Performance Evaluation and the Balanced Scorecard Chapter 23

Explain why and how companies decentralize Learning Objective 1 Explain why and how companies decentralize

Decentralized Operations Companies decentralize as they grow Split operations into different divisions or operating units Top management delegates decision-making to unit managers Copyright (c) 2009 Prentice Hall. All rights reserved.

Advantages and Disadvantages of Decentralization Copyright (c) 2009 Prentice Hall. All rights reserved.

Advantages Outweigh Disadvantages Copyright (c) 2009 Prentice Hall. All rights reserved.

Responsibility Centers Manager is responsible for: Cost center ? Revenue center Profit center Investment center Copyright (c) 2009 Prentice Hall. All rights reserved.

Explain why companies use performance evaluation systems Learning Objective 2 Explain why companies use performance evaluation systems

Performance Measurement When companies decentralize, top management needs a system to communicate goals to subunit managers Copyright (c) 2009 Prentice Hall. All rights reserved.

Limitations of Financial Performance Measures Financial measures tend to be lag indicators Management also needs lead indicators Tendency to focus on short-term achievements Copyright (c) 2009 Prentice Hall. All rights reserved.

Learning Objective 3 Describe the balanced scorecard and identify key performance indicators for each perspective

Balanced Scorecard Management must consider both financial and operational performance measures Measures should be linked with company goals and strategy Financial measures are only one measure among many Uses key performance indicators Copyright (c) 2009 Prentice Hall. All rights reserved.

Examples of critical factors and corresponding KPIs COMPANY GOALS Examples of critical factors and corresponding KPIs CRITICAL FACTORS Customer satisfaction Operational efficiency Employee excellence Financial profitability KEY PERFORMANCE INDICATORS Market share Yield rate Training hours Revenue growth Copyright (c) 2009 Prentice Hall. All rights reserved.

Four Perspectives Financial Customer Internal Business Learning and Growth Copyright (c) 2009 Prentice Hall. All rights reserved.

Financial Perspective How do we look to shareholders? KPIs: Sales revenue growth Gross margin growth Return on investment Copyright (c) 2009 Prentice Hall. All rights reserved.

Customer Perspective How do customers see us? Customer concerns: KPIs: Customer satisfaction Market share Number of customers and repeat customers Rate of on time deliveries Copyright (c) 2009 Prentice Hall. All rights reserved.

Internal Business Perspective At what business processes must we excel? Three factors: Innovation Operations Post-sales service Copyright (c) 2009 Prentice Hall. All rights reserved.

Learning and Growth Perspective How can we continue to improve and create value? Three factors: Employee capabilities System capabilities Company’s climate for action Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-15, letters a thru k Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-15, letters l thru w Copyright (c) 2009 Prentice Hall. All rights reserved.

Use performance reports to evaluate cost, revenue, and profit centers Learning Objective 4 Use performance reports to evaluate cost, revenue, and profit centers

Performance Reports Report financial performance of responsibility centers Cost center Revenue center Profit center Copyright (c) 2009 Prentice Hall. All rights reserved.

Performance Reports Management by exception Should focus on information, not blame Some variances are uncontrollable Copyright (c) 2009 Prentice Hall. All rights reserved.

Use ROI, RI, and EVA to evaluate investment centers Learning Objective 5 Use ROI, RI, and EVA to evaluate investment centers

Investment Centers Performance measures: Return on investment (ROI) Residual income (RI) Economic value added (EVA) Copyright (c) 2009 Prentice Hall. All rights reserved.

Return On Investment (ROI) ? ROI ? ? ? ROI Copyright (c) 2009 Prentice Hall. All rights reserved.

ROI ? Profit margin ? ? Capital turnover ? Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-18 ? % ? % Operating income ROI Total assets Residential ? % $63,700 $196,000 Professional $162,400 ? % $406,000 Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-18 (continued) Operating income Profit margin Sales Residential $63,700 ? % $580,000 Professional $162,400 ? % $1,100,000 Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-18 (continued) Capital turnover Sales Total assets Residential $580,000 ? $196,000 Professional $1,100,000 ? $406,000 Copyright (c) 2009 Prentice Hall. All rights reserved.

Exercise 23-18 (continued) Profit margin Capital turnover ROI Residential ? % 2.96 10.98% Professional 2.71 ? % 14.76% Copyright (c) 2009 Prentice Hall. All rights reserved.

Residual Income (RI) Compares division’s operating income with minimum operating income expected given the size of the division’s assets Copyright (c) 2009 Prentice Hall. All rights reserved.

Residual Income RI ? Minimum acceptable income minus Minimum acceptable income Minimum acceptable income ? Total assets Copyright (c) 2009 Prentice Hall. All rights reserved.

Residual Income Advantages Promotes goal congruence better than ROI Incorporates management’s minimum required rate of return Can use different target rates of return for divisions with different levels of risk Copyright (c) 2009 Prentice Hall. All rights reserved.

Economic Value Added (EVA) Special type of RI calculation Considerations: Income available to stakeholders Assets used to generate income for stakeholders Minimum rate of return required by stakeholders Copyright (c) 2009 Prentice Hall. All rights reserved.

Economic Value Added EVA ? Total assets Current liabilities ? % minus Copyright (c) 2009 Prentice Hall. All rights reserved.

Advantages of Performance Measures Return on investments Residual income Economic value added Copyright (c) 2009 Prentice Hall. All rights reserved.

Limitations of Performance Measures Measurement issues Short-term focus Copyright (c) 2009 Prentice Hall. All rights reserved.

End of Chapter 23