copyright © 2007 prentice-hall. all rights reserved 1 performance evaluation and the balanced...
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Copyright © 2007 Prentice-Hall. All rights reserved1
Performance Evaluation and the Balanced Scorecard
Chapter 12
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Objective 1
Explain why and how companies decentralize
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Decentralized Operations
• Operations are split into divisions• Advantages:
– Frees top management time– Supports use of expert knowledge– Improves customer relations– Provides training– Improves motivation and retention
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Decentralized Operations
• Disadvantages:– Duplication of costs– Problems achieving goal congruence
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Responsibility Centers
• Subunit whose manager is accountable for specific activities– Cost center– Revenue center– Profit center– Investment center
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Objective 2
Explain why companies use performance evaluation systems
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Goals of Performance Evaluation Systems
• Promoting goal congruence and coordination
• Communicating expectations• Motivating Unit Managers• Providing Feedback• Benchmarking
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Limitations of Financial Performance Measures
• Management needs both– Lag indicators– Lead indicators
• Tendency to focus on short-term achievements
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Objective 3
Describe the balanced scorecard and identify key performance
indicators for each perspective
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Balanced Scorecard
• Measure company’s activities in terms of its vision and strategies
• Financial and operational performance measures are considered
• Link company goals to key performance indicators
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COMPANY GOALS
CRITICAL FACTORS(customer satisfaction, operational efficiency, employee excellence, financial profitability)
KEY PERFORMANCE INDICATORS (KPIs)(market share, yield rate, employee training
hours, revenue growth)
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Four Perspectives
• Financial perspective• Customer perspective• Internal business perspective• Learning and growth perspective
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Financial Perspective
• How do we look to shareholders?• Strategy to increase company profits
– Increase revenue growth– Increase productivity
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Customer Perspective
• How do customers see us?• Strategy - Customer satisfaction
– Product price– Product quality– Sales service quality– Product delivery time
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Internal Business Perspective
• At what business processes must we excel?
• Three factors– Innovation – Operations – Post-sales service
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Learning and Growth Perspective
• Can we continue to improve and create value?
• Three factors– Employee capabilities– System capabilities– Company’s climate for action
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E12-161. Financial Perspective-
“How do we look to shareholders?”
3. Internal Business Perspective- “At what
business processes must we excel?”
4. Learning and GrowthPerspective-“Can we
continue to improve and create value?”
2. Customer Perspective-“How do customers see us?”
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1. Financial Perspective
3. Internal Business Perspective
4. Learning and GrowthPerspective
2. Customer Perspective
Revenue Productivity
PriceQuality
Sales serviceDelivery time
Innovation Operations Postsales service
Employee Capabilities
System Capabilities
Climate for Action
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E12-18
a. Customer perspectiveb. Learning and growth perspectivec. Financial perspectived. Internal business perspectivee. Learning and growth perspectivef. Internal business perspective g. Customer perspectiveh. Internal business perspective
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E12-18
i. Customer perspectivej. Financial perspectivek. Internal business perspectivel. Learning and growth perspectivem. Internal business perspective n. Financial perspectiveo. Internal business perspectivep. Customer perspective
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E12-18
q. Learning and growth perspectiver. Financial perspectives. Customer perspectivet. Internal business perspective u. Internal business perspectivev. Learning and growth perspectivew. Internal business perspective
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Objective 4
Use performance reports to evaluate cost, revenue, and profit centers
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Performance Reports• Report financial performance of
responsibility centers• Cost center – focus on flexible budget
variance• Revenue center – focus on flexible budget
variance and sales volume variance• Profit center – focus on flexible budget
variance– Includes allocated charges from service
departments
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E12-19
Racer-Subunit X Actual
Flexible budget
Flexible budget
variance%
Variance
Direct materials $28,100 $26,000Direct labor 13,500 14,000Indirect labor 26,000 23,000Utilities 12,000 11,000Depreciation 25,000 25,000Repair & Maint 4,300 5,000 Total $108,900 $104,000
$2,100 U 8.08% U
500 F 3.57% F3,000 U 13.04% F1,000 U 9.09% U
0 0700 F 14.00% F
4,900 U 4.71% U
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Objective 5
Use ROI, RI, and EVA to evaluate investment centers
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Investment Centers
• Financial evaluation must measure– Income generated– Effective use of center’s assets
• Performance measures– Return on investment (ROI)– Residual income (RI)– Economic value added (EVA)
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Return On Investments
Operating income ÷ Total assetsOr
Operating incomeSales
SalesTotal assetsX
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ROIOperating income
SalesSales
Total assetsX
Sales margin =Operating income
Sales
Capital turnover =Sales
Total assets
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ROI
Advantages• Expanded equation provides additional
information• Can be used to compare across divisions
and with other companies• Useful for resource allocation
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E12-21 Req 1
Professional:$173,000 ÷ $420,000 = 41.19%
Residential:$62,000 ÷ $188,000 = 32.98%
ROI = Operating income ÷ Total assets
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E12-21 Req 2
Professional:$173,000 ÷ $1,030,000 16.80%
Residential:$62,000 ÷ $555,000 11.17%
Sales Margin = Operating income ÷ Sales
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E12-21 Req 3
Professional:$1,030,000 ÷ $420,0002.4524
Residential:$555,000 ÷ $188,000 2.9521
Capital Turnover = Sales ÷ Total Assets
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E12-21 Req 4
Professional:16.80% x 2.452441.20%
Residential:11.17% x 2.952132.97%
ROI = Sales margin x Capital turnover
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Residual Income
• Compares division’s operating income with minimum operating income expected given the size of the division’s assets– Positive – income exceeds target rate of
return– Negative – income does not meet target rate
of return
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RI
Operating income – Minimum acceptable income
Minimum acceptable income = Target rate of return x Total assets
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RI
Advantages:• Promotes goal congruence better than
ROI• Incorporates management’s minimum
required rate of return• Can use different target rates or return for
divisions with different levels of risk
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E12-22 Req 1
Professional:$173,000 - ($420,000 x 25%) = $68,000
Residential$62,000 - ($188,000 x 25%) = $15,000
Residual Income = Operating income – Minimum acceptable income
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Economic Value Added
After-tax operating income – [(Total assets – Current liabilities) x WACC%]
WACC% - weighted average cost of capital
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E12-22 Req 2
Professional:($173,000 x 70%) – [($420,000 - $150,000) x 15%]$80,600
Residential($62,000 x 70%) – [($188,000 - $68,000) x 15%] $25,400
EVA = (After-tax operating income) – [(total assets – current liabilities) x WACC%]
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EVA
Advantages• Considers wealth created just for investors
and long-term creditors• Promotes goal congruence
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Limitations of Financial Performance Measures
• Measurement issues - how to define “total assets”
• Short-term focus
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End of Chapter 12
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