Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Performance Management
About the Paper
This is one of the Most Interesting and tough Courses in Skills Level, as Some of Us Might Have Known
This Before and One Of The Difficult paper To Do In An Online Platform Like this because of the
Calculative Nature of It and It's Technicality. Even in Physical Classes, IT used to Be Confusing, talk less
of Mere Online Class, which Is Not Audio Visual. But, In Shaaa Allah.... We are Gonna Try Our Best To
Give You The Best. May Allah Crown Our Efforts with Success.
The Syllabus at a glance
➢ Section A - Cost planning
20% of the Syllabus
This Contains Chapter 1 - 5.
And the Major Topics we have here are:
▪
➖ Modern Mgt Accounting Techniques (ABC, Target Costing, Life Cycle Costing, Through Put
Accounting, Backflush Accounting, Environmental Accounting, Kaizen Accounting)
▪
➖ Learning Curve Theory
▪
➖ Quality Cost (A New Topic)
➢ Section B - Planning and Control
20% of the Syllabus
This comprises of Chapters 6 - 8 of the Pack.
Where we have 2 Major Topics
▪
➖Budgetary and Budg. Control, and
▪
➖Variance Analysis
➢ Section C - Performance Mgt and Control
20% of the Syllabus.
This Covers Chapter 9 - 12
▪
➖Performance Analysis (Written)
▪
➖Transfer Pricing (One of the Most Confusing Topics in PM, If not The Most)
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➖Divisional Performance.
➢ Section D - Decision Making
30% of the Syllabus
This Covers from Chapter 13 - 27.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
The Bulk of the Topics in the Course are from here:
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Relevant Costing Techniques
▪
Short Term Decision Making Techniques.
▪
Linear Programming
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Pricing Techniques
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Risk and Uncertainties
▪
Working Capital Management
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Capital Budgeting Decision
➢ Section E - Strategic Models
This covers 5% of the Syllabus
This comprises of chapter 28 only
All the models covered in CSME. This Part is Purely Written.
➢ Section F - Mgt Info. Systems and Project Mgt
This covers 5% of the Syllabus
Chapters 29 &30.
Purely written as well.
That Analysis is Very important and Needful. As a Student, you should know what you are going into and
how you should Capture it. As a Facilitator, That's the 1st thing I use to do for all Courses and it worked
for Me as a Student. So, if it worked for me, it will definitely work for you as well. It makes students flow
better in study since each of the topics links to one another. And I will urge you guys to study in this
Format as well. It Will Help You A Lot.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Chapter 1
Introduction to strategic planning and control
Management Accounting
The overall purpose of management accounting is to provide relevant and reliable information so that
managers can make well-informed decisions. The Value of management accounting depends on the
quality of information provided and whether it helps managers make better decisions or not.
In other words, the purpose of management accounting is to provide information for:
▪ Planning
▪ Control, and
▪ Decision Making.
Those are the 3 concepts in which performance management is drawn on. Let's take them one after
another.
✍️ Planning - This includes setting objectives for the organisation and making plans to achieve those
objectives. In order to make sensible plans, information is needed. Example of plans includes budgets,
sales plans, weekly production schedules, capital expenditure plans, etc.
✍️ Control - Controlling the performance of an organisation involves monitoring actual performance to
compare with plans, then where appropriate, taking control action. Example of control exercise is that of
variance analysis.
✍️ Decision Making - The end result of planning and controlling is for managers to make informed
decisions.
Levels of strategic planning
Planning is a hierarchical activity, linking strategic planning at the top with detailed operational planning
at the bottom. According to R. N. Anthony (1965), there are 3 levels of planning in an organisation:
1. Strategic Planning
2. Tactical Planning, and
3. Operational Planning
The main focus of this chapter is strategic planning.
Process of strategic planning
1. Setting of objectives
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
2. Strategic Analysis
3. Strategic Choice
4. Evaluating strategies
5. Implementing strategies
6. Review and control
A brief explanation of each of them
✍️ A Clear objective needs to be set and this may be in form of mission statement.
✍️ Strategic Analysis - This has to do with both:
•
•
External Analysis which is threats and opportunities.
Internal analysis which is strength and weaknesses in terms of organisation's products, resources,
customers, management and technical knowhow.
✍️ Strategic Choice - Which of the strategies the organisation is adopting. It involves how they want to:
•
•
•
•
Take advantage of the opportunities they have
Protect against threats
Make full use of strengths
Eliminate weaknesses.
✍️ Evaluation of Strategies - Before an entity will chose a strategy, an evaluation should be done as to
its suitability, feasibility and acceptability.
✍️ Implementation of strategy - After the company must have evaluated the one they opt for, how to
put into action is the next question. In a way that stakeholders will not be affected.
✍️ Review and control - After the strategy must have been implemented, should any variance occur
between what we expect and actual result, appropriate control measure should be taken.
Levels of management
In a well structured organisation, there are hierarchy of managers, from senior management down to
junior managers then to supervisors. The responsibilities of Managers vary according to their position in
the management hierarchy. The levels are same as decision making processes.
1. Strategic Management
2. Tactical Management
3. Operational Management.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
1. Strategic management - They are concerned with setting objectives for the organisation and develop
plans to achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level
managers. They monitor actual performance to assess whether planning targets deceleration by strategic
management are achieved. Their main function is usually associated with budgets and Budgetary control.
3. Operational Management - This is the management of day-to-day operations and activities. The
planning horizon is usually short and requires immediate decision. This is usually saddled with
supervisors and Frontline managers who monitors daily efficiency level.
Potential Conflict between strategic plans and short term decisions
In practice, problems occur with a large number of managers when local managers take decisions which
are inconsistent with long term strategies of the senior management. The following are some of the
reasons why thus may happen:
👉 When Local Managers are rewarded for achieving short term objectives, whereas organisation sees
beyond that.
👉 When local managers feel strategic plans are unfair to them.
👉 When Local Managers are unaware of the strategic Plans due to poor communication within the
society.
Chapter 2
Overview of cost planning and control
Business Information
Information is a processed data and management could not make decisions without information. However,
information can vary in quality and managers can only make better decisions when they have better
quality information.
Levels of management
1. Strategic management - They are concerned with setting objectives for the organisation and develop
plans to achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level
managers. They monitor actual performance to assess whether planning targets deceleration by strategic
management are achieved. Their main function is usually associated with budgets and Budgetary control.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
3. Operational Management - This is the management of day-to-day operations and activities. The
planning horizon is usually short and requires immediate decision. This is usually saddled with
supervisors and Frontline managers who monitors daily efficiency level.
Each of those management levels require different information need. Strategic management need strategic
information. Tactical management needs tactical information while operational management needs
operational information. For example:
✍️ Strategic Information which is needed by strategic managers has the following characteristics:
✓ It is usually Summarised and not detailed.
✓ Longer term in nature
✓ Often forward looking
✓ Sourced from both internal and external source.
✓ Usually contain qualitative information rather than quantitative.
✓ It captures overall objectives of the organisation as a whole.
✓ Prepared on an adhoc basis, rather than regular.
✓ There is a high degree of uncertainty in the information, because of its futuristic nature.
✍️ Tactical Information - This are information used to decide how the resources of the organisation
should be used. They are information relating Budget where plans are expressed in financial terms.
Tactical information has the following characteristics:
✓ It is often about individual departments and functions not overall as strategic.
✓ Also Summarised form of information but a bit level of detail than strategic information.
✓ Generally Relevant to short and medium term.
✓ Often concerned with performance measurement.
✓ Data sourced from both internal and external sources but more from with in the organisation.
✓ Often prepared on routine or regular basis. For example, monthly, or weekly performance reports.
✓ Consists of mainly quantitative information rather than qualitative.
✓ Though, there is a degree of uncertainty but much less than strategic.
✍️ Operational Information - This is that one needed by Frontline managers or supervisors to enable
them organise and monitor operations, make on the spot decisions whenever operational issues arise.
They have the following characteristics:
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
✓ Usually task specific, about specific transactions, specific job, daily workloads, etc.
✓ Usually detailed in nature.
✓ Relevant to very short term
✓ Relates to daily transactions
✓ Data comes exclusively from within the organisation.
✓ Often prepared frequently
✓ Consists mainly of quantitative information
✓ Information are usually factual and with less uncertainty.
Sources of information
There are 2 Major sources of information
1. Internal Sources - A Control system such as a management accounting system must obtain data from
within the organisation for planning and control purpose. Potential internal sources include:
•
Financial accounting records
•
Human resources records maintained to support payroll systems.
•
Production information
•
Sales Information
•
Minutes of meetings
2. External Sources - Managers also need information about customers, competitors and other elements in
their business environment. This is needed for strategic planning and control. Examples are information
needed about customers, competitors, suppliers, regulatory environment, economic or financial
environment. Potential sources include:
•
Market Research
•
Trade journals
•
Suppliers Price list
•
Newspapers and other media
•
Government reports and statistics
Limitations of external information
1. It might not be accurate
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
2. It might be incomplete
3. It might not be detailed enough
4. It might not be available when required
5. It might be misinterpreted.
Cost of information
For information to be Useful, it should be captured and processed. Capturing and processing data costs
some money. Costs associated with hardware, software, analysis, interpretation and procuring modern
computing equipment can amass huge amounts.
Methods of gathering information
1. Observation - This method involves looking into the process being executed by others and
understanding how a program or system actually operates.
2. Interview - By asking questions verbally and documenting them in a paper. This could be useful when
there is a need to understand the interviewee's response in more depth.
3. Questionnaire - This can be used to gather information in a structured way from a large number of
people.
Ethics in Performance Management
Chapter 3
Modern Management Accounting Techniques
Traditionally, management accounting systems provides accounting information obtained from
accounting records and other data within the organization. Commonly management accounting techniques
includes absorption costing, marginal costing and CVP Analysis, pricing techniques, budgeting, standard
costing, Budgetary control and variance analysis.
For various reasons, questions have been raised about the relevance of traditional management accounting
techniques that they do not serve the needs of management in the modern business environment.
▪
▪
Traditional management accounting techniques do not provide all the information needed by
managers in manufacturing companies where total quality management (TQM) or Just in time
(JIT) techniques are used.
Traditional techniques like absorption Costing is probably of limited value in a manufacturing
environment where production processes are highly automated and production overhead costs is a
much more significant element of cost than direct labour.
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Performance Management
▪
▪
▪
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Traditional methods focus on manufacturing costs, whereas many modern companies operates in
service industry rather than manufacturing.
Traditional techniques focus on cost control and cost reduction techniques which indicates lower
production costs and higher profits. Whereas modern organizations now focus on customers
satisfaction and how to meet customers need in terms of quality, reliability and speed of delivery.
Traditional management accounting techniques do not provide managers with strategic decisions
as they focus on short term decisions. However, modern managers need information about
competitors, customers, development in technology and other external factors to make strategic
decisions.
In a nutshell, for a management accounting Information system to be Useful in an organization, it must be
able to provide variety of information - Financial and non financial, long-term and short term. In an
increasingly competitive global market environment, business organizations must be able to deliver the
customer's need more successfully than their competitors. Many businesses compete with each other on
the basis of product quality, delivery, reliability, customer satisfaction, after sales services.
Problem with standard costing and variance analysis
Kaplan and Johnson have argued that standard costing and variances should not be used in a modern
manufacturing environment for either cost control or performance measurement. They argued that
standard costing technique ignores quality costs and innovation which are key factors in a modern
successful operations.
However, standard costing systems are still relevant due to the following reasons:
1. Standard costs can be useful for budgeting even in a total quality management environment.
2. Managers need short term (real time) feedback on costs. They need to know whether costs are under
control and variance analysis provides thus.
3. Standard Costs for existing products can provide a useful starting point for planning cost for a new
product.
4. Standard costs can be useful for target costing techniques, so far the difference between standard cost
and target cost is cost gap. Manager then focus on this gap and how it's to be closed.
New Trends in Management Accounting
The following are new techniques developed in management accounting.
1. Target costing
2. Life Cycle Costing
3. Throughput accounting
4. Backflush accounting
5. Activity Based Costing
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
6. Product Profitability Analysis
7. Segment Profitability Analysis
Some of these techniques have been developed in response to changes in manufacturing methods and
systems.
Activity Based Costing (ABC)
Activity based costing is modern method of costing developed as a remedy to the weaknesses embedded
in the traditional absorption Costing method. In modern manufacturing environment, activities are more
complex and automated that apportioning costs needs to be much looked into.
Criticism of absorption Costing
The aim is to calculate full cost of production per unit. No serious issue with direct cost of material and
labour as there is a link between the cost and its activities driven by it. Where major issue lies is in the
production overhead costs, they are highly relative and cannot be traced directly to a particular production
process. So, there is a need for apportionment and traditionally, time spent in production (direct labour
hour or machine hour) are used to apportion them. This has been criticised in the modern manufacturing
set up due to the following reasons:
•
•
•
The basis is arbitrary and not justifiable.
Difficulty to use for budgeting, pricing and other forms of decision making.
Inaccurate product costs
Activity Based Costing Method
A better method for calculating full cost per unit. This links costs more accurately and avoids arbitrary
apportionment or guess work. There is no difference as to how direct material cost and labour costs are
allocated, those are direct. The major difference is how production overhead costs are apportioned.
Instead of using direct labour hour or machine hour, we make use of activities to apportion overhead costs.
Identifying Activities
One of the major problem with ABC method is deciding which activities create or drive costs. There are
many Activities within a manufacturing firm and it is not always clear which activity to use. Examples of
activities are:
•
•
•
•
•
•
Material handling and storage
Quality control and inspection
Customer order processing
Repairs and maintenance
Purchasing
Machines
Although, ABC is often concerned with production costs but can also be applied to activities outside
production such as sales and distribution.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Cost drivers and cost pools
For each activity, there should be a cost driver, a factor which determines the cost of activity. For
example, material purchasing is an activity, while number of customer orders is a cost driver. Cost pool is
simply the overhead expenditure allocated and apportioned to an activity.
Justification of ABC
1. Modern manufacturing processes are becoming more complex, so arbitrary appointment is not
appropriate.
2. In a multiproduct environment, ABC method is more relevant.
3. Because of mechanisation, overhead is no more an insignificant part of organisation total cost.
Limitations of ABC
1. ABC method could be very expensive to apply.
2. It's difficult to apply in practice.
3. It focuses on rearranging costs rather than reducing it.
4. There is no difference in profit reportable.
Target Costing
Origin of target costing
Target costing originated in Japan in the 70s. This began as a result of customers demanding more
diversity in products that they bought, and the life cycle of products were getting shorter. This means that
new products had to be designed more frequently to meet customers need. Companies then became aware
that large proportion of costs of making a product are committed at the design stage, before the product
goes into manufacture.
Purpose of target costing
This is a method of strategic management of costs and profits where target is set for maximum cost of a
product or service then work out on how to achieve this target. It is used for business strategy by
companies that operate in a competitive market where new products are continually introduced into the
market in order to compete successfully.
Closing the target cost gap
As said earlier, the major rationale here not just to determine the estimated cost and the target cost, rather
to close the cost gap that exists between the 2. This can be achieved with the following methods:
1. Re-designing the product - By using more cost efficient component to design the product.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
2. Reducing Material cost - Target costing involves the entire value chain of a product. Costs should be
managed from the point of purchase of raw materials from the supplier up until when it reaches the final
consumer.
3. Eliminating non value additive features or activities of the product design - Something is non value
additive if costs the organisation but fails to add anything of value to the customer.
4. Train staff in more efficient techniques and working methods - Improvement in efficiency will reduce
cost.
5. Achieving economies of scale - By producing in larger quantities and Also purchasing larger quantities
of materials.
Life cycle costing
This is a modern management technique which considers the total costs associated with a product or asset
over its estimated useful life or life span. The principle here is that not only the initial acquisition cost is
considered here, some annual running costs needs to be considered as well. For example, in acquiring a
printer, initial cost of Printer A may be less than Printer B. But printer B costs more in changing
cartridges than A. So, all those needs to be put into consideration at initial stage.
This applies to:
•
•
Asset acquisition, and
Introduction of new products to the market.
Categories of life cycle costs
1. Acquisition and set up costs (Market entry cost for products) - These are usually one off capital
expenditure.
2. Operational or running costs - These are recurring costs and may be annual or quarterly or monthly as
the Case May be.
3. End of life cost - These are costs incurred to withdraw a product from the market or demolish an asset
at the end of its life.
Life cycle costing involves proper cost identification, estimation and discounting techniques, which takes
into account time value of money.
Benefits of LCC
✓
✓
✓
✓
Improved evaluation of options
Improved forecasting
Improved understanding of the tradeoff between performance of an asset and its cost.
Improved management awareness about the consequences of decisions.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Problems of LCC
✓ Availability of data
✓ Difficult and time consuming
✓ In practice, organizations are structured in a way that different managers are responsible for the
purchase decision of an asset. So, there is a potential integration issue.
Life cycle costing and product life cycle
Most products made in large quantities go through a life cycle which consists of several stages. They
include:
They have 4 Major Stages:
➖Introduction Phase
➖Growth Phase
➖Maturity Phase
➖Decline Phase.
But, some added:
➖ Research and Development Phase (Before Introduction Phase)
➖Withdrawal Phase (After Decline Phase)
But, the Most important and widely acceptable Stages are the 1st 4.
Let me Now take them one after another
➖ Introduction Phase: The Stage the product of a Company is freshly introduced to the Market.
Everyone will be talking about it and willing to Buy it. At this stage, sales and profit will be Low Because
no Much recognition is Derived yet. The Product is just gaining ground. We can relate this to A Man as
well That Stage of life we pass through that we were small in age and size. Our thinking is Childish
Because we were children. No one is thinking about making money as we are now. All what we are after
is how to eat, play, sleep and Watch Cartoons.
➖Growth Stage: This Stage, the product is getting well known and more Patronisers come in. The profit
grows Because the sales grew already.
➖Maturity Stage: This is when the Recognition, Sales of the Product gets to its Peak. Then, the profit
derived from the product gets to its pinnacle. At this Point, no increase in the Profit derived from the
Product again.
➖Decline Stage: The Product starts fading out of the Market and Sales Drop. So do Profit. At this point,
the Company has 2 Options, either they Withdraw it from the Market or they repackage it.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Each Stage of the Product or asset has its own Peculiar Costs, Sales and Profit. And That’s what
Constitute the Diagram of the Model.
Computation of life cost per unit
Life Cost = Total life cycle cost/Total expected life unit
Throughout accounting
This is a traditional costing technique which is associated with theory of constraints. A theory that
postulates that an entity always has a constraint that sets a limit on the achievement of its goals.
Management are therefore required to identify what the constraint is, then eliminate this constraint so that
performance can be improved.
Through put Accounting has some similarity with limiting factor analysis. However, where traditional
limiting factor technique make use of marginal costing method, throughput differs in that sense with the
assumption that Labour Costs are not variable costs, rather they are fixed.
Assumptions in throughput accounting
1. Where traditional marginal Costing methods assumes labor cost to be variable, throughput accounting
assumes that labour are paid fixed monthly or weekly wages or salaries and are thereby fixed, not variable.
2. Only material and component cost are variable in throughput accounting because they are from external
source.
3. Business makes real profit by adding value and value is only added by selling goods to customers.
Throughput, Inventory and operating expenses
•
•
•
Throughput - This can be said to be 'Contribution' in traditional marginal costing technique.
Throughput = Sales Less variable costs (which is raw material and component cost).
Operating costs - These are other expenditure aside from material and component costs, which
are not assumed to be variable. This includes Labour Costs.
Inventory - Inventory are investments tied up in the business. These earn nothing until finished
goods are sold, then throughput is a created.
Performance Measurement Ratios in throughput accounting
1. Throughput accounting ratio = Throughput per hour of bottleneck resources/Operating expenses per
hour of bottleneck resources
2. Throughput productivity = Throughput/Operating Expenses x 100
The higher this ratio, the better for the organisation. An objective is to increase this ratio by increasing the
throughput or reducing operating expenses.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Backflush Accounting
This goes in line with JIT system. As the name implies, costs are calculated after production has been
completed. They are allocated between cost of goods sold and inventory in retrospective manner. Costs
are not built up as work progresses through production process. The aim is to eliminate detailed
accounting transactions that is carried out in a cost accounting system environment. It focuses on the
output of the organisation and then work it back in the allocation of costs rather than tracking the
movement of materials through the production process.
Backflush accounting and traditional cost accounting
Under the traditional systems, manufacturing costs are segmentally tracked down through the process. Ie.
From raw materials, to work in process, to finished goods. However, in modern manufacturing world,
where most manufacturing processes are just in time and inventory is smaller, an alternative method
which fits in is Backflush accounting.
Environmental Management Accounting
Traditional management accounting technique often ignores environmental related costs in arriving at
their decision. In modern organizations, environmental issues are significant in terms of both strategy and
cost because:
•
•
Poor environmental behaviour behaviour can result in significant costs or losses such as fines for
excessive pollution, cost of law suits, environmental taxes.
Environmental behaviour can affect the perception of customers, and their attitudes to a company
and their products.
Environmental management accounting provides managers with financial and non financial information
to support their environmental decision making.
Chapter 5
Quality and quality costs
Introduction
Success in business depends on satisfying the needs and requirements of customers. An essential part of
meeting customers' needs is to provide the quality that customers require. Quality is therefore an
important aspect of product Design and marketing. Poor quality in production will result in losses due to
rejected items and wastage rates, sales returns by customers and loss of reputation.
An entity should then seek to minimise quality-related costs. In order to do this, quality related costs
should be measured, analyzed and controlled. However, many organisations do not capture this in their
management accounting system.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Quality-related Costs
This are expenses incurred to prevent defects and losses due to internal and external failure of a product
or service, through failure to meet agreed specification.
An organisation must incur costs to deal with quality in the sense that:
➖ Required quality are maintained in production - Cost of conformance
➖ When poor quality occurs, they are corrected - Cost of non - conformance
Dr Armand Feigenbaum is considered a 'quality guru', he developed the concept of total quality control
(TQC) in the 1950s. He has got the following analysis and categorisation.
Formula for Quality Costs
Total Quality Costs = Cost of conformance + Cost of non-conformance
(Cost of control)
(Costs of failure)
Where,
Cost of conformance = Prevention Costs + Appraisal Costs
Cost of non-comformance = Internal Failure Costs + External Failure Costs
Costs of conformance
Appraisal Costs
No matter how much money is spent to prevent quality failure, some failures will certainly occur. So,
some inspection checks are needed to test whether quality standards are being maintained, and if possible
to identify defective items that do occur.
Appraisal costs are the cost incurred to detect defective items before being delivered to customers.
Quality inspections are conducted on goods supplied before subjected to production and defective
materials are returned back to suppliers. Also, during production process, quality check are carried out on
finished products. Any defective items are either reworked or scrapped.
In large organisations, where items are bought in large quantities, inspecting 100% of items would be
impossible. For this reason, it is usual for quality inspection to be carried out in sample basis.
Prevention Costs
These are costs of action to prevent quality problem from arising, by preventing or reducing the number
of defects. The following are example of measures that might be taken to reduce quality failures:
✓ Quality planning - by paying closer attention to getting specifications right particularly in product
design.
✓ Investing in systems and equipment to achieve the required quality.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
✓ Training staff to recognise the importance of quality and getting things right.
✓ Choosing the best suppliers that can deliver quality.
Costs of non-conformance
Internal Failure Costs
These are failures that occur when products are defective because they do not meet specific requirements
and are discovered before being delivered to customers. They would have been detected by customers if
delivered like that and lead to external failure. They are usually found at inspection process and when
discovered, they are either reworked to meet required quality standards or rejected totally and thrown out.
Costs associated with internal failure include:
•
•
•
Variable cost of items that are scrapped.
Incremental cost of reworking them
Cost of production time lost due to defective products.
External Failure Costs
These are failure costs arising after the product must have been delivered to the customers. They include
the costs of:
•
•
•
•
•
•
Dealing with customers complaints
Carrying out repair work under a guarantee or warranty.
Transport costs when recovering faulty items from customers.
Transport costs of returning them back to customers.
Legal costs, when a customer takes the organisation to court.
Cost of reputation lost when customers stop buying from the organisation.
Total Quality Management
TQM is a philosophy of quality management which originated from Japan in the 1950s. According to
CIMA, its an integrated and comprehensive system of planning and controlling all business functions so
that products or services are produced which meet or exceed customer's expectations.
TQM as against traditional view, is of the view that it is impossible to identify or measure all quality costs
especially cost of lost reputation. The aim should therefore be to work towards zero defects and to achieve
this, it will be necessary to spend more money on prevention costs. The TQM approach to quality costs is
to get things right in the 1st time.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Chapter 6
Budgetary control systems
Introduction
A budget is a financial or quantitative statement prepared and approved ahead of a defined period of time
for the purpose of attaining certain objectives.
Purpose of Budget
1. A means of Accountability.
2. Its an Economic and Financial Document.
3. Allocation of Available Resources.
4. A Means of Assessing Executive's Performance.
Uses of Budgets to Govt:
1. As a Guide for Present And Future.
2. As Performance Evaluator.
3. As Planning Tool.
4. Motivational Tool.
5. Communication Tool to the Citizens.
6. Cost Reduction Techniques.
7. To Distribute Economic Resources.
The Master Budget
This is the final approved budget, presented in the form of financial statements - a budgeted income
statement and statement of financial position for the end of the financial year. However, the master budget
is a result of a large number of detailed plans, many of them prepared at a departmental or functional level.
Functional budgets
This vary for a particular aspect of the entity's operations. The functional budgets that are prepared vary
with the type of business and industry. In a manufacturing company, they include:
•
•
•
A sales budget
A production budget
Materials Purchase Budget
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Conversion costs budget
Principal Budget Factor
This is the factor that sets a limit to the volume and scale of operations. The most important factor is sales
demand or expected sales volume. That will determine the volume of production.
Stages of Preparing Budget
For a manufacturing company, the process of preparing budget is more complex than other types of
organisations:
✓ Stage 1 - Provision and communication of budget guidelines to relevant managers.
✓ Stage 2 - Identify the Principal Budget Factor. Mostly sales volume.
✓ Stage 3 - Prepare the functional budget for the principal budget factor. Ie. Sales budget.
✓ Stage 4 - Prepare other functional budgets, like inventory, production budget, labour usage,
material usage and purchases budget.
✓ Stage 5 - Submit the functional budgets to the budget committee for review and approval.
✓ Stage 6 - Prepare the Master Budget which summarises the plans for the budget period. The
master budget might be presented in form of a budgeted income statement, budgeted statement of
financial position, and budgeted Cashflows statement for the next financial year.
✓ Stage 7 - The master budget and the supporting functional budgets should be submitted to the
board of directors for approval.
✓ Stage 8 - Upon approval, it should be communicated to the managers responsible for their
implementation.
✓ Stage 9 - Control Processes start. After the budget has been approved, actual performance should
be monitored by comparing it with the budget, then any significant differences (variances) should
be investigated.
Budgeted Systems
✓
✓
✓
✓
✓
•
Top-down Budgeting vs bottom up budgeting
Periodic Budgeting vs rolling or continuous budgets
Incremental Budgeting vs zero based budgeting
Activity based budgeting
Feed forward control
Top-down Budgeting - A system where by the targets are set at senior management level, perhaps
by the board of directors or by the budget committee. This will be imposed on the low level
divisions who are required to prepare a budget for their own operations that is consistent with the
budget imposed on them from above.
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•
Bottom-up budgeting - This is a situation where budgeting starts at the lowest level in the
management hierarchy where budgets are prepared. This may be at departmental level, then
submitted to the next level of management in the hierarchy, say the following divisional level,
which will be combined and coordinated into a divisional budget. Eventually, budgets from each
division will be submitted up to the budget committee or the Board of directors.
In a system like this, lower level management are likely to have more inputs to the budget
decision making than that of Top-down system. This is applicable in a largely decentralised
organisation.
•
Periodic Budgets - This is a budget for a particular period of time, typically the financial year.
The budget is not revised during the year, and fixed for the period. Traditional budgeting systems
are periodic systems.
•
Rolling budgets - Also called continuous budget because it is continuously updated say every
quarter of the year for a 12 months period. Rolling budgets might be particularly useful for cash
budgeting because an organisation must have sufficient cash to meet its requirements. The main
advantage of this is that its continuous review makes it responsive to changes in the business
conditions.
Traditional/Incremental System
Under this Method, Next Year's Figures are derived by adding a percentage to the current year own.
Based on Factors Like Inflation, Trends of Economic Events, Available Funds.
Advantages
1. Simple to Understand.
2. Cheaper to produce.
3. Suits our country's Level of Devt.
4. Past projects can be continued.
Disadvantages
1. Past Errors can be Carried forward.
2. It does not fund new programmes.
Zero-Based Budgeting (ZBB)
A method introduced by Peter Phyrr of Texas, Popularized by the former president of the USA Jimmy
Carter in 1976. Under this technique, resources are not allocated based on previous figures. All Govt
expenditures are assumed to kick-start from the Beginning, From Zero. It is usually Used by the
Executive, legislative members, Govt Ministries and Parastatals.
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Advantages of ZBB
1. Allows Optimum Allocation of Resources.
2. Good For Profit Oriented Projects.
3. Measures Performance.
4. Reduces Wastages.
5. Change is Allowed.
6. Important Projects can continue to be funded.
Disadvantages of ZBB
1. Its not Good for Recurrent Expenditure, Therefore, its not being successful in the Public Sector.
2. Sometimes, lack of unreliable Data.
3. Bureaucrats do not Like it.
Activity based budgeting
This is a planning system under which costs are associated with activities and Budgeted expenditures are
then compiled based on the expected activity level. ABB is an extension of ABC which is an alternative
to traditional absorption costing system. ABC system assumes that overhead costs are caused by activities
and the cost of activities are driven by factors other than production volume. For each activity, there
should be a cost driver which is the factor that determines the cost of activity. In a situation where an
organisation uses ABC system, budgets are prepared based on that.
Behavioural aspects of budgeting
The effectiveness of budgeting and budgetary control depends largely on the behaviour and attitudes of
managers and possibly other employees. Budgets provides performance targets for individual managers if
they are rewarded for achieving targets, budget could provide them with an incentive and motivation to
perform well. When budgeting creates motivation in individuals, the human aspect of budgeting is
positive and good for the organisation. Unfortunately, human behavior in the budgeting process often has
a negative effect due to the following reasons:
•
•
•
•
Misunderstanding and worries about cost cutting
Opposition to unfair targets set by senior management
Sub-optimisation
Budget slack or budget bias
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1. Misunderstanding and worries about cost cutting
Budgeting is often considered by managers involved to be an excuse to cut their costs, and because of that,
they resent having to reduce their spending and pose a hostile attitude to the entire budget process. The
fear and hostility can exist even when senior management do not have a cost cutting strategy.
2. Opposition to unfair targets set by senior management
When senior managers use budgeting process to set unfair and unrealistic targets for the year, their
subordinates may unite in opposition to what the senior managers are trying to achieve. Senior managers
should communicate and consult with individuals affected by setting reasonable targets and try to win
them.
3. Suboptimization
When their is lack of coordination amongst different managers in the organisation which is not in the best
interest of the organisation as a whole. One may be trying to achieve something that is not in line with the
overall goal of the organization.
4. Budget Slack
This has been identified as the international overestimation of expenses or underestimation of revenue in
the budget process. Managers who prepare budgets may try to overestimate costs so that it will be much
easier to keep actual spending with in the budget limit or underestimate revenue in their budget so that it
will be easier for them achieve their revenue targets As a result budget slack, budget targets are lower
than they should be.
Participation in budget setting
Individuals should be allowed to participate meaningfully in the budget setting so that they can be
motivated to improve performance and be more committed to their work.
Advantages of such are:
•
•
•
•
Better planning decisions
Better communication of goals
Better understanding of the target setting process
Stronger motivation to achieve targets
Disadvantages are:
•
•
•
•
It might be Difficult for junior managers to understand the overall objectives of the organisation
which Budget is designed to meet.
Participation may not be effective when individuals lack experience.
Participation should be real. Because in practice, senior managers might be pretend to be
encouraging participation, but disregard the ideas of their subordinates.
When not properly managed, participation disrupt optimum decisions.
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Factor affecting participation
a) Nature of the task - The Effectiveness of participation depends on the nature of the work, and the
extent to which employees have control over the way it is being done.
b) Organisation Structure - Participation is like to be more effective in a decentralised organisation,
where local managers have more influence over their own budgets.
c) Personality of the employees - Some types of individual are more likely to be motivated than
others.
Beyond Budgeting
Beyond Budgeting Round Table (BBRT) is a European-wide research project set up in 1998 investigating
whether entities would benefit from the abolition of budgeting. They claim that several successful
European companies have stopped preparing budgets. Instead, they use a 'responsibility model' for
decision making and performance measurement. The ideas are associated with the writing of Jeremy
Hope and Robin Fraser.
Weaknesses in traditional budgeting
Hope and Fraser argued that traditional budgeting system is inefficient and inadequate for the needs of
modern businesses. In a continually changing business environment, traditional budgeting budgeting
system find it difficult to adapt to rapid changing world.
According to Beyond Budgeting Round Table, there are 10 problems with the traditional budgeting
control systems:
•
•
•
•
•
•
Budgets can be time consuming and expensive - In spite of computer technology and the use of
budget models, it still take four to five months in a large company to prepare annual budgets for
next year. Budgets has been observed to take 20% of the time of senior managers and financial
controllers.
Traditional budgeting adds little value to the entity upon using valuable management times that
could be used better in other ways.
Traditional budgeting tails to consider shareholders value because it focuses on internal matters
and not enough on external business environment.
Rigidity and inflexibility - Managers concentrate on achieving agreed budget targets, which may
not be in the best interest of organisation as a whole.
Budgets protect spending but fails to I reduce costs - In real life, managers are expected to spend
their entire budget allowance or else money will be taken away from their budget allowance next
year.
Traditional budgeting discourages innovation since managers are expected to achieve a fixed
target and fixed budget does not encourage continuous improvement. Managers will be reluctant
to exceed their spending limits even if extra spending is necessary, because this will put their
bonus as risk.
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Traditional budgeting focuses on sales targets and not customers satisfaction. Meeting sales target
is short term in nature. If customers are not satisfied, sales will be affected in the long run.
Beyond Budgeting Model
The model is an alternative to traditional budgeting system which is based on dependency model of
management and organisation culture. An alternative to that is 'responsibility model' where decision
making and performance measurement are delegated to line managers. Instead of having fixed, these
managers agree performance targets which are reviewed regularly and amended as necessary in response
to changing circumstances and unexpected events.
The idea here is that responsibility should be delegated to operational managers who should be
empowered to take decisions in response to changing circumstances and a good solution to that is
continuous rolling forecasting budget.
Principles of Beyond Budgeting Model
•
•
•
•
•
•
•
•
•
•
•
•
Governance
Responsibility for performance
Delegation
Structure
Coordination
Leadership
Setting goals
Formulating strategy
Anticipatory management
Resource Management
Measurement and control
Motivation and rewards
Chapter 7
Variance Analysis
Introduction
A standard costing system is a system of control which enables deviation from budgets to be analysed in
detailed in which cost can be effectively controlled.
Types of standard
1. Ideal standard - A standard that is established on perfect working condition. This type of standard
gives no room for breakdown, spoilage, or idle time. It is not attainable in practice.
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2. Attainable standard - This is a standard that is established on a normal operating condition. A
standard where allowances would be provided for losses, inefficiencies, fatigue, etc. It is known as
practical standard.
3. Current Standard - This is a type of standard that is established for use over a short period of time. It
is based on the current working condition of the entity.
4. Basic Standard - This is the type that is used for a long period of time, and used to show trend trends.
Analysis of Variances
Variance is the difference between the standard cost/price and actual cost/price for a given period. A
given variance may be favourable or adverse. Variance is analysed into production costs variances and
sales variances.
Production Cost Variances
•
Direct Material Cost Variance
i) Material Price Variance = (SP - AP) AQ (Act Qty Purchased)
ii) Material Usage Variance = (SQ – AQ Used) SP
Note: Some questions may give both actual quantity of materials purchased different from actual quantity
used. Material purchases should be used for Price Variance while Material used should be used for usage.
In the reconciliation statement, adjustment should be made for us to have a reconciled actual profit.
Material unused constitute closing stock and should be taken way from the material purchased valued at
standard cost.
•
Direct Labour cost Variance
i) Labor Rate Variance = (SR - AR) AH
ii) Labor Efficiency Variance = (SH - AH) SR
iii) Idle Time Variance = (AH Paid for - AH Worked For) SR
•
Variable Overhead Variances
i) Variable Overhead Expenditure Variance = (SR - AR) AH
ii) Variable Overhead Efficiency Variance = (SH - AH) SR
•
Fixed Overhead Variances
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i) Fixed Overhead Expenditure Variance = (BH x SR) - (AH x AR)
ii) Fixed Overhead Volume Variance = (SH - BH) SR
That is analysed into 2:
a) Fixed Overhead Efficiency Variance = (SH - AH) SR
b) Fixed Overhead Capacity Variance = (AH - BH) SR
Sales Variances
•
Sales Price Variance = (Budgeted Profit - Actual Profit) Actual Qty Sold
In Some Questions, students may be required to make use of Contribution Margin instead of
Profit Margin, depending on the costing method used, whether Absorption or Marginal Costing
Method.
•
Sales Volume Variance = (Budgeted Sales Qty - Actual Sales Qty) Budgeted Profit or Margin
Note that the in determining whether Favourable or adverse, sales variances results will be the exact
opposite of Cost Variances.
Reconciliation of Budgeted Profit with Actual Profit
Budgeted Profit (Budgeted Units x Std Profit)
Xx
Add/Less
o
o
Sales Price Variance
Sales Volume Variance
x / (x)
x / (x)
Standard Profit
Xx
Xx
Adjustment For Cost Variances
o
o
o
o
o
o
o
o
o
Material Price Variance
Material Usage Variance
Labor Rate Variance
Labor Efficiency Variance
Voh Efficiency Variance
Voh Expenditure Variance
Foh Expenditure Variance
Foh Efficiency Variance
Foh Capacity Variance
x/(x)
x/(x)
x/(x)
x/(x)
x/(x)
x/(x)
x/(x)
x/(x)
x/(x)
Actual Profit
Xx
Xx
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The Actual profit to be derived must be the same with that in the question.
Chapter 8
Advanced Variances
▪ Material Mix & Yield Variance - An Extension to Material Usage Variance
▪ Sales Mix & Quantity Variance - An Extension to Sales Volume Variance
▪ Planning & Operational Variances
▪ Market Share & Market Size Variances
Material Mix and Yield Variances
This is an advancement of the material usage variance, and it is applicable when there are 2 or more input
materials in production of an item.
a) Material Mix - This measure the effect on costs of changing the combination (mix) of 2 or more
inputs in production process. Variance is calculated when the actual mix of materials is higher
than the standard mix.
b) Material Yield - This is the difference between the actual Yield from a given input and standard
Yield. It indicates the effect on costs of material inputs yielding more or less output than expected.
Note that in calculating Material Mix and yield variance, there is a need to determine the revised quantity
(revising the actual quantity using the proportion of the standard quantity). It is also known as standard
mix of actual quantity. At times, the question may give this, or else students may be required to determine
this themselves.
Formula
a) Material Yield = (SQ - RQ) SP
b) Material Mix = (RQ - AQ) SP
Sales Mix & Quantity Variances
This is also applicable when a company sells more than one product, then the volume variance can be
splitted into mix and quantity variance.
a) Sales Mix = (BQ - RQ) SPM
b) Sales Qty = (RQ - AQ) SPM
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Planning and Operational Variances
These are advanced variances for Direct Materials and Direct Labour Cost Variances. This arises as a
result of the difference between what was set as standard at the beginning of the year and what the
standard turned out to be due to some occurrences during the year before being compared to the actual
result at the end of the year.
This can be analysed below:
Original Standard (Ex Ante)
-
Revised Standard (Ex Poste)
Planning Variance
-
Actual Standard
Operational Variance
The Major Issue is that the original standards might be out of date due to the time they are prepared. So
their may be a need to revise it to reflect the change.
Features of Planning Variance
•
•
•
It occurs due to Planning Error
It arises as a result of changes over time
It's occurrence is uncontrollable because it could be a general reason affecting the general
economy like inflation, recession, outbreak of disease, minimum wage for labour.
Features of Operational Variance
•
•
•
It occurs due to operational Factors
It arises as a result of Management Action
It is Controllable because it is internal.
So, planning variances can be analysed as thus
1. Material Price Variance can be split into:
a) Planning Price Variance = (SP - RP) AQ
b) Operational Price Variance = (RP - AP) AQ
2. Material Usage Variance Can be Split into:
a) Planning Usage Variance = (SQ - RQ) SP
b) Operational Usage Variance = (RP - AQ) SP
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Same thing can be replicated for Direct Labour Variance
1. Labour Rate Variance
a) Planning Labour Rate Variance =
b) Operational Labour Rate Variance =
2. Labour Efficiency Variance
a) Planning Efficiency Variance =
b) Operational Efficiency Variance =
Benefits of Planning and Operational Variances
Market Size and Market Share Variance
This is a further analysis of the Sales Volume Variance. Some scholars have argued that:
1. Market Size is a Planning Variance because it goes beyond the control of the management. While
2. Market Share Variance is an Operational Variance because it is controllable by the management.
Market Size Variance is the effect on sales volume, if the Actual total size of the market is larger than
expected (Favourable Market Size Variance) or smaller than expected (adverse market size Variance).
Market share Variance is calculated by taking the actual total market size and comparing the expected
sales volume, if the Budgeted market share had been achieved, and actual sales.
Chapter 9
Performance Analysis
Introduction
In practice, business organizations need to measure performance at overall level or segmental level, in
order to ascertain whether they have done well compared to what they expect to do. Performance can be
measured both financial and non-financial.
Financial Performance
This is concerned with the extent to which the financial objectives of an organisation are being met. This
has to do with measurement in monetary terms.
✓ For businesses - Their main financial objective is to make profit.
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✓ For non profit organisations - Their own financial objective is not to make profit, rather to keep
spending within limits.
Non-financial performance
This is a performance that is not measured in monetary terms. Most of them are the contributing factors to
overall financial performance. Examples of non financial performance in business are customer
satisfaction, innovation, labour productivity, output capacity, etc. All these can be measured as well.
Financial Performance indicators (FPIs)
Performance indicator is a tool to measure or evaluate the success of an organisation in relation to a
particular activity. Therefore a financial performance indicator is used to measure a quantitative aspect of
an organisation. Financial performance indicators include:
👉 Financial Ratios
👉 Variance Analysis
👉 Absolute measures of sales, costs and profits.
Ratio Analysis
This is a measure of entity's performance and it is a relationship between two or more items to present
financial information in a more understandable form.
Ways of comparing Ratios
➖ Comparison with different company
➖ Comparing with previous years (Trend)
➖ Comparison with industry average
Categories of financial ratios
1. Probability Ratios
✓
✓
✓
✓
✓
✓
✓
ROCE
ROA
ROE
Gross Profit Margin
Net Profit Margin
Overhead percentage
Net cost plus
2. Short term Liquidity
✓ Current ratio
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✓ Quick or acid test ratio
3. Efficiency Ratios
•
•
•
•
Inventory Turnover or Average Inventory Days
Receivables Turnover or receivables days
Payable turnover or payable days
Asset turnover
4. Long term solvency
•
•
Gearing ratio
Interest Cover
5. Investors ratio
✓
✓
✓
✓
✓
✓
✓
EPS
DPS
P/E Ratio
Dividend Cover
Earnings Yeild
Dividend Yeild
Dividend payout ratio.
Limitation of interpretation techniques
1. Differences in accounting policies
2. Ratios are calculated from historical costs and can be misleading.
3. Differences in calculation of Ratios.
4. Difference in industry of operation.
5. Use of creative accounting
Non-financial performance indicators (NFPIs)
Financial performance alone does not give a complete picture of the performance of an entity. Financial
performance is the result of other factors such as market Share and customer satisfaction. The following
areas are where non financial indicators are identified:
•
•
•
Human resources
Customer satisfaction
Quality
✍️ Human Resources
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A well motivated and trained workforce is vital to an organisation in achieving its objectives. For that,
possible NFPIs include:
1. Labour Turnover
2. Labour Productivity
3. Absenteeism rate
4. Average hours worked.
5. Idle time
✍️ Customer Satisfaction
Customers are so important because they ultimately determine the level of profits for an organisation.
Their satisfaction can be measured using the following:
1. Percentage new subscribers
2. Number of complaints
3. Results of customer's satisfaction surveys
4. Speed of complaint resolution
✍️ Quality
Quality is linked to customer's satisfaction. As treated in earlier chapter, resolving quality issues has a
direct cost (e.g. the cost of replacing an item) and indirect costs (e.g. lost of goodwill leading to future lost
sales). Possible quality measures include:
1. Proportion of returns
2. Proportion of sales
3. Number of successful inspections
4. Proportion of re-worked items during production.
NFPIs for different departments
For different departments in an entity, performance targets can be set, which includes:
👉 Sales and customer service
•
•
•
•
Calls per hour
Average waiting time
Proportion of returning customers
Proportion of satisfied customers
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👉 Online Sales
•
•
•
Number of visits to website
Website down time
Delivery times
👉 Inventory Control
•
•
•
Proportion of wastage
Number of stockouts
Average Inventory holding
👉 Sustainability/Environmental measures
•
•
•
Proportion of recycling
Annual percentage reduction in CO2 emissions
Proportion of components sourced from green materials
Performance and sustainability
Balanced Score Card
A Concept developed by Kaplan & Norton in the 90s, for measuring performance relating to both
Financial & Non financial Objectives, Long & Short Terms Objectives.
The Rationale behind BSC is that there are several perspectives to Performance and targets should be set
for each of them.
They are:
Customer Perspective
Internal Perspective
Innovation & Learning Perspective
Financial Perspective
Explanation
1. Costumer Perspective: This has to do with What Customers Value and their Needs, Satisfaction,
Convenience & Quality.
2. Internal Perspective: Internal Perspective deals with Strengths of the Entity and their Resources,
Competencies and Capability.
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3. Innovation & Learning: This is saying for an organisation to survive in this Present Economy, it must
not be Stagnant. How to maintain that Competitive Position by Developing New Products or new ways of
doing Services.
4. Financial Perspective: How the Organisation creates value for its Shareholders enhancing their wealth
and make more Profit.
Performance measurement in service industry
Service industries are increasingly rampant in this Modern Day Economy. Eg. Hotels, Entertainment,
Holiday & Travel Industry, Professional Services, Banking, Recruitment Services, Cleaning Services, etc.
Measuring Performances in the Service Industry differs from that of Manufacturing due to the following
Reasons:
Study this acronym - SHIP
Simultaneity: Unlike manufacturing companies, where goods have to be produced before being sold to
customers. In Service industry, providing the service and receiving the service by the Consumer happens
at the Same Time. Ie. Both are Simultaneous in Nature.
Heterogeneity: Unlike Production of Products in a Manufacturing Company, where Products are
specifically the Same. In Service Industry, its not the Same. Service Companies attend to Customers in
different ways. Eg. If U Call MTN Customer Care, they will attend to u based on Your Peculiar Problem.
Intangibility: Their Products can not be seen, nor Hold. But if valuable, we can notice.
Perishability: It's impossible to store a Service For Future Consumption. Unlike manufacturing &
retailing companies, there is no stock of Unused Services. The services must be provided when the
Customer Wants it.
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Fitzgerald & Moon Building Block Model
Those 2 Guys Propounded a Model to measure Performance in Service Industry. They gave 3 Building
Blocks to measure performance in a Service Industry
1. Dimensions
2. Rewards
3. Standards
Let's Take them one after another
❖ Rewards: How we give back Sth to the person that achieved the Performance Targets. There are
3 Aspects here:
▶ Motivation: If they achieve performance targets, they may be Paid Bonus.
▶ Awareness of the Motivation Metric: If Employees knew Bonus exists, they perform well.
▶ Individuals should only be responsible for aspects of financial performance they can control.
❖ Standard: This has to do with how we Measure the Performance. Setting Standards for
measuring performance. This can be analysed in 3 Aspects:
▶Whether the Standard is Fair or equitable to all Managers.
▶ Whether they are Achievable.
▶ Whether Consumers accept it as their Own.
❖ Dimensions of Performance: There are 6 Elements here, namely:
▶Profit, Measuring Financial Performance
▶Competitiveness, measuring Sales or Company's Share.
▶ Quality of Service, Measured by Customer Satisfaction and Number of Complaints from Customers.
▶Flexibility: No Rigidity In delivering Work. Since its Based on Customer's Request.
▶ Innovation: Possibility of new services introduced.
▶ Resources Utilisation: How well a Company Utilised its Resources.
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The Model
Chapter 10
Other aspects of performance measurement
Measuring performance in non-profit organisations
NFPOs objective is not to make profit, rather it is provision of service to the society of which the service
will have to be provided within the constraint of the resources at disposal. Example of NFPOs are Charity,
clubs and societies or publicly owned organisations.
Value for money
This originated in the public sector organisations as a way of assessing financial performance. In public
sectors, conventional profit based measures are not appropriate because the objectives is not to make
profit. The concept of VFM has now been widely adopted by commercial organisations as a means of
assessing performance on a broader basis than just profit.
The concept simply means an organisation should get good value from the money spent. Example :
➢ Economy - Not Spending more than what is necessary to obtain the required resources. This will
make the entity to avoid spending on unnecessary items.
➢ Efficiency - Getting high volume of output from the resources used. Efficiency of employees is
often referred to productivity. It can also be achieved by making better use of machines and
equipment.
➢ Effectiveness - Achieving objectives of the entity with the available resources used. Using
resources efficiently has no value if the resources are not used in a way to achieve objectives. For
example, a manufacturing company may improve efficiency and produce a larger quantity with
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its available machines. However, if the extra output can not be sold, the organisation has not
achieved its objectives of maximising profit.
In Summary,
•
Economy means doing it cheaply - Comparing Money spent with inputs acquired.
•
Efficiency means doing it well - Comparing inputs used with outputs achieved.
•
Effectiveness mean doing the right thing - Comparing output achieved with objectives.
Four (4) things; Money inputs outputs and resources.
Problems with VFM in practice
1. Measurement difficulties - It is not always possible to measure efficiency and effectiveness. Even if it
is relatively easy to measure the output of a manufacturing company, it is not so easy to measure that of a
service department like human resources. Some functions in the organisation, their objective is not
quantifiable.
2. Over emphasis on cost savings - VFM often focus on ways to reduce costs without considering the
impact on quality of goods or services rendered. If quality not up to standard, customers may stop buying.
3. Calculating VFM measures - There are no regulations about the measurement of the 3Es in VFM. This
makes it difficult to undertake meaningful performance comparisons between organisations and possibly
between units of organisations.
Chapter 10
Transfer Pricing
Introduction
In a group of companies, one company may supply goods and services to another. Or in large company,
which has divisionalised structure, one division might sell to another in the same company. This will form
a cost for the buying division and a profit for the selling division. For Accounting purposes, these internal
transfers of goods or services are given a value. Transfers could be recorded at cost and not at usual
external selling price.
Transfer Price
This is the price at which goods or services are sold by one division within a company to another division
in the same company. The overall profit of the group or the company is not affected.
Methods of Transfer Price
1. Marginal cost
2. Full Cost
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3. Cost plus
4. Market Price
Objective of transfer pricing
Transfer prices are set to make it possible for divisionalisation to operate successfully within a company,
and:
•
•
Give autonomy to divisional managers to make decisions.
Enable the company to measure the performance of each division in a fair manner.
Factors that should be considered when setting the transfer pricing policy are:
•
•
•
•
•
•
•
The policy should lead to transfer prices that are fair to both the internal supplier and the internal
customer and should provide them both with an incentive to carry out the internal transaction
where it is worthwhile from the Group’s viewpoint to do so.
The policy should reflect the capacity constraints and market demand for the item being
transferred. Therefore, the transfer price should take account of the supplier’s opportunity cost.
The policy should provide autonomy to both the internal supplier and the internal customer to
make their own decisions concerning internal transactions.
There must be divisional structure.
Each division must be a profit or investment centre.
One of the divisions must be willing to transact business with the others.
The transfer pricing policy must be tax efficient by reducing the overall tax burden of the
company.
The bulk of what of what Transfer Pricing entails is Practicals and enough questions could be practiced in
the past questions.
Chapter 12
Divisional Performance
Introduction
In a large organisation, the degree of authority delegated by top management to lower level operating
managers can be viewed as a continuum. There are 2 possible practices:
1. Centralisation - Where all decisions are made from the head office and no power is delegated to
division heads or branch managers.
2. Decentralisation - A Situation where responsibilities are delegated to divisional managers or unit
heads. Each operating unit has its own management team which reports to the head office. Divisions in
this regard, refers to either a geographical area or a product line.
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Advantages of a decentralised setting
✓
✓
✓
✓
It increases motivation of the divisional managers.
It reduces time of decision making
It allows better decision since they have local knowledge.
It's a form a training to them should they rise up to strategic position.
Disadvantages of decentralised setting
•
•
•
•
Lack of goal congruence (ie. where divisional managers work towards achieving their own goal
rather than overall goal of the head office.
There is sub optimality in the system.
Management may lose control
Lack of economies of scale
Responsibility Centers
In a decentralised organisation, performance of each managers can be categorised into 4:
•
•
•
•
Cost Centres - This is a department or a unit for which costs are established. Organisations only
spend on the department. In a cost center, managers only has control over controllable cost and
performance is measured using Variance analysis, because they are responsible for keeping cost
under control.
Revenue Centres - This is a unit within an organisation for which revenue is established. No
measurement of cost or profit here. Managers are only accountable for revenue streams coming in
through that unit or division.
Profit Centres - This is a Department or division within an organisation where both cost and
revenue are established. Profit is then determined by deducting costs generated from that division
from its own costs. Here, managers have control over oontrollable costs and sales prices, and
performance is measured by their profit.
Investment Centres - This is a department where managers is not only responsible for costs and
revenues from the division only, but also responsible for decision relating to investments in assets
of that division. A manager here usually has authority to Purchase new assets, like plant and
equipment, furnitures and fittings, etc. So, at the end of each year, his performance is not only
measured by profit, but profit in relation to the investment employed. His performance is
measured by Return on investment, residual income, and other Ratios.
Evaluation of divisional performance
In order to carry out proper evaluation of performance in an organization, we need to understand within
an organisation, profits that are controllable and traceable to a particular division.
✓ There are costs controllable by the divisional manager
✓ There are also costs traceable to his division, and
✓ There are costs not traceable to or controlled by him. Example is share of overhead costs
allocated from head office.
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Tools/Methods for assessing divisional performance
1. Return on Investment or ROCE
2. Residual Income
3. Economic Value Added
Return on Investment (ROI)
This is calculated for an investment center to ascertain whether it has succeeded in achieving a target ROI
for the financial year, or whethet ROI has improved between one year and another. Some organisations do
give bonus to divisional managers on the basis of ROI achieved by its division. This may push them
towards improving the ROI of their division and to avoid anything that will reduce it. Then, this becomes
a serious problem especially when investment decision is involved. The problem is that investment
decisions are meant for longer term, and a new investment that reduces ROI in the 1st year may increase
it in subsequent year. Whereas, an investment center may therefore reject an investment because of its
short term effect on ROI, without giving proper consideration to the longer term.
Formula for ROI = EBIT/CE x 100
Advantages of ROI
•
It relates the profit of the division to the capital employed, and the divisional manager is
responsible for both profit and capitalemployed;
•
ROI is a percentage measure and can be used to compare the performance of divisions of
different sizes;
•
ROI as a measure of financial performance is easy to understand;
•
It focuses attention on capital as well as profit, and encourages managers to sell off unused assets
and avoid excessive working capital (inventory and receivables);
•
ROI ensures goal congruence between different divisions and the firm; and
•
It measures profitability better than other measures of investment.
Disadvantages of ROI
There are also disadvantages in using ROI as a measure of the performance of an investment centre.
These includes:
•
Investment decisions might be affected by the effect they would have on the division‟s ROI in the
short term, and this is inappropriate for making investment decisions;
•
There are different ways of measuring capital employed. ROI might be based on the net book
value (carrying value) of the division at the beginning of the year, or at the end of the year, or the
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average for the year. Comparison of performance between different organisations is therefore
difficult;
•
When assets are depreciated, ROI will increase each year provided that annual profits are
constant. The division‟s manager might not want to get rid of ageing assets, because ROI will fall
if new (replacement) assets are purchased; and
•
ROI is an accounting measure of performance. An alternative system of performance
measurement that includes non-financial performance indicators, such as a balanced scorecard
approach, might be more appropriate.
Residual Income
An an alternative to using a percentage form of measurement, residual income measures the performance
of an investment centre in absolute value. As the name implies, this is the profit remaining for an
investment centre after deducting interest paid on investment of such division.
Residual Income is calculated as
Controllable Profit xx
Less notional interest on average controllable investment xx
Residual income
Advantages of Residual Income
There are several advantages in using residual income as a measure of the performance of an investment
centre. These include:
•
It relates the profit of the division to the capital employed, by charging an amount of notional
interest on capital employed, and the division manager is responsible for both profit and capital
employed;
•
Residual income is a flexible measure of performance, because a different cost of capital can be
applied to investments with different risk characteristics;
•
Residual income concept takes a long term view of divisional performance; and
•
Residual income performance measures are reconcilable to planning decisions using techniques
such as NPV and IRR.
Disadvantages of residual income
There are also disadvantages in using residual income as a measure of the performance of an investment
centre. These are:
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Residual income is an accounting-based measure, and suffers from the same problem as ROI in
defining capital employed and profit;
Its main weakness is that it is difficult to compare the performance of different divisions using
residual income. Larger divisions should earn a bigger residual income than smaller divisions;
and
Residual income is not easily understood by management, especially managers with little
accounting knowledge.
Economic Value Added
This is method devised by stern stewart (a management consultancy firm) in measuring economic profit.
The method is a trademark to the firm. It is argued that using residual income (accounting profit) to
measure performance of a division is not appropriate enough. Economic profit is better because it reveals
the value of the business during the year. One of the important reason for criticizing accounting profit is
because account profit is determined using accounting concepts an conventions so can not represent the
real economic value of an organization.
Peter Drucker opined that “until a business returns a profit that is greater than its cost of capital, it
operates at a loss”. Therefore, experts have challenged accounting profit as a good measure of increase in
the value of a business and have proposed a measure of real economic profit. In their view, this will lead
to better measurement of the increase in value of a business during a given period of time. O
Benefits of EVA over RI
1.
2.
3.
4.
It measures creation of value by a company.
It focuses on longterm profitability
It is simple to apply and operational managers can understand
Reward based on EVA aligns with interests of the management or shareholders rather than bonus
system based on accounting profit.
5. Can be used in investment appraisal.
6. Can be used in goodwill and share valuation.
Formula for EVA
NOPAT – (Capital employed x WACC)
Chapter 13
Relevant Costs
Introduction
Section C is The Largest Section in the Syllabus and this Particular Topic is Very Important as far as The
Syllabus is concerned as a Whole. Because any topic treated afterwards, still draws Back to your Sound
Understanding of this Particular Topic. Also, ICAN Says Question 1, 40 Marks will usually be tested
from the Core Areas of the Syllabus, and this Section C tends to be the Area, considering the Weight of
Percentage it carries, and the length of Chapters in it. From Chapter 13 - Chapter 27.
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What is a Relevant Cost?
A Relevant Cost is used to assess The Consequences of any Mgt Decision. Management Make Decisions
about The Future and not the Past or Present. Therefore, You as A Management Accountant, needs to
provide them with A Quantitative Or Computational Analysis of Only those Costs that are Relevant, any
time a Decision is to be Made. In a Nutshell, a relevant cost is a Future Cashflows.
In A Decision Making Technique, For you to determine whether a cost is Relevant or not, U Must
Consider the following:
A Relevant Cost should be:
•
Cash Based: ie. Not dealing with Non-cash items, like Depreciation.
•
Futuristic Cost: Not Past/Sunk Cost.
•
Incremental/Differential Costs: As addition to the usual Costs.
•
Variable/Direct in Nature.
•
Specific Fixed Cost. Not General.
•
Opportunity Costs.
Irrelevant Costs are:
✔ Non Cash Costs like Depreciation, Internal Job Done which The Company did not pay Cash, Use of
Spare time.
✔ Past or Sunk Cost
✔ General /Apportioned Fixed Costs.
✔ Committed Cost: Costs which Makes no difference Whether Something is done or not. You will
Definitely Pay it, because u have entered into an Agreement To Pay It.
Terminologies in Relevant Costing
1. Incremental Costs: Those Additional Costs arising as a result of Taking A Decision. Ie. What led to
them is the fact that a Decision is made. If not, they will not come to Exist. This is usually Useful Under
Further Processing Decision.
2. Avoidable Costs: They can be avoided if a Particular Decision is not Made. While Unavoidable,
whether u make the Decision, or not, U still incur them. Eg. Variable Cost. This is usually common in
Shut Down Decision.
3. Committed Costs: Costs already agreed upon by the Organisation. Whether U enter into a new
decision or not, U Will Pay it.
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4. Sunk Costs: They are Past Costs, and has nothing to do with the Future.
5. Opportunity Costs: Benefit Lost by Chosing an alternative course of Action.
Uses of Relevant Costing Techniques
1. To Calculate Minimum Price to charge for A Product.
2. Accept or Reject Situation (Chapter 18)
3. Make or Buy Decision (Chapter 18)
4. Continue or Discontinue(Shutdown) Situation (Chapter 18)
5. Further Processing Decision. (Chapter 18)
6. Capital Budgeting Decision (Chapter 25 - 27).
Can you see the Important of this Particular Topic to all the other Topics in this Section. Very Very
Important.
Each of all those terminologies has Separate Examples in The Pack.
You Can Study Them on your Own. Because we still have Enough things to Look At.
Identification of Relevant Costs
This is one of the most Important Aspects of Relevant Costing. In a Big Scenario Question, How do we
Identify the Relevant Costs of:
✔ Material
✔ Labour, and
✔ Overhead.
Relevant Cost of Material
1. If non of the Materials is currently held in Stock, then Relevant Cost of Material is the Purchase Cost.
2. If the Required Materials are Currently held as Stock, the Following Rules Apply:
➖ If The Material is in Regular Use, then Replacement Cost is Relevant.
➖ If not in Regular Use, then Opportunity Cost is the Relevant Cost.
Note: Opportunity Cost Higher of :
🔹Net Disposal Value, or
🔹Net Benefit from Alternative Use.
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Relevant Cost Of Labour
1. If Labour is Temporary, Relevant Cost is Hourly Rate.
2. If Labour is Permanent, then, the Following Rules Apply:
➖ Not Fully Utilised, Relevant Cost is Zero Value.
➖ Fully Utilised, but:
🔹There is Overtime, Relevant Cost is Overtime Rate.
🔹No Overtime, Relevant Cost is Opportunity Cost.
Relevant Cost of Overhead
Only Variable Costs are relevant. Fixed Cost is not Relevant, except Specific or Incremental.
Chapter 14
Cost-Volume-Profit (CVP)Analysis
Introduction
This Stands for the relationship between costs and profits and how they change with changes in the
volume of activities. CVP analysis is an application of marginal costing concepts. This topic is very
important as any principle learnt here will be applicable throughout the course.
Assumptions of CVP Analysis
1. Costs are either fixed or variable.
2. Variable cost per unit is the same at all level of activity (output/sales).
3. Total fixed costs are normally assumed constant at all levels of output.
4. Contribution per unit is constant for each unit sold.
5. The selling price is constant for every unit sold.
Contribution
This is measured as sales revenue less variable costs. While profit is measured as contribution less fixed
cost. Contribution per unit is sales price minus variable cost per unit.
Contribution to sales ratio
Contribution per unit/Selling Price per unit
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Or Total Contribution/Total Sales
Break even Point
This is the volume of sales required in a period to break even. Ie. to me neither profit not loss. At break
even point, profit is zero. What it then indicates is that such volume of sales must be sufficient enough to
earn a total contribution that covers the fixed cost alone without making profit.
Calculating BEP
➖ BEP as a number of units to be sold
= Total fixed cost/Contribution per unit.
➖ BEP expressed in Sales Revenue Value
= Total Fixed Costs/Contribution to sales ratio
Margin of Safety
This is the difference between the budgeted sales (in unit or in Naira) and the BEP Sales (in units or in
Naira). It is usually measured as a percentage of the budgeted sales, but can also be in units or in volume.
It is called margin of safety because it is the maximum amount by which actual sales can be less lower
than budgeted sales without incurring a loss. A high margin of safety indicates a low risk of making loss.
Formula
Margin of Safety = Budgeted sales - BEP Sales
Margin of safety ratio = Budgeted Sales - BEP Sales/Budgeted Sales
Target Profit
Management might decide to ascertain what volume to sell in order to make a target profit. What it then
indicates is that such volume of sales must be sufficient enough to earn a total contribution that covers the
fixed costs and then makes a target amount of profit.
Units sales to ascertain target profit = Total Fixed Cost + Target profit/Contr. Per unit
Sales revenue to ascertain target profit = Total FC + Target Profit/Contr to Sales ratio.
Break Even Chart
Another method to do breakeven analysis is by plotting it on a graph. The graph will show all volumes of
output and sales.
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Multiproduct CVP Analysis
All the analysis up there, we have assumed that the company is only making and selling single product.
The technique can be extended to a Multiproduct situation. In order to tackle this, we need to make
further assumptions which might seem unrealistic. Assumption that products are sold in a set ratio which
does not change with volume.
This allows us to tackle similar problems in two ways: We either use
•
•
Weighted Average Contribution per unit and weighted average C/so ratio per unit.
Contribution per batch and weighted average C/S ratio for the batch (assuming that goods are
sold in the budgeted sales mix).
Questions under Multiproduct CVP analysis can be so technical and confusing. Students should practice
questions in the Pack and past questions.
Importance of CVP Analysis
▪
▪
▪
▪
It provides a valuable insight into the relationship between costs, revenue and profits.
It allows managers to understand profit impact on decisions under consideration.
CVP analysis can provide important information about sales strategies, cost control, and decision
making.
It allows managers to understand the minimum number of items needed to be sold in order to
generate a target profit. This can be very useful when launching new product.
Weaknesses of CVP analysis
This rests on the series of underlying assumptions which may not hold true in reality.
Chapter 15
Limiting Factor
Introduction
In practice, there could be a shortage of key production resources such as items of direct materials, labor
or machine capacity. In these circumstances, those factors setting a limit to the volume of products to be
produced or sales and profits in a particular period are called limiting factors or constraints or bottle neck
(Through put Accounting). The difference between this topic and throughput accounting is that this uses
marginal accounting and contribution technique, while TA uses through put by not considering labour
cost as variable cost.
Identifying the limiting Factor
In examination questions, the examiner might not be explicit with that particular factor that is limited in
an organisation. Students must identify it by calculating the resources needed to meet particular
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production or sales then compare it with the available ones. In most cases, it used to be machine or labour
hours, but it could be any other as well.
In this chapter, techniques to tackle a single limiting factor is looked into. In a situation where there are
more than one limiting factors, we make use of Linear Programming technique.
Steps to calculate optimum profit
1. Calculate the contribution per unit
2. Identify the scarce resource
3. Determine the contribution per unit by dividing the contribution per unit with the limiting factor.
4. Rank the products using the results in 3 above
5. Prepare a production plan by allocating outputs or sales based on ranking, until it reaches the
scarce resource where the remaining will be allocated to it.
Chapter 16
Linear Programming
Introduction
This is useful when there are 2 or more limiting factors or constraints. Ranking based on contribution per
limiting factor could not be used. To decide the mix of products to make or sold in order to maximise
profits, a linear programing problem has to be formulated.
Linear programming is a mathematical method for determining a way to achieve the best outcome (such
as maximum profit or lowest cost) subject to a number of limiting factors or constraints.
What constitutes the best outcome depends on the objective (whether to minimise cost or maximise
profit). The equation constructed to represent the best outcome is known as the objective function.
Overall approach (For 2 Products Situation)
•
Formulate the problem
1. Define the variables
2. Formulate the objective function
3. Formulate the constraints
•
Solve the problem (Graphical Method)
4. Plot the constraints on graph
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5. Identify the feasible region
6. Identify the values of the 2 products that lead to optimum value of the objective function.
Simultaneous Equation
Instead of reading the optimum values on the graph, this can be determined using simultaneous equation.
The exact values of x and y will be determined.
Usefulness of Linear Programming Model
i. It is used to solve limiting factor decision when there are at least two limiting factors;
ii. It can be used to calculate “shadow price” of a limiting factor;
iii. It can be used to determine additional unit of the limiting factor which can give extra contribution;
iv. It helps management to identify slack that might be used by management to identity the amount
of constraint that is not used in the optimal solution; and
v. It is used in solving operational problems.
Limitations of Linear Programming Model
i. It cannot be used to solve limiting factor situation when there is a single limiting factor;
ii. Uncertainty is not taken care of;
iii. Parameters are assumed to be consistent;
iv. It is only useful when solving allocation problems involving more than one limiting factor;
v. For non-financial Managers, it could be complex;
vi. It assumes complete linearity. In practice however, the liner relationship may not hold because of
quantity discount of raw material, the presence of learning curve, etc.
vii. It assumes divisibility of products. In practice, fractions of products cannot be produced and sold.
viii. It assumes profit maximization. In practice, organizations may have other objectives
Chapter 17
Further Aspects of Linear Programming
Dual Prices
In a linear programming function, every constraint has a dual price which is also known as shadow price.
This is the change in the objective function that is brought about if a constraint is changed by a unit.
Dual prices of limiting resources always have a value. This may be positive or negative depending on
whether it is calculated by reducing or increasing availability of a resource and whether a problem is
maximising or minimising.
Steps to calculate Dual Prices
1. Increase the limit of the 1st constraint by 1
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2. Recalculate values for the Variables.
3. Recalculate the value of the objective function then compare the new figure to the value of the
objective function in the original solution.
The difference is the dual price of the constraint. The same process is then repeated for the other
constraint.
Simplex Method
As against using the graphical method, which is flawed with its limitation to 2 products only. Simplex
method can be used for more than 2 products and more than one constraint. It requires introduction of
slack variables and formulation of tableau until the optimum values are determined.
Chapter 18
Other Decisions
Introduction
In chapter 13, we were able to Launch one of the Important Concept in Performance Management;
Relevant Costing. We Learnt the Principles in Chapter 13. Today, we are moving to Chapter 18, Where
we will learn the Application of those Principles learnt earlier. Decisions that are based on Relevant
Costing Techniques.
To start with, Relevant Costing is Useful for both:
✔ Short Term Decisions: Decisions that Result into Immediate increase in Cashflows or Profit.
✔ Longterm Decisions: Capital Investment Decisions, that takes several years before you recover your
Outlay.
Example of Management Decisions where Relevant Costing is used are:
1. One off contract Decisions
2. Make or Buy Decisions
3. Shut down Decision
4. Joint Product Or Further Processing Decision.
Make or Buy Decision
This is a decision whether to:
✔ Make An Item Internally or to buy it from External Supplier.
Or
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✔ Do Some Works With Internal Resources, or to Outsource it to another Contractor.
In A Situation Like this, both Financial & Non-Financial Factors need to be Considered.
•
Financial Consideration is based on which Alternative Produces the Highest Profits, lowest Cost.
While,
•
Non Financial Considerations, in the Case of Outsourcing Include:
👉 Loss of Control over the Work Outsourced.
👉 It Can Cause some employees to be redundant.
👉 Sensitive Information may be lost to Competitors.
Scarcity of Resources: This is a Scenario that use to arise before a Company will decide to Outsource his
Operations, or some part of its Operations instead of doing it inwardly. When the Company is already in
Full Capacity, and they can only carry out some parts of the Company's Activities and Let Out Others.
Chapter 19
Pricing Decision
Introduction
The selling price of a company charges on its product and services is very important because it affects the
volume of sales demand and profit margin per unit. Though the ability of companies to decide what price
to charge differs from one to another. It is determined according to the size of the company and the
market it operates in.
On that note, there are:
•
•
Price Makers - These are companies that dominate the market they operate in. They can charge
lower prices to maintain the market.
Price Takers - These are companies who do not dominate the market and have to take the prices
determined by other entities. They are able to charge lower prices in order not to run at loss, at the
same time afraid of charging higher prices so that customers will not switch to rival.
Factors affecting pricing decision
•
•
•
•
•
•
Quality of product
Product mix
Income of the customers
Cost incurred on product
Price and demand relationship
Price of substitute goods
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Price of complementary goods
Inflation
Product life cycle
Consumer taste and fashion
Advert and marketing
Pricing Strategies
➖ For New Market - Monopoly Position
1. Market skimming pricing - When an entity introduces a new product to the market, they charge high
prices and sell small units to a small part of the market in the early period in order to generate maximum
return per unit. It might be based on the attitude of the buyers who might decide to gain prestige from
buying new product at first. But as time goes on, the price gradually reduces slowly because competitors
will set into the market with their new product. This pricing strategy is normally effective for new “high
technology” products such as flat screen television sets, laptops, etc.
However, it is usually a shortterm pricing strategy that cannot usually be sustained for a long period of
time. It can also be used with a differentiated product of high quality, e.g. cars.
Features
▪
▪
▪
Low volume, high prices
For short term strategy
There is a barrier to enter the market in form of brand, patent and technology iinnovation.
2. Market Penetration Pricing - It is an alternative pricing strategy to market skimming pricing strategy
when a new product is introduced to the market. Under market penetration pricing strategy, the aim is to
introduce the product into the market with a low selling price in order to create a high sales demand as
quickly as possible. This can help the company to capture the market before competitors can introduce
rival products.
This pricing strategy can be used when a company is using a cost leadership strategy, because low price
will help a company to obtain a large market share which can further lead to economies of scales and
lower costs.
Features
•
•
•
Low price, mass sales
Substantial initial investment
High risk since it might be at competitors advantage
Forms of Pricing
1. Cost-based Pricing
2. Demand-based pricing
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3. Market-based Pricing
Cost Based (Cost-Plus) Approach
▪
Full Cost Plus Pricing
This involves calculating the full cost of a product and adding a profit margin toarrive at a selling price.
Profit is expressed as either:
-
a percentage of the full cost (a profit mark-up) or;
a percentage of the sales price ( a profit margin)
It is useful when operating on historical basis; for planning purposes, appraisal of divisional performance
and stabilising product prices.
▪
Marginal Cost Plus Pricing
Under this pricing strategy, the marginal cost of the product is calculated and a mark up or profit margin
is added to the marginal cost to arrive at the selling price. This is useful in preparing marginal costing
statements.
Advantages of cost based pricing
1. It is easy to apply
2. Cost is covered and there will be a profit.
3. It's used for profit making.
Disadvantages of cost based pricing
1. Its purely internal and requires judgemental figures
2. It ignores market condition
3. Choice of margin or markup is arbitrary
The difference between marginal cost and full cost pricing is that Fixed overhead is added to the total
costs before apply profit percentage.
Demand-based Pricing
This is a research based pricing determined by looking at the economic forces of demand and supply like:
✓ Competition
✓ Nature of product
✓ Location
One of the major advantages of this approach is that, not only does it generates prpfit rather it maximises
it.
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Demand Curve Equation
P = a - bq
Where a = Price, b = Change in price/Change in quantity
Steps in maximising profit
1. Calculate demand equation (a, b). P = a - bq
2. Derive the marginal equation MR = MC, in order to derive Q.
Where MR is a - 2bq
3. Substitute the q (Units) you got in step 2 above into the demand equation to get P.
That's the Optimal Price, which will produce the maximum profit for the organisation.
Return on investment (ROI) Pricing
This method of pricing strategy is used in a decentralised environment where an investment centre within
a company is required to meet a target return on capital employed. Prices are set to achieve a target
percentage return on the capital invested. This is needed in divisional performance appraisal.
Formula to derive this pricing method is
Budgeted total cost of division + Target ROI% on Capital Employed / Budgeted Volume x 100
Chapter 20
Risk and decision making
Introduction
In the real world, a lot of business decisions involves some risks or uncertainty. The decision maker might
base his decision on what he thinks will happen, but there is some possibility that the actual outcome will
be different possibly better or worse than expected.
✓ Risk - This occurs when the future outcome from a decision could be any of several possibilities.
✓ Uncertainty - This occurs when there is insufficient information about what will happen in the
future. It is therefore likely that future figures are not accurate because they are estimates.
Risk Preference
This terminology describes the attitudes of a decision maker towards risk. Decision makers might be seen
as:
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•
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Risk Averse - This person, in making a decision, tries not to select a course of action that is more
risky unless the expected return is higher enough to justify the extra risk.
Risk Neutral - This one ignores risk entirely in making decision by selecting the course of action
with the highest expected return regardless of risk.
Risk takers / Risk Seeker - This one takes extra risks in the hope of earning a higher return.
Methods of Risk
1. Expected Values
2. Decision Tree
3. Value of perfect & Imperfect information
4. Simulation
5. Sensitivity Analysis
6. 3 Model Assessment - Maximax, Maximin, and Minimax Regret
Expected Value
This is weighted average value calculated using probability estimates of possible outcomes.
Sensitivity Analysis (What if)
The purpose of this is to assess how NPV of a project will be affected if cash flows estimates are worse
than expected. That means to establish a sensitivity margin, we first need to calculate NPV, then start
changing the variables. The Variables are:
❖ ▫️ Selling Price - Revenue
❖ ▫️ Sales Volumes - Contribution
❖ ▫️ Variable Cost
❖ ▫️ Fixed Cost
❖ ▫️ Discount Factor or Cost of Capital
❖ ▫️ Initial Investment
❖ ▫️ Year of the Project
Calculation of Sensitivity Margin (SM)
S.M to Cashflows = Npv/PV of the Cashflows
S.M to Number of Years = Discounted PBP
S.M to Discounting Factor = IRR
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Interpretation
Depending on whether it is cost or revenue. At what percentage will the variable rise or fall before NPV
becomes Zero. It can be calculated on percentage or absolute value.
Chapter 21
Working Capital Management
Introduction
Working Capital is an Integral part of Investment Decision Making which an Entity needs to run its Day to - Day Operations. It is simply represented with (Current Assets - Current Liabilities).
This is a Bundle of Topic on its own which is broken down into several packages like:
•
➖ Cash Operating Cycle
•
➖ Overtrading
•
➖ Funding Principles
•
➖ Receivables & Payables Mgt.
•
➖Inventory Management
•
➖Cash Management.
What Constitutes Working Capital itself?
➖Current Assets: Inventory +Receivables + Cash/Cash Equivalent + Prepayments.
Minus
➖Current Liabilities: Payables + Overdraft
The Need for W. C Management
In order for an entity to run a Business Successfully, the following must be Managed Properly:
▪
👉 Invest in Inventory to avoid Stock out.
▪
👉 Sell Goods/Services to Customers on Credit.
▪
👉 Obtain Credit Sales from Suppliers.
▪
👉 Manage Cash and Short Term Investment to avoid Liquidity Problem.
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👉 Obtain Overdraft from Bank.
Although, an entity should maintain a Balance concerning Working Capital. Ie.
 They should Avoid Excess of it because it reduces Profit.
 Avoid Shortage of it at the Same time because it causes Liquidity Issue.
Factors Determining the Level of W.C an entity should Hold
The Question now is how can an Organisation determine the Quantity or Amount of Working Capital
they should?
The Following Factors Influence that:
1. Type of the Industry: In Practice, manufacturing setups hold more inventories than Retailers.
2. Length of W. C Cycle: Big Coys Have More Longer Days than another...
3. Level of Activities: Big Companies have more Inventories, more Debtors, more creditors
dealing with than Small Ones.
4. Management Attitude to Risk: It depends on whether the Mgt of the Coy are Risk Seekers or
Risk Averse.
Funding of Working Capital
1. Aggressive Funding Policy/Short Term Funding:
2. Conservative Funding Policy/Long Term Funding.
What we are Saying is that what Kind of Finance should we use to Buy Inventories?
Before we will be able to answer that Question, we need to highlight the Classes of Working Capital we
have:
Classes of Working Capital
1. Permanent Working Capital: This is the minimum level of Working Capital Which is Required that the
Company should old all the Time. Ie. Minimum Level of Inventories, Minimum Level of Receivables,
Minimum they can Buy from Payables(Trade Creditors).
This can be Funded using Long-term Funding.
2. Fluctuating Working Capital: They are those that may be required for a particular period of time. Eg.
For Seasonal Period, some manufacturing companies may want to sell in Bulk to Customers to take
advantage of that period.
In such a situation, they need a short term Funding because its for temporary Reason.
Note:
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 ➖ Short Terms means is to Use Payables and Overdraft to buy a bulk of Inventory and Sell to
Customers.
While
 ➖Long Term is to make use of Equity and Long Term Debt.
Note: Each has advantages and Disadvantages. In a Nutshell, a question might just come that. What is
the Best Way a company can fund its Working Capital? It's a Subjective Question The Answer depends on
what Class of Working Capital The Management want to Invest in.
Cash Operating Cycle
This is also known as Working Capital Cycle and its the Average length of time it takes a Company to
Buy Goods/Services from Supplier, Converting those Goods to Finish Goods, then selling it to Customers,
then receiving Payments from them to settle Suppliers.
It's a Cycle. Ie.
From
SUPPLIERS (Raw Materials) ➡ WIP ➡ FINISHED GOODS ➡ CUSTOMERS ➡ CASH
➡SUPPLIERS.
In Simple Terms, the length of Days that it takes us to convert our Goods/Services to Cash. It is usually
Measured by Number of Days/ Week/Month... Depending on What you Multiply with.
And the Interpretation is that the Longer the Cash Operating Cycle, the more the investment in W. C. But,
the shorter the better.
The Formula is Simply:
Receivables Days + Inventory Days - Payable Days = Cash Operating Cycle.
If you are Familiar with Your Ratio Analysis Very Well, this should not be difficult at all.....
Pls. Kindly go to Chapter 21 of your Pack and Solve that Simple Question on Cash Operating Cycle...
Computation of Working Capital Cycle
It's By Dividing Balance Sheet Figure with Profit/loss Figure.
Ie.
✔ Receivables Days = (Average Receivables/Credit Sales) x 365Days.
(If no Credit Sales Specified, Assume all sales are on Credit)
✔ Payable Days = (Av. Payables/Cos) x 365
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Or (Av. Payables/Purchases) x 365.
✔ Inventory Days: We have 3 Kinds of Inventory. Raw Materials, Work in Progress and Finished
Goods.
➖ RM Days = RM/Purchases) x 365
➖ WIP Days = WIP/Cos) x 365
➖FG Days = FG/COS)x 365
Example:
Pls. Kindly go to Chapter 21 of your Pack and Solve that Simple Question on Cash Operating Cycle.
Page 671 of the Pack
Overtrading (Undercapitalization)
This means carrying on an Excessive Volume of trading in relation to the Amount of Long term Capital
Invested in the Business. Ie. When a Business is doing beyond its Capacity, growing beyond what it can
control, we said the business is Overtrading.
Symptoms of Overtrading.
How do you detect an organisation Is Overtrading?
The Following Symptoms Help👇👇👇
 High Growth Rate.
 Large increase in Inventory & Trade Receivables.
 Inability to Pay Creditors as they fall due.
 Large increase in Bad Overdraft.
 Low Profitability as a result of high Administrative Expenses.
 Lack of Permanent Funding.
We can then deduce that too much of Short term Funding is Tantamount to Overtrading.
Measures of Overtrading
If You hold a Financial Statement of a particular Company, how do you detect whether they are
Overtrading or not? As a Professional Accountant, these are the things you check:
(1) Liquidity Ratios; Current & Quick.
(2) Check the Change in Cash Balance (Previous Vs. Current)
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(3) Check Overdraft.
(4) Check Payable Days.
(5) Check Sales Revenue.
(6) Permanent Funding. (Share Capital + Debt).
Consequences of Overtrading.
1. Eventual Insolvency, the business can die at anytime.
2. Suppliers will refuse to sell on Credit.
3. Bank will refuse to allow more Overdraft.
Remedial Action
1. Increase Longterm Capital (Share + Long term Debt)
2. Reduce Operating Cost to increase Profit.
Practical Exercise, Page 681.
There is A Question on Overtrading that is in the Pack and the Solution is just after it.
Chapter 22
Management of Trade Receivables and Payables
Introduction
Trade Receivables are otherwise known are Debtors. Every successful company cannot do away without
selling on credit. All they just need to do is to manage it.
Benefits of Giving Credit.
👉 To sell at high Volume.
👉 To Retain Customers.
Cost of Giving Credit
Because there are benefits, the following costs are attached:
1. Finance Costs: Trade Receivables are finance with Long-term Capital. So, it attracts Cost of Capital.
2. Bad Debts: The More you sell to your Customers on Credit, the more the risk of Bad Debt.
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3. Administrative Expenses: Some Debtors can be stupid, so you will need to chase them before they pay.
This will cost you some Admin expenses like Transport, Phone Calls, or at the extreme, litigation.
A Company should be able to match the Cost Against the Benefits... (Cost/Benefits Analysis)
Giving Credit to Customers
Before any company will decide to give credit to Customers or not, there should be some checks and
procedures which defers between a New Customer or an Existing Customer.
✅ Existing Customer: It depends on Past experience with him whether he's being paying promptly
before or not.
✅ New Customer: The Following Credit Checks are Important:
 Asking for trade reference from other Suppliers he has being dealing with.
 Asking for a reference from his banker.
 Carrying out Ratio Analysis on his Most Recent FS.
Content of a Credit Term
If we are saying a company should design a Credit Terms, what does it mean? Its the Combination of the
Following:
1) Credit Period: Commonly within 30 - 60Days.
2) Credit Limit: Maximum Amount a Coy can give out.
3) Interest Charges on Overdue Payments (Though, this one is not practicable because the person self is
finding it difficult to pay the Main Money)
4) Discount for Early Payment.
Note: All these are usually found on Invoice.
Efficient Collection of Debts
When a credit is given then, there should be an efficient procedure in ensuring that customers pay on
time.
They include:
1) Sending Invoice on time.
2) Sending Reminders regularly.
3) Ensure that Credit terms are not exceeded.
Exercises on This.
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Let's Check Question on Page 714 & 718 of the Pack.
Debt Factoring
Debt Factors are specialist organisations that assist Companies with the management of Receivables and
financing of Debts. This is usually common with Small and Medium Sized Organisations that have large
number of Debtors turning to bad debts and does not have an efficient debt collection procedures.
Services offered by them
1. Trade Receivables Administration.
2. Credit Insurance
3. Debt Financing.
Explanation
1. Trade Receivables Administration: A Factor will take over the Administration of trade Receivables
on behalf of the Company, though you will pay them for this. What they do is by:
•
👉 Sending out invoices on behalf of the Client.
•
👉Payment collected by the Factor.
•
👉Chase Customers with Late Payments.
Example on Factoring.
Check Page 721 of your Pack.
2. Credit Insurance: Additionally, aside from trade Receivables administration, they also agree to
provide insurance against Bad Debts.
This is Known as Non-Recourse Factoring Or Factoring Without Recourse. The agreement is that if a
customer of the Company refuses to pay an Invoice that was issued by the Factor, the factor bears that bad
debt and pay the Company in Full. They also offer "With Recourse Factoring" which is the opposite of
this.
3. Debt Finance: With this service, the factor provides Advances of Trade Receivables to The Company
without collecting it yet. Let's say May be 80% of the Debt is given to the Company in advance at an
agreed interest Rate. Then, after the factor is able to collect the Full Money, he remits the Remaining 20%.
Benefits of using a Factor
1. It saves administration costs.
2. With Non-Recourse Factoring, Bad debt is reduced.
3. Its a source of Finance.
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Each of them is attached to a Cost. For example:
➖ Service Charge is for Collection & Administration of Trade Receivables.
➖Commission Charge for Credit Insurance.
➖Interest Charges for Debt Financing.
Discount Policy
A company might adopt a policy for reducing trade Receivables by offering a Cash Discount for Early
Payment. This has both advantages and Disadvantages.👌👌
👉 The Advantage is that it reduces cost of Capital.
👉 While the Disadvantage is that it reduces Annual Profits.
Invoice Discounting
This is the same thing with Debt Factoring only that an Invoice Discounter only provides one of the 3
Services provided by a Factor, which is Debt Financing on a small number of Selected Invoices. He does
not provide other 2, administration of Receivables, or provision of credit insurance against Bad Debt.
Chapter 23
Inventory Management
This is a Package of Topic on its own. So, under it we will study:
👉 EOQ
👉Reorder Level
👉Just in Time
Costs Associated with Inventory
1. Purchase Costs
2. Ordering Cost
➖ Delivery Cost
➖ Telephone Cost
➖ Checking Cost.
3. Holding Costs: This Entails
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➖ Insurance Costs
➖ Warehousing
➖ Obsolescence, deterioration and theft.
➖ Cost of Capital tied down
4. Stock out cost
The Economic Ordered Quantity (EOQ)
This is a Mathematical Model used to Calculate the Optimal(Best) Quantity of Inventory to order from a
supplier each time an order is made.
It's Limiting Assumptions
 👉 Annual Demand is constant.
 👉Purchase price is constant, no discount.
 👉 Lead time is constant and known.
 👉 There is no stockout in the System.
 👉 The only relevant costs are Annual Holding Costs and annual ordering costs.
Practical Aspects of EOQ.
It's usually represented with the Letter Q. And it has its has some Relevant Formulas as we might have
known from previous Studies.
Lets check the pack for possible examples.
 Example 1 is a straight forward Question..
 Example 2 is a little bit advanced because it introduced Price Discount
 Same thing with Example 3. Where we have to compare 3 Different Scenarios.
If we actually Sit down and study those things on our own, we will get to understand them well.
Reorder Level
This is Another Technique of managing inventory. This is asking the question that at what point should
an Inventory of a company reach before they order for new stock.
We should not have 2 Much Inventory to avoid Wastage or Spoilage. At the same time, we should not go
out of stock so that we can meet up Customers Demand.
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Let's Take Examples in the Pack...
This is Best tackled by the following Formulas:
✅ Reorder Level = Max. Demand x Max. L. T
✅ Minimum Level/Buffer Stock = ROL - (Av. Dem x Av. LT)
✅ Maximum Stock = ROL + ROQ - (Min. Dem x Min. LT)
✅ Average Level = Min Level + Max. Level.
Just in Time (JIT)
This is a System which originated from Japan in the 70s. A radically different approach to inventory
management compared to the traditional methods of EOQ and ROL.
It follows the following principles:
➖ Holding too much of Inventory is not necessary, because it increases holding costs.
➖ If there is no immediate demand for Finished Goods, the production department should not produce.
➖ Similarly, Raw Materials should be obtained only when they are actually needed for Production.
There is a Problem Associated with this in the Real World.
There are 2 Systems:
1. JIT Production
2. JIT Purchasing.
•
JIT Production: This says don't Produce Finished Goods and keep in store without having ready
to sell them to the Market.
In order for this to work:
👉 Production Times must be very Fast.
👉Production must be reliable, No Stoppage or bottle neck.
👉 Suppliers must deliver to us on time.
•
JIT Purchases: This is Saying that don't Buy Raw Materials except you are in need of them for
Production Purpose.
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Kindly Read up your Pack For The Remaining Stuff under Inventory Management.... 👉👉👉
We are done with Inventory Management.
JIT Problem in Practice
1. Zero Inventory is not possible in some industries.
2. Difficulty in arranging a reliable supplies with some suppliers.
Chapter 24
Cash Management
Cash Models
Those Models are useful in Determining:
 👉 How Much Cash to hold & How much to invest in short terms investment.
 👉Then, when a company is a dire need of Immediate Cash, how much investment should they
sell to obtain Cash?
They are 2:
1. Baumol Model
2. Miller Orr Model.
Baumol Model
This is based on similar principles to that of the EOQ Model used for Inventory Control. It assumes that a
company spends cash regularly on expenses and that to obtain the cash, it has to sell short term
investments. The purpose of this model is to calculate the optimal amount of cash that should be obtained
each time that short term investments are sold.
Assumptions
 The Company uses constant Rate of Cash Through out the Year.
 The Company can replenish its Cash immediately as soon as it runs out of cash.
 Cash is replenished by selling Short Term Investments.
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 Holding Cash has a Cost. That's Opportunity Cost of not investing it to earn interest. (Similar to
Holding Cost of EOQ 'Ch').
 Selling Short term Securities to obtain cash also has a Transaction Cost. (Similar to Ordering Cost
in EOQ 'Co').
However, we need to know a bit about the Statistical Details of the Model Anyway. 👌
Cash is usually represented with X as against Q in Inventory Management. And it takes the Formula
Method of that of EOQ. Only that terminologies are different.
Miller Orr Model.
The Baumol Model Assumes that Cash payments are evenly spread over time and are constant each
period. In reality, this is unlikely to happen. There are more Uncertainties over the timing of cash
payments and Receipts. So, the Miller Orr model recognises this uncertainty in Cash flows which is
measured statistically. However, we do not need to know the Statistical Details of the Model Anyway.
Please master the formula in the pack. Though, the examiner will give us this in the examination hall.
Chapter 25
Introduction to Capital Budgeting
Introduction
Capital Expenditure refers to a spending on a non current asset, or investing in a new line of business, or
purchase of a new business. As a result of capital expenditure, a new fixed asset appears on the financial
statement, in the statement of financial position.
Appraising Investments
Before an entity undertake a capital expenditure, they should assess whether the project is viable or not.
As a general rule, projects are not undertaken unless:
They are expected to provide a suitable financial RETURN
The RISK attached to the investment is acceptable.
Features of Investment Projects
✓ They usually involve an asset or a business acquisition.
✓ They usually involve several useful life.
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✓ Returns on investment consists largely on net income.
✓ The asset might have a disposal value at the end of the useful life
✓ They might also need an investment in working capital which is usually recouped at the end of
the project.
Methods of Investment Appraisal
•
Traditional Method - ARR & PBP
•
Modern Method - NPV & IRR
✍️ Account Rate of Return (ARR)
ARR measures the impact of investment on accounting profit term. It is similar to ROCE except that
ROCE is a measure of financial returns for a company or business as a whole, but ARR measures the
financial returns from a specific capital project.
Differences between ARR and ROCE/ROI
1. Objective - The objective of ROCE is to measure performance of the business as a whole, while
ARR is appraise investment in a capital project.
2. Time Period - ROCE is just for a year, but ARR is for the whole life of the project.
3. When Necessary - ROCE is carried out on historical information, so it relates to the past. While ARR
is for future prospects.
4. Use - ROCE is only for appraisal remarks, while ARR is for decision making.
5. Scope - ROCE is on a whole business, while ARR is on individual asset.
Formula
ARR = Estimated average annual accounting profit/Average investment
Where, Accounting Profit = Total Profit - Total Depreciation
Average Investment = Initial Cost + Residual Value/2 + Working Capital (If any)
✍️ Payback Period (PBP)
This is a measure of cash flow, not profits like ARR. It is the length of time it takes a capital project to
recover its cash outflows.
•
Formula - For Equal Annual Cash flows
Investment /Cash flows per annum
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If the cash flows are not the same on annual basis, cash flows will be cumulated and removed from initial
outlay until the project becomes positive, that becomes the the PBP.
Chapter 26
The Discounted Cashflows Techniques
Introduction
This is the modern technique in investment appraisal which considers time value of money. Time value of
money explains between time and money. A sum of money today is far more better than the value
tomorrow. The Reasons for that are inflation, risk of what tomorrow may hold and opportunity cost.
The Concept leads to hypothetical terms of:
•
Compounding - Future Value of Present Amount
Ie. FV = PV(1 + r)n
•
Discounting - Deriving present value of future cash flows
Ie. PV = FV/(1 + r)n
✍️ Net Present Value (NPV)
This is the value of cash flows that will maximise shareholder's wealth. It is theoretically most sound
method to use and it represents value of the business in absolute terms.
✍️ Internal Rate of return
A method which is estimated rather than calculated. It is the point at which NPV becomes Zero. There is
an inverse relationship between the Net Present Value and the Discounting Factor. As the DF goes up, the
NPV reduces, closer to zero until it gets to zero point. This point can be plotted on graph but there is
formula which is represented through linear interpolation.
Specific things to know in DCF technique
•
Annuity - A Series of equal cash flows every year.
Formula = 1-(1+r)-n/r
•
Perpetuity - A series of equal cash flows which runs each and every year till eternity.
Formula =
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Advanced Application of DCF
Under the advanced application, the following will be considered:
✓ Relevant Costs
✓ Inflation
✓ Taxation
✓ Risk and uncertainties
✍️ Relevant Costs
Investment is a form of decision making, so it used the theory of relevant costing. We should note that
ARR Method of appraisal uses accounting profits, so it ignores the concept of relevant costing while PBP,
NPV and IRR use cash flows, so relevant costing theory is useful for them.
Rules are:
1. Only Future costs are relevant. Past costs are not.
2. Only Cash costs are relevant, non cash costs are not. Eg. Depreciation.
3. Only Variable Cost and incremental fixed costs are relevant. Fixed costs and allocated costs are
not relevant.
4.
Ignore any financing cash flows like interest. It has been taken care of by the Discounting Factor.
Relevant Costing
➖ Relevant Cost of material
➖ Relevant cost of labour
➖ Relevant cost of existing equipment
➖ Relevant cost of investment in working capital
➖ Opportunity cost
Relevant Costing of existing equipment
When new capital equipment is to be purchased for a project, the relevant cost is the purchase cost of the
equipment which is part of the initial capital expenditure. However, in a situation where a project is going
to make use of an equipment which the business already owns, the relevant cost of such is its
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✍️ Inflation
In investment appraisal, we have 2 cash flows:
•
Money Cash flows - This already includes inflation, and the discounting factor to use here is
Money Rate of return/Money Cost of Capital
•
Real Cash flows - This does not reflect inflation, and the discount rate to use is real rate of return
or Real Cost of capital.
For examination purpose, we should always assume that all cost of capital is in money terms or money
rate of return, that is every cost of capital given reflects inflation, except otherwise stated.
Also, we should assume that all the cash flows given are in real terms. They do not reflect inflation, so
inflation rate will be given to make them reflect it. Care should be taken as to when to start inflating the
cashflows, whether it will start from year 1 or year 2.
Students should read the question very well to ascertain whether the Costs (Selling Price, Variable costs,
incremental fixed costs) are stated in Year Zero terms or year 1 terms. That will give a clear guidance as
to when to start inflating them.
👉 If the question states that they are in year zero term - Then we start inflating them by year 1.
👉 If the question states that the cash flows are in year 1 - They inflating them will start from
year 2.
When to use MRR or RRR
✍️ Money Analysis - This is used when there are more than one inflation rates, whether the question
states so or not.
In that case, inflate all the cash flows with their appropriate inflation percentage because they are all in
real terms (of course that's why they gave you many inflation rates).
Then, use money rate of return.
✍️ Real Analysis - This is applicable when there is a single inflation rate given in the Exam question.
Knowing fully well that all cash flows are already stated in real terms, we can't make used of that
inflation rate to inflation the different cash flows given because it won't be specific for one. Except if the
question gave one cash flow.
So, what we need to do is restate the money cost of capital to real cost of capital using fisher's formula or
effect.
(1 + m) = (1 + r) (1 + i)
Where, m = Money Cost of capital given
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r = Real cost of capital unknown
i = General Inflation Rate given.
Note, using the 2 analysis, NPV should be the same.
✍️ Taxation in Capital Budgeting
There are 2 major considerations as to tax in investment appraisal.
•
Tax Payable/relief on estimated profits or Loss.
•
Tax relief on Capital Allowance.
We need to take them one after another.
Tax Payable on Profits
 ▪️ Tax Base is the incremental profit.
 ▪️ Timing of the tax can either be actual year basis or preceding year basis. Students should look
out for this in the Question. But, if the question is silent assume PYB and state your assumption.
Capital Allowance or Tax Depreciation
 ▫️ The Method to use should be determined from the question. Whether straight line basis or
reducing balance method.
 ▫️ When to claim capital allowance is also very important and can be played upon by the examiner.
Always know what the examiner states. Capital allowance can be claimed either in:
In Advance (From Year 0), or
In Arrears - From Year 1.
If the question is silent, always make use of the 2nd technique. Also, when to claim capital allowance is
different from when tax is paid. Take Note!
 ▫️ The relevance of ascertaining the capital allowance of the asset is not for the sake of capital
allowance itself, but Tax relief on it.
 ▫️ When the asset is finally scrapped, we should ascertain whether it is sold at profit or loss,
because there could be balancing allowance or balancing charge. This can lead to additional tax
relief (Balancing Allowance) or tax payable (Balancing Charge).
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Chapter 27
Replacement Theory
Replacement of an asset
This is considering how long an asset should be used before being replaced. What year will it be optimal
for them to replace an asset. This is not a decision of whether to buy an asset to not.
The following cost considerations relate to that:
•
Purchase Cost of the asset
•
Running cost - Because the more we use the asset, running cost keep increasing as the asset gets
older.
•
Tax Relief on running cost - This is an allowable expense for tax purpose.
•
Tax relief on capital allowance - This will affect tax savings.
•
Scrap or residual Value at the end of the useful life - This may reduce as the year increase and the
asset gets older. An entity can not sell an asset the same amount when selling it at the end of year
2 or at the end year 3.
•
Revenue is not usually relevant here expecially when it is same every year. That's why it's called
replacement COST.
Decision Rule
The frequency of replacement that gives the minimum present value of cost.
If Every 2 Years, that means they will replace in at the end of Year 2, then in the 4th Year, another time
will be in year 6th.
If Every 3 Years, that Means they will replace in Year 3, then in year 6 then in year 9.
Methods of Asset Replacement
✓ If dealing with 2 or more Machines - We determine which one provides lesser cost.
✓ If dealing with one machine - We determine the frequency of years.
In this case, NPV might not be a best method to use because we are either dealing with different machines
with different years or a machine where NPV is derived for different years. So, NPV will not produce a
Good Comparison.
The Method to use is known as Equivalent annual cost or equivalent annual value by dividing the NPV or
PV with Cumulative Discounting Factor or annuity factor.
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Formula
EAC = NPV/AF
That's the method to use when dealing with projects with unequal lives and we are to chose one of them.
Ie they are mutually exclusive (Choosing one will not make you to choose the other).
Chapter 28
Strategic Models and Performance Management
Introduction
Modern business environment is dynamic and do not only require manipulation of numbers to succeed.
There is a need for use of some management tools and strategic models to analyse the problem an
organization is encountering and profer necessary solution. We are going to be looking at some strategic
models in this chapter.
PESTEL Analysis
P - Political Factors
E - Economic Factors
S - Socio-Cultural Factors
T - Technological Factors
E - Ecological Factors
L - Legal Factors
The Model is Widely used most especially when the Scenario is More of External Environment of the
Company than Internal. Each Major Factor has other Sub-Factors Under Them.
Once You read the question, the Understanding of what to bring under each Factor will Flow in.
Also, its part of Analysis as well that u Criticise the Model...
For Example, PESTEL Has the Following Limitations:
➖ No Quantitative Approach to its Application. Managers only use their Descretion in Classifying them.
➖ No Way to rate them whether one has more influence than another.
➖ Its Limited to Macro Economic Environment Only.
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PORTER'S DIAMOND
A Model propounded by Michael Porter, dealing with International, National and Regional Competitive
Advantages.
Michael Porter came into conclusion that Industries in one particular Country or Region of a country
perform better than others due to some Advantages that are present in the Country/Region.
He Gave Four Major Factors and placed them in form of Diamond where each of them connects to one
another from sides and within.
The 4 Factors are:
➖ Favourable Factors Condition
➖Related and Supporting Industries
➖Demand Conditions in the Home Market
➖Firm's Strategy, Structure And Rivalry.
Study this Acronym.
FFC
RSI
DC
FSS
Let me Explain them in the Most Short and Concise Way.
1. FFC: As the Name Implies, those factors of production that are Favorable for Organisations
Operating in those Areas.
Such Factors Could either be:
Basic, or
Advanced.
✔Basic Factors are the Natural Resources. Eg. Land, Mineral Resources, Water, Good Weather, Etc..
✔Advanced factors are man made like Labour Skills, Technology and Social Infrastructure that The
Govt of that Country or Region put in Place.
What Porter is trying to make us know is that Some Companies enjoying these factors will definitely
perform well than companies that their own Factors of Production is not Favourable. And In some
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countries, their Government has assisted Companies Operating there with Stable Social Infrastructure like
Uninterrupted Power Supply, Good Road, etc. Weather is not as Favourable as it is in some Regions Or
Country.
2. RSI: By their name, u shall understand what they stand for. Industries that are Related and not
only that they Support One Another. With that, they will be able to explore more advantages and
pull more opportunities than their counterparts.
3. FSSR: The Strategy that a company employs, their Organisation Structure and the way they
compete with other companies will assist them a lot.
4. DC in Home Market: Charity, they say, begins at home.... Michael Porter is making us to
understand that when Home Customers demand a lot of the products, it will serve as a bedrock to
move Internationally. A Very Good Example is the Chinese Economy.
Limitations of the Model.
It is not applicable to Multinational Coys.
It does not take Note of developing countries.
Its only applicable to Macro Environment.
When is the Model Applicable.???
It's applied in a scenario where One Company is Compared to its Counterparts in another Country or
Region. If you are lucky, the Question will specify. But, if the Question wanna be Tough a little, they
might not specify.
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Porter's 5 Forces
Another Beautiful Work of Michael Porter. This one is used to analyse certain industries might become
and remain profitable than another.
In other words, The Forces that drives a particular industry to make more profit or hinder them from
making profits.
There are 5 Forces:
Threats from Potential Entrants
Threats from Close Substitute
Bargaining Power of the Customers.
Bargaining Power Of Supplier.
Competitive Rivalry
1. Threats from Potential Entrants: Michael Porter propounded that if an industry Is Profitable, more
Companies will want to Come in. In the process, the industry will become more competitive and
competitive. And then, Profit will reduce.
To avoid this, the company can set Barriers to Entry which are:
Economies of Scale
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Technological Know How
Govt Regulations
Access to Distribution Channel
2. Bargaining Power of the Customers: When Customers demand for Lower Price or improved quality. It
will affect Profitability.
3. Bargaining Power of the Supplier: When Suppliers can charge high prices. This will affect the Profits
of companies in that Industry.
4. Threats from Close Substitute: The Threat posed as a result that Consumers can go for another Product
instead of their own.
5. Competitive Rivalry: When the Coys in the Industry are also Competing with one another.
They Might Reduce their Profitability, because they can result into Reduction of Price or reduction of
Quality.
See the Diagram below:
Life Cycle Model
A Model designed for Product's Life Cycle or Asset's Life Cycle. It can be used to analyse:
▪️A Product, or
▪️An Asset.
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The Rationale behind this model is that every product/asset as the case may be has its own Life Cycle.
Just like we Men as well.
We Move from one stage of life to another. These stages form our Life Cycle. Infancy ➡Childhood
➡Adolescence➡ Youthfulness ➡Adulthood➡Oldage
This is applicable to an asset/product.
They have 4 Major Stages:
➖Introduction Phase
➖Growth Phase
➖Maturity Phase
➖Decline Phase.
But, some added:
➖ Research and Development Phase (Before Introduction Phase)
➖Withdrawal Phase (After Decline Phase)
But, the Most important and widely acceptable Stages are the 1st 4.
Let me Now take them one after another
➖ Introduction Phase: The Stage the product of a Company is freshly introduced to the Market.
Everyone will be talking about it and willing to Buy it. At this stage, sales and profit will be Low Because
no Much recognition is Derived yet. The Product is just gaining ground. We can relate this to A Man as
well That Stage of life we pass through that we were small in age and size. Our thinking is Childish
Because we were children. No one is thinking about making money as we are now. All what we are after
is how to eat, play, sleep and Watch Cartoons.
➖Growth Stage: This Stage, the product is getting well known and more Patronisers come in. The profit
grows Because the sales grew already.
➖Maturity Stage: This is when the Recognition, Sales of the Product gets to its Peak. Then, the profit
derived from the product gets to its pinnacle. At this Point, no increase in the Profit derived from the
Product again.
➖Decline Stage: The Product starts fading out of the Market and Sales Drop. So do Profit. At this point,
the Company has 2 Options, either they Withdraw it from the Market or they repackage it.
Each Stage of the Product or asset has its own Peculiar Costs, Sales and Profit. And That’s what
Constitute the Diagram of the Model.
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Pls. Kindly Study It from your Pack
Application of the Model
The Model is applicable where you are dealing with Selecting Pricing Strategy for a Product... And
Whether a Product should still stay in the Market or not. The Stage it is will determine that.
One of the Limitations of the Model is that One might not easily distinguish the Stages from one another.
Boston Consulting Group (BCG) Matrix
This is an empirical research conducted by a management consulting company known as BCG. They
based their analysis on 3 Key Areas:
➖ Market Growth
➖ Market Share
➖ Cash Flows (arising from the Combination of the 2).
They presented a 2 by 2 Matrix where Left Vertical Side Represents Market Growth and Top
Horizontally represents Market Share.
The Question is what's the Understanding of the 2 Concepts in respect to Company's Performance and
Activity?
➖Market Growth: This is the Probability that People will buy the Product of the Product.
For example, in 2015, the Coy sells 30, then, in 2016, the sales increase to 40 then, in 2017, it increases
to 50. We say the Company has a High Growth Rate.
In A Nutshell, Growth is Measured Horizontally. On a Straight Line
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➖Market Share: As the Name Implies, this is percentage that the Company sells out the Total Market
Sales.
For Example, it we have 10 Companies selling Car in Nigeria and all of them sold 1000 Cars during the
year, but our company alone sold 200 Cars. That means, our company have gained (200/1000) 20% of the
Total Market Share.
Note: Market Share is Measured Vertically.
Application of the Model.
The Model is applicable to:
➖Portfolio of Products: In a Situation where you wish to select which Product is performing well or
which one is Under performing.
➖Strategic Business Units or Subsidiaries of a Group Company: This Model can also be used to
analyse a Big Company with different business units. For instance, Dangote Group of Companies now.
They Have Dangote Sugar, Dangote Cement, Dangote Salt, etc. Each of them is a Business Unit. U can
use it to Analyse which of the units is performing well or not. Also, in the Case of a Group Company
with Many Subsidiaries selling different Products. U can use this same model to analyse which subsidiary
is Performing well or not, and decide whether to Dispose off the subsidiary or not.
The Model Itself
There are 4 Quadrants namely:
1. Star (High Growth + High Share): These are the Market leaders products. Products like these generate
Net cash flows but at reasonable Low amount, because the company will be spending more cash to
maintain the High Position of Growth it has in the Market, than what they earn from it.
The Strategy the Company should employ with them is to use money gained from Cash Cows to continue
financing it.
2. Cash Cow (Low Growth + High Shares): As the Name Implies Cash Cow, The Product has highest
percentage of Customers buying it while the product itself is no more growing in the market. This makes
the Product to generate more Cash than what the Company Invests in it. This is the Point where the
Company reap what they sow In a Product.
The Strategy is that they should no more spend to develop the product, rather use the Bundle of Cash
generated from it to Develop other Products like Stars and Problem Child.
3. Question Mark/Problem Child (High Growth + Low Share): The Company still spend a huge amount
of money to Develop the Product, but yet, no reasonable market share in Compensation for the Money
spent on it. It raises a Question Mark ? What should we Do?
Whether they should continue to invest on it Ní o or Withdraw it from the Market. The Simple Strategy
Here is that the Company Increase the Product Life or increase its investment.
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4. Dog: This product is Tantamount to a Decline State of Product Life Cycle. The Company should not
even bother to invest more on it because there's no certainty that they will recoup their investment at all.
If it still bring in little Cashflows, the company can decide to enjoy it for a few Moment and then decide
to Withdraw it (in the case of Product) or Close the Unit down or Dispose off the Subsidiary, as the Case
may be.
Limitations of the Model
It is limited to only 2 Factors in analysing competitiveness of a Product while there are other Factors
as well. E.g. Quality, Branding, Pricing Etc...
The Definition of Market itself might not be easily determinable in Real Life.
How to Determine whether the Market is Growing or not is Another Problem.
What's Remaining in that Chapter is Opportunity & Threats. But, we are gonna do it Together Under
SWOT Analysis In Chapter 4.
Study the Diagram below:
✔ Strategic Capability:
Ability of a firm to Outperform its Competitors through effective use of their Resources & Competencies.
2 Key words are important there.
Resources, What we have &
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Competencies, how we use them.
That is looking at the market from an internal point of View, building our areas of core Competencies
instead of looking outward to competitors. By the time we get outside to the market, it becomes a
problem to the Competitors.
✔ Customers Need:
Since market can also be defined as customers as earlier said, we look at our products from the Point of
View of our customers, who they are and what do they Need.
Customers' Need are the reason why They Buy Goods. Eg:
 -Price
 -Quality
 -Better Design
 -Convenience of Product
 -Advert or Sales Promo.
Categories of Customers
1. Individual Customers
2. Industrial Customers
3. Government Organisations
Those are self Explanatory.
Critical Success Factors (CSFs)
The Idea behind this is that for a product or service to be Successful, it must have Value. Therefore, CSFs
are factors or features or components Our products must possess for them to be Successful in the Market
and Outperform Competitors Products.
Several Success Factors could be Shortlisted, out of which might be:
-Charging Low Prices,
-Locating Office at a Favourable Environment.
-Employing Skilled Labour.
-Etc.
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However, not all of them might be Critical to the Success of the Organisation. Therefore, we need to look
at them from a Scale of Preference Point. Which comes first after another. This Leads Us To Another
Important Concept Key Performance Indicators KPIs.
Key Performance Indicators(KPIs)
These are Quantitative Measures to evaluate monitor and control the Attainment of CSFs.
6 Step Approach to Using CSFs
According to Johnson Etal, they are :
✔ Identify the Success Factors for Profitability.
✔ Identify The Critical Competence.
✔ Develop The Level of Critical Competence.
✔ Identify Appropriate KPIs for each Critical Competence.
✔ Give Emphasis to developing Critical Competence.
✔ Monitor the Firm's Achievement of it's KPIs.
Benchmarking
This is a Competitive Analysis by comparing the performance of an Organisation with that of another
organisation which is performing better in the industry. Then, that organisation becomes the "Benchmark".
The Rationale behind this is not just to compare, but to identify our own area of Weaknesses that they are
performing well in it and adopt it(If Possible).
Types/Methods of Benchmarking.
Note, there is no widely acceptable types for Benchmarking. So, just stick to one.
➖ Internal Benchmarking: This is within the Organisation itself. Comparing a particular Biz unit/branch
with another in the Same Organisation.
➖Customer Benchmarking: Comparing our Products with what the Customer Expects.
➖Operational Benchmarking: Comparing our own operation or process with that of another company.
➖Competitive Benchmarking: This is the most Widely used. Comparing our overall performances with
that of the Most Successful Competitor.
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Benefits of Benchmarking.
1. It makes the Company better performing.
2. It makes the Company to continue improving.
Problems with Benchmarking include:
1. Difficulty to get some confidential information.
2. The Process might be hectic.
There is usually a Process to adopt, depending on what the Organisation wants.
Porter's Value Chain
This is Another Work of Michael Porter. The Guy Actually Tried a lot in the Field of Strategic
Management. Propounding a Quite number of Management theories and Formulating a reasonable
number of Models. If You are actually familiar with this Paper very well, you will understand what I
mean. His name comes out every 2 2 Pages.
Meaning: A Value Chain is set of Activities that a product or Service of an organisation will pass
through before reaching the Final Consumers. What Porter is saying is that Each Activity should add
Value to the product. If not, they are regarded as Non Value Additive...
He Now Gave 2 Categories of Activities:
Primary Activities, and
Secondary Activities
Primary Activities are:
1. Inbound Logistics
2. Operations
3. Outbound Logistics
4. Marketing & Sales
5. Services (After Sales)
Primary Activities include:
✔Inbound Logistics: This is Dealing with Buying of Raw Materials and keeping save for Production
Purpose. The Major Players here are the Suppliers.
✔Operation: Those Raw Materials bought are to be transformed into Finished Goods that are for the
usage of the Final Consumers. But, they will pass through production processes which is Work in
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Process...
This One is Dealing with Factory and Factory Workers in the Case of Manufacturing
Company and its very important and should be Managed Well...
✔Outbound Logistics: This has to do with Keeping of Finished Goods Save until they are readily sold
to Customers. Some Companies used to Keep them in Warehouses...
✔After Sales Services: Some products do not end with just Buying. Installation, Fitting, Maintenance at
intervals and other After sales Services should be rendered as well....
It makes the Company More Competitive than Other...
✔Marketing and Sales: One of the Most Important Chain as well. Its dealing with Channel of
Distribution and Advertising. Our Products should be known to the Consumers and even if they know,
how do we get it across to them.
Secondary Activities include:
1. Procurement
2. Technology Devt
3.
Human Resources Management
4.
Corporate Infrastructure
✔Procurement: This has to do with Purchasing of Assets.. Its a procedure that a company embarks on
that makes them to be able to get the best and efficient Assets and Inventory.
✔Corporate Infrastructure: This is referring to the Organisation Structure. How the company is managed.
Those in charge of Governance. Those giving policies... Any Policy they adopt can either make or Mar
the Organisation.
✔Technology Development: As the Name Implies, present day companies should not be left out In the
Advent of Technology and technological Development. They make life easier.
✔Human Resources: Even with the Advent of Technology, machines can still do some things. Infact, it's
Man that will operate the machines. Human Beings could be very difficult to manage. A successful
organisation should understand that without the staff, the organisation will not be able to move forward.
Manage them well and treat them like Humans, not animals. Even if you pay them for the Job
The Model is Very useful but has some limitations. One of it is that It does not consider the External
Factor in the Organisation.
Diagram below:
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Resources and Competencies➖
A Resource is an asset, item, material, skill and knowledge that an entity has control over. This is a
Strength of organisation and it could be useful under SWOT analysis.
While Competency is the ability to put the Resources together to achieve the Best. Both of them work
hand in hand. It's one thing to have something, but another thing is to be able to make good use of it. We
have Threshold Resources and Unique Resources.
We also have Threshold Competencies and Core Competencies.
✔ Threshold Resources /Competencies are those ones an Organization Need as a Minimum
Requirement, to be able to Succeed in A Given Industry.
✔ While Unique Resources/ Core Competencies are those ones that Only the firm possesses it in That
Industry. This is what will make them Competitively Different from Others, and it will make them
Perform Better.
Categories of Resources:
✅Human Resources: Managers and Employees.
✅ Physical Resources: Assets and Raw Materials.
✅ Financial Resources: Cash in hand and at bank.
✅ Intellectual Resources: Intangible Assets like Patents, copyright and brands... Ability to innovate and
R&D.
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Ansoff's Growth Matrix
Another Guy like me and you as well propounded a 2x2 Matrix as well in 1957.
He argued that there
should be a link between a Company's Current Product, its future product and the market at which he
wishes to operate.
The Matrix placed Market on the Horizontal Left Side and Product on the Vertical Top side in relation to
Existing Market and New Market.
The Model Itself
The Four Strategies include:
✅ Market Penetration Strategy: As seen in the Matrix, this relates to existing product and existing
market. I.e. An entity seeks to sell more of its existing products in its existing market. This is a sensible
choice to make when People still demand for the Product. Ie, the market is growing rapidly.
✅ Market Development Strategy: Still on Existing Products, but probably its Fading away in the
Market that people are no more interested in it anymore. The Company takes it to a new Place (Market) or
look for new buyers, it will be new to them.
✅ Product Development Strategy: This is an innovation strategy, where we see that our Customers are
loyal to us and they still wish to continue buying from us. We Development New products with the help
of our Research and Development department. A Very Good Example of this is Mobile Phones in Nigeria.
Eg. Infinix, Tecno, Huawei, Apple, etc..
✅ Diversification: Where Company moves from what they sell to a totally different something by
acquisition of another company. This can be Concentric or Conglomerate Diversification.
Application of this Model:
This model is applicable in A Situation where a company is faced with the Marketing Strategy to make
use of for their products. Whether they should Differentiate the Product ni ó or Change the Market. It
depends on how the Question Comes Anyway.
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Gap Analysis Model
This is Subscript Model to Ansoff Growth Matrix. And It's saying that there may be a Gap Between:
✔ The Position A Business Entity wants to be by the end of the Planning Period, and
The Position it is likely to be if it does not have a Change of Strategy.
This Model is used to close this Strategic Gap. In a Nutshell, looking at the Gap Covered By An
Organisation if these Strategies are applied in terms of Profitability.
Withdrawal of Strategy
A Strategy adopted by a company in relation to A Product, may be withdrawn totally if the company
deems fit.
Ie. A Company may decide to:
1. Reduce the range of Products offered to the Market.
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2. Pull Out from One Market for another.
3. No longer operate in a Market at all.
Reasons behind this are:
1. Inability to compete more effectively.
2. Poor Financial Results.
3. A Decline in the Sale of The Product.
4. A Decline in the size of the Market.
5. If the Company decides the Product is not a Core Product.
Chapter 29
Information systems and performance management
Introduction
When a raw data is processed into a meaningful form, it becomes information. Managers need
information to make different decisions, depending on the level of management it is. Aside from making
decisions Information can also be used to coordinate activities and measures performance and improve
business processes.
Levels of management
1. Strategic management - They are concerned with setting objectives for the organisation and develop
plans to achieve those objectives. This is usually carried out by senior managers in an organisation.
2. Tactical Management - This has a shorter term planning horizon. This is carried out by middle level
managers. They monitor actual performance to assess whether planning targets deceleration by strategic
management are achieved. Their main function is usually associated with budgets and Budgetary control.
3. Operational Management - This is the management of day-to-day operations and activities. The
planning horizon is usually short and requires immediate decision. This is usually saddled with
supervisors and Frontline managers who monitors daily efficiency level.
Each of those management levels require different information need. Strategic management need strategic
information. Tactical management needs tactical information while operational management needs
operational information. For example:
✍️ Strategic Information which is needed by strategic managers has the following characteristics:
•
•
It is usually Summarised and not detailed.
Longer term in nature
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•
•
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Often forward looking
Sourced from both internal and external source.
Usually contain qualitative information rather than quantitative.
It captures overall objectives of the organisation as a whole.
Prepared on an adhoc basis, rather than regular.
There is a high degree of uncertainty in the information, because of its futuristic nature.
✍️ Tactical Information - This are information used to decide how the resources of the organisation
should be used. They are information relating Budget where plans are expressed in financial terms.
Tactical information has the following characteristics:
•
•
•
•
•
•
•
•
It is often about individual departments and functions not overall as strategic.
Also Summarised form of information but a bit level of detail than strategic information.
Generally Relevant to short and medium term.
Often concerned with performance measurement.
Data sourced from both internal and external sources but more from with in the organisation.
Often prepared on routine or regular basis. For example, monthly, or weekly performance reports.
Consists of mainly quantitative information rather than qualitative.
Though, there is a degree of uncertainty but much less than strategic.
✍️ Operational Information - This is that one needed by Frontline managers or supervisors to enable
them organise and monitor operations, make on the spot decisions whenever operational issues arise.
They have the following characteristics:
•
•
•
•
•
•
•
•
Usually task specific, about specific transactions, specific job, daily workloads, etc.
Usually detailed in nature.
Relevant to very short term
Relates to daily transactions
Data comes exclusively from within the organisation.
Often prepared frequently
Consists mainly of quantitative information
Information are usually factual and with less uncertainty.
Qualities of Good Information
1. Relevance - A Good information must be relevant for its intended users.
2. Reliability - Information must be accurate and complete enough for its intended purpose.
3. Timeliness - Information must be available in time to its users and not when no more needed.
4. User confidence - Information must be realistic that users should have confidence in it.
5. Value more than cost - The benefits of that information must be more than its cost.
Accessibility of information
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Business information in performance management systems should be readily accessible so that the user of
it can be able to find it when he or she needs it. In modern IT adapted organisations, information can be
obtained immediately on demand. In particular, data base can make large amounts of information
immediately available through the use of internet and computer database.
Security of information
Although, as we said above, information should be accessible to authorised users, but should also be
secured from unauthorised access. The following methods can be used to secure data:
1. Physical Security - Places where computers are kept should only be accessible to authorised staff.
2. Software Security - By the use of passwords and encrypted data, soft files should be safe.
3. Anti-virus software - To avoid destruction or corruption of data by hackers and crackers, anti virus
should be installed on systems and updated on regular basis.
4. Use of backup files - No matter what, circumstances beyond control may warrant that data are totally
corrupt or lost. To avoid that, files should be duplicated and kept somewhere else for retrieval purpose.
The best backup device is the cloud.
Sources of information
There are 2 Major sources of information
1. Internal Sources - A Control system such as a management accounting system must obtain data from
within the organisation for planning and control purpose. Potential internal sources include:
▪
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Financial accounting records
Human resources records maintained to support payroll systems.
Production information
Sales Information
Minutes of meetings
2. External Sources - Managers also need information about customers, competitors and other elements in
their business environment. This is needed for strategic planning and control. Examples are information
needed about customers, competitors, suppliers, regulatory environment, economic or financial
environment. Potential sources include:
•
•
•
•
•
Market Research
Trade journals
Suppliers Price list
Newspapers and other media
Government reports and statistics
Limitations of external information
1. It might not be accurate
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2. It might be incomplete
3. It might not be detailed enough
4. It might not be available when required
5. It might be misinterpreted.
Cost of information
For information to be Useful, it should be captured and processed. Capturing and processing data costs
some money. Costs associated with hardware, software, analysis, interpretation and procuring modern
computing equipment can amass huge amounts.
Big Data
The term refers to huge volume of data available to a business on daily basis. Big data can be analysed for
insights that leads to better strategic decisions. An American IT by the name Doug Laney described big
data as having the following characteristics:
✓ Voluminous - This is a large volume of data available more than what a single customer can
handle.
✓ Velocity - This refers to the speed in which the data becomes available to the user. Data streams
in at an unprecedented speed and must be dealt with in a timely manner.
✓ Variety - Data comes in all types of format. From structured, numeric, ununstructur, and etc.
Recording Data
There are many different ways of capturing data and recording it in an information system. Recording
data depends on circumstances, and also on the nature of the data required. For example:
✓ Record of labour hour spent on particular tasks - This can be recorded on time or job sheet.
✓ Records of material used - Material requisition notes.
✓ Data about customer satisfaction - Customer feedback surveys.
The system of recording data should be made as convenient as possible for the one inputing it to the
information system.
Methods of data collection or gathering information
(i) Observation Method: Observation method is a method during which data from the field are collected
through monitoring or systematic viewing. It could be either participatory or not.
Advantages:
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Subjectivity and bias are eliminated;
Method is reliable and dependable;
System analyst gets current data and
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Observation results are independent of respondent‟s variable.
Disadvantage
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It is an expensive method (more time is required).
Limited data.
Unforeseen factors may interfere with observational task.
Respondents‟ opinion cannot be recorded on certain subjects.
Consciousness of being monitored may affect respondents and this performance may be
susceptible to observers‟ bias.
(ii) Interview Method: This is a method of collecting data which involves presentation or oral /verbal
stimuli and reply in terms of oral/verbal responses. Most times, it is regarded as a face-to-face survey
process. It could also be personal, group or telephone interviews.
Advantage
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Data are gathered in greater depth.
Flexibility in restructuring the questionnaire.
Interviewer, by his skill, can overcome resistance.
Interviewer can collect supplementary information about respondent’s personal characteristics
and environment which has value in interpreting results.
Fast to obtain information.
Eliminates ambiguity.
Disadvantages
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Little time is given to respondents.
Survey is restricted to respondents who have telephones.
Not suitable for intensive survey where comprehensive responses are required.
Biased data may be obtained.
Time consuming.
Can be costly.
Very difficult to develop interview questionnaire because it should be short, simple, less
ambiguous, relevant, non-offensive or non-irritating, and concise.
(iii) Questionnaire Method: This method of data collection is quite popular, particularly in the case of
big enquiries. The questionnaire is mailed to respondents who are expected to read and understand the
questions and write down the reply in the space meant for the purpose in the questionnaire itself. It could
be structured or unstructured questionnaire type.
Advantages
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It can be achieved at lower costs even when the geographical area covered is large.
Respondent‟s claims are free from bias.
Adequate time to think of responses.
Non-reachable respondents may be conveniently contacted.
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Large samples can be used, so results are more reliable.
Reduces chance of evaluation bias because same questions are asked of all respondents.
Popular method.
Can be subjected to mathematical or statistical analysis to make the results scientific.
Disadvantages
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Low rate of return of duly filled questionnaire.
Can be used only when respondents are educated and cooperative.
It is inflexible.
Omission of some questions.
Difficult to know if the expected respondents have filled the form or it is filled by someone else.
Slowest method of data collection and therefore may not be timely.
Items may not have same meaning to all respondents.
Good survey questions are difficult to develop.
iv) Case Study Method: It is essentially an intensive investigation of the particular phenomenon/event
under consideration. Important characteristics are as follows:
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The researcher can study one single variable or more of such variables for his purpose; and
The selected variable is studied intensively.
Advantages of Case Study Method
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An opportunity for an in-depth and detailed examination of the entity.
More relevant and reliable data is gathered.
Disadvantages of Case Study Method
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•
Data gathered is restricted to the situation under study and at that particular time, and this may not
be relevant to future applications.
Usually, it is time consuming to collect, organise and analyse data.
(v) Panel Method: In this method, data are collected from the same sample respondents at the same
interval either by mail or by personal interview. This is used for studies on:
•
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•
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Expenditure Pattern;
Consumer Behaviour;
Effectiveness of Advertising; and
Voting Behaviour and so on.
Advantages
•
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Useful in aerodynamics and highly technical cases.
Extremely versatile tool for creative modeling.
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Disadvantages
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Too technical.
Costly.
Limited application.
(vi) Experiment Method: An experiment is a controlled study in which the researcher attempts to
understand cause-and-effect relationships. The study is "controlled" in the sense that the researcher
controls:
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How subjects are assigned to groups; and
Which treatments each group receives.
Advantages
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It is scientific.
Reliable.
Eliminates bias.
Disadvantages
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Expensive.
Time consuming.
(vii) Focus Group: Gathering information through a small demographically diverse group of people in
guided or open discussion about a subject matter with a view to determining reactions that can be
expected from a larger population.
Advantages
•
Information is obtained from a diverse group of people and therefore could be more reliable and
real to life.
Disadvantages
•
Result can be influenced by the researcher based on his/her reading of the group discussions. So,
it could be biased.
(viii) Tally/Counting: This involves gathering data by recording actual performance through physical
counting.
Advantages
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Scientific.
Accurate.
Reliable.
Disadvantages
Could be cumbersome.
Time- Consuming.
Useful only for small population.
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(ix) Literature Review Documentations and Records: This involves searching for available written
data from past records, documents, statistical details and other records.
Advantages
•
Involves the use of verifiable empirical documented data sources which can be referred to
subsequently.
Disadvantages
•
•
Because it is historical, it therefore may not be suitable for current or future situation.
Basis of compilation may be flawed
Effect of IT on performance management
Information technology has improved the quality of service providers with the provision of instant access
to to customer's files and prompt action to their request. Through the use of telephone, email, internet
services, businesses can be done easily online.
IT assists in the following areas
1. Collection of data
2. Storage of data
3. Access to data
4. Communication of information
Significance of modern IT Systems
1. Instant access to data - Information can be quickly gotten from the database by all authorised personnel
through a network connection.
2. Remote input - In a traditional performance management systems, data was input to the computer by
specialist staff. There was often a high rate of input errors. In order to reduce errors of input into the
computer system by specialist staff, modern IT systems have developed an automated input of data by a
non finance operating staff at the point of sale.
3. Instant access to external sources of data - With the use of modern IT systems, managers now have
access to external information from the internet. Either free of charge or through subscription. An
effective management and use of IT system gives competitive advantage to companies.
e-business and performance management
E-business is the exchange of business information using electronic networks. Transactions with
customers and suppliers might involve transfer of information not necessarily transfer of money. This has
changed the nature of market place in which goods and services are bought or sold. It also changes the
nature of the relationships between Customers and suppliers.
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Globalisation and advent of e-commerce
Globalisation refers to the process of denationalization of clusters of political, economical and social
activities. It is an evolution which is systematically restructuring interactive phase among nations, by
breaking down barriers in the area of culture, commerce, communication and several other fields of
endeavour. Globalisation is a growing worldwide interdependence of people and countries made possible
as a result of huge advances in technology. Barriers in trade are broken down and the world major
financial markets are integrating as a result of globalisation. It is a world without frontiers where business,
products, people and their ideas are freely disseminated and diffused. It makes global exchange of
knowledge, commerce and culture to freely interact. With the aid of satellite communications, internets,
fibre optics cable, digital information transactions, and highspeed computers, management of any
organization can safely monitor the activities and trend of their company’s performance. It ensures strong
economic integration.
Globalisation makes possible the wide spread of materials, wealth, knowledge and culture. Corporate
work places can be effectively managed online. It has equally made it easier to open up other countries
market, thereby leading to expansion of trade. Internet technology has revolutionized communication. It
enhances easy, cheap and quick access to people and information worldwide. Globalisation has given rise
to global market value system, global marketing, access to international financial market and it has
effectively removed the world trade barriers. Hence, with the attendant benefits that come with
globalization, managers of organizations can increase their entities productivity from any remote area of
the world and receive information as and whenever required.
Management Information System (MIS) is the effective use of information to aid the activities of
managers. The activities of managers include:
➢ Presentation of materials which is enhanced by the use of word processing equipment such as
word processors. The use of spreadsheets also aid the presentation and preparation of accounting
information.
➢ Teleconferencing, which involves conferencing of managers in different locations also aid the
effectiveness of managers. Electronic Commerce (e-Commerce) is another area of MIS where
wide varieties of goods and services are made available to enhance the activities of the managers.
The production of good information also enables the company to gain more competitive advantage over
rivals of the same line of business and it encourages specialization by managers. Globalisation enables
companies to gain more competitive advantage over rivals in the same line of business. Wide varieties of
goods and services are made available. Specialization is enhanced as excess products have markets.
The criticisms against globalization
Despite the numerous benefits of globalization, it is not without criticisms. It has been argued that
globalization has widened the gap between the rich and the poor. Though global wealth has increased, it
is held in fewer hands, organizations and countries.
▪
Globalisation brought about environmental degradation. The quest for growth and profitability by
orgasniations has made many of the companies to abandon or ignore environmental protection
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and sustenance. Environmental pollution is rampant and environmental offenders are daily
increasing. Though globalization has enriched the world scientifically, economically, politically
and socio-culturally, there appears to be no global government to regulate globalization.
▪
Globalisation has made different countries and cities of the world to be under one roof, but
democracy is literarily eroded and seeds of stability eroded in most countries. This has negative
effect on organizations performance.
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Human animal and plant diseases can spread more quickly through globalization. Economic
depression in one country can trigger adverse reaction across the globe. It can lead to capital
flight where funds are moved from country where interest on return on investment is low to a
country where the interest is high.
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Companies are faced with greater competition. This can put smaller organisations at a
disadvantage as they do not have resources to compete on global scale. Globalizations do not
maximize sustainable economic growth. With globalisation comes the activities of fraudsters,
hackers etc.
The major barriers to e-business include:
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(i) Set-up costs: It can be fairly expensive for a small company to establish a website for selling
its products and taking payment by credit card, debit card, Inter-switch or PayPal. For example, it
will be expensive for a small company to set up a website showing an online catalogue with
photograph, keeping records of inventory balances, and with a facility to debit customer credit
cards.
▪
(ii) Type of business: Some products and services are easier to sell on the internet than others.
For example, computer firms sell products very successfully over the internet as their products
can be perfectly specified in writing. However, it is much more difficult to sell items of clothing.
No matter how much detail about clothing items that is provided on the website or how many
photographs that are provided, there are difficulties with selling such goods ‘by catalogue’.
Companies that do sell clothing by internet have to budget for large amount of sales returns.
▪
(iii) On-going operating cost: A website has to be updated frequently to keep it interesting (and
accurate), and it might be necessary to keep making special offers to encourage customers to keep
revisit the site.
▪
(iv) Time to establish the system: It takes time to establish a website that customers know about
and wants to visit.
▪
(v) No in-house skills: A company might not employ individuals with the knowledge or skills to
maintain a website. However, this should not be a serious barrier to ebusiness, especially if the
employer is prepared to give suitable training to staff.
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Virus
Viruses are computer softwares that are designed to deliberately corrupt computer systems. Virus can be
introduced into a system on a file containing the virus. A virus may contain:
•
•
In a file attachment to an e-mail; or
On backing storage device such as a CD.
Types of virus
The following are the commonest viruses:
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Trojan horses: This is a type of virus that disguises itself, often hidden with other software or files;
•
Worms: This is a corrupt data that replicates itself within the system, moving from one file or
programme to another;
•
Logic bombs: This is a virus that is designed to start working (corrupting the files or data
processing) when a certain event occurs;
•
Time bombs: This is a virus that is designed to start working (corrupting the files or data
processing) on a certain date;
•
Denial of service: This virus renders the system unusable by legitimate users; and
•
Trap doors.
The following steps can be taken to guide against virus attack:
• Installation of anti-virus software which must be updated yearly;
• Restriction on the use of floppy disks, re-writeable CDs and USB storage medias;
• Firewall software and hardware should be used to prevent unauthorized access from the internet;
• Staff should be encouraged to delete suspicious e-mails without opening any attachments; and
• There should be procedures, communicated to all staff, for reporting suspicion of any virus as
soon as they appear.
Preventing Company’s Data from Activities of Hackers And Virus
Various measures might help to prevent hacking into a system, or to detect when a hacker has gained
unauthorized access. The following controls can be used to prevent or detect hacking:
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Physical security measures to prevent unauthorized access to the computer terminals of the
Company;
The use of passwords;
The encryption of products that are sent via internet;
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Uses of audit trails, so that transactions can be traced through the system when hacking is
suspected;
Network logs, whereby network servers record attempts to gain access to the system;
Use of firewalls;
Data masking; and
Data scrambling.
Chapter 30
Implementing performance management systems
Accessibility to Information
An important factor in the design of a performance management system is the way in which the
information is made available to intended users. Management with performance responsibilities should
have information to do their work. IT systems make this possible sometimes, but there is a risk of
information overload which makes users to lose track of the most important and relevant of them and in
turn, not make the best use of the information they are given.
Employer/Employee Relationship
The advent of IT based system, the relationship between employer and employee is enhanced because
information need not going through hierarchical structure before it gets to the top managers. A junior
employee can send message to the CEO through the use of Email directly without any intermediary.
Home working
IT has also made it easier for individuals to work from home without a physical office.
Advantages
✓ Reduction in Cost since there is no need for office accommodation.
✓ Lack of disruption to work. For example, transportation.
✓ Attractive working conditions.
Disadvantages
✓ Management control problem
✓ Isolation
✓ Dissociation from the work team
Email and work practices
With emails, individuals have immediate access to information and responses to queries. It makes
communication more faster.
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Limitations of using email
1. Large amounts of junk mails
2. Exposure to viruses
3. Security problems
4. Gossiping with others
5. Delay from feedback
6. Errors of typing and attaching wrong documents
7. Other Technical Problems
Socio-technological System design
This is an approach to system design of IT systems that recognises social factors in the operation of the
system together with technical functions. The most efficient IT system is that which satisfy the need of
the users in terms of social interaction, so that as they carry out their work, they also interact with one
another.
1. Technical aspect - This has to with running or operating the system.
2. Social Aspect - Satisfying the social needs of the operator as well. Example of social needs
include:
o
o
o
Communicating with others outside the organization.
Interacting with other employees.
Need for creativity in the work.
The potential risk with working in a computerised environment is that computers isolate individuals, even
when physically working together. Employees spend too much time looking at the computer screen more
than having to conversate with one another.
However, current working environment should be Socio-technological in nature so that individuals can
interact socially, distract away from work sometimes through chatting, visual communication, and then
come back.
Challenges in the development of Management Information System (MIS)
The MIS development team is faced with various challenges from the requirement gathering phase to the
implementation phase due to technological and human challenges and the type of data and information
required. Some of the challenges are listed below:
• Lack of internet connectivity: The lack of understanding about passwords and security policies
caused situations where passwords were even written on sticky notes and pasted on monitors, etc.
• A major problem of introducing an MIS in an organization is the nature of the company,
structure, product, personnel, etc. These will always pose a challenge. When the system is
introduced to the staff, some of them may be reluctant to use the system because of lack of trust
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in computer systems. In addition to that, the infrastructure and security policy implementation are
difficult tasks.
Another challenge is the shortage of human resources within the MIS team. The problem
associated with data gathering, analysis, training, and documentation activities, are all human
resource problems.
Bad Communication: Lack of understanding/planning for customer, organization and other
stakeholders‟ requirements/needs for the project.
Unclear Requirements: Unclear requirements will lead to changes in the course of the project,
which will increase delivery time and bring about customers‟ resentments.
Increasing Cost: This will lead to added labour and project cost. Thus making the project less
profitable and takes away interest from stakeholders.
Delayed Project Delivery: The impact of operational challenges and the introduction of software
with less functionality will result in delayed project delivery.
Market Pressure: Another important aspect is the rapid development of software to meet the
ever-changing market demands.
Knowing the Technical needs: This is about understanding programming languages, the
frameworks, the systems and the algorithms needed for a particular information system to be
successful.
Design Patterns: Identifying the right design patterns for your information system software and
establishing an actual design review, quality evaluation criteria and design management is
something highly neglected today because of the time and effort it takes.
Quality Control: Building quality and maintaining same to serve multitude of customers.
Security: Security of data/information is highly important especially with today’s cyber warfare
and attacks. Use of Password, Physical security and limited access to a system is imperative.
Debugging challenges: Dealing with bugs through debugging as a process of locating and fixing
a software or hardware-related error or problem is critical to the successful Management of an
information system.
Problems areas with implementing an Information System
When an Information system is designed, developed and implemented, several problem areas must be
managed carefully. The potential problems are:
•
•
The new system should contribute to the economic, financial or operational performance of the
organisation.
The new system is likely to have an impact on organisational and social matters, and this may call
for resistance from them.
Experience shows that the Last one is the major problem affecting new systems due to significant impact
on organization's culture, structure and working practices.
Organisation Impact Analysis
This is the analysis on the likely impact that a new system would have on an organisation. The
contribution to economic, cultural, structural and social aspects of work. All of these should be considered
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at an early stage of the project development, up to the implementation of the new system, as well as post
implementation review.
The following should be considered:
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•
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Economic Benefit - Whether the expected benefit from the system meets the expected cost.
Human Related Issues - This has to do with training of staff, health and safety issues,
Motivating them to be user compliant and assessing their work condition. If all these human
related issues are not considered properly, there could be a resistance.
System Implementation - This is another important area of organisational impact analysis. The
period of transition from the old system to new one. Management should consider any likely
disruption the implementation of the new system could cause on the organisation and how long it
might last.
Organisation Structure, culture and power - There should be an assessment of how the system
will impact those important 3 areas:
👉 Structure - This has to do with their organization structure and flow of authority.
How the new system might impact this, probably some staff are transferred to other
aspects of work, or some relieved.
👉 Culture - This are sets of important assumptions and practices, often unstated or
documented, but which members of an organisation share in common.
👉 Balance of power within the organisation is also required. Information and
knowledge gives power to whosoever possess and control them, and this may alter the
balance of power in an organisation with the introduction of new systems.
Organisation Impact Analysis is inevitable because it helps management to identify potential problems
that new systems might create and something can be done to resolve it before hand.
Success and failure of information systems
The aim of the management is to ensure as much as possible that each new information system is a
success. The following factors determine success for a new IS :
•
•
•
•
•
•
Achieving the objectives of the system
Financial Benefits
User satisfaction
System availability
Level of usage
Difficulty in using the system
Key success factors of developing systems project
1. Aims - Aim of the project should be clearly defined.
2. Organisation✓ The project should have sufficient resources
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It should have support of the top management
It should also have employees support
Communication channels should be adequate
Control Mechanisms should be in place and in use.
Contractors should be responsive to their clients.
3. People
✓ The project manager should be competent.
✓ The project team should also be competent.
Why IT projects fail
Failure is the opposite of success, and therefore any factor that determines success of a project can also
determine its failure. Though, success and failure are both relative measures. Some systems are more
successful than others, while some are much of a failure than others.
A new system may be described as a failure if any of the following outcomes arise:
•
•
•
•
If it functions inefficiently
If it is implemented, but fails to meet user's requirements
If it is implemented but meets strong resistance from users.
If it costs more than expected.
There could be economic factors, political factors, social or technological factors to why a project may
fail. PESTEL
Reasons for user resistance
Users are often resistant to change, they are reluctant to use a new system and could criticise it strongly.
There are 3 general theories about the nature of user resistance. These are:
•
•
•
People-oriented theory
System-oriented theory
Interaction theory
✍️ People-oriented Theory - This theory concentrates on resistance to a new system because it is seen
by individuals or groups of individuals as a threat to their social relationships at work. For example,
resistance to a new system may arise when it causes more shifting at work or make staff to work from
home.
✍️ System oriented theory - This theory concentrates on resistance to a new system because of
dissatisfisfaction with the system design. May be the system is difficult to understand and the user could
not cope.
✍️ Interaction Theory - This concentrates on the interaction between the system and its users. A new
system may be seen as a threat to person's job or status.
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Lewin's Change Process
Force Field Analysis
This is a model for managing Change. An organisation may decide to dump one strategy for another,
therefore, calling for a Change. A Strategic Change needs to be Managed Well otherwise the objective
that's to be derived from such strategy will not be achieved.
A Guy Called Lewin, some years ago suggested that there are 2 Categories of Forces in a Situation of
Change:
▪
The Driving Forces, and
▪
The Restraining Forces.
✅Driving Forces: They are those Supporting the Change, While
✅Restraining Forces: Those ones Opposing the Change.
He argued that the change might not work if the Restraining Forces are stronger than the Driving Forces,
because Human Beings by nature does not like Change.
The Following Factors can either be Driving or Restraining Forces:
1. People involved themselves.
2. Attitudes of Employees.
3. Policies of the Entity.
4. Organisation Structure
5. Resources Available.
Another Model of Change is 3 Level Model.
"Unfreeze, Change & Referee".
1. Unfreeze: People are used to their old ways of Activities and its not easy to just change them like that.
It takes a serious persuasion of the employees that the change is necessary.
We persuade them by making them see the lapses in the Current System and show them how the Future
of the change will look like.
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2. Movement (Change itself) : Then, after you have decoupled them, you introduce the new system
successfully.
3. Refreeze (Consistency): As Argued by Lewin that once change is done, an organisation should put
some monitoring tactics in place so that people do not turn back to their old ways of life.
Nine key elements of project management
The responsibilities of the project manager will be to manage each of these nine elements.
Scope
At the outset of the project, the project manager will define the scope of the project and set objectives.
These will then need to be agreed with the Board of Directors before the project begins and form the basis
for the overall project direction.
Risk management
The project manager will be responsible for identifying any major risk associated with the project (e.g. a
supplier delivering late), and managing these risks through transferring risks to other parties, avoiding
risks or accepting them and managing the consequences as they happen.
Integration
The project manager will need to develop plans for the development and implementation of the new
systems. This will ensure that the process happens quickly and easily and uses the resources in the best
way. To integrate the new system into the organisation, these plans will need to consider change in
management issues. People have been using the old system for a while and will need to adapt to the
change in approach. It may also mean changing job roles and working practices which could cause
conflict and staff dissatisfaction if not effectively managed.
Time
Each of the activities will need to be defined and their duration estimated. They can then be sequenced
and time schedules made, using techniques such as Gantt Charts or Network Analysis. This will help to
ensure that the project is well organised and co-ordinated.
Cost
A budget for the project must be defined. This might be done through cost estimates from suppliers or by
costing each specific element of the project individually. Throughout the course of the project, the project
manager will need to monitor costs and take control action if costs are not in line with budget.
Quality
It is project manager‟s responsibility to develop the Project Quality Plan which outlines expected quality
of the new information and systems. They will need to monitor progress against this plan and ensure that
the quality objectives are met. This will mean ensuring that the systems are developed by experienced
suppliers and adequate testing is undertaken prior to the system going live.
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
Resources
This will involve the acquisition and effective management of staff, materials, buildings and equipment,
and ensuring that each of these resources is adequately co-ordinated and managed.
Communication
Communication to all stakeholders will need to be undertaken on a regular basis. This will include
reporting to the Board of Directors on progress, and agreeing with any major changes in the scope. It will
also involve good team communication and management to ensure team members remain motivated and
committed to the project.
Procurement
The project manager will be responsible for procuring goods and services from external suppliers. This is
likely to include the design and development of the new information system since ABC Limited has little
in-house expertise.
Motivation
Motivation is a key role in managing people for productivity, hence every team member should be given
the opportunity to own the tasks assigned to him/her. The project manager is expected to provide the
required enabling environment for team members to excel.
The skills required by the project manager are as follows:
1. Change management skills: He/She will have to be skilled in understanding the people aspects
of the change and helping to overcome resistance to change. This may involve knowledge of
change management tools;
2. IT skills: Since the project is IT-based, some IT knowledge and ability will help the project
manager to understand the key issues and negotiate effectively with suppliers;
3. Leadership: Leadership involves obtaining results through personal direction and influence. The
project manager will need to be able to create a vision for the team, be assertive, inspire and
motivate staff;
4. People skills: The project manager will need to understand the concerns and motivations of team
members and to effectively manage them. This may involve the use of a suitable management
style and understanding of approaches to motivation of staff. The aim will be to create a
motivated and happy team that works well to achieve the project‟s goals;
5. Communication skills: A key role of the project manager is communication with staff, suppliers
or the Board of Directors. He/She will therefore have to be able to use a variety of
communication methods (i.e. presentations, meetings, reports, e-mails) and know when to use
these appropriately and be skilled at using each;
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Performance Management
By: Yusuff Kabiru Aremu ACA, 08169069670
@ Apex Professional Associates
6. Problem-solving and decision-making skills: There will inevitably be many decisions to be
taken during the course of the project and problems to be overcome. The project manager needs
to be an analytical thinker who will be able to solve problems as they arise and who is firm and
decisive so that the project is not delayed;
7. Negotiation skills: Negotiation with suppliers and internal departments is an inevitable part of
the process. The project manager will need to understand the basis of negotiation in order to
ensure the best outcomes are achieved for the organisation. This may involve being able to
understand leverage points over potential suppliers, to see the other parties‟ perspective being
firm and willing to walk away when the deal is not right; and
8. Planning skills: The project manager will need project planning skills, and need to be able to use
project management software to make and monitor plans. Knowledge of techniques such as Gantt
Chart and Network Analysis will facilitate this process. Some basic financial knowledge or
expertise would be an asset to help with the budgeting and cost monitoring process.
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