Financial and Non Financial performance measurements Financial and Non-Financial Performance Measurements Performance measurement is the comparison of actual performance to expected performance, to evaluate where organization objectives are being met. Performance measurement ensures that what gets measured gets improved. It focuses attention on the items measured. Poorly designed measures can result in misguided decisions. Financial Performance Measures (or Financial Performance Indicators FPI) Financial performance measurement is evaluation of the performance of an entity, based on monetary values e.g profitability, sales, costs, asset value etc. Ratio analysis is applied on “Statement of Financial Position” and “Income statement” values to compute profitability ratios (e.g gross profit margin, net profit margin), liquidity ratios (e.g current ratio, acid test ratio), efficiency ratios (e.g asset turnover, days in inventory, payables period, receivables period), investor ratios (e.g price earnings ratio) and risk ratios (gearing, interest cover) Ratios are comparative measures i.e to have meaning they must be compared with ratios of previous periods, or ratios of competitors, or industry averages etc. Non- Financial Performance Indicators (NFPIs) Not every aspect of a business can be measured using monetary terms, this is true especially for qualitative aspects of a business e.g customer satisfaction, innovation, employee involvement, literacy levels. NFPIs use non-monetary values to measure performance. NFPIs tend to reflect the long term condition of the company. Long lasting effects are generated when NFPIs are used in decision making. Many companies believe NFPIs are important, nonetheless few companies employ NFPIs in practice. The infrequent utilization of NFPIs is due to either: difficulty in measuring qualitative aspects, or lack of systems that record NFPI data, or simply due to resistance to change. Several ideas can be used to measure NFPIs but none can be comprehensive enough. For example: Qualitative aspect Customer satisfaction Level of security Reliability Product quality Innovativeness Areas to be assessed (goals) Financial Return to Shareholders Maintain High Market Share To be known as responsible employer To Grow and Survive autonomously Examples of NFPIs/ or measures No of Repeat customers; No. of customer complaints; No. of returned goods Number of breaches; amount spent on security; No. of successful drills No. of complaints; No. of returned goods No. of repeat customers; customer survey No. of new products; amount spent in research Measures of performance Earnings per share; return on investment, net profit margin Number of customer switching from our product to competitors, sales growth relative to competitors, number of new customers Ranking by external bodies; staff survey; turnover rate Profit growth; return on capital employed; sales growth Issues in Using Financial Performance Measures to Measure Performance Short-termism. If a reward is based on these measures a manager could act in a dysfunctional manner in order to improve the measure but to the detriment of the business in the long run. For instance to improve ROCE a manager could fail to invest for him to reduce capital employed but increase ROCE. Manipulation of results. Creative accounting could be used to manipulate the figures reported in the financial reports. Static position. The ratios by using financial reports reflect only the position at one point in business, and not representative of the position throughout the year. Comparative measures. They can only be assessed in comparison to other periods, companies or industry measures. They cannot be used in isolation. Red flag. They do not give a definitive answer as to what the problem is but rather points out areas for further investigations. Concentration on too few variables. Performance measurement systems focus entirely on those items which can be expressed in monetary terms; managers will concentrate on only those variables and ignore other important variables that cannot be expressed in monetary terms. Performance reports should therefore include not only costs and revenues but other important variables, to give an indication of expected future results from present activity. Lack of information on quality Traditional responsibility accounting systems also fail to provide information on the quality or importance of operations. It is important to measure failure rates and other measures of quality. Financial measures do not convey the full picture of a company’s performance, especially in a modern business environment. In today’s worldwide competitive environment companies are competing in terms of product quality, delivery, reliability, after sales service and customer satisfaction. None of these variables is directly measured by the traditional responsibility accounting system, despite the fact that they represent the major goals of world class manufacturing systems. Models for Measuring Organizational Performance Several models have been developed to measure holistic performance of organizations using a combination of FPI and NFPIs. These models include: The balanced scorecard, the building block model and value based management (VBM). 1. The Balanced Scorecard (BSC) This is a performance measure that tends to encourage a behavior that is consistent with organization’s strategy i.e gets rid of dysfunctional behavior. It creates a performance measurement framework that is used to clarify, communicate and manage strategy. To ensure that the measurement is holistic, the balanced scorecard focuses on four main perspectives. Financial. How do we create values for our shareholders? The goal under this perspective could be set as, increase net profit margin, increase revenue, increase market share. Customer. How can we increase customer value? Improve how they view us? Goals could include increase the number of new and returning customers, customer service, low price, on time services. Internal business process. Which processes should we excel at to meet our customer and financial objectives? Automate invoicing, reduce heating process by 2 days. Innovation and learning. How can we ensure continued improvement to create future value? Training staff. The steps in the process of developing a BSC are: o Identify the key outcomes critical to the success of the organisation. o Identify the processes that lead to these outcomeso Develop key performance indicators for these processes (these are sometimes termed metrics). o Develop reliable data capture and measurement systems. o Develop a mechanism for reporting these to the relevant managers and staff. o Enact improvement programmes to ensure that performance improves. Advantages Focuses on both financial and non financial factors. This will give sustainable, long-term success It provides external and internal information Can assist in 'driving down' the corporate strategy to divisions and functions: o by forcing them to develop success measures for their function related to corporate goals; o by providing them with control information to modify their behaviour. Can assist stakeholders in evaluating the firm if measures are communicated externally Disadvantages - - - - It’s hard to select some performance measures e.g customer satisfaction It may difficult to obtain some information/data Could lead to information overload if many measures are chosen Does not lead to a single aggregate summary control. The popularity of measures such as ROI has been because they conveniently summarize 'how things are going'. Measures may give conflicting signals and confuse management. For example, if customer satisfaction is falling together with the financial indicators, do management sacrifice one or the other? Involves substantial shifts in corporate culture to implement: o the need to shift to understanding the business as a set of processes rather than departments; o need for a system of identifying value-adding as well as cost-adding activities; potential subjugation of short-term financial measures to longer-term strategic measures; a change to the role of performance measures from a command and control approach based on responsibility to an information provision approach.
