copyright © 2008 prentice hall all rights reserved 12-1 performance evaluation and the balanced...

Copyright © 2008 Prentice Hall All rights reserved12-1

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 CentersResponsibility Center

Manager is responsible for…

Examples

Cost Center Controlling Costs Production line at Dell computer

Revenue Center Generating Sales Revenue

Midwest sales region at Pace Foods

Profit Center Producing profit through generating sales and controlling costs

Product line at Anheuser-Busch

Investment Center Producing profit and managing the division’s invested capital

Company divisions such as Walt Disney World Resorts


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 GOALSCOMPANY GOALS

CRITICAL FACTORS(customer satisfaction, operational efficiency, employee excellence, financial profitability)

CRITICAL FACTORS(customer satisfaction, operational efficiency, employee excellence, financial profitability)

KEY PERFORMANCE INDICATORS (KPIs)(market share, yield rate, employee training

hours, revenue growth)

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 for customer satisfaction Product price Product quality Sales service quality Product delivery time


Internal Business Perspective

• At what business processes must we excel to satisfy customer and financial objectives?

• 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


E12-17 Sketch the Balanced Score Card

E12-17 Sketch the Balanced Score Card

1. 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

Price

Quality

Sales service

Delivery time

Innovation Operations Postsales service

Employee Capabilities

System Capabilities

Climate for Action


E12-19: Classify KPI’s by Balanced Scorecard Perspective

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


E12-19: Continued

i. Customer perspectivej. Financial perspectivek. Internal business perspectivel. Learning and growth perspectivem. Internal business perspective n. Financial perspectiveo. Internal business perspectivep. Customer perspective


E12-19: Continued

q. Learning and growth perspective

r. Financial perspective

s. Customer perspective

t. Internal business perspective

u. Internal business perspective

v. Learning and growth perspective

w. 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


E12-21: Complete and Analyze a Performance Report

Racer-Subunit X Actual

Flexible budget

Flexible budget

variance%

Variance

Direct materials $28,100 $26,000

Direct labor 13,500 14,000

Indirect labor 26,000 23,000

Utilities 12,000 11,000

Depreciation 25,000 25,000

Repair & Maint 4,300 5,000

Total $108,900 $104,000

$2,100 U 8.08% U

500 F 3.57% F

3,000 U 13.04% U

1,000 U 9.09% U

0 0

700 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 Investment (ROI)

Operating income ÷ Total assets

OrOperating income

SalesSales

Total assetsX


ROI

Operating incomeSales

SalesTotal assets

X

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


E12-23: Compute Each Division’s ROI

Professional:

$173,000 ÷ $420,000 =

41.19%

Residential:

$62,000 ÷ $188,000 =

32.98%

ROI = Operating Income ÷ Total Assets


E12-23: Compute Each Division’s Sales Margin and Interpret Results

Professional:

$173,000 ÷ $1,030,000

16.80%

Residential:

$62,000 ÷ $555,000

11.17%

Sales Margin = Operating income ÷ Sales


E12-23: Calculate Each Division’s Capital Turnover

Professional:

$1,030,000 ÷ $420,000

2.4524

Residential:

$555,000 ÷ $188,000

2.9521

Capital Turnover = Sales ÷ Total Assets


E12-23: Expanded ROI Formula

Professional:

16.80% x 2.4524

41.20%

Residential:

11.17% x 2.9521

32.97%

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 of return for divisions with different levels of risk


E12-24: Calculate Each Division’s RI

Professional:

$173,000 - ($420,000 x 25%) = $68,000

Residential

$62,000 - ($188,000 x 25%) = $15,000

Residual Income =

Operating income – Minimum acceptable incomeAre the divisions meeting or exceeding

management’s minimum

required rate of return? If yes, what does this

mean?


Economic Value Added

After-tax operating income –

[(Total assets – Current liabilities) x WACC%]

WACC% – weighted average cost of capital


E12-24: Calculate Each Division’s EVA

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%]Have the divisions

created wealth for their

stockholders and long term creditors? How

can you use EVA to answer this question?


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

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