CIA 3004

Strategic Management Accounting

TOPIC 7
Performance Management
Systems 2
(Contemporary Approach)
Outline
 The purposes of performance measurement
 Conventional performance measurement
 Contemporary performance measurement
 Non-financial measures for operational
control
 Strategic performance measurement systems
 Benchmarking
 Warning signs of an inadequate performance
measurement system
 Designing an effective performance
measurement system
The purposes of performance
measurement
 Communicate the strategy and plans of the
business and align employees’ goals (goal
congruence)
 Allow manager to track their own performance
against targets and take corrective action
 Evaluate subordinates’ performance, and
provide rewards
 Guide senior managers in developing future
strategies and operations
Traditional financial performance
measures
 Problems with using traditional financial
performance measures

May
encourage
Emphasise actions
Focus on Provide
only one that
the limited
perspectiv decrease
consequen guidance
e of both
ces, not for future
performan sharehold
the causes actions
ce er and
customer
value
Problems with conventional
financial performance measures
The strength of financial
performance measures
Traditional MAS
Contemporary performance
measurement systems
 Includenon-financial and financial measures
 Have a strategic orientation - directly
measure areas that provide competitive
advantage
 Use external benchmarks
 Emphasise continuous improvement
Non-financial measures for
operational control
 Non-financial measures reflect the drivers of
future financial performance
◦ Improvements will flow through to financial
performance
 More actionable
◦ Easier to investigate the source of low
performance, compared to low cost variances
 More understandable and easier to relate to,
particularly at the operational level
Non-financial measures for
operational control (cont’d)
 Customer satisfaction
◦ Measured by survey administered to
customers
 Defect measures
◦ Measurement of faults in a product that
occur during the manufacturing process
◦ Support a high-quality strategy
 Quality
◦ Periodic inspections or testing of products
Non-financial measures for
operational control (cont’d)
 Stock status
 Accident report
◦ Safety statistics
 Multi-skilling
◦ Number of employees who have attained
skills to allow them to undertake a range of
operational tasks
 Machine downtime
◦ Number of hours (or percentage of total
production hours) that machines are unable
to operate
 Delivery on time
Selecting operational measures

 Productivity
◦ The ratio of outputs produced per unit of input
◦ A measure of efficiency

Number of units produced

Labour productivi ty 
Number of direct labour hours

Number of units produced

Total factor productivi ty 
Cost of all inputs to production
Advantages of non-financial measures

May emphasise strategy

Can be the drivers of future

financial performance

Are more understandable and

easier to relate to

May be more timely

May be more actionable

The problems with non-financial
performance measures
 Wide choice of non-financial measures
available
 Development can be ad-hoc and undirected
 Managers must necessarily make trade-offs
between achieving some measures and not
others
 Some measures lack integrity
◦ Accuracy of the data, opportunity for
manipulation
 Some measures are not easily translated into
financial outcomes
Does non-financial performance
lead to financial performance?
 Improvements in non-financial measures will
not result in improved profits if
◦ Management has selected the wrong critical
success factors
◦ Management fails to utilise freed-up
resources, following on from improvements in
non-financial measures
◦ There is a lag between financial and non-
financial performance
◦ There are incentives to engage in
dysfunctional behaviour, such as
manipulating measures or maximising
Strategic performance
measurement systems (SPMS)
 Translates strategy into an integrated set of financial
and non-financial measures across a range of
perspectives
 Examples include the balanced scorecard (BSC),
performance prism, intangible asset scorecard
 All provide the potential to identify cause and effect
relationships between a variety of measures and the
financial performance of the organisation and its
strategies
The Balanced Scorecard
 The balanced scorecard translates an organization’s
mission and strategy into a set of performance
measures that provides the framework for
implementing its strategy

 Itis called the balanced scorecard because it balances

the use of financial and nonfinancial, internal and
external, short and long term, leading and lagging,
objective and subjective performance measures to
evaluate performance.

 Many companies have introduced a Balanced Scorecard

to manage the implementation of their strategies
The Balanced Scorecard
(cont’d)
A performance measurement system that
identifies and reports on performance
measures for each key strategic area of the
business
 The Kaplan and Norton model translates an
organisation’s mission and strategies into
objectives and performance measures
 Has four perspectives:
◦ Financial
◦ Customer
◦ Internal business processes
◦ Learning and growth
The Balanced Scorecard
(cont’d)
 Financial perspective
◦ Reflects perspective of the shareholder
◦ Summarises the financial outcomes of decision and
actions
◦ Measures include cost and product measures, ROI,
cash flow measures, shareholder value measures

 Customer perspective
◦ Measures the company’s success in achieving
customer value
◦ Outcome (lag) measures include customer
profitability, market share, number of new customers
◦ Lead indicators include on-time delivery, number of
defects
The Balanced Scorecard
(cont’d)
 Internal business processes
◦ Objectives relate to specific processes that
contribute to customer and financial objectives
◦ Measures of cost, product quality, time-based
measures, new product development

 Learning and growth

◦ Focus is on the capabilities of the organisation to
achieve superior internal processes that create both
customer and shareholder value
◦ Delivers long-term growth and improvement
◦ Measures focus on employee capabilities,
capabilities of information systems and
 The Balanced Scorecard: From
Strategy to Performance Measures
Financial
Has our financial What are our
performance improved? financial
goals?

Customer What customers do Vision

Do customers recognize that we want to serve
and and
we are delivering more value? Strateg
how are we going to
win and retain them? y
Internal Business What internal busi-
Processes ness processes are
Have we improved key critical to providing
business processes so that we value to
can deliver more value to customers?
customers?
Learning and Growth
Are we maintaining our ability
to change and improve?
The Balanced Scorecard
Flowchart
A balanced scorecard should have measures
that are linked together on a cause-and-effect
basis.

Internal Learning
Financial Customer Business &
Process Growth

23
Strategy maps
A visual representation that explains the cause
and effect relationships linking the objectives
of the four perspectives of the BSC and the
organisation’s objectives
 May also identify linkages between lag and led
measures
 A tool to communicate to mangers the
components of the strategy and the processes
that will help achieve it
Strategy maps (cont’d)
Lag and lead indicators
 Lag indicators
◦ Monitor progress towards the organisation's objectives
◦ Difficult to monitor directly
◦ Summary of financial measures, market share,
customer satisfaction

 Lead indicators
◦ Measures that drive the outcomes and provide
information that is actionable and manageable
◦ Relate to the processes and activities of the business
◦ Improvements in these measures should, over time,
flow through to improvements in lag indicators
Lag and lead indicators
(cont’d)
Lag and lead indicators
(cont’d)
Benchmarking
 A process of comparing the products, functions and
activities in an organisation against external businesses

1. Identify areas for improvement

2. Identify the functions/activities to be benchmarked,
and performance measures
3. Select benchmarking partners
4. Data collection and analysis
5. Establish performance goals
6. Implement plans
Forms of benchmarking
 Internal benchmarking
◦ Benchmarking operations that are internal to the
larger business group
 Competitive benchmarking
◦ Benchmarking with companies in the same industry
 Industry benchmarking
◦ Against companies that have similar interests and
technologies within an industry
◦ Performance measures and practices are directly
comparable
 Best-in-class or process benchmarking
◦ Benchmarking against the best practices that occur
in any industry
Benchmarking against
competitors’ cost structures
 Costs can be inferred by using publicly
available information, such a sales volume,
market share, product mix
 Industry-sponsored databases
 Stockbroking firms
 Specialist benchmarking consulting firms may
provide data
Warning signs of an inadequate
performance measurement system
 How does a firm know when its performance
measurement system is inadequate?
◦ Performance is acceptable on all dimensions,
except profit
◦ Customers do not buy product, even when
prices are competitive
◦ Managers are not concerned when
performance reports are not supplied
◦ Significant time is spent debating the
meanings of measures
◦ Measures have not changed for some time
◦ The business strategy has changed
Designing an effective
performance measurement system
 Link to strategy and goals of the organisation
◦ Encourages goal congruence
 Keep it simple
◦ Measures should be understandable and easy
to communicate with employees
 Recognise controllability
◦ Responsibility for achieving measures should
relate to activities and processes which
employees can control
 Emphasise the positive
 Be timely
◦ Measures reported as close as possible to the
Designing an effective performance
measurement system (cont’d)
 Relate to benchmarking
◦ Against external standards
 Embrace participation and empowerment
◦ To promote motivation and goal congruence
 Include only a few performance measures
◦ Rule of thumb is that no person should be
responsible for more than four or five
measures
 Link to rewards
◦ Motivational
Designing measures for
continuous improvement
 Continuous improvement can be built into
performance measurement systems by:
◦ Selecting relevant performance targets that
focus on problem areas and moving to other
measures when performance has improved
◦ Defining and re-defining the measure to
provide scope for improvement and
increasing the challenge
◦ Making the performance target more
challenging by making the performance
target more difficult over time
Behavioural implications of
changing performance measures
 Resistance to change may be more likely
when:
◦ Individuals consider targets unfair or
unachievable
◦ Individuals’ rewards are affected by changes

 Changes are most likely to succeed if:

◦ They are supported across the entire
organisation
◦ Bottom-up approaches are included
◦ New measures should not be seen as an ‘add
Operational Performance Measures

 To help companies understand whether they are creating

and delivering products and services as planned and with
appropriate levels of efficiency.
 To strive for continual improvement in their operations and
activities, and for that reason operational control measures
tend to focus on the key activities in which the organization
engages.
 Focusses on key activities which could be part of any of the
three nonfinancial perspectives in a company’s balanced
scorecard.
 Raw Material and Scrap

 Number of vendors
 Raw material as a percentage of total cost
 Lead time for material delivery
 Percentage of orders received on time
 Material purchase-price variances
 Scrap as a percentage of raw-material cost
 Quality of raw material
Production and Delivery
 Manufacturing cycle time
 Velocity
 Manufacturing cycle efficiency
 Percentage of on-time deliveries
 Percentage of orders filled
 Percent of services without re-visit
Inventory

 Average value of inventory

 Average amount of time various inventory items are held
 Ratio of inventory value to sales revenue
 Number of inventoried parts
Productivity

Financial measures
Aggregate or total productivity
(output in dollars ÷ total input in
dollars)
Partial or component productivity
(output in dollars ÷ a particular
input in dollars)
Operational (physical) measures:
 Partial or component productivity measures. These measures express
relationships between inputs and outputs, in physical terms. For
example: Service visits made per day per employee
 Square feet of floor space required per finished product per day
 Machinery

 Hours of machine downtime

 Percentage of machine availability
 Percentage of bottleneck machine
 Percentage of on-time routine maintenance procedures
 Setup time
 Product switchover times
Innovation and Learning
 New products or services
 Percentage of sales from new products
 New services introduced by this firm versus introductions by
competitors
 Process improvements
 Number of process improvements made
 Cost savings from process improvements
Product and Service
Quality
 Customer acceptance measures:

Number of customer complaints

Number of warranty claims
Cost of repeat service visits
Number of products returned
Cost of repairing returned products
◦In-process quality measures:
 Number of defects found
Cost of rework
◦Quality costs
END of LECTURE