Purpose of performance measures
resource allocation, incentive compensation, divisional and business unit evaluation, budgeting and planning, and setting targets etc. To manage and monitor performance in many areas of the organization including: financial, customer, internal processes, employees, and suppliers.
What is strategy?
Stragegy describes how an organization uses its activities and resources to achieve its objectives. For a business, the objective is to ethically maximize financial value.
What is execution?
Execution includes the performance measures used (1) to ensure the strategy of the organization is being executed and (2) to monitor performance. To be successful, an organization must have an effective strategy and an effective execution system in place.
Performance measures are the specific ways an organization measures outcomes and activities related to achieving its strategy.
Classification of performance measures
Classfied into a number of categories. The measures can be financial or non-financial, and can include traditional performance measures found in financial statement and cost accounting systems, as well as performance measures on customer performance, supplier performance, environmental performance, etc.
Frameworks for performance measures
There are a number of different types of performance measurement system and frameworks used in organizations. Balanced scorecard and Valued-based management are evolved in 1990's.
Balanced scorecard is a strategic performance measurement and management framework for implementing strategy by translating an organization's mission and strategy into a set of performance measures. Generally 4 perspectives: Financial, Customer, Internal Business Processes, and Learning and Growth.
Value-Based Management (VBM)
VBM involves the use of value-based metrics (performance measures) in a strategic management system and as such may be viewed as a financial scorecard. ROI, economic profit, economic value added (EVA), cash flow ROI, and residual income.
When is appropriate to use EVA?
EVA is particulary useful for incentive compensation, resource allocation and investor relations. Executive compensation and incentive compensation firmwide is the most popular target of EVA.
4 perspectives of balanced scorecard?
(1) Financial (2) Customer (3) Internal Business (4) Learning and Growth
it focuses on return on investment and other supporting financial performance measures: profitability, return on invested capital, and reveue growth.
it focuese on performance in areas that are most critical to the customer: customer satisfaction and customer retention.
Internal Business Process perspective
it focuses on operating effectively and efficiently and includes performane mesures on cost, quality and time for processes that are critical to the cutomers: number of defects and cycle time.
Leaning and growth perspective
it focuses on performance measures relating to employees, infrastructure, teaming and capabilities necessary for the internal processes to achieve customer and financial objectives.: emplyee satisfaction, hours of training per employee, and IT expenditures per employee.
Components of the balanced scorecard
(1) strategic objectives (2) performance measures (3) baseline performance (4) targets (5) strategic initiatives
What is strategic objectives?
a statement of what the strategy must achieve and what is critical to its success
What is perfirmance measures
it describe how success in achieving the strategy will be measured and tracked
What is baseline performance?
The current level of performance for the performance measure
The level of performance or rate of impprovement needed in the performance measure
key action programs required to achieve strategic objectives
Difference between strategic objectives and initiatives?
Strategic objectives focus on "what" is to be achieved, while initiatives focus on "how" it will be achieved and performance measures, baseline and targets relate to how it will be measured.
Value chain in the balanced scorecard framework is the sequence of business processes in which usefulness is added to the products or services of a company, including the innovation process, operation process, and post-sales process. The value chain is one way to describe the internal process perspective in the balance scorecard and its performance measures.
Characteristics of balanced scorecard?
(1) Strategy focused, (2) balanced, (3) includes both financial and non-financial measures, (4) cause-and-effect linkages, (5) unique to the strategy
Performance measures are drived by mission, vision, and strategy. The balanced scorecard communicates the strategy to all members of the organization
in terms of financial and non-financial measures, leading and lagging measure, internal and external measures.
Performance measure are connected using cause-and-effect linkages. include performance drivers (leading indicators) and outcome performance measures (lagging indicators).
examples of financial perspective measures in the balanced scorecard
Return on investment, economic profit, economic value added (EVA), cash flow ROI, free cash flow, net income/sales ratio, revenue growth, cost of sales %
examples of customer perspective
Customer satisfaction, customer retention, customer acquisition, % of business from customer referrals
examples of internal process perspective
on-time delivery, cost per unit, % of late orders, total cost of quality, cycle time, process efficiency, inventory turnover, lead times, order backlog, inventory obsolescence, # of patents, # of technology and product partners, warranty costs, # of failures or defects, # of projects
examples of learning and growth perspective
Employee turnover, employee satisfaction and engagement, # of 6-sigma black belts, % of R&D employees, R&D expenditure as a percent to sales revenue
Return on investment. Net Income/Ave. total assets (= investments)
DuPont ROI analysis
ROI (Net Income/Ave. total assets) = [Profit Margin] (Net Income / Net Sales) x [Assets Turnover] (Net Sales/ Ave. total assets)
Net income - Inerst on investment = Net income - (rate of return x Investment, invested capital)
Economic Value Added. NOPAT (net operating profit after taxes) - (wacc x net assets) * Net assets = Total assets - Current liabilities
Net Operating Profit After Taxes
Free Cash Flow
NOPAT + Depreciation or Amortization exp - Change in net working capital - capital expenditure = Free cash flow