1. Measuring Up: Performance Reporting and Measuring
MIR 889
Andrew Graham
Queen’s University

2. Why Measure? To know how you are doing relative to: Plan Competition
Change pressures
Benchmarks
Targets
Commitments

3. Why Measure? To identify improvement opportunities.
To make decisions based on facts and data that everyone agrees on and understands
Measure changes to stakeholders wealth; put in simple terms, the value of a firm.
To be able to adjust to changing realities.

4. Limitations of Financial Performance Measures
Financial measures tend to be lag indicators -“After the fact”
Management also needs lead indicators -“Before the fact”
Lag focuses on variance, comparison to plan, ratios – all good and useful
Lead focuses on resilience, adaptation, risk and opportunity
In the past, performance measurement revolved almost entirely around financial performance. On the one hand, this focus makes sense because the ultimate goal of a company is to generate profit. On the other hand, current financial performance tends to reveal the results of past actions rather than indicate future performance. For this reason, financial measures tend to be lag indicators (after the fact), rather than lead indicators (before the fact). Management needs to know the results of past decisions, but they also need to know how current decisions may affect the future. To adequately assess the company, managers need both lag indicators and lead indicators.
Another limitation of financial performance measures is that they tend to focus on the company’s short-term achievements, rather than on long-term performance. Why is this the case? Because financial statements are prepared on a monthly, quarterly, or annual basis. To remain competitive, top management needs clear signals that assess and predict the company’s performance over longer periods of time.

5. Lead indicators as value drivers
Many non-financial indicators can serve as lead indicators in certain settings.
Common examples are:
Market share, backlog (book-to-bill ratio), new product introductions, new product development lead times, product quality, customer satisfaction, employee morale, personnel development, inventory turnover, bad debt ratio, or safety
If the organization tracks the right set of leading indicators and gives them proper importance weightings then profits do not really have to be measured (for results control purposes). The profits will inevitably follow. Empirical evidence, particularly focused on customer satisfaction, appears to support the premise that some non-financial measures are significantly associated with future financial performance and contain additional information not reflected in past financial measures.

6. Lag Indicators
In contrast to lead indicators, lag indicators are measures that point to earlier plans and their execution.
Financial performances are lag indicators.
Many times, financial performances are too late to affect future products and services.
Therefore, we need multiple measures that include both financial and non-financial measures.
For example, when analysts and other evaluators report that the products and services sold by VCB are profitable and add the VCB firm value, they are reporting lag indicators.
Remember: Lag indicators of financial performance are important and because financial performance is sometimes too late does not mean that you can ignore them or even nor measure them. Such an action would be unwise and could lead to greater difficulties in an increasingly competitive environment.

7. Performance Measurements In a Changing World
In the global, technology-driven, decentralized environment, measuring
Financial performance, while important, is not adequate.
Even if less than precise, other measures of performance are required.
These measures should be capable of measuring multiple attributes of an organization.

8. The Strategy Focused Organization
Mission – What we do
Vision – What we aspire to be
Strategies – How we accomplish our goals
Measures – Indicators of our progress

9. A Model for Strategic Planning Environmental Scan Strengths Weaknesses
Opportunities Threats
A Model for
Strategic
Planning
Values
Mission &
Vision
Strategic Issues
Strategic Priorities
Objectives, Initiatives, and Evaluation

10. Linking it all together….
Strategic Direction
Create Environment
For Change
Strategic Performance Management System
Communicate Strategies
Define Objectives
Implement BSC
Balanced Scorecard
Measure Performance
Improve Processes
Evaluate and Adjust
Continuous Improvement
Redefine Initiatives
Linking it all together….

11. The Balanced Scorecard What is it?
The Balanced Scorecard is a management tool that provides stakeholders with a comprehensive measure of how the organization is progressing towards the achievement of its strategic goals.

12. 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
The balanced scorecard recognizes that management must consider both financial performance measures and operational performance measures when judging the performance of a company and its subunits. These measures should be linked with the company’s goals and its strategy for achieving those goals.
The balanced scorecard represents a major shift in corporate performance measurement. Rather than treating financial indicators as the sole measure of performance, companies recognize that they are only one measure among a broader set. Keeping score of operating measures and traditional financial measures gives management a “balanced” view of the organization.
Management uses key performance indicators—such as customer satisfaction ratings and revenue growth—to measure critical factors that affect the success of the company.

13. 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
As shown here, key performance indicators (KPIs) are summary performance measures that help managers assess whether or not the company is achieving its goals.
KEY PERFORMANCE INDICATORS
Market share
Yield rate
Training hours
Revenue growth

14. Financial Customer Internal Business Learning and Growth
Four Perspectives
Financial
Customer
Internal Business
Learning and Growth
The balanced scorecard views the company from four different perspectives, each of which evaluates a specific aspect of organizational performance:
1. Financial perspective
2. Customer perspective
3. Internal business perspective
4. Learning and growth perspective
Companies that adopt the balanced scorecard usually have specific objectives they wish to achieve within each of the four perspectives. Once management clearly identifies the objectives, they develop KPIs that will assess how well the objectives are being achieved. To focus attention on the most critical elements and prevent information overload, management should use only a few KPIs for each perspective.

15. Financial Perspective
How do we look to shareholders?
Ultimate goal is to generate income for owners
KPIs:
Sales revenue growth
Gross margin growth
Return on investment
Working capital used
Financial Ratio Analysis
Performance relative to expectations
Industry comparisons
The financial perspective helps managers answer the question, “How do we look to shareholders?” The ultimate goal of companies is to generate income for their owners. Therefore, company strategy revolves around increasing the company’s profits through increasing revenue growth and increasing productivity. Companies grow revenue through introducing new products, gaining new customers, and increasing sales to existing customers. Companies increase productivity through reducing costs and using the company’s assets more efficiently. Managers may implement seemingly sensible strategies and initiatives, but the test of their judgment is whether these decisions increase company profits. The financial perspective focuses management’s attention on KPIs that assess financial objectives, such as revenue growth and cost cutting. Some commonly used KPIs include: sales revenue growth, gross margin growth, and return on investment.

16. Customer Perspective How do customers see us? Customer concerns: KPIs:
Top priority for long-term success
Customer concerns:
Product price
Product quality
Sales service quality
Product delivery time
KPIs:
Customer satisfaction
Market share
Number of customers and repeat customers
Rate of on-time deliveries
The customer perspective helps managers evaluate the question, “How do customers see us?” Customer satisfaction is a top priority for long-term company success. If customers are not happy, they will not come back. Therefore, customer satisfaction is critical to achieving the company’s financial goals outlined in the financial perspective of the balanced scorecard. Customers are typically concerned with four specific product or service attributes: (1) the product’s price, (2) the product’s quality, (3) the sales service quality, and (4) the product’s delivery time (the shorter, the better). Since each of these attributes is critical to making the customer happy, most companies have specific objectives for each of these attributes.
Businesses commonly use KPIs, such as customer satisfaction ratings, to assess how they are performing on these attributes. No doubt you have filled out a customer satisfaction survey. Because customer satisfaction is crucial, customer satisfaction ratings often determine the extent to which bonuses are granted to restaurant managers. Other typical KPIs include percentage of market share, increase in the number of customers, number of repeat customers, and rate of on-time deliveries.

17. Internal Business Perspective
At what business processes must we excel?
Three factors:
Innovation
KPI: Number of new products developed
Operations
KPIs:
Product efficiency – number of units produced
Product quality – defect rate
Post-sales service
KPIs
Number of warranty claims
Average wait time on phone for customer service
The internal business perspective helps managers address the question, “At what business processes must we excel to satisfy customer and financial objectives?” The answer to this question incorporates three factors: innovation, operations, and post-sales service. All three factors critically affect customer satisfaction, which will affect the company’s financial success.
Satisfying customers once does not guarantee future success, which is why the first important factor of the internal business perspective is innovation. Customers’ needs and wants change as the world around them changes. Companies must continually improve existing products and develop new products to succeed in the future. Companies commonly assess innovation using KPIs, such as the number of new products developed or new-product development time.
The second important factor of the internal business perspective is operations. Efficient and effective internal operations allow the company to meet customers’ needs and expectations. For example, the time it takes to manufacture a product (manufacturing cycle time) affects the company’s ability to deliver quickly to meet a customer’s demand. Production efficiency (number of units produced per hour) and product quality (defect rate) also affect the price charged to the customer. To remain competitive, companies must be at least as good as the industry leader at those internal operations essential to their business.
The third factor of the internal business perspective is post-sales service. How well does the company service customers after the sale? Claims of excellent post-sales service help to generate more sales. Management assesses post-sales service through the following typical KPIs: number of warranty claims received, average repair time, and average wait time on the phone for a customer service representative.

18. Learning and Growth Perspective
How can we continue to improve and create value?
Three factors:
1) Employee capabilities
KPIs:
Hours of employee training
Employee commitment and turnover
Number of employee suggestions implemented
Dollars per worker on Workers Compensation
Sales dollars per worker
The learning and growth perspective helps managers assess the question, “How can we continue to improve and create value?” The learning and growth perspective focuses on three factors: (1) employee capabilities, (2) information system capabilities, and (3) the company’s “climate for action.” The learning and growth perspective lays the foundation needed to improve internal business operations, sustain customer satisfaction, and generate financial success. Without skilled employees, updated technology, and a positive corporate culture, the company will not be able to meet the objectives of the other perspectives.
First, because most routine work is automated, employees are freed up to be critical and creative thinkers who therefore can help achieve the company’s goals. The learning and growth perspective measures employees’ skills, knowledge, motivation, and empowerment. KPIs typically include hours of employee training, employee satisfaction, employee turnover, and number of employee suggestions implemented.
Second, employees need timely and accurate information on customers, internal processes, and finances; therefore, other KPIs measure the maintenance and improvement of the company’s information system. For example, KPIs might include the percentage of employees having online access to information about customers, and the percentage of processes with real-time feedback on quality, cycle time, and cost.
Finally, management must create a corporate culture that supports communication, change, and growth.

19. Learning and Growth Perspective
2) System capabilities
KPIs:
Percentage of employees with online access to customer data
Percentage of processes with real-time feedback
3) Company’s climate for action
A balance of responsibility and authority
The learning and growth perspective helps managers assess the question, “How can we continue to improve and create value?” The learning and growth perspective focuses on three factors: (1) employee capabilities, (2) information system capabilities, and (3) the company’s “climate for action.” The learning and growth perspective lays the foundation needed to improve internal business operations, sustain customer satisfaction, and generate financial success. Without skilled employees, updated technology, and a positive corporate culture, the company will not be able to meet the objectives of the other perspectives.
First, because most routine work is automated, employees are freed up to be critical and creative thinkers who therefore can help achieve the company’s goals. The learning and growth perspective measures employees’ skills, knowledge, motivation, and empowerment. KPIs typically include hours of employee training, employee satisfaction, employee turnover, and number of employee suggestions implemented.
Second, employees need timely and accurate information on customers, internal processes, and finances; therefore, other KPIs measure the maintenance and improvement of the company’s information system. For example, KPIs might include the percentage of employees having online access to information about customers, and the percentage of processes with real-time feedback on quality, cycle time, and cost.
Finally, management must create a corporate culture that supports communication, change, and growth.

20. Performance Reports
Report financial performance of responsibility centers
Cost center
Difference between actual results and budget
Changes in labor dollars or hours
Changes in purchased price vs. quantity discount
Revenue center
Variance due to selling more or less units than expected
Variance due to price changes
Profit center
Focus on both revenue and cost variances
Responsibility accounting performance reports capture the financial performance of cost, revenue, and profit centers. Responsibility accounting performance reports compare actual results with budgeted amounts and display a variance, or difference, between the two amounts. Because cost centers are only responsible for controlling costs, their performance reports only include information on actual versus budgeted costs. Cost center performance reports typically focus on the flexible budget variance—the difference between actual results and the flexible budget.
Likewise, performance reports for revenue centers only contain actual versus budgeted revenue. Revenue center performance reports often highlight both the flexible budget variance and the sales volume variance. The sales volume variance is due strictly to volume differences—selling more or fewer units than originally planned. The flexible budget variance, however, is due strictly to differences in the sales price—selling units for a higher or lower price than originally planned. Both the sales volume variance and the flexible budget variance help revenue center managers understand why they have exceeded or fallen short of budgeted revenue.
However, profit centers are responsible for both controlling costs and generating revenue. Therefore, their performance reports contain actual and budgeted information on both their revenues and costs.

21. Performance Reports Management by exception
Only material variances are investigated
Should focus on information, not blame
Some variances are uncontrollable
Example: increase in costs due to a natural disaster
Managers use management by exception to determine which variances in the performance report are worth investigating. For example, management may only investigate variances that exceed a certain dollar amount (for example, over $1,000) or a certain percentage of the budgeted figure (for example, over 10%). Smaller variances signal that operations are close to target and do not require management’s immediate attention.
Regardless of the type of responsibility center, performance reports should focus on information, not blame. Analyzing budget variances helps managers understand the underlying reasons for the unit’s performance. Once management understands these reasons, it may be able to take corrective actions.
But some variances are uncontrollable. Managers should not be held accountable for conditions they cannot control. Responsibility accounting can help management identify the causes of variances, thereby allowing them to determine what was controllable, and what was not.

22. Performance Reporting
Variances
Differences between budgeted and actual amounts.
Audit
A systematic process of objectively obtaining and evaluating evidence of the firm’s performance, judging the accuracy and validity of the data, and communicating the results to interested users.
Financial Ratio
An arithmetic comparison of one financial measure to another, generally used to monitor and control financial performance.

23. Example of a Performance Report

24. Widely Used Financial Ratios

25. Widely Used Financial Ratios

26. Widely Used Financial Ratios
FIGURE 14–7c
May 16, 2006
LIS580- Spring 2006
G.Dessler, 2003

27. Widely Used Financial Ratios

28. Ratio Analysis: Factors Affecting Return on Investment

29. Caution Ratios are valuable, but…..
They do not provide answers in an of themselves and are not predictive
They should be used with other elements of financial analysis
There are no “rules of thumb” that apply to interpretation of ratios

30. Limitations of Performance Measures
Measurement issues
Total asset figure in equation
Nonproductive assets
Gross book value vs. net book value
Depreciation may artificially inflate measures
Short-term focus
Figures are for a one-year time frame
Incentive to management to cut essential spending to increase measurement
Performance measures have drawbacks that management must keep in mind when evaluating the financial performance of investment centers.
Measurement Issues: The ROI, RI, and EVA calculations appear to be very straightforward; however, management must make some decisions before these calculations can be made. For example, all three equations use the term total assets. Recall that total assets is a balance sheet figure, which means that it is a snapshot at any given point in time. Because the total assets figure will be different at the beginning of the period and at the end of the period, most company’s choose to use a simple average of the two figures in their ROI, RI, and EVA calculations.
Management must also decide if it really wants to include all assets in the total asset figure. Many firms are continually buying land on which to build future retail outlets. Until those stores are built and opened, the land (including any construction in progress) is a nonproductive asset, which is not adding to the company’s operating income. Including nonproductive assets in the total asset figure will naturally drive down the ROI, RI, and EVA figures. Therefore, some firms will not include nonproductive assets in these calculations.
Another asset measurement issue is whether to use the gross book value of assets (the historical cost of the assets), or the net book value of assets (historical cost less accumulated depreciation). Many firms will use the net book value of assets because the figure is consistent with and easily pulled from the balance sheet. Because depreciation expense factors into the firm’s operating income, the net book value concept is also consistent with the measurement of operating income. However, over time, the net book value of assets decreases, because accumulated depreciation continues to grow until the assets are fully depreciated. Therefore, ROI, RI, and EVA get larger over time simply because of depreciation rather than from actual improvements in operations. In addition, the rate of this depreciation effect will depend on the depreciation method used.
In general, calculating ROI based on the net book value of assets gives managers incentive to continue using old, outdated equipment because its low net book value results in a higher ROI. However, top management may want the division to invest in new technology to create operational efficiency (internal business perspective of the balanced scorecard) or to enhance its information systems (learning and growth perspective). The long-term effects of using outdated equipment may be devastating, as competitors use new technology to produce and sell at lower cost. Therefore, to create goal congruence, some firms prefer calculating ROI based on the gross book value of assets. The same general rule holds true for RI and EVA calculations: All else being equal, using net book value will increase RI and EVA over time.
Short-Term Focus: One serious drawback of financial performance measures is their short-term focus. Companies usually prepare performance reports and calculate ROI, RI, and EVA figures over a one-year time frame or less. If upper management uses a short time frame, division managers have an incentive to take actions that will lead to an immediate increase in these measures, even if such actions may not be in the company’s long-term interest (such as cutting back on R&D or advertising). On the other hand, some potentially positive actions considered by subunit managers may take longer than one year to generate income at the targeted level. Many product life cycles start slow, even incurring losses in the early stages, before generating profit. If managers are measured on short-term financial performance only, they may not introduce new products because they are not willing to wait several years for the positive effect to show up.
The limitations of financial performance measures confirm the importance of the balanced scorecard. The deficiencies of financial measures can be overcome by taking a broader view of performance, including KPIs from all four balanced scorecard perspectives, rather than concentrating on only the financial measures.