ACCA - P5 Advanced Performance Management - Passport ATC 2009
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SUMMARY OF KEY THEORY
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PERFORMANCE MEASUREMENT SYSTEMS AND
DESIGN
This section focuses on the different types of information that
may be required from the management accounting system,
and the factors that influence this.
Strategic planning, management control and operational
control
Different types of information will be required for the
different levels of management:
Strategic planning
Mainly external
High level
Ad hoc
Longer term, forecasts
Management control
Mostly internal
Covers medium term
Structured and detailed
Operational control
Exclusively internal
Transaction based
Short term- day by day
Management structure
A divisionalised structure (whereby each division
represents a separate business area) will require a
system that provides detailed information to the
manager of the division on all aspects of the division’s
activities.
In a functional structure, each manager will be provided
with information relevant to the running of their
function (e.g. sales, production.)
In a divisionalised structure, top management will rely
on high level performance measures to evaluate the
divisional managers. In a functional structure, top
managers will see the detailed picture and are likely to
be the only level at which the overall activities of the
organisation can be seen on a consolidated basis.
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Objectives of management accounting and management
accounting information
Planning – setting the objectives and strategy of the
organisation
Control – ensuring the organisation remains on course
to meet its objectives
Decision making – seeing the likely outcome of
decisions.
Accountability – ensuring that the resources of the
organisation.
Contingency Theory of management accounting
There is not one management accounting system that is
appropriate for all organisations.
The nature of the most appropriate management accounting
system depends on contingent factors:
The external environment (e.g. changing v stable)
Competitive strategy
Technology- production process used.
Firm and industry specific variables.(size of firms,
manufacturing v service etc)
Knowledge and observability factors- relates to the
nature of control systems.
Anticipated human behaviour
The design of a management accounting system should
consider the impact it will have on the behaviour of those
who use it.
Behavioural controls may be appropriate for employees
doing repetitive tasks such as manual labourers. (E.g.
close supervision).
Behavioural constraints such as authority limits on bank
accounts may be appropriate for employees with more
responsible roles.
Where the work is not routine, and staff cannot be
closely watched (e.g. because they work at clients’
offices), the organisation may rely on cultural controls.
Responsibility Accounting
In organisations that use responsibility accounting, the
organisation should provide details to each manager of the
costs and revenues under their control- budgeted and actual.
There is likely to be emphasis on financial measures.
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CORPORATE STRATEGY
Mission statement
A statement that describes the basic function of an
organisation.
May focus the attention of managers and staff on the
main purpose of what they are doing.
May define the organisations values and culture.
Assists management in setting the objectives and
strategy of an organisation.
Many mission statements are in practice little more than
marketing documents full of meaningless phrases.
Corporate objectives
Corporate objectives apply to the whole organisation.
Objectives are specific embodiments of the mission
May be set in quantitative terms- e.g. increase profits by
x% per annum.
Selecting strategic objectives
Strategic objectives describe how the organisation will
achieve its objectives.
Selection may involve identifying the organisation’s
competitive advantages (e.g. using SWOT analysis),
and the basis on which it will compete (e.g. using
Porter’s generic strategies- see below.)
Strategic objectives should then be “cascaded” down
the organisation, whereby objectives should be set for
operational managers, based on the organisation’s
strategic objectives.
Planning Gap
Gap analysis involves comparing the predicted results of an
organisation over the planning period with the desired
results, formulated in the previous stage.
Profits
Present Years
Current
forecast
Planning
gap
Objective
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Strategies to narrow the gap
Improvements in internal efficiency e.g. increased
productivity
Expanding the business by producing new products or
entering new markets.
Strategic planning models
Porters five forces model
The competitive nature of an industry can be characterised by
5 forces:
threat of new entrants
bargaining power of buyers
bargaining power of customers
threat of substitutes
competitive rivalry
In order to form a competitive strategy, companies should
choose one of the following generic strategies:
Price leadership
Differentiation
Market focus
Boston consulting group matrix
The matrix helps management to categorise the company’s
products, based on two criteria:
the nature of the market- high growth or mature
the company’s share of the market
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Ansoff’s product market matrix
The matrix offers four strategic methods to achieve growth
Existing
Products
New Products
Existing
markets
Market
Penetration
Product
Development
New Markets
Market
Development
Diversification
PERFORMANCE MEASUREMENT
Financial performance evaluation
Benefits to shareholders
Main objective of an organisation, from the perspective of
the owners, is to maximise wealth. Financial performance
evaluation is therefore normally performed from the
perspective of the shareholders.
Objectives of survival and growth
Unless the organisation survives, everything else is
irrelevant. Performance evaluation should include
liquidity (e.g. current ratio), gearing ratios and cash
flow to ensure survival.
Growth indicates that the organisation is succeeding in
a dynamic environment. Growth leads to increase in the
market value of the company. Growth can be measured
as growth in revenues, growth in profits.
Ratios
Ratios should be used sparingly in the exam, as more marks
are likely to be awarded for meaningful comments than for
calculating ratios. The following is a summary of the more
commonly used ratios:
Return on capital employed (ROCE)
Equity
taxbeforeProfit
× 100
debt termlong plusEquity
taxandinterest beforeProfit
× 100
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Profit margins
Gross profit margin =
Revenue
profit Gross
× 100
Net profit margin =
Revenue
profitNet
× 100
Liquidity
Current ratio =
s
liabilitie
Current
assetsCurrent
× 100
Gearing
Gearing ratio =
debt plusEquity
Debt
× 100
Earnings before interest, tax amortisation and depreciation
Sometimes used as a measure of “underlying
performance of an organisation
May be justified on the basis that it is a proxy for cash
flow from operations
May be appropriate for divisional managers who do not
make investment or financing decisions
Conflict between Short Run and long run financial
performance
Short run improvements in financial performance may
be at the expense of longer term- e.g. cutting back on
R&D spending.
Performance measurement should encourage a longer
term view- possibly by using a mix of financial and non
financial performance indicators. (See below)
In the long run, the value of a company is equal to the
net present value of its future income streams,
discounted at the companies cost of capital.
Relationship between profits and share values
Price earnings ratio =
shareper
shareper price
Earnings
Market
Traditionally, P.E. ratio was used as a valuation tool-
the value of a company could be ascertained by
multiplying its profits by an industry average P.E. ratio.
If the share price is higher than this, the shares are
overvalued.
Modern valuation methods focus on expected earnings
or expected future cash flows.
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Sometimes investors expectations are overly optimistic-
such as during the dot com boom of the 1990s, when
shares in internet companies enjoyed excessive values,
even though in many cases the companies had yet to
make profits.
Expectations are forward looking, unlike traditional
financial performance measures, which focus on the
past.
Non-financial performance indication (NFPIs)
Use of NFPIs in addition to financial measures has
several advantages:
They focus on the drivers of future business
performance (e.g. quality)
Using only financial measures may lead to short term
behaviour
May be less easily manipulated
May be complied more quickly.
Key performance indicators
Key performance indicators measure how the
organisation performs in relation to its critical success
factors.
Operational performance indicators
Having set operational performance indicators,
managers should set performance indicators at all levels
of the business- both financial and non financial- that
are consistent with the key performance indicators.
FURTHER APSECTS OF PERFORMANCE
MEASUREMENT
Balanced scorecard approach
This is an attempt to combine financial indicators and non-
financial indicators to cover all relevant areas of performance
such as:
Financial perspective – designed to make the company
survive and prosper by reference to profitability, cash
flow, market share
Customer perspective – designed to give responsive
supply and quality and is concerned with on-time
delivery, % of returns and customer satisfaction.
Internal business perspective – designed to give
manufacturing excellence and productivity and is
concerned with reduced cycle times and engineering
efficiency
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Innovation and learning perspective – designed to
reduce the time to market and improve technological
leadership by looking at the number of new product
introductions and the time to develop the next set of
products.
The performance pyramid (Lynch & Cross)
The performance pyramid is a framework for performance
measurement that aims to ensure all departments in the
organisation are working towards the same objectives- the
strategy of the organisation.
Corporate
vision
Marketing
performance
Financial
performance
Customer
satisfaction
Flexibility
Productivity
Quality
Delivery
Cycle
time
Waste
OPERATIONS
BUSINESS UNITS
BUSINESS OPERATING
SYSTEMS
DEPARTMENTS
M
E
A
S
U
R
E
S
O
B
J
E
C
T
I
V
E
S
External
effectiveness
Internal
efficiency
Objectives are set at top, and based on these, objectives
are set for all other levels in the organisation.
Performance measures are set at all levels of the
organisation that aim to measure how the organisation
is working towards the objectives.
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There is a horizontal aspect to the pyramid- for
example, at the business operating systems level, better
flexibility feeds into better customer satisfaction and
productivity.
Fitzgerald and Moon
The following characteristics that distinguish services from
manufacturing businesses:
Simultaneity- the consumption of the service takes
place at the time of performance
Perishability- services cannot be stored
Heterogeneity- each time a service is performed, it will
be different.
Intangibility- what consumers value in a service can be
difficult to determine.
In their building blocks model, Fitzgerald and Moon defined
six “dimensions” through which the performance of a service
industry can monitor its performance:
Profitability
Competitiveness
Quality
Resource utilisation
Flexibility
Innovation
Non profit organisations
Performance measurement in non profit organisations is
complicated by the fact that:
There are many stakeholders- possibly with differing
objectives. Which objectives are the priority ones?
The organisations have limited resources within which
to try to achieve their aims.
Performance measurement in the non profit sector
focuses on the “three ees:
Economy (e.g. total costs per hospital bed)
Efficiency (e.g. patients treated per doctor)
Effectiveness- how good is the hospital (e.g. how
many patients do not return within three months.)
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Potential problems of performance measurement systems
A poorly performed performance measurement system can
lead to the following problems:
Tunnel vision- managers focus only on things which are
measured, and ignore important factors that are not
measured.
Goal incongruence- where the targets given to a
manager may conflict with the organisations overall
objectives
Myopia- (short sightedness)- where short term goals are
achieved at the expense of long term performance
Misrepresentation- where the performance indicators
are presented in a way that distorts the underlying
message. (For example "only 3 of our customers were
dissatisfied- this may sound good- but what if they were
the three largest customers?)
Measure fixation- where managers take action to
achieve the measured target without actually achieving
the underlying goal behind the objective- for example,
doctors cutting waiting lists by not allowing patients to
make appointments.
Ways to reduce the problems
Participation of staff in the design of the scheme
Encourage long tem view (e.g. through use of share
option schemes)
Regular auditing of the system by experts
Audit data to identify manipulation.
CORPORATE FAILURE
Causes of corporate failure (Argenti)
Bad management
Poor accounting information
Over trading
High gearing
Undertaking big projects
Failure to respond to change
Quantitative signs of corporate failure
Declining profit margins
Decreasing sales volume
A rapid increase in gearing
A fall in liquidity ratios