ACCA - P5 Study text - Emile Woolf INT

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Paper P5

Advanced performance management

CHAPTER

Introduction to strategic

management accounting

Contents

1 Introduction to strategic planning and control

2 Levels of management and management

information

3 Strategic management accounting

4 Strategic objectives, customer satisfaction and

adding value

5 The effect of IT on management accounting

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Introduction to strategic planning and control

 Definition of strategic planning and control

 Advantages of formal strategic planning

 The strategic planning process

 Closing the planning gap

 Performance management systems

 Linking performance measurement to strategy

1 Introduction to strategic planning and control

1.1 Definition of strategic planning and control

‘Strategic planning and control’ within an entity is the continuous process of:

 identifying the goals and objectives of the entity

 planning strategies that will enable these goals and objectives to be achieved

 setting targets for each strategic objective (performance targets)

 implementing the strategy

 converting strategies into shorter-term operational plans

 monitoring actual performance (performance measurement and review)

 taking control measures where appropriate when actual performance is below

the target.

Other aspects of strategic planning and control are:

 re-assessing plans and strategies when circumstances in the business

environment change

 where necessary, changing strategies and plans.

1.2 Advantages of formal strategic planning

Companies usually have a formal strategic planning process, because a formal

system of planning:

 clarifies objectives

 helps management to make strategic decisions. Strategic planning forces

managers to think about the future: companies are unlikely to survive unless

they plan ahead

 establishes targets for achievement

 co-ordinates objectives and targets throughout the organisation, from the

mission statement and strategic objectives at the top of a hierarchy of objectives,

down to operational targets

 provides a system for checking progress towards the objectives.

Chapter 6: Introduction to strategic management accounting

However, planning must also be flexible. Plans and targets must often be changed

in response to events in the business environment, or in response to changes in the

business environment. For example, to succeed in a fast-changing and competitive

business, it may be necessary to react to a new initiative by a rival company.

Changes in strategic plans

Strategic plans often cover a period of several years, typically five years or longer.

They are prepared on the basis of the best information available at the time, using

assumptions about the nature of the business environment – competitive conditions,

market conditions, available technology, the economic, social and political climate,

and so on.

However, the business environment can change very quickly, in unexpected ways.

Changes can create new threats to a company, or they can create new business

opportunities. Whenever changes occur, a company should be able to respond –

taking measures to deal with new threats, or to exploit new opportunities.

The response of a company to changes in its environment could mean having to

develop new strategies and abandon old ones. When changes are made, the original

strategic plan will no longer be entirely valid, although large parts of it might be

unaffected.

Strategic planning in practice is therefore often a mixture of:

 formal planning, and

 developing new strategies and making new plans whenever significant changes

occur in its business environment.

Responding to unexpected changes by doing something that is not in the formal

plan is sometimes called ‘freewheeling opportunism’. It means making unplanned

decisions, to take advantages of opportunities as they arise, or to deal with

unexpected threats.

1.3 The strategic planning process

Different methods and approaches may be used to develop strategic plans. Some of

these methods will be described in more detail in later chapters.

A basic approach to strategic planning is shown in the following diagram.

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External analysis

External analysis involves an analysis of developments outside the organisation that

are already affecting the organisation or could affect the organisation in the future.

These are external factors that might affect the achievement of objectives and

strategy selection.

An external analysis might consider:

 the political situation in each country where it has operating subsidiaries

 changes in the law, and how these affect the organisation

 changes in economic conditions

 social factors and cultural factors, such as an increasing average age in the

population

 technology changes: the development of the internet and e-commerce, for

example, have had enormous consequences for business within the past few

years

 the competitive environment, such as the entry of a new competitor into the

market, or the ‘globalisation’ of the market.

An external analysis should identify opportunities and threats that face the

organisation. Strategies might be developed to exploit opportunities or take

counter-measures to deal with threats.

Chapter 6: Introduction to strategic management accounting

Internal analysis

Internal analysis looks at the strengths and weaknesses within the organisation – its

products, existing customers, management, employees, technical skills and ‘know-

how’, its operational systems and procedures, its reputation for quality, the quality

of its suppliers, its liquidity and cash flows, and so on.

SWOT analysis

SWOT analysis is the analysis of the strengths and weaknesses of an organisation,

and the opportunities and threats in its environment. This method of strategic

analysis is often used by organisations as a starting point for strategic planning.

Strategic management accounting can assist with SWOT analysis by trying to put

costs or benefits to particular strengths, weaknesses, opportunities and threats, so

that strategic managers are able to assess their importance.

SWOT analysis is explained in more detail later.

Identify corporate objectives

A strategic plan should set out the ways in which an organisation intends to achieve

its objectives. One way of doing this is to prepare a forecast of what is likely to

happen if the company carries on with its current plans and policies, and does not

take any new strategic initiatives.

 This forecast of expected results should be quantified. Typically they will be

quantified in the form of a financial statement, such as an annual income

statement over the next five-year or ten-year period.

 The forecast should be compared with what the organisation wants to achieve –

its strategic objectives. The objectives must be quantified in similar terms to the

forecast.

The difference between what is expected (given no new initiatives) and what is

desired is a planning gap.

Gap analysis

Gap analysis involves an analysis of the planning gap:

 identifying the corporate objectives for the organisation, and what strategic

management wants the organisation to achieve each year over the planning

period

 comparing these strategic targets with the expected actual results, if there are no

changes in strategy and no new planning initiatives.

 The gap is the difference between these two.

(Note: Gap analysis is sometimes described as an analysis of the difference between

‘Where we are’ and ‘Where we want to be’.)

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Company

objectives

(e.g. annual

profits)

Time

Desired

position

Planning

horizon

Position if no

action is taken

1.4 Closing the planning gap

Strategies should be developed to close the gap, so that expected performance is in

line with the strategic aims and objectives. Budgets and operational plans are then

formulated in order to implement each chosen strategy.

Gap analysis is an aspect of strategic management, and so may be examined in a

business strategy paper. It may also be examined within P5 as an aspect of

Performance Management.

The gap may be measured in a number of different ways, depending on how the

company defines its objectives. For example, a planning gap may be measured in

any of the following ways.

 Annual profitability (the difference between actual and expected profits in each

year of the strategic planning period)

 Annual sales revenue (the difference between actual and expected sales revenue

in each year of the strategic planning period)

 Market share (the difference between actual and expected market share in each

year of the strategic planning period).

Business strategies must be devised that will close the planning gap, and give the

organisation a plan for achieving its objectives. When the planning gap is expressed

in terms of annual profitability or sales revenue, strategies for ‘closing the gap’ may

be a combination of any or all of four types:

 Market penetration strategy. These are strategies for increasing the company’s

market share in its existing markets. For example, a company may develop an

acquisition strategy, and seek to take over one or more of its direct competitors.

Alternatively, a company may develop a strategy for increasing sales by means

of additional spending on marketing.

 Market development strategy. This is a strategy aimed at finding new markets

for the company’s existing products, for example by expanding geographically

into new regional markets. A company may seek to expand from a national base

and become a global company.

 Product development strategy. This is a strategy aimed at developing new

products for the company’s existing customers. For example, the rapid

developments in mobile telephone and small computer technology are examples

Chapter 6: Introduction to strategic management accounting

of new product developments designed to attract existing users of mobile

phones and lap-top computers.

 Diversification strategy. This is a strategy of producing new products for new

markets and new customers. This is a high-risk strategy, because the company

lacks knowledge and experience of both the products and the markets

(customers), andit will be competing against experienced rival companies.

1.5 Performance management systems

A system of performance management is concerned with the following:

 setting targets for the achievement of the entity’s main strategic objective

 setting targets for each strategy that is implemented for achieving the main

strategic objective

 setting targets at all levels of management within the entity: all planning targets

(at all levels within the entity) should be consistent with the strategic targets and

objectives

 measuring actual performance

 comparing actual performance with the targets

 where appropriate, taking control measures

 where appropriate, changing the targets.

In many organisations, performance measurement systems are also used in a system

of incentives and rewards, and managers are given a reward (often a cash bonus)

for achieving or exceeding one or more agreed performance targets.

Performance measurement is therefore concerned with planning and controlling, at

all levels within an organisation.

1.6 Linking performance measurement to strategy

The measures of performance used throughout an organisation should be linked to

the corporate strategy of the organisation, and should be consistent with corporate

strategy. This means that there has to be consistency between performance

measures at all levels in the organisation, from operating levels up.

The performance measures that are used should focus on targets where success is a

critical factor.

The performance measures that are chosen should do the following:

 Measure effectiveness – the effectiveness of processes, and the effectiveness of

products and services in meeting customer needs

 Measure efficiency – the use of resources within the organisation

 Include ‘external’ measures from outside the organisation as well as internal

measures

 Be a mixture of financial and non-financial measurement, and qualitative and

quantitative measurements

Paper P5: Advanced performance measurement

 Focus on the long-term as well as the short-term

 Be flexible so that the measures used are continually changed in response to a

changing business environment

 Recognise the trade-off between different measures of performance: for example,

it is often necessary to make compromises to reach a suitable balance between

short-term and long-term targets

 Recognise the motivational effect that performance measurements can have on

employee and management behaviour.

Chapter 6: Introduction to strategic management accounting

Levels of management and management information

 Levels of management

 Information for different management levels

 Performance management and management accounting

 Strategic and operational information for performance measurement

 Potential conflict between strategic plans and short-term decisions

2 Levels of management and management information

In ‘traditionally-structured’ large organisations, there is a hierarchy of managers,

from senior management down to junior managers and supervisors. The

responsibilities of managers vary according to their position in the management

hierarchy.

Even in small organisations, the nature of management activities can be analysed

into different levels.

The purpose of this chapter is to consider the differing information requirements of

managers at different levels in the decision-making hierarchy, and in particular at

the information requirements for strategic decision-making. Management

accounting systems should be capable of providing the information required by

managers at all levels.

2.1 Levels of management

A common approach to analysing levels of management and management decision-

making is to identify three levels:

 strategic management

 tactical management

 operational management.

Strategic management

Strategic management is concerned with:

 deciding on the objectives and strategies for the organisation

 making or approving long-term plans for the achievement of strategic targets

 monitoring actual results, to check whether these are in line with strategic

targets

 where appropriate, taking control action to bring actual performance back into

line with strategic targets

 reviewing and amending strategies.

A strategy is a plan for the achievement of a long-term objective. The main objective

of a profit-making entity may be to maximise the wealth of its owners. Several

Paper P5: Advanced performance measurement

strategies are selected for the achievement of this main objective, and each

individual strategy might have its own specific objective.

Strategic planning is often concerned with developing products and markets and for

long-term investment. For example, a company seeking to increase its profits by

10% a year for the next five years might select the following strategies:

 Marketing strategy: to expand into markets in other countries (with specific

countries selected as planning targets for each year of the plan)

 Innovation strategy: to invest in research and development (with a target to

launch, say, two new products on the market each year for the next five years)

 Investment strategy: to invest in new technology (with a target, say, of replacing

all existing equipment with new technology within the next five years).

Tactical management

Tactical management is associated with the efficient and effective use of an

organisation’s resources, and the control over expenditure. In a large organisation,

tactical managers are the ‘middle managers’.

Tactical management is concerned with implementation and control of medium-

term plans, within the guidelines of the organisation’s strategic plans. For example,

budgeting and budgetary control are largely tactical management responsibilities.

Operational management

Operational management is the management of day-to-day operating activities. It is

usually associated with operational managers and supervisors.

At an operational level, managers need to make sure on a day-to-day basis that they

have the resources they need and that those resources are being used efficiently. It

includes scheduling of operations and monitoring output, such as daily efficiency

levels.

There isn’t a clear dividing line between tactical management and operational

management, but essentially the differences are a matter of detail. Tactical

management may be concerned with the performance of an entire department

during a one-week period, whereas operational management may be concerned

with the activities of individuals or small work groups on a daily basis.

2.2 Information for different management levels

Information should be provided to managers to help them to make decisions. The

nature of the information required varies according to the level of management and

the type of decision. Within organisations, there are management information

systems that provide this information. A major element of the overall management

information system should be the management accounting system.

A management accounting system should provide information for strategic

management, tactical management and operational management.

ACCA - P5 Study text - Emile Woolf INT - 2010

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