P2 – Advanced Management Accounting CH7 – Alternative measures of performance Page 1 Chapter 7 Alternative measures of performance Chapter learning objectives: Lead Component Indicative syllabus content B.2 Discuss issues arising from the use of performance measures and budgets for control. (a) Prepare performance reports for the evaluation of projected and actual performance. • Key metrics for the assessment of financial consequences including profitability, liquidity and asset turnover ratios, return on investment, residual income and economic value. • Benchmarking. • Analysis of reporting by dimension (e.g. segment, product, channel). (b) Discuss traditional and non-traditional approaches to performance measurement. • Non-financial performance indicators. • Balanced Scorecards (BSC). (c) Discuss the criticisms and behavioural aspects of budgeting in responsibility centres. • Behavioural issues in budgeting: participation in budgeting and its possible beneficial consequences for ownership and motivation; participation in budgeting and its possible adverse consequences such as ‘budget padding’ and manipulation; setting budget targets for motivation; implications of setting standard costs etc. • Criticisms of budgeting and the arguments for and against ‘beyond budgeting’.
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P2 – Advanced Management Accounting CH7 – Alternative measures of performance
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Chapter 7 Alternative measures of performance Chapter learning objectives: Lead Component Indicative syllabus content
B.2 Discuss issues arising from the use of performance measures and budgets for control.
(a) Prepare performance reports for the evaluation of projected and actual performance.
• Key metrics for the assessment of financial consequences including profitability, liquidity and asset turnover ratios, return on investment, residual income and economic value.
• Benchmarking.
• Analysis of reporting by dimension (e.g. segment, product, channel).
(b) Discuss traditional and non-traditional approaches to performance measurement.
(c) Discuss the criticisms and behavioural aspects of budgeting in responsibility centres.
• Behavioural issues in budgeting: participation in budgeting and its possible beneficial consequences for ownership and motivation; participation in budgeting and its possible adverse consequences such as ‘budget padding’ and manipulation; setting budget targets for motivation; implications of setting standard costs etc.
• Criticisms of budgeting and the arguments for and against ‘beyond budgeting’.
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1. Non-financial performance indicators
Problems with financial performance indicators • Do not identify the causes of performance, only the effect of it.
• Focus only on variables that can be expressed in monetary terms, ignoring other important variables that cannot be expressed in monetary terms.
• Focus on the past.
• Do not convey the full picture of a company's performance in a modern business environment, e.g. quality, customer satisfaction.
• Focus on the short term.
NON-FINANCIAL PERFORMANCE INDICATORS Non-financial performance indicators are measures of performance based on non-financial information that may originate in and be used by operating departments to monitor and control their activities without any accounting input. CIMA Terminology
As with all performance indicators, the most effective NFPIs will be both specific and measurable.
EXAMPLES OF NON-FINANCIAL PERFORMANCE INDICATORS (NFPIS)
Competitiveness
• Information can be obtained by carrying out regular market surveys on both internal
and external sources and using these to compile reports.
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Activity level
• Information is drawn mainly from internal sources.
Productivity
• Information is drawn mainly from internal sources.
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Quality of service
• The most relevant information would be from internal sources.
• This could be reinforced by periodic customer survey.
Customer satisfaction
• Relevant information comes from customer surveys.
• Internal sources can also be helpful.
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Quality of staff experience
• Information can be taken from internal sources; much would come from colleges and
external trainers.
• Exit interviews and confidential staff opinion surveys are also helpful.
Innovation
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2. Benchmarking The establishment through data gathering of targets and comparators, permitting relative levels of performance and particular areas of underperformance to be identified. The adoption of identified best practices should improve performance.
Reasons for benchmarking • To become aware of the need for change
• Learning from others in order to improve performance
• Gaining a competitive advantage in the private sector
• Improving services in the public sector
Different types of benchmarking Internal benchmarking
• Internal benchmarking is a process in which a company or an organisation looks within its own business to try and determine the best practice or methodology for conducting a particular task.
• The aim is to find the best practice available to get the job done with minimum effort or resources.
• The idea is to benchmark processes across the organisation, leading to more efficiency.
• It leads to continuous improvement, which in turn leads to increased efficiency.
• It identifies those divisions of a business that are doing well and study their practices, which makes them more efficient than other sites. Once that is done, internal benchmarking begins with setting some level of a performance metric that a company wants a certain division of the business to reach.
Test Your Understanding 1 ABC Company wants to compare warehousing and shipping of products from one site of the company to warehousing and shipping of a product from a different warehouse of the company.
This is an example of: A. Competitive benchmarking
B. Internal benchmarking
C. Metric benchmarking
D. Diagnostic benchmarking
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Competitive benchmarking • Competitive benchmarking is a process of comparing your company against a number
of competitors using a set collection of metrics.
• It is used to measure the performance of a company and compare it to others over time.
• It includes looking at the practices behind these metrics. This means companies can look to define ‘best practice’ for specific metrics and compare this to their own approach.
• A competitor’s product might be dismantled in order to learn about its internal design and performance. This technique of benchmarking is called reverse engineering.
Functional benchmarking • Functional benchmarking is a comparison to similar or identical practices within the
same or similar functions outside the immediate industry.
• Functional benchmarking is carried out with organisations that are not direct competitors.
Test Your Understanding 2 A fast food restaurant operator is comparing its buying function with buying in a supermarket chain. This is an example of:
A. Functional benchmarking
B. Competitive benchmarking
C. Generic benchmarking
D. Internal benchmarking
Strategic benchmarking • Strategic benchmarking is a form of competitive benchmarking aimed at reaching
decisions for strategic actions and organisational change.
• Companies in the same industry might agree to join a collaborative benchmarking process managed by an independent third party such as a trade organisation.
o Each company in the scheme submits data about their performance to the scheme organiser.
o The organiser calculates average performance figures for the industry as a whole from the data supplied.
o Each participant in the scheme is then supplied with the industry average data, which it can use to assess its own performance.
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Other approaches to benchmarking Metric benchmarking:
• The practice of comparing appropriate metrics to identify possible areas of improvement.
Process benchmarking:
• The practice of comparing processes with a partner as part of an improvement process.
Diagnostic benchmarking:
• The practice of reviewing the processes of a business to identify those that indicate a problem and offer a potential for improvement.
3. The Balanced Scorecard
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• The scorecard is 'balanced' in the sense that managers are required to think in terms of all four perspectives to prevent improvements being made in one area at the expense of another.
• The balanced scorecard (BSC) is a strategic planning and management system that organisations use to:
- Communicate what they are trying to accomplish
- Align the day-to-day work that everyone is doing with strategy
- Prioritise projects, products, and services
- Measure and monitor progress towards strategic targets
The system connects the dots between big picture strategy elements such as
• mission (our purpose)
• vision (what we aspire to)
• core values (what we believe in)
• strategic focus areas (themes, results and/or goals)
• initiatives (projects that will help us reach our targets)
Test Your Understanding 3 In which of the four perspectives of a balanced scorecard is the objective “increase the percentage of the products that give 80% of sales” most likely to fall?
A. Learning and growth perspective
B. Financial perspective
C. Customer perspective
D. Internal business process perspective
Test Your Understanding 4 In which of the four perspectives of a balanced scorecard is the objective “reduce unit cost” most likely to fall?
A. Internal business process perspective
B. Financial perspective
C. Learning and growth perspective
D. Customer perspective
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4. Beyond budgeting • Due to criticism of the annual budgeting process, some companies have adopted a
beyond budgeting approach where, instead of preparing traditional budgets and measuring the performance of managers against budget targets, performance is measured using ‘market-related targets’.
• The operation of an organisation can be meaningfully planned-for in some detail for an extended period into the future.
• This plan can be used to guide, control and coordinate the activities of numerous departments and individuals within the organisation.
J Hope and R Fraser define beyond budgeting as a generic name given to a body of practices intended to replace budgeting as a management model. The core concept is the need to move from a business model based on centralised organisational hierarchies to one based on devolved networks.
CIMA defines beyond budgeting as the idea that companies need to move beyond budgeting because of the inherent flaws in the budgeting process, especially when used to set incentive contracts. It is argued that a range of techniques such as rolling forecasts and market-related targets can take the place of the traditional budget.
6 principles of beyond budgeting A BB implementation should incorporate the following 6 principles:
1. The organisational structure should have clear principles and boundaries.
2. Managers should be given goals and targets that are based on relative success and linked to shareholder value.
3. Managers should be given a high degree of freedom to make decisions – a BB organisational chart should be flat.
4. Responsibility for decisions that generate value should be placed with front-line teams. This is consistent with TQM and BPR.
5. Front-line teams should be made responsible for relationships with customers, associated business and suppliers. Direct communication between all parties should be facilitated. This is consistent with the SCM concept.
6. The information support system should be transparent and ethical.
Benefits of beyond budgeting Weaknesses of beyond budgeting
Faster response time Requires a large initial investment of time Higher staff motivation Better innovation
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Improved communication Operational management may not have the skills to make congruent strategic decisions Better customer relationships
Improved customer and supplier loyalty Lower costs Failure to meet benchmarks can be
demotivating More accurate forecasts Consistent with TQM and BPR
Test Your Understanding 5 A faster response time and lower costs are benefits of:
A. TQM
B. SCM
C. Beyond budgeting
D. The balanced scorecard
5. Solutions to Test Your Understanding Questions
Test Your Understanding 1 Correct option: B
ABC Company is using internal benchmarking since it wants to compare the warehousing and shipping of products from one site of the company with a different warehouse in the company, not with another company.
Test Your Understanding 2 Correct option: A Since a supermarket chain is not a direct competitor of the fast food chain but the two tend to operate in a similar industry, this is an example of functional benchmarking.
Test Your Understanding 3 Correct option: A Increasing the percentage of the products that make up 80% of the sales is an objective that would appear in the learning and growth perspective.
Test Your Understanding 4 Correct option: A
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Reducing the unit cost is an objective that would appear in the internal business process perspective.
Test Your Understanding 5 Correct option: C A faster response time and lower costs are benefits of beyond budgeting.
