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CHAPTER

1

Introduction Introduction to Performance Performance Management

 ACCA P5  Advanced Performance Management Management

Study Notes By:  Shaista Aziz

UPDATED FOR

2013 EXAMS

CHAPTER

1

Introduction to Performance Management

 ACCA P5  Advanced Performance Management Management

By: Shaista Aziz

Study Notes

Introduction to CHAPTER TABLE OF CONTENTS Performance Management

1

Chapter #

Title of Chapter

1

Introduction to Performance Management

2

Budget Preparation

Page #

05

CHAPTER

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Introduction to Performance Management

Shaista Aziz, an ACCA finalist, teaches Accountancy and management subject to to different professional qualifications like FIA, ACCA etc at ACCA LIVE. LIVE. She invites feedback from students, visitors and teachers to help make this publication and others even better.

Although this publication has been written keeping the students studying paper P5 of ACCA course, however, the students of other professional qualifications like CA, CIMA CI MA and ACCA etc. who want to test their their Performance Management basics and advanced techniques can also consult these study notes. notes. This book can be used in addition to official study texts by ACCA. Author has given every effort that topics discussed discussed in these notes provide sufficient material to help students not only pass the exam but also to to understand the topics. Book is written written in plain English for clear understanding. Even though though that author has taken great care and has reviewed these notes, still if you find any mistakes and areas that need correction you can let us know. Also if you have any suggestion in making this this book and other resources even this better then it will be much appreciated. Students are advised to visit http://pakaccountants.com for more resources related to ACCA P5 and other other professional qualifications. Students also have different facilities at their disposal absolutely absolutely free like discussion forums, forums, LIVE! Sessions with tutors, tutors , study material, video lectures, exam tips, tips, subject related articles, ask tutor and many others.

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So, So, it’s that simple. More you share by sharing it with your friends and everyone you know. Help others to get a help for yourself!  © PakAccountants.com 2013 This book is provided FREE of cost online. This book is for students and for students only for their individual use.

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Introduction to Performance Management

CHAPTER CHA PTER

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Introduction to Performance Management

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Introduction to Performance Management Performance management  Performance management can focus on managing the performance of an organization, a department, employee, or even the processes to ensure that goals are consistently being met in an effective and efficient manner. PM is also known as a process by which organizations align their resources, systems and employees to strategic objectives and priorities

In managing the performance, we are aiming to improve the performance of the organization, process and the employees. Performance is managed through focusing on following aspects so that performance is improved. 1. 2. 3. 4. 5.

Planning Developing controlling Measuring Monitoring

6. Rating 7.

Rewarding Application of performance management.

This is used most often in the workplace, can apply wherever people interact, schools, churches, community meetings, sports teams, health setting, governmental agencies, social events and even political settings - anywhere in the world people interact with their  environments to produce desired effects.

Benefits.

Managing employee or system performance facilitates the effective delivery of strategic and operational goals. There is a clear and immediate correlation between using performance management programs or software and improved business and organizational results.

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Introduction to Performance Management Budgetary planning and control To manage performance there should be plan to achieve (budgets)

Budget  “A budget is a financial document prepared to project future income and expenses for a specified period of time”

A budget can be prepared for one person, a family, group of people, business, government or multinational multinational organization.

Examples Cash budget an estimate of company’s cash position for a specific period of time Operating budget an estimate of company’s forecasted revenue and expenses ,mostly for a

period of one year or less. i)

Sales budget

ii)

Labor budget

iii) iv)

Production budget. Expense budget

v)

Capital budget

Budget period Is the time period specified in budget or to which budget relates. e.g. Sales budget for one month.

Budget committee Is the group of individuals responsible for the preparation and review of the budgets. Managing Director is usually the chairman of the budget committee

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Introduction to Performance Management Accountant is usually the “budget Officer” Representatives from all departments of organizations are also present on the budget

committee.

Budgetary planning Budgetary planning is an initial process before preparing budgets, by which a company or individuals evaluate their current income and expenses and analyze the projection of their future cash inflows and outflows.

Budgetary control Is simply a technique to control the performance of operations covered in budget through comparing actual results with planned or budgeted results. There is continuous monitoring and adjustment of performance if differences arise. Approaches for budget preparation There are two different methods and techniques used to prepare budgets. 1. Top down approach 2. Bottom up approach

Top down approach In this type budget is prepared by the top management without involving the ultimate budget holder and those budgets are imposed on them. Suitability

Top down budgets are suitable for 1.

small organizations organizations

2. Newly formed organizations

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Introduction to Performance Management 3. when operational managers lacks expertise and skills to prepare budgets 4. in the period of economic hardship.

Advantages

1. Strategic plans and objectives are incorporated in budgets more appropriately as they are prepared by strategic management. 2. Resources utilized in budgets more effectively as the seniors managers know well about the resources available. 3. Time to prepare budgets decreased. Disadvantages

1. Dissatisfaction and demotivation among the employees. 2. Budgets prepared through this technique may be unrealistic because they do not incorporate the input of ultimate budget holder, who implements that budget. 3. Team spirit might disappear.

Bottom up approach

In this type the budgets are prepared through participation participation of all lower levels of managers and then forward it to strategic management for review and approval.

Suitability

Bottom up approach for budget preparation is most suitable for following 1. Large organizations. organizations. 2. In the period of economic boom.

Advantages

1. These budgets tend to be more accurate and realistic

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Introduction to Performance Management 2. These budgets can have positive impact on morale of employees because employees assume an active role in providing financial input to the budgeting process. 3. Sharing of knowledge between several levels of management. 4. It improves coordination and communication. 5. Senior managers get free to focus on developing strategies strategies to meet objectives of  organizations. Disadvantages

1. It will take more time to prepare and then to implement budgets. 2. Changes made by the senior managers at the time of approval may cause dissatisfaction. 3. Lower managers may set easy budgets and try to incorporate budgetary slack and budget bias. 4. Budgets may b inaccurate if manages have less experience to prepare them.

1. Incremental budgeting Through this method, current budgets are prepared on the base of previous budgets. In this some extra amount is added or subtracted from the previous budgets. So the forthcoming budget shows the final increase or decrease of previous one. There is no justification justification for extra input or resources. Suitability

1. Incremental budgeting is suitable for the organizations where the management does not want to spend more time for budget preparation. 2. Suitable for the organizations organizations having good cost control and stable environment. Advantages

1. Easy to understand and to prepare it also. 2. Less time consuming 3. Cost effective method 4. It can reduce inter-departmental conflicts. 5. These budgets are relatively stable. Disadvantages

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1. It incorporates budget slack due to due to overestimation or underestimation underestimation of  resources. 2. Shows dysfunctional behavior. 3. It does not incorporate changes effectively. 4. More risky and sometimes gives incorrect picture for forthcoming years.

Zero based budgeting A zero-based zero-based budgeting start from a “zero base” and every function within an organization is analyzed for its needs and costs. Budgets are then buil t around what is needed for the upcoming period, regardless of whether the budget i s higher or lower than the previous one.

Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.

Zero based budgeting is an alternative to incremental budgeting. Aim

In this budget all the allowances given for expenditures must be justified before final approval, so that it eliminates wasteful wasteful allowances and budgetary slacks. ZBB allows top-level strategic goals to be implemented into the budgeting process.

Suitability

ZBB is suitable for preparing overhead expenditure budgets.

Components of ZBB 1. Decision packages 2. Ranking 3. Resources allocation 4. Budget preparation

 Advantages

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Introduction to Performance Management 1. Appropriate allocation allocation of resources and allowances as it is based on needs and benefits of operations rather than the previous allowance given. 2. It removes wasteful spending as all the expenditures expenditures must be justified. 3. It improves the quality of operations in the organization as all the activities are continuously reviewed and assessed before approval. 4. It identifies opportunities for outsourcing.

Disadvantages 1. It takes longer time to prepare the ZBB. 2. It is difficult to justify every expenditure. 3. It is difficult to establish the framework for decision packages. 4. More costly 5. It requires specific training due to its complexity. complexity.

Rolling budget  Rolling budget is not itself a method for budget preparation but it is simply a technique to update or revise budget continuously. “In this budget is extended at regular periods by adding next budget period to full budget, after the completion of first budget period” Example…

A 12 month rolling budget that runs from Jan 1 st 2012 to 31 st Dec 2012, after the end of month Jan, the budget will be extended from 1 st Feb. 2012 to 31 Jan 2013  A rolling budget could use 3-m onth periods or quarters instead of m onths. Also, a company might have a 5-year rolling budget for capital expenditures. In this case a full year will be added to replace the year that has just ended. This 5-year rolling budget means that management will always have a 5 year planning horizon.

Rolling budget is also called a continuous budget. It may b incremental or ZBB. Suitability

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Introduction to Performance Management It is more suitable to the organizations working in rapidly changing environment. Advantages

1. Rolling budgets continuously incorporates changes from previous periods; therefore, these budgets are more up to date and realistic. 2. More responsive to changes in external and external environment. 3. The benefit of a rolling budget is that the company’s management will always have a budget that looks forward for one full year.

Disadvantages

1. A rolling budget is that it is similar to preparing a new budget again and again, so

it will take more time and money. 2. Every time new budget plan must be communicated to all the managers affected by the changes, so there is risk that managers may not informed about the new budget plan. 3. Preparation of rolling budgets is not advisable when the circumstances or conditions are not constantly changing.

Fixed budget  A budget which remains constant and does not incorporate changes through the budget period, irrespective irrespective of any changes from the plan in actual activity level experienced. Fixed budget is also called a static budget. Suitability

Fixed budget is prepared at single level of o f activity, so more suitable for organizations working in stable environment.

 Advantages 1. Once budget is prepared, it needs no revision until the completion of whole budget period so it will save time and money.

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Introduction to Performance Management 2. Strategic management focuses more attention towards the policies to accomplish budget plan and other organizational objectives.

Disadvantages 1. These budgets are more uncertain due to lack of revision and changes in external and internal environment. environment. 2. These budgets may become unrealistic very soon. 3. These budgets give rise to large variances. 4. These budgets cannot avail opportunities due to their static nature. 5. These budgets can be prepared only at one activity level.

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Functional budgets A functional budget is a budget which relates to any of the functions of an organization or department. Functional budgets include     

Sales budgets Production budgets Labour budgets Material usage budgets Material purchase budgets

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Introduction to Performance Management Sales budgets Sales budget is principle budget factor. It is also called primary budget. It is most important budget because all other functional budgets are derived from it. Sales budgets are prepared on the basis of products, type of customers and salesman.

products

Market demand

Sales price / unit

A

1000

£10/unit

Budgeted sales value (£) 10000

B

500

£5/unit

2500

total

10500

Production budget  Production budget is prepared on the basis of sales budget. After preparing sales budgets, production budget is prepared on the basis of market demand. Products

A

B

Budgeted sales volume

1000

500

Add: Closing stock of finished goods Total stock requirement Less: Opening stock of finished goods Total production requirement

100

50

1100 200

550 100

900

450

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Labour budget  Labour budget is prepared on the basis of budgeted production requirement. products Production requirement/Budgeted production

A 900

B 450

Std.labour Hrs /unit

3

2

Total budgeted labour Hrs. Std. labour cost /Unit Total budgeted labour cost

2700 £5 £13500

900 £5 £4500

Material usage budget  Budgeted material usage budget depends on production requirement. It can be simply calculated by multiplying budgeted production units with material required per unit. Budgeted material usage = budgeted production × standard material usage per unit

Example. Budgeted material usage(A) = 900units × 2 (kg) = 1800(kg) Budgeted material usage (B) = 450 × 3 (kg) =1350(kg)

Material purchase budget  Material purchase budget is prepared by material usage budget.

Materials

A

B

Budegeted material usage( kg) Add:Closing stock of 

1800

1350

500

400

Total

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Introduction to Performance Management raw material( kg) Total requirement for raw material (kg) Less:Opening stock of  raw material (kg) Total purchase requirement (kg) Cost per kg Budgeted purchase cost

2300

1750

300

250

2000

1500

2 4000

3 4500

8500

Master budget  Master budget is the combination of all functional budgets and it gives overall picture of  planned performance for the budget period. Master budget includes following three budgets. 1. Budgeted trading and profit and loss account. 2. Budgeted balance sheet. 3. Cash budget.

Cash budget  Cash budget is simply prepared by subtracting total cash outflows All businesses, no matter what type or size, need to properly develop a plan for their expected cash intake and spending. This plan is commonly known as a cash budget, and it can be prepared quarterly or annually. The cash budget starts with the beginning cash balance to which is added the cash inflows to get cash available. Cash outflows for the period are then subtracted to calculate the cash balance before financing.

CASH BUDGET FOR 90 DAYS Beginning cash balance

$ 320,000

Add: Estimated collections on accounts receivable

750,000

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Introduction to Performance Management Estimated cash sales

250,000 $1,320,000

Deduct: Estimated payments on accounts payable

$ 800,000

Estimated cash expenses

150,000

Contractual payments on long-term debt

150,000

Quarterly dividend

50,000 $1,150,000

Estimated ending cash balance

$ 170,000

Behavioral aspects of budgeting and beyond budgeting There are two general approaches to the budgeting process: Traditional Budgeting and Beyond Budgeting. .

Traditional budgeting Traditional Budgeting Budgeting we all know well: the top-down, command and control approach with authority firmly seated at the executive level. It gives fixed and rigid rules and flexibility for continually changing business. As a result, business organizations may be much too slow and inflexible in reacting to business developments. Hope and Fraser have also argued that the traditional budgeting is inefficient and inadequate for the needs of modern businesses. Limitations of traditional budgeting

There are following problems with traditional budgeting and budgetary control system.

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Introduction to Performance Management 1. Time consuming 2. Expensive 3. Adds little value 4. Failure to consider shareholders value 5. Rigid and inflexible 6. Fail to reduce cost 7. Discourage innovation 8. Culture of dependency

Behavioral implication and limitations of budgeting

1. 2. 3. 4. 5. 6. 7.

Meeting only lowest targets Using more resources than necessary Window dressing Ensuring to spend all the budget Providing inaccurate forecast Meeting the target but not beating it Avoiding risk

Beyond budgeting Beyond budgeting round table was set up in 1998. According to beyond budgeting, budgets should be abolished and there should be a system in which authority and responsibility is given to operational managers who should work together to achieve the strategic objectives Traditional budgeting is based on dependency model in which there is system for centralized control by senior management. While beyond budgeting is a responsibility model in which decision making and performance management are delegated to line managers. There are no strict and rigid rules in responsibility model and targets are reviewed and amended regularly in response to changing circumstances. Performance management in beyond budgeting model

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Introduction to Performance Management There are twelve basic principles in beyond budgeting model of performance management. 1. Governance 2. Responsibility for performance 3. Delegation 4. Coordination 5. Structure 6. Leadership 7. Setting goals 8. Formulating strategy 9. Anticipatory management 10. Resource management 11. Measurement and control 12. Motivation and rewards

From above first six principles are concerned with establishing an effective organization organization and culture of behavior and last six principles are concerned with establishing an effective system of  performance measurement.

Comparison Comparison of traditional budgeting with beyond budgeting is commonly in following three areas.

Management style: command and control vs. empower and coach Seat of authority: centralized centralized bureaucracy vs. decentralized teams Performance measurement: measurement: fixed targets vs. relative targets

Conclusion

Hope and Fraser have argued that traditional budgeting systems are weak and should not be used while beyond budgeting model is much more easily applied.

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Introduction to Performance Management Performance indicators Performance indicators are the key success areas through which organization can improve its operations to meet the corporate goals and objectives. objectives.  An organization may use KPIs to evaluate t he performance of all its busi ness operations.

Different organizations may have different performance indicators depending on nature of  business and its operations.

Categorization of key performance indicators KPIs can be summarized into the following sub-categories: 1. 2. 3. 4. 5. 6.

Financial performance indicators Non financial performance indicators Qualitative performance indicators Quantitative performance indicators Leading performance indicators Lagging performance indicators

Benefits 1. Decisions can be made fast and quick. 2. A team can work together to a common set of measureable goals 3. Performance is measured accurately 4. Weak performing areas identified quickly Process to identify or to establish key performance indicators

Key performance indicators (KPIs) are ways to periodically assess the performances of  organizations, business units, and their division, departments and employees The key stages in identifying KPIs are:

1. Identify all business processes. 2. Resources need to accomplish these processes. 3. Ranking of most important processes. 4. Get all results of comparisons meeting business goals 5. Investigating variances and reevaluate processes

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Introduction to Performance Management Examples of KPIs. 1. Profitability 2. Turnover 3. Customer attraction 4. Status of existing customers 5. Outstanding balance 6. Collection of bad debts 7. New acquisition

Ratio analysis Financial and non financial ratios are used to measure performance after identification identification of key performance indicators Financial ratios

Financial ratios are used to measure financial concerns in profit seeking organizations. organizations. Financial ratios are usually categorized into following categories. 1. Profitability Profitability ratios 2. Liquidity ratios 3. Growth ratios 4. Investment ratios 5. Management efficiency ratios 6. Debt equity ratios

Profitability Profitabilit y ratios Profitability Profitability ratios are used to measure the profit against sales and investments investments of business. These ratios also measure the efficiency of operations by management. management. High profitability ratios show that business is generating more after deducting all its expenses Gross profit margin = Gross Gross profit /Sales × 100

Gross profit margin ratio used to assess the business ability to generate profit from sales after deducting cost of sales. High gross profit margin ratio shows that management has good control over cost of sales. Net profit margin

= Net profit / Sales × 100

Net profit margin ratio used to assess profit from sales after deducting all its expenses including depreciation, depreciation, tax and interest expenses.

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Introduction to Performance Management If management has good control to meet its expenses then it will give rise to high net profit margin ratios. On the other hand, the decline of both above ratios shows that business has low margin of  safety and it may have high risk to convert its positive margin to negative margin and at the end business will have to suffer net loss.

Liquidity ratios Liquidity ratios are used to assess the business ability to meet its all short term obligations or liabilities from its liquid assets. Liquid assets or liquidity of the business is ‘’ how quickly business is able to convert its assets into cash ‘’

It means that business must possess liquid cash. Liquidity ratios are Current ratio

= Current assets / current liabilities

Current ratio is the most famous liquidity test of any business. This ratio shows business ability to meet its shot term liabilities from short term assets or current assets Current ratio of 2:1 is usually considered as a good ratio to measure liquidity performance of  business. Current ratio of 1:1 indicates that business can meet all its current liabilities from its current assets. While the current ratio less than 1:1 indicates that business has liquidity crisis and it may have risk to meet obligations over the next 12 months. Quick ratio or acid test ratio = Current asset – asset – stocks / Current liabilities

Quick ratio or acid test ratio is more prudent measure of liquidity. It shows that how many times current assets of the business excluding inventory cover the current liabilities. Quick ratio of 1:1 or above indicates fair liquid state of the business. Cash ratio = Cash and cash equivalents / Current liabilities

Cash ratio shows how radially cash and cash funds are available to pay its creditors.

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Introduction to Performance Management Growth ratios Growth ratios are used to measure the performance of business compared with previous years or with industry sector to get results that how business is improving or growing with all its operations Increase of sales or (sales %) = current year sales  – Last year sales /Last year sales × 100 This ratio gives that how much sale is increasing as compared to previous years that results in more profitability.

Growth in net income or (net income %) = Current year’s net income – last year’s net income /last year’s

net income × 100

This ratio also compares current y ear’s net income to previous years that how and to what extent it is increasing. High growth ratios show that business is expanding and growing in a right direction to meet its objectives and goals. Investors are more interested to know these ratios because it explicitly puts a value on the expected growth in earnings of a company.

Stock market or Investment ratios This set of financial ratios is used to measure how efficiently the money invested in a company is providing a return to investors. Return on equity

= Profit Profit before interest and tax /Equity /Equity × 100

Return on capital employed

= PBIT /Equity + Long term debts × 100

Most valuable measures measures of how well a company is performing performing for its shareholders. shareholders. The higher the return on equity, the better it is. Return on assets = PBIT / Asset × 100 ROA ratio is used to understand how effectively the management is using business‘s assets to

generate earnings. Divined yield = Dividend per share / Market value per share × 100 Dividend per share = Dividend paid or proposed / Number of ordinary shares Dividend payout = Dividend paid or proposed / PAIT × 100

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Introduction to Performance Management The above ratios indicate company’s policy of dividend towards shareholders.

It is most important for equity shareholders to know the value of share in comparison with industry sector. So above ratios may also indicate future prospects for shareholders.

Dividend cover = PAIT /Dividend paid or proposed

This ratio indicates availability of profits to pay dividends to all shareholders according to dividend policy. The negative ratio shows that company has no sufficient profits to pay return to shareholders Earning yield = Earnings per share /Market value per share × 100

Earning yield is the total return of shareholders to their investment. It may also give comparison with industry sector, so if earning yield is low than a benchmark then it shows that share of the company is overvalued.

Earnings per share = PAIT / weighted avg. number of shares

Earnings per share is most important ratio to determine the performance of business. It indicates the availability of profits to pay dividend to shareholders and then to reinvest in business also Growth in earning per share results in higher share prices.

Management efficiency ratios Management efficiency ratios are helpful to measure the performance of management in relation to stock and some other operations controlling controlling by them. Revenue per employee = Total revenue / Total employees

This ratio indicates the efficiency of employee and show that how much individual employee is contributing towards total revenue of business.

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Introduction to Performance Management Receivables turnover turnover ratios = Trade receivables receivables / Credit Credit sales × 365 It measures

how many times accounts receivable have been collected by the management in a

given period of time. It shows that management policies to collect debts from its debtors.

Inventory turnover turnover ratio = Average stock stock or inventory / Cost of sales × 100

This ratio indicates that how frequently management using its stock for production. High inventory turnover ratios show increased production and finally increased revenue. Asset turnover ratio = Net sales / Total assets This ratio tells

how well a company uses its assets to generate revenue.

High turnover ratios show that management is using its assets more efficiently but low turnover ratios show that assets are not being used optimally by the management.

Debt equity ratios/ risk profile ratios Financial risk is calculated using following ratios. Debt equity ratio = Long term debt / Equity × 100

This ratio indicates that how much business is using investments from lenders as compared with its personal investment (Equity) It shows company’s financial leverage.

High debt equity ratio shows that business is financing more from debt that is more risky.

Interest cover cover ratio = Profit before interest interest / Interest

Interest cover ratio indicates that how much company is able to pay its interest expenses. Interest expense is the amount, company pays on its debt. High interest cover ratio shows that business has sufficient profits to meet interest expenses.

Non financial measures They are the measures based on non financial information

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Introduction to Performance Management Only financial measures according to traditional performance measurement system are not sufficient to measure accurate performance in competitive environment.

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Non financial performance indicators can be classified as 1. Quantitative measures 2. And qualitative measures Quantitative measures

These are the measures calculated easily and expressed in numbers Examples

No. of warranty claims No. of customer’s complaints No. of customer’s reorders

Non productive hours Quantitative measures

These measures are subjective and non numeric and are based on judgment. Examples 

Quality ratings



Customer’s satisfaction level



Cleanliness



Safety

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Introduction to Performance Management

 Alternative models models of performance performance measurement  measurement  In addition to traditional performance performance measurement system some alternative models are developed to improve performance measurement system. They are following A. Balanced score card B. Fitzgerald and Moon model C. Performance pyramid

Balanced score card Need for balanced score card

As we have discussed earlier, that only traditional performance measurement system is not sufficient to measure performance accurately which only focus on financial aspects. If an organizati o rganization on is making good profits, it does not mean that organization is performing well. It may happen that customers are not satisfied from the quality of products but currently they have no option to switch to another organization. But it may possible that in near future they switch to another supplier for better quality and economic prices. It will create negative impact on the organization, and profits may convert into losses. So from above week performing areas are not fully identified by the traditional performance measurement measurement system which is non financial perspective. Not only this perspective perspective (customer satisfaction) but many other non financial perspectives perspectives are ignored in traditional performance measurement systems which are very helpful and important to achieve long run organization’s goals and objectives

Development

Kaplan and Norton developed balanced score card in 1990s for better performance measurement. As the name suggests, there will be balance in measuring financial and non financial indicators. The four areas are covered by balanced score card.  

Customer satisfaction

Internal efficiency  Innovation and learning  Profitability

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Customer satisfaction To what extent our customers are satisfied from us? To determine the extent of customer’s satisfaction, we have to understand first that what

customers value from our organization. So organization can focus to improve performance performance on areas valued by customers. It might be the following 

Product quality



Product price



Delivery time



Credit period



After sale services



Discount policies



Inspection



Honesty

Important ratios to measure performance in this area.

The following ratios applied to determine that how well organization is performing in this area. The positive results from these ratios indicates that customers are satisfied ,but on the other hand negative results capture our attention to focus on improvement to give better results. 

Number of customer’s complaints  Number of new customers acquired  Number of on time deliveries  Number of late deliveries 

Number of deliveries returned  Customer satisfaction level

Internal efficiency What processes must the organization perform with excellence? To achieve this perspective organization should focus on the operations of all processes e.g. Production and marketing.

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Introduction to Performance Management Firstly the management should seek to determine key operations of business which adds value or contribution towards overall organization’s per formance and then focus to improve and

maintain excellence in these operations. Important ratios to measure internal efficiency 

Labor efficiency ratios



Number of faulty goods



Average time taken for production of a unit



Speed of producing management information



Stock turnover ratios

Innovation and learning How we can improve and create future value to our organization in competitive environment? To achieve this perspective organization should maintain its competitive position through acquisition of new skills and development of new products. Management focus on learning and growth areas that ultimately helps to improve expertise and generate new ideas to develop new products and new markets. Technology also helps to invent new products to compete with their competitors. Carefully performance is measured through following ratios to get results either organization is performing well or not. Ratio analysis 

Revenue per employee  Revenue generated by new employees  Time taken to develop new products 

Number of training sessions  Process time to maturity  Revenue generated by new products 

Labor turnover ratio

Financial perspective How we can create value for our shareholders? To achieve this perspective organization should focus on financial areas e.g. profitability profitability Following financial measures helps to determine determine financial performance of business towards shareholders.

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

Return on capital employed (ROCE)



Return on investment (ROI)  Earnings per share (EPS)  Economic value added (EVA) 

Cash flows  Revenue growth 

Market share

 Advantages of balanced score score card  

Removes drawbacks from traditional performance measurement system Balanced scorecard is not only a performance measuring tool but it is equally helpful to manage the performance also.



It takes both internal and external factors that may impact on business organization.



Both financial and non financial perspectives perspectives are discussed in it.



It helps to achieve strategic goals through focusing on measures related with company’s

goals and objectives. 

It provides better results about strategic feedback and learning.



It gives comprehensive picture of overall business operation and activities.



Improve creativity and growth.

Disadvantages In addition to its benefits, there are some drawbacks also. 

In four perspectives of balanced score card there are different targets for each perspective, so conflicts may arise about what the targets should meet first.



It is difficult to obtain and measure non financial data.



It is difficult to categorize and focus on the improvement of all the four perspectives equally.



If management fails to look at all perspectives then it will give rise to disappointing results.

Usage of balanced score card Balanced score card is equally effective to measure the performance of both private and public organizations.

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Introduction to Performance Management It mainly focuses on measuring and managing performance of organization’s organization’s own processes

rather than comparing performance to other organizations through benchmarking. It can be used as wide ranging driver of organizational change. change.

Performance pyramid Performance pyramid is another method for measuring performance. It was developed by Lynch and Cross in 1991. Lynch and Cross covered all the aspects of performance measurement unlike traditional measurement system in which only financial aspect is covered. Performance pyramid evaluates performance of the organization through internal and external effectiveness. Lynch and Cross argued that organization operates at different level and management’s focus to achieve objectives also varies from each another.

Structure of performance pyramid

Performance pyramid supports or links each management level so that performance measurement at each level achieve ultimate vision or mission of the organization. Performance pyramid consists of three level having nine dimensions. 

Corporate level  Strategic business level  Operational level

Corporate level Corporate level describes the vision or mission of the organization. Long term objectives objectives with relation to market and financial perspectives are set here to achieve corporate vision of the organization. It has following two aspects. 

Market measures : measures performance against external effectiveness



Financial measures: measures performance against internal efficiency or

effectiveness.

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Strategic business level At business level strategies are developed and objectives are put together to support corporate level. At this level three areas are majorly focused by the management. Customer satisfaction: at this level strategies are developed to meet customer’s expectat ions and then performance performance is measured against customer’s satisfaction.

It covers external perspective. Flexibility: covers both external and internal perspectives through measuring efficiency of all

business operations. Productivity: it covers internal perspective through measuring performance in production and

management of resources needed.

Operational level Operational level is key level for performance measurement. With a large number of performance targets at operational level leads to achievement of each higher level with corporate objectives. Four aspects are discussed here. 

Quality: it measures the quality of products to satisfy customers that also achieve

corporate aim of the organization in market satisfaction. 

Delivery: it measures the performance of management to deliver products or services to

customers. 

Process time : measures the performance in all functions related with production and all

other procedures. E.g. production cycle time 

Waste: it measures the performance performance of management in reduction of non value added

activities. In performance pyramid all the aspects support or interact with each another horizontally as well as vertically. Example

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Introduction to Performance Management If production cycle (process time) is reduced it will enhance productivity and then reduce delivery time to satisfy customers and it will ultimately improve financial performance hence achieved corporate vision. Strengths of performance pyramid

Performance pyramid has following positive features that give strengths to this model. 

It eliminates limitations in traditional performance measurement system.

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It covers all the areas the aspects through measuring internal and external effectiveness.

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Performance Performance pyramid links operational targets with corporate vision.  It gives performance hierarchy to the organization that support each another to achieve performance in higher level. 

It enables the organization to focus on all business operations. Weaknesses of performance pyramid

There are some weaknesses also in this model.

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It may increase the cost of organization because it is expensive implementation. implementation.

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Conflicts may arise in measuring performance performance that interlink with each another.

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Difficult to identify factors that are crucial to success.

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Staff turnover may increase because they become demotivated due to strict monitoring and measurement. measurement.

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Introduction to Performance Management Performance measurement measurement in service industry Many organizations earn profits through providing services rather than manufacturing products and trading. Examples. There are many examples for service organizations. Hotel and restaurants, entertainment clubs, traveling industry, cleaning services and professional services like banking, teaching and advocacy. Performance measurement in service industry is different as compared to manufacturing industry due to following unique factors. 

Simultaneity: Simultaneity: unlike manufacturing industry, services are produced and delivered at the same time so difficult to inspect and measure the quality.

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Perishability Perishabil ity : in service industry it is is impossible to store a service for future use because it is only generated at the time of consumption. Services are provided at the customer requests.

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Heterogeneity: unlike manufactured products ,services cannot be produced and delivered with same standard and specification every time. There must be some difference or variability variability in performance. While products are manufactured manufactured with same standard and specification in large number of units.

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Intangibility: Intangibility: services are intangible (cannot be seen and touched) and valued by the customers.

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No transfer of ownership: services cannot become the property of customers customers because they are consumed as they received. Example

A hairdresser ,he is providing services to customers. The production and consumption of haircut is at same time ( simultaneous ) , during hair cut performance of hairdresser is intangible and the services will be variable to next customer (heterogeneity). Hair cuts are perishable because hair dresser cannot store them in demanding situation.

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Building Blocks Model in service industry Due to above difference in both industries, there must be different performance setting and performance measurement in service industry. Fitzgerald and Moon in 1996 gave a Building Blocks Model to measure performance in service industry. According to Fitzgerald and Moon ,performance is evaluated by the combination of three Building Blocks. 

Dimensions

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Standard

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Rewards

Dimensions Profit Competitiveness Quality Resource utilisation Flexibility Innovation Stewards Ownership Achievability Equity

Rewards Clarity Motivation Controllability

Dimensions These are the key aspects of performance that should be measured in order to access performance. These dimensions or aspects are as follows. 

Profit (financial performance) performance)

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Competitiveness

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Quality

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Innovation

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Resource utilization

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Flexibility Profit (financial performance)

To measure the financial performance of the service organization, focus should be o n profitability. How an organization is making profits either high or low. Following measures will be helpful to determine profitability 

Gross profit margin

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Net profit margin

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Return on capital employed

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Return on investment Competitiveness

This dimension will focus on factors that may give competitive advantage. Examples 

Growth in sales

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Market share

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Retention rate of customers Quality This dimension will focus on the standard of service that how well the services and provided and valued by the customers. It is achieved through measuring following ratios 

Number of complaints by the customers

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Customers dissatisfaction level

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Positive or negative feedback by the customers

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Moving trend of customers towards competitors

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Decreasing trend of customers Flexibility

Flexibility determines that how efficiently organization is delivering services to its customers. It will be achieved through measuring following ratios

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Speed in responding to customers

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Number of services delivered V orders received from customers

Resource utilization

The aspect will determine that how efficiently the resources are utilized to satisfy customers demand. Efficiency of management is also involved here. It will be achieved through measuring following ratios 

Percentage of available time utilized in production of services

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Percentage of idle time

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Efficiency /productivity /productivity measures

Innovation

This aspect will determine determine competitive advantage in near future through measuring following ratios 

Number of new services offered delivered

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Research and development for generating new services

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Technology used compared with its competitors