service against that
produced by competitor (may require reverse engineering).

Short-termism and manipulation

Short-termism is when there is a bias towards short-term rather than long-term performance.
Organisations often have to make a trade-off between short-term and long-term objectives. Decisions
which involve the sacrifice of longer-term objectives include the following.
 Postponing or abandoning capital expenditure projects, which would eventually contribute to
growth and profits, in order to protect short term cash flow and profits.
 Cutting R&D expenditure to save operating costs, and so reducing the prospects for future
product development.

Non-Financial Performance Indicator

Non-financial performance refers to every aspect of operations within a business except the financial
aspect, and performance targets can be set for every- department throughout the entity. Some indicators
are:
 Product quality or quality of service
 Speed of order processing or speed of any other processing cycle
 Customer satisfaction
 Brand awareness amongst target customers
 Labour turnover rate
 Number of man-days of training provided for employees
 Amount of down-time with IT systems
 Number of suppliers identified for key raw material supplies
 Length of delays on completion of projects
 Capacity utilised (as a percentage of 100% capacity).

BALANCED SCORECARD

A useful approach for a complete strategic performance evaluation is to include both financial and non-
financial factors for an organisation, using the balanced scorecard. The balanced scorecard measures an
organisation’s performance in four key areas:
1. Customer satisfaction
2. Financial performance
3. Internal business process
4. Learning and growth
The justifications of balanced scorecard over the traditional measures are that:
 Accounting figures are easily manipulated and as such unreliable changes in the business and
market environment do not show in the financial results of a company until much later.
 Factors other than financial performance must therefore be targeted.

Perspective Questions Possible Measures

Customer How do customers perceive the  % Sales from new
perspective firm? customers
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 % On time deliveries
 % Orders from enquiries
 Customers survey analysis
Internal How well the business is  Unit cost analysis
business performing.  Process/cycle time
perspective What process must we excel  Value analysis
at to achieve our customer  Efficiency
and financial objectives?
Innovation and Can we continue to improve and  Number of new products
learning create value?  introduced
perspective  Time to market for new
 Products
 % sales from new products.
 Amount of training.
Financial How do we create value for  Market share.
perspective our  Profit ratio.
shareholders?  Return on investment.
 Economic value added.
 Return on capital employed.
 Cash flow.
 Share price.

Criticism
The targets for each of the four perspectives might often conflict with each other. When this happens,
there might be disagreement about what the priorities should be.
The term 'balanced' scorecard indicates that some compromises have to be made between the different
perspectives.
2. Example 1: Jamair was founded in September 2007 and is one of a growing number of low-cost
airlines in the country of Shania.
Jamair’s strategy is to operate as a low-cost, high efficiency airline, and it does this by:
- Operating mostly in secondary cities to reduce landing costs.
- Using only one type of aircraft in order to reduce maintenance and operational costs. These planes
are leased rather than bought outright.
- Having only one category of seat class.
- Having no pre-allocated seats or in-flight entertainment.
- Focusing on e-commerce with customers both booking tickets and checking in for flights online.
The airline was given an ‘on time arrival’ ranking of seventh best by the country’s aviation authority,
who rank all 50 of the country’s airlines based on the number of flights which arrive on time at their
destinations. 48 Jamair flights were cancelled in 2013 compared to 35 in 2012. This increase was due
to an increase in the staff absentee rate at Jamair from 3 days per staff member per year to 4·5 days.
The average ‘ground turnaround time’ for airlines in Shania is 50 minutes, meaning that, on average,
planes are on the ground for cleaning, refuelling, etc for 50 minutes before departing again. Customer
satisfaction surveys have shown that 85% of customers are happy with the standard of cleanliness on
Jamair’s planes.
The number of passengers carried by the airline has grown from 300,000 passengers on a total of 3,428
flights in 2007 to 920,000 passengers on 7,650 flights in 2013. The overall growth of the airline has
been helped by the limited route licensing policy of the Shanian government, which has given Jamair
almost monopoly status on some of its routes. However, the government is now set to change this
policy with almost immediate effect, and it has become more important than ever to monitor
performance effectively.
Required: For each perspective of the balanced scorecard, identify one goal together with a
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corresponding performance measure which could be used by Jamair to measure the company’s
performance. The goals and measures should be specifically relevant to Jamair. For each pair of
goals and measures, explain why you have chosen them. (9 marks) [From: December 2014, ACCA]

BUILDING BLOCK MODEL

Fitzgerald and Moon (1996) suggested that a performance management system in a service organisation
can be analysed as a combination of three building blocks. These are shown in the following diagram,
which is known as the 'building block model'. Building blocks for performance measurement systems
(Fitzgerald and Moon 1996)

External Considerations in Performance Measurement

The external factors that affect an organisation vary according to the type of organisation and the
environment in which it operates. Broad categories of external factors include:
 Political and legal developments: new laws may affect what a company is allowed to do or is not
permitted to do, and this change could affect its performance
 Economic conditions and economic developments
 Changes in public attitudes and behaviour
 Technological changes
 Competition in the market.

Stakeholders:
 The interests of each stakeholder group differ, and each group has different expectations about
what the organisation should do. They also judge its performance in different ways.
o Shareholders – wealth maximization
o Lenders – Interest Cover
o Major suppliers – Accounts payable period
o Customers – quality, service
o Employees – pay, promotion, career, satisfaction
o The government and the general public – taxes, employment, environment

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PERFORMANCE MEASUREMENT IN NOT-FOR-PROFIT ORGANIZATION (NPO)

NPO faces following problems in measuring performance measurements:

- The problem of non-quantifiable objectives – social welfare
- The problem of multiple objectives

Performance measurement in not-for-profit organisations

Not-for-profit organisations may have some non-quantifiable objectives but that fact does not exempt
them from the need to plan and control their activities.
A common method of assessing public sector performance is to assess value for money (VFM).

Value for Money

The performance of not-for-profit organisations or departments of government may be assessed on the
basis of value for money 'VFM'. Value for money is often referred to as the '3Es':
 Economy means spending within limits, and avoiding wasteful spending. It also means achieving
the same purpose at a lower expense.
 Efficiency means getting more output from available resources. Applied to employees, efficiency
is often called 'productivity'.
 Effectiveness refers to success in achieving end results or success in achieving objectives.
Whereas efficiency is concerned with getting more outputs from available resources,
effectiveness is concerned with achieving outputs that meet the required aims and objectives.
3. Example 2: Bus Co is a large bus operator, operating long-distance bus services across the country.
There are two other national operators in the country. Bus Co’s mission is to ‘be the market leader in
long-distance transport providing a greener, cleaner service for passengers nationwide’. Last month, an
independent survey of 40,000 passengers was carried out, the results of which are shown in the table
below:
Table: Bus passenger satisfaction % by national operator
Operator Overall satisfaction Value for money Punctuality Journey time
Bus * 67 80 82
Prime * 58 76 83
Express * 67 76 89
* denotes that the percentage has not yet been calculated.
The ‘overall satisfaction’ percentages, which have not yet been inserted into the table, are calculated
using a weighted average which reflects the importance customers place on each of the other three
criteria above. The weightings used are as follows:
Value for money - 40% Punctuality - 32% Journey time - 28%
The managing director (MD) of Bus Co has said: ‘Independent research has shown that our customers
are the most satisfied of any national bus operator. We are now leading the way on what matters most
to customers – value for money and punctuality.’
Required:
(a) Calculate the ‘overall satisfaction’ percentage for each operator. (2 marks)
(b) Taking into account all the data in the table and your calculations from part (a), discuss

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whether the managing director’s statement is true. (4 marks)

Required:
Briefly define ‘efficiency’ and ‘effectiveness’ and suggest one performance measure for EACH,
which would help Bus Co assess the efficiency and effectiveness of the service it provides. (4
marks) [From: December 2015, ACCA]
Hints: (a) 75.36%, 70.76% , 76.04% Efficiency - Occupancy rate of buses, Utilisation rate for buses
Effectiveness - Percentage of customers satisfied with cleanliness of buses, Percentage of carbon emissions
relative to target set

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