copyright © 2007 prentice-hall. all rights reserved 1 performance evaluation and the balanced...

Copyright © 2007 Prentice-Hall. All rights reserved1

Performance Evaluation and the Balanced Scorecard

Chapter 12


Objective 1

Explain why and how companies decentralize


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


Decentralized Operations

• Disadvantages:– Duplication of costs– Problems achieving goal congruence


Responsibility Centers

• Subunit whose manager is accountable for specific activities– Cost center– Revenue center– Profit center– Investment center


Objective 2

Explain why companies use performance evaluation systems


Goals of Performance Evaluation Systems

• Promoting goal congruence and coordination

• Communicating expectations• Motivating Unit Managers• Providing Feedback• Benchmarking


Limitations of Financial Performance Measures

• Management needs both– Lag indicators– Lead indicators

• Tendency to focus on short-term achievements


Objective 3

Describe the balanced scorecard and identify key performance

indicators for each perspective


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


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)


Four Perspectives

• Financial perspective• Customer perspective• Internal business perspective• Learning and growth perspective


Financial Perspective

• How do we look to shareholders?• Strategy to increase company profits

– Increase revenue growth– Increase productivity


Customer Perspective

• How do customers see us?• Strategy - Customer satisfaction

– Product price– Product quality– Sales service quality– Product delivery time


Internal Business Perspective

• At what business processes must we excel?

• Three factors– Innovation – Operations – Post-sales service


Learning and Growth Perspective

• Can we continue to improve and create value?

• Three factors– Employee capabilities– System capabilities– Company’s climate for action


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?”


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


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


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


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


Objective 4

Use performance reports to evaluate cost, revenue, and profit centers


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


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


Objective 5

Use ROI, RI, and EVA to evaluate investment centers


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)


Return On Investments

Operating income ÷ Total assetsOr

Operating incomeSales

SalesTotal assetsX


ROIOperating income

SalesSales

Total assetsX

Sales margin =Operating income

Sales

Capital turnover =Sales

Total assets


ROI

Advantages• Expanded equation provides additional

information• Can be used to compare across divisions

and with other companies• Useful for resource allocation


E12-21 Req 1

Professional:$173,000 ÷ $420,000 = 41.19%

Residential:$62,000 ÷ $188,000 = 32.98%

ROI = Operating income ÷ Total assets


E12-21 Req 2

Professional:$173,000 ÷ $1,030,000 16.80%

Residential:$62,000 ÷ $555,000 11.17%

Sales Margin = Operating income ÷ Sales


E12-21 Req 3

Professional:$1,030,000 ÷ $420,0002.4524

Residential:$555,000 ÷ $188,000 2.9521

Capital Turnover = Sales ÷ Total Assets


E12-21 Req 4

Professional:16.80% x 2.452441.20%

Residential:11.17% x 2.952132.97%

ROI = Sales margin x Capital turnover


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


RI

Operating income – Minimum acceptable income

Minimum acceptable income = Target rate of return x Total assets


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


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


Economic Value Added

After-tax operating income – [(Total assets – Current liabilities) x WACC%]

WACC% - weighted average cost of capital


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%]


EVA

Advantages• Considers wealth created just for investors

and long-term creditors• Promotes goal congruence


Limitations of Financial Performance Measures

• Measurement issues - how to define “total assets”

• Short-term focus


End of Chapter 12

copyright © 2007 prentice-hall. all rights reserved 1 performance evaluation and the balanced...

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