acca p5 - advanced performance management passcards 2013-1

ACCAPAPER P5ADVANCED PERFORMANCEMANAGEMENT

PASSCARDS

FOR EXAMS UP TO JUNE 2014

ACP5PC12_ACCA Passcards 20/08/2012 12:47 Page 1

File Attachment9781445392332.jpg

Professional Paper P5Advanced Performance Management

(000)ACP5PC10_FP.qxp 8/18/2012 9:23 PM Page i

First edition 2007, Seventh edition September 2012ISBN 9781 4453 9672 9

e ISBN 9781 4453 9233 2British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from theBritish Library

Your learning materials, published by BPP LearningMedia Ltd, are printed on paper obtained from traceablesustainable sources.

Published byBPP Learning Media Ltd,BPP House, Aldine Place,142-144 Uxbridge Road,London W12 8AAwww.bpp.com/learningmedia

Printed in the UnitedKingdom by RicohRicoh HouseUllswater CrescentCoulsdonCR5 2HR

All rights reserved. No part of this publication may bereproduced, stored in a retrieval system or transmitted, inany form or by any means, electronic, mechanical,photocopying, recording or otherwise, without the priorwritten permission of BPP Learning Media.

BPP Learning Media Ltd

2012

(000)ACP5PC10_FP.qxp 20/08/2012 16:11 Page ii

Page iii

Welcome to BPP Learning Medias ACCA Passcards for Professional Paper P5 Advanced PerformanceManagement.

They focus on your exam and save you time.

They incorporate diagrams to kick start your memory.

They follow the overall structure of the BPP Learning Medias Study Texts, but BPP Learning Medias ACCAPasscards are not just a condensed book. Each card has been separately designed for clear presentation.Topics are self contained and can be grasped visually.

ACCA Passcards are still just the right size for pockets, briefcases and bags.

ACCA Passcards should be used in conjunction with the revision plan in the front pages of the Kit. The planidentifies key questions for you to try in the Kit.

Run through the Passcards as often as you can during your final revision period. The day before the exam, tryto go through the Passcards again! You will then be well on your way to passing your exams.

Good luck!

ContentsPreface

(000)ACP5PC10_FP.qxp 8/18/2012 9:23 PM Page iii

ContentsPreface

Page1 Introduction to strategic management

accounting 12 Performance management and control of

the organisation 173 Business structure, IT developments and

other environmental and ethical issues 234 Changing business environment and

external factors 395 Performance management information

systems 496 Management information, recording and

processing and management reports 597 Performance hierarchy 678 Scope of strategic performance measures

in the private sector 759 Divisional performance and transfer

pricing issues 85

Page10a Strategic performance measures

in not-for-profit organisations 9510b Non-financial performance indicators 10111 The role of quality in management

information and performance measurement systems 105

12 Performance measurement: strategy, reward and behaviour 121

13 Alternative views of performance measurement and management 131

14 Strategic performance issues in complex business structures 141

15 Predicting and preventing corporate failure 147

16 Current developments, issues and trends 153

(000)ACP5PC10_FP.qxp 8/18/2012 9:23 PM Page iv

1: Introduction to strategic managementaccounting

Topic List

Planning, control, decision making andmanagement information

Corporate planning

Planning and control: strategic andoperational

Multinational aspects

SWOT analysis

Benchmarking

This chapter introduces strategic managementaccounting and how it fits into the planning and controlprocess of an organisation.

The chapter also explains how organisations set strategicplans and control their outcomes.

There is an explanation of some of the techniques usedto do this and some of the factors that affect strategicplanning.

(001)ACP5PC10_CH01.qxp 8/18/2012 9:24 PM Page 1

BenchmarkingPlanning, control, decision makingand management information

Corporate planning

SWOTanalysis

Multinationalaspects

Planning and control:strategic and operational

The process of deciding on the objectives of theorganisation, on changes in these objectives, on theresources used to attain these objectives, and on thepolicies that are to govern the acquisition, use anddisposal of the resources.

Long term and wide scope Generally formulated in writing Widely circulated Doesnt trigger direct action, but series of lesser

plans Includes selection of products, purchase of non-

current assets, required levels of company profit

Characteristics of strategic informationStrategic planning

Strategic decisionsStrategic decisions are long-term decisions,characterised by wide scope, wide impact, relativeuncertainty and complexity.Most strategic decisions are unique, so theinformation needed to support them is likely to be ad-hoc and specially tailored to the decision.


1: Introduction to strategic management accountingPage 3

Management controlThe process by which managers ensure thatresources are obtained and used effectively andefficiently in the accomplishment of the organisationsobjectives. It is sometimes called tactics or tacticalplanning.

Short-term and non-strategic Management control planning activities include

preparing annual sales budget Management control activities include ensuring budget

targets are (at least) reached Carried out in a series of routine and regular planning

and comparison procedures Management control information covers the whole

organisation, is routinely collected/disseminated, isoften quantitative and commonly expressed in moneyterms Cash flow forecasts Variance analysis reports Staffing levels

Source of information likely to be endogenous (fromwithin the organisation)

Characteristics of management accountinginformation

Management accounting information forstrategic planning and decision making Incorporates forecasts/estimates/risk and

uncertainty analysis Has an external orientation Forward looking and outward looking Helps to ensure goal congruence



Corporate planning

SWOTanalysis



Long-term strategic plans can conflict with the shorter-term objectives of management control.

Performance measures/control measures do not take strategic direction into account.

Strategic imperatives might not be properly communicated to middle management.

Strategic planning information might be difficult to measure.

Management control and strategic planning compared

ExampleThe decision to launch a new brand of frozen foods is a strategic plan, but the choice of ingredients for themeals is a management control decision.



Performance managementActivity designed to improve anorganisations performance and ensurethat its goals are being met

Performance management systemsPlans, with set guidelines and targets, to helporganisations measure how efficiently goals are beingmet, and to identify areas where performance can beimproved

Organisation has to establish its goals andobjectives before it can assess whether theyare being met.

Once performance targets have been set, anorganisation can measure whether its goalsand targets are being achieved.

Often linked to employee reward programmesso employees are rewarded for helping anorganisation reach its goals.

Performance measurement is an importantcontrol in an organisation.



Corporate planning

SWOTanalysis



Management control v operational control

Operational control/planningThe process of ensuring that specifictasks are carried out effectively andefficiently. Short-term and non-strategic

Occurs in all aspects of anorganisations activities andneeded for day to dayimplementation of plans

Often carried out at shortnotice

Information likely to have anendogenous source, to bedetailed transaction data,quantitative and expressed interms of units/hours

Includes customer orders andcash receipts

Characteristics of operationalcontrol

ExampleStrategic planSenior management decidesales should increase by 5% pafor at least five years.Management control decisionSales quotas are assigned toeach sales territory.Operational control decisionManagers of sales territoriesspecify weekly targets for eachsales representative.

Operational control decisions aremore narrowly focused, carried outwithin a shorter time frame and takenby managers less senior in theorganisation.Operational control focuses onindividual tasks whereasmanagement control is concernedwith the sum of all tasks.



Performance management systemsshould have clear links betweenperformance measures at the differenthierarchical levels of the organisation.

Means all departments and divisions willbe working towards the same ultimategoal.

Illustrated by performance pyramid (seechapter 13).

Strategic planning

Operational control

Managment control

Anthony hierarchy



Corporate planning

SWOTanalysis



Overall strategicstance

Businesssunderlying values

and/or

Strategicanalysis

Companys internal resources andfacilities: current performance,

comparatives

POSITION AUDIT

eg PEST factors, competitive forces,turbulence

ENVIRONMENTAL ANALYSIS

eg Strengths, Weaknesses,Opportunities, Threats; Gap analysis

CORPORATE APPRAISAL

Why the business exists at allWhat the business is

MISSION

The relevance of the mission todifferent stakeholders

GOALS

How the mission can be achievedDesirable outcomes of corporate

activity

OBJECTIVES

Often the same.Terms used interchangeably.



Strategicchoice

Strategicimplementation

Options generation

Options evaluation

Choice

CORPORATE STRATEGIC CHOICE

1

2

3

eg Marketing strategies, productionstrategies

STRATEGY IMPLEMENTATION

Assess actual performance in thelight of plans etc

REVIEW & CONTROL

TACTICS ACTUAL PERFORMANCE



Corporate planning

SWOTanalysis



Corporate Strategy

Operational/functionalStrategies

Business levelStrategy

Levels of strategyCovers business as a whole

Issues such as: diversifying or restricting activities investing survival or growth

How an organisation approaches a particular market

Choice of generic strategies: cost leadership differentiation focus

Involves decisions made at operational leveleg product pricing; personnel and recruitment

Operational strategies are crucial in implementingcorporate and business level strategies successfully.



Corporate planning

SWOTanalysis



Linking strategy andoperations

The achievement of long-termgoals will require strategicplanning which is linked to short-term operational planning ... Ifthere is no link between strategicplanning and operationalplanning the result is likely to beunrealistic plans, inconsistentgoals, poor communicationand inadequate performancemeasurement.

Strategic planning and control versus operational planning and control

Strategic

Broad brush targetsWhole organisationExternal inputExternal focusFuture orientated, feedforwardcontrolPotential for double loopfeedback (ie opportunity tochange the plan)

Long term

Operational

DetailedActivities of departmentMainly internal informationInternal focus, on actual proceduresMore concerned with monitoringcurrent performance against planMainly single loop feedback(performance must change, not theplan)

Short term

Page 11 1: Introduction to strategic management accounting



Corporate planning

SWOTanalysis



Strategic controlTo encourage the measurement of theright things, organisations can instituteformal or informal systems of strategiccontrol. Formal systems require theidentification of milestones ofperformance (strategic objectives).

Focus on what matters in thelong term

Identify and communicatedrivers of success

Support organisational learning Provide a basis for reward Measurable Meaningful Acceptable Described by strategy and

relevant to it Consistently measured Re-evaluated regularly

Desirable features of strategicperformance measures

Linkages Diversity Criticality Change Competitive advantage

Guidelines for a strategic control system

The key to strategic control isensuring that the right thingsget measured.

False alarmsmotivate managers toimprove areas where thereare few benefits to theorganisation

Gaps are important areasthat are neglected (egcustomer satisfaction)

Different measures applyto different industries



Corporate planning

SWOTanalysis




Cultural factors (eg international hasfragmented, diverse markets)

Economic factors (eg international hasmultiple (unstable?) environments)

Competitive factors (eg little informationabout many more competitors ininternational business)

Political factors (often significant ininternational businesses)

Technological factors (eg training problemsin international businesses)

Differences between domestic and internationalbusinesses

Establishing realistic standards Determining controllable cash flows Currency conversion Bases of comparison

Problems of performance measurement

Exchange rate fluctuations Risk Cost structure Accounting policies Transfer prices Workforce Government policy Life cycle Level of domestic competition

Examples of problems when setting objectives

Potential issues in managing foreign subsidiaries Planning: is strategic planning co-ordinated by corporate centre or at national level? Control: is control centralised or do foreign subsidiaries have autonomy?

Performance measurement



Corporate planning

SWOTanalysis



SWOT analysis How SWOT can guide strategy formulationA critical appraisal of the strengths andweaknesses, opportunities and threats inrelation to the internal and externalenvironmental factors affecting anorganisation, in order to establish its conditionprior to the preparation of a long-term plan.

Identify weaknesses which need to beaddressed

Identify key aspects of performance(CSFs) which need to be measured(through KPIs)

Help set targets (eg to take advantage ofopportunities)

Determine information needs (eg toreport on KPIs).

1 Match strengthswith marketopportunities

2 Convert weaknesses intostrengths and threats intoopportunities

Strengths Weaknesses

Opportunities Threats

Conversion

ConversionM

atc

hin

g

Internal to the company

Existindependently

of thecompany

SWOT and performance management



Corporate planning

SWOTanalysis




Functional

Internal Comparing one operating unit or function withanother in the same industryComparing an internal function with the bestexternal practitioners, regardless of industry

Competitor Gathering information about direct competitorsusing, for example, reverse engineering

Non-competitor Particularly relevant for not-for-profit organisations.Compare against organisations in the sameindustry although they are not competitors.

TTypes ofypes ofbencbench-h-

markingmarking

Benchmarking

The establishment,through datacollection, of targetsand comparators,which will allowrelative levels ofperformance (andparticularly areas ofunderperformance)to be identified. Byadopting identifiedbest practices, it ishoped thatperformance willimprove.

Provides basis for establishingstandards of performance

Sets targets that areachievable

Can be a spur to innovation

Advantages

Implies one best way of doing things Yesterdays solution for tomorrows problem Catching-up exercise Potential negative side effects of what gets

measured gets done.

Disadvantages


Notes


2: Performance management and control of the organisation

Topic List

Budgeting

Not-for-profit organisations

Beyond budgeting

Budgets are short-term plans which provide short-termtargets within the framework of the longer-term strategicplans (covered in Chapter 1). Some of the contents ofthis chapter are brought forward from earlier studies andwill provide background to exam problems on higher-levelbudgeting issues.

Not-for-profit organisations and their specific budgetissues are considered, before use look at the concept ofbeyond budgeting which tries to address some of theproblems faced in traditional budgeting.


Not-for-profitorganisations

Beyond budgeting

Ensures organisations objectivesare achieved

Compels planning Communicates ideas and plans Coordinates activities Allocates resources Authorises expenditure Provides a framework for

responsibility accounting Establishes a system of control Provides a means of performance

evaluation Motivates employees to improve

performance

Uses of budgeting As a budget has different purposes, it mightmean different things to different people.

Forecast Yardstick Target Means of allocating resources

Incremental Flexible Zero based Rolling Activity based

Alternative budget systems

Budgeting

You should know the detailbehind the following points.

Long-term plan Limiting factor Budget manual Sales budget Production capacity Functional budgets Discretionary costs Consolidation and

coordination Cash budget Master budget

Prior knowledge


2: Performance management and control of the organisationPage 19

Strengths and weaknesses

Zero-basedbudgeting

Rolling budget

Pros Easy to

prepare

Can beflexed toactuallevels

Encouragesslack

Doesnt lookto improveperformance

Assumes3Es in place

Responds tochanges inenvironment

Reviews costbehaviourclosely

Improvesefficiency ofresource allocation

Timeconsuming

Needstraining

Needs aparticipativeapproach

Pros Reduces uncertainty in

an unstableenvironment

Most recentplans used

Budgets alwaysseveral monthsahead

Pros ConsCons

Flexible budgeting

Identifiessparecapacity

Pros Cons

Cons

ABBPros Identifies critical

success factors

Looks at activity in depth

Cons Time consuming Difficult to identify

responsibility andaccountability foractivities

Incremental budging

Timeconsuming

Not necessaryin a stableenvironment

Managers may not see value ofcontinuousupdating

Prone to error if standardsincorrect

Irrelevant in a mainly fixedcost environment



Beyond budgeting

Budgeting

Not-for-profit organisationAn organisation whose ... prime goal is not assessed byeconomic measures. Bois

Funding PlanningFunding comes from government rather than usersand is a political decision. So no clear linkbetween providing more service and funding.

Poor performance can lead to higher levels offunding

The political system affects planning. Changes inpriorities and funding can be imposed at will.

Limited control is offered over funding.

Budgeting in public sectorCharacterised by incremental, short-term (oneyear) bid budgets.


Beyondbudgeting

2: Performance management and control of the organisationPage 21


Budgeting

Beyond Budgeting

Two fundamental concepts underlie the BeyondBudgeting approach: Adaptive management processes Devolved organisation and decision making

Beyond Budgeting is a set of guiding principles thatpropose abandoning traditional budgets in favour of analternative general management model based ondecentralised decision making, personal respon-sibility, maximising value and adaptability to change.

Add little value

Waste valuable management time

Can result in dysfunctional behaviour

Conflict between communicating corporategoals and financial control

Often based on bargaining and not the bestmodel of resource consumption

Incompatible with a drive towards continuousimprovement

Insufficient external focus

Criticisms of traditional budgeting (Hope and Fraser)



Beyond budgeting

Budgeting

Factor Traditional budgeting Beyond Budgeting

Time frame Short-term focus Longer-term focus

Basis of rewards Focus on individual departments and divisions; self-interestOrganisation viewed as one team.Focus on learning and innovation.

Strategic planning Company-led approach to strategicmanagementCustomer-led approach to strategic management

Resource allocation To operating units or departments Allocated to strategic initiatives rather than departments

Co-ordination Link functional budgets to one anotherDetermined by requirements to meet customer needs

Performance reports Primarily based on historical, financial indicatorsMultifaceted, multi-level information.Forward looking as well as historical.

Traditional budgeting and beyond budgeting compared


3: Business structure, IT developments and other environmental and ethical issues

Topic List

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

In this chapter we look at the way businesses arestructured and how they co-ordinate their resources.We also look at how data systems and MIS provideinformation on changes happening in the organisation.Then we look at stakeholders, their roles and effect onthe organisation.Finally, we consider ethics, which is a vital component ofmodern organisational behaviour.


Stakeholdersand ethics

Data andMIS

Businessstructure/information

Teamwork andempowerment

Businessintegration

Business processre-engineering

Business structureOrganisations vary in the way they arrange their activities. Differences in organisational structure affect informationneeds and how performance is measured.

Vertical flow Functions tend to be isolated

Information needs Performance measurement

Functionalform

Economies of scale Hard to identify results for individual

products or markets People don't understand how business

works as a whole

Lateral communication Information and advice rather than instructions and

commands Levels of information need: operational, financial,

management information

Freedom to set standards by divisionalmanagers

Tendency for centre usurp divisionalprofits

Divisional performance not direcltyassessed by markets.

Outsourcing of personnel and assetsis common

Functions and services sharedbetween organisations

Divisionalform

Networkform

Autonomy lower down the organisation Formal communication between centre and divisions Use of transfer prices to set performance standards



Data andMIS



Businessintegration


3: Business structure, IT developments and other environmental and ethical issuesPage 25


The fundamental rethinking and radicalredesign of business processes to achievedramatic improvements in criticalcontemporary measures of performance suchas cost, quality, service and speed.

Processes should be designed to achieve a desiredoutcome (rather than focus on existing tasks).

Personnel who use output from a process shouldperform the process.

There is no differentiation between informationgathering and information processing.

Geographically-dispersed resources should betreated as if they were centralised.

Parallel activities should be linked, not integrated. There is no distinction between workers and

managers. Information should be captured once, at source.

Principles of BPR which influence systemsdevelopment

A process is a collection of activities that takesone or more kinds of input and creates anoutput.



Data andMIS



Businessintegration


ImplicationsImplicationsof BPR fof BPR fororaccountingaccounting

systemssystems

Performancemeasurement

Measures must be built around processes notdepartments. This may affect the design of responsibilityaccounting systems.

Reporting There will be a need to identify where value is beingadded.

Activity ABC might be used to model the business processes.

Structure Complexity of the reporting system will depend onorganisational structure.

Variances New variance analyses may need to be developed.




Data andMIS



Businessintegration



Business integrationAll aspects of a business mustbe aligned to secure the mostefficient use of the organisationsresources to achieve itsobjectives effectively.

McKinsey 7S modelThe McKinsey 7S model describes the links between the organisationsbehaviour and the behaviour of individuals within it.

Hard

Soft

SHAREDVALUES

STRUCTURE

STAFF

STYLE

SYSTEMSSTRATEGY

SKILLS

Four particular aspects of linkagehighlighted in the P5 syllabus: People Operations Strategy Technology



Data andMIS



Businessintegration


People implement the strategyand enable the organisation to

pursue its mission: humanresources; motivation

People mustbe to use

technology effectivelytrained

Techno

logy e

nables

new str

ategic

option

s

to be p

ursued

Strategy is made or brokenat operational level

Technologyfacilitatesoperations

People

Technology

Strategy

Operations:Most people work here

THE CUSTOMERINTERFACE

Linkage between people,operations, strategy andtechnology

People issues Quantity Motivation Skills level Deployment

Strategy issues Direction Implications for resources

Operations issues Procedures Customer relations Empowerment Quality

Technology issues Equipment Information Work organisation



Value chainThe value chain is another model for looking atbusiness integration. It provides an overall perspectiveof the activities of the business, which might easily beseen in isolation in functional departments.

The ultimate value a firm creates is measured by theamount customers are willing to pay for itsproducts/services above the cost of carrying outvalue activities.

To be successful, anorganisation needs toensure that thecharacteristics of all ofits activities areconsistent with eachother.



Data andMIS



Businessintegration


Characteristics of information needs of a team-based/empowered organisation

Mixture of financial and non-financialinformation. Teams carry out activities but maynot know the financial implications.

Transparency and immediacy. Teams needinformation quickly if they are to work flexibly.

Common data definitions. These are necessaryto enable comparison between teams.

Relevance Aggregation. It should still be possible to obtain a

broad view of how the organisation is doing. Responsibility centres. A budget for each team

might be required, as determined by theactivities in which it is involved.

Impact ofImpact ofempoempowermentwerment

on manaon managg ementementaccountingaccounting

systemssystems

Information must be disseminated throughout the organisation rather thanhanded down through the hierarchy.

Employees need to be given responsibility and the authority to make decisionswithin defined parameters.

Rather than issue orders, managers must be able to create conditions in whichthe organisation can prosper and front line staff must be able to deliverappropriate customer service.



Data andMIS



Businessintegration



Consideration of Information needs formanufacturing business

Characteristics that distinguish services frommanufacturing

Cost behaviour Innovation Quality Valuation Time

Inseparability/simultaneity Variability/heterogeneity No transfer of ownership

Perishability Intangibility

Information forservice businesses

Small service businesses, whose expenses aremainly overheads, provide a model in miniature ofthe requirements of activity based costing (ABC).

Service industries in particular rely on their staffand so management information must includeintangible factors such as how customers feelabout the service, as well as the key drivers ofservice costs (eg repeat business, churn rate).

The information required may varydepending on whether theorganisation offers mass servicesor personal services.

Operational information is likely tobe largely qualitative.



Data andMIS



Businessintegration


Remote input of data Instant access to data

Via distribution of data

Word processing Electronic schedules Desktop databases Web publishing Voicemail E-mail

Officeautomationsystems

Via sharing of data

Groupware

Intranets

Extranets

Software that can be used by collaborative work groups (messaging, views of an informationdatabase, public folders)

Internal networks used to share information. Remote access is quick and easy.

Network accessible to authorised outsiders. A popular means for business partners toexchange information.

A number of data capture techniques allow staff toinput data to the organisations system whether ornot they are in the office.

Laptop computers Bar coding and EPoS devices



Databases Provide comprehensive files of data for a number of different users. Avoid data redundancy andwastage of space, and reduce errors/inconsistencies from multiple data input.

Databasemanagement

systems(DBMS)

Software systems which organise the storage of data in a database in the most appropriateway.

Datawarehouses

Contain data from a range of internal and external sources. Query and reporting tools facilitatemanagement reporting and analysis.

Datamining Software which looks for different (sometimes previously unknown) patterns in groups of data(eg retail companies can find customers with common interests).

Enterpriseresourceplanning(ERPS)

Packages which aim to integrate all of an organisations applications (including manufacturing,distribution, inventory, invoicing, accounting, HRM, marketing) to give a single point of access.Link business processes and financial control, so can support management tools such as theBalanced Scorecard.



Data andMIS



Businessintegration


Management information system (MIS)A system to convert data from internal and externalsources into information and to communicate thatinformation, in an appropriate form, to managers atall levels in all functions to enable them to maketimely and effective decisions for planning, directingand controlling the activities for which they areresponsible.

Not all information will be collected and processed(but will be kept in managers heads).

Information will not be disseminated to appropriatemanagers.

Communication of information will not be timely.

Consequences of MIS development withoutformal planning

Dissatisfaction among employees who believe theyshould be told more

Lack of understanding of what targets to achieve are Lack of information about how well work is being

carried out

Consequences of a poor MIS

Definition of functions of individuals and their areasof responsibility in achieving objectives

Definition of areas of control within the organisation Information required for an area of control should

flow to the manager responsible for it

Essential characteristics of an MIS



Decision support systems Expert systems Executive information systems

Modelling systems More competition requires better competitor intelligence Faster response means information must be produced

quickly and be up to date

Examples of impact of increasing competition

Increasing competition as above Behavioural impact on management accounting system

of operating in different markets

Examples of impact of increasing globalisation

Factors to consider when setting up a management accounting system (just one part of an overall MIS) Output required (identify the information needs of managers) When the output is required Sources of input information

Management accounting systems



Data andMIS



Businessintegration


Groups or individuals whose interests aredirectly affected by the organisations

activities

Stakeholders

ExampleInternal Employees, managementConnected Owners, investors,

suppliers, customers,lenders

External Government, localcommunities, pressuregroups, unions

A: Minimal effort B: Keep informed; little

direct influence but mayinfluence more powerfulstakeholders

C: Treat with care; oftenpassive but capable ofmoving to segment D;keep satisfied

D: Key players strategymust be acceptable tothem, at least

Level of interestHighLow

Low

High

PowerA B

C D

Stakeholder mappingStakeholders interests are likely to conflict. Stakeholder mapping helps theorganisation to establish its priorities and set up its system of corporategovernance.

Remember: Relationship between stakeholders and organisation is two-way. Stakeholders can influence an organisation'sperformance, but an organisation's performance also affects its stakeholders.



The extent to which an organisation will exceed itsminimum obligation to stakeholders.(Johnson, Scholes &Whittington)

Conflicting views of the organisations responsibilitiescreate ethical dilemmas for managers at all levels.

Short-term stakeholder interest: obey the letter of thelaw

Long-term stakeholder interest: behave ethically toenhance image and reduce pressure for regulation

Multiple stakeholder obligations: the expectations ofother groups of stakeholders may be considered, as wellas any right they may have

Shaper of society: ensuring society benefits fromactions is more important than financial and otherstakeholder interests (eg for public sector organisations)

Dealing with corrupt or unpleasant regimes Honesty in advertising Employees cost or asset? Corrupt payments to officials extortion, bribery or

gift? The local culture must be considered.

Ethical stance Ethical dilemmas

Corporate ethicsHas three contexts: interaction with society, effects ofroutine operations, behaviour of the individuals.

Ethics are ideas about right and wrong that set standards for conduct. Ethics are important to business becausesociety considers such things important. There are also rules of professional conduct to consider. Ideas of right andwrong have become more fluid and less absolute. As a result there is a greater scrutiny of organisations behaviour

since it is likely to be less subject to definitive internal rules.



Data andMIS



Businessintegration


Employees and management Shareholders

Consumer groupsSuppliers

Government

Organisations should seek to align the interests oftheir staff with those of the organisation (eg throughreward systems)

Shareholders often take a short-term view of theirinvolvement in an organisation.

Central government sets the regulatory framework.Local government has devolved powers and localinfluence (eg local taxes)

Consumerism reflects the increased importanceand power of consumers. Highlights that consumersatisfaction is likely to be crucial to long-termprofitability.

Can influence the cost and quality of goods andservices

Stakeholders and business performance


4: Changing business environment and external factors

Topic List

Changing business environment

Risk and uncertainty

Factors to consider when assessingperformance

Government regulation

In this chapter, we look at the economic, fiscal andenvironmental factors which affect strategicmanagement. Businesses need to consider the risks anduncertainty from these external factors in their strategicdecision-making, and we also look at some aspects ofrisk and uncertainty in this chapter.


Factors to consider whenassessing performance

Changing businessenvironment

Governmentregulation

Risk anduncertainty

Manufacturingorganisations

Service organisations

Product life cycles

ThenPre 1970s, there was little internationalcompetition, costs were passed on tocustomers, minimal efforts were made tomaximise efficiency/reduce costs/improvemanagement practices.

Pre 1980s, many were government-ownedmonopolies or protected by highly regulated,non-competitive environments. Costincreases were covered by increasing prices.Cost systems were not deemed necessary.

Organisations could rely on years of highdemand for products.

NowThere is massive internationalcompetition, and global networksfor acquiring raw materials anddistributing high quality, low-pricedgoods.

Privatisation and deregulation hasresulted in intense competition, anincreasing product range and aneed for sophisticated costingsystems.

Competitive environment,technological innovation anddiscriminating and sophisticatedcustomer demand require continualproduct redesign and quick time tomarket.

Changing competitive environment


4: Changing business environment and external factorsPage 41

Changing customer requirementsSuccessful organisations make customer satisfactiontheir priority.

Manufacturing processes must be sufficientlyflexible both to accommodate new productdesign and to satisfy the demand for greaterproduct diversity.

Traditional manufacturing systems

Jobbing industries

Batch processing

Mass/flow production

Recent developments

Group technology/repetitive manufacturing

Dedicated cell layout

Changing manufacturing systems

Cost efficiency

Quality

Time

Innovation

Key success factors

Continuousimprovement

Employeeempowerment

Total value chainanalysis

New managementapproaches





Risk anduncertainty

Be innovative and flexible Be able to deal with short product life cycles Be able to offer product variety whilst maintaining

or reducing costs Reduce set-up times and inventories Have the greatest possible manufacturing flexibility

To compete, organisations need to......

Materials requirement planning (MRPI) Manufacturing resource planning (MRPII) Enterprise resource planning (ERP) Optimised production technology (OPT) Just-in-time (JIT)

Production management strategies linked toAMT

Production management strategies

Computer-aided design (CAD) Computer-aided manufacturing (CAM) Flexible manufacturing systems (FMS) Electronic data interchange (EDI)

Advanced manufacturing technology (AMT) helps them to do this.

The traditional approach to determining materialsrequirements is to monitor the level of inventories constantlyso that once they fall to a preset level they can be re-ordered.This ignores relationships between different inventory lines(demand for a particular item is dependent on demand forassemblies/subassemblies of which it forms a part).Modern computer techniques integrate such relationships

into the inventory ordering process.





Risk anduncertainty


Risk and uncertainty

Physical (eg earthquakes, fire, equipment breakdown) Economic (not even government forecasts are perfect) Business (eg new competitors) Product life cycle (different risks exist at different stages) Political (eg sanctions) Financial (eg risk to stakeholders caused by debt

finance)

Types of risk and uncertainty

Strategic planning deals with future events: the futurecannot be predicted.Strategic planning is therefore susceptible to risk anduncertainty, much of which is exogenous.





Risk anduncertainty

Expected valuesThe expected value (EV) of a decision is calculated asEV = px

where p = the probability of an outcome occurring,and x = the value (profit or cost) of that outcome.

Risk preferenceDecisions will be influenced by stakeholders appetitesfor risk and their attitude to risk.

Decision-makers attitudes to risk can also influencethe way they analyse potential business decisions.

Decision-makers have to consider the potentialupsides and downsides of a particular course ofaction.

Their attitude to risk can determine the decision-making criteria they think are most appropriate:

Maximin (Maximising the minimum profits) Maximax (Maximising the maximum profits) Minimax regret (Minimising the regret from

making the wrong decision)

Risk seeker Risk neutral Risk averse





Risk anduncertainty


The main factors in the macro-environment which canaffect an organisation's performance can be identifiedusing PEST analysis

Political Economic Socio-cultural Technological

Collectively, these factors represent opportunitiesand threats an organisation could face

The level of competition in an industry affects theindustrys ability to sustain profits.

The level of competition is determined by

Five competitive forces:

The threat of new entrants The threat of substitute products or services The bargaining power of customers The bargaining power of suppliers The rivalry amongst current competitors in the

industry





Risk anduncertainty

ExamplesEconomic Consider local economic trends interest and exchange rates and inflationInflation Is inflation driving up wage rates or being caused by pay settlements?Legal Consider the impact of employment law or industry regulators.Political Is government policy affecting competition? Are incentives being offered to locate in a

particular area?EU Think about product standards and labour costs.Cultural These can affect the motivation and satisfaction of employees, the adaptability of the

organisation and its image.Businesscycle Is the economy booming or in recession?When comparing performance across different countries, consider problems such as distance and remotenessof divisions from HQ, transfer pricing difficulties, currency exchange rate fluctuations and variation inmanagement and worker skills.





Risk anduncertainty


Types of organisation under government regulation Types of regulations by regulators

Purpose of regulations

Business eg Royal Mail operates on acommercial basis in the UK

eg NHS in the UK

National security

eg Water firms in the UK arestill, effectively, monopolies

eg British Telecom in the UK

Free at delivery

Public good

Privatised utility

Privatised utilitywith competition

Regulation of supply

Regulation of quality

Regulation of prices

Promote competition Protect customer welfare Use private cash to enhance quality Reduce public spending Ensure government subsidies are well spent


Notes


5: Performance management informationsystems

Topic List

Accounting information needs

Management accounting information

Management accounting systems

This chapter introduces management accounting andinformation systems, and how they could be used tomeasure performance.

Remember that we looked at strategic planning,management control and operational control informationin Chapter 1.

A variety of topics are considered, including the type oforganisation and the objectives of managementaccounting information.


Managementaccounting systems

Managementaccounting information

Accountinginformation needs

Management accountinginformation can be used to supportstrategic planning, control anddecision making.

Strategic management accountingdiffers from traditional managementaccounting because it has anexternal orientation and a futureorientation.

Analysis of competitors costs Product profitability Customer profitability Pricing decisions Cost/benefits of capacity expansion Analysis of decisions to enter (or leave) a business area Brand values Shareholder wealth Impact of acquisitions and mergers Analysis of competitors potential reactions to a strategy

Examples of strategic management accounting


5: Performance management information systemsPage 51

Management controlThe process by which managers ensure that resourcesare obtained and used effectively and efficiently in theaccomplishment of the organisations objectives. It issometimes called tactics or tactical planning.

Short-term and non-strategic Management control planning activities include

preparing annual sales budget Management control activities include ensuring

budget targets are (at least) reached Carried out in a series of routine and regular

planning and comparison procedures Management control information covers the

whole organisation, is routinelycollected/disseminated, is often quantitative andcommonly expressed in money terms Cash flow forecasts Variance analysis reports Staffing levels

Sources of information likely to be endogenous(from within the organisation)

Characteristics of management control

Management control decisions need tosupport an organisations strategic plans.





Operational control/planningThe process of ensuring that specifictasks are carried out effectively andefficiently.

Short-term and non-strategic Occurs in all aspects of an

organisations activities andneeded for day to dayimplementation of plans

Often carried out at shortnotice

Information likely to have anendogenous source, to bedetailed transaction data,quantitative and expressed interms of units/hours

Includes customer orders andcash receipts

CharacteristicsExampleStrategic planSenior management decidesales should increase by 5% pafor at least five years.Management control decisionSales quotas are assigned toeach sales territory.Operational control decisionManagers of sales territoriesspecify weekly targets for eachsales representative.

Management control v operational controlOperational control decisions are morenarrowly focused, carried out within ashorter time frame and taken bymanagers less senior in theorganisation.Operational control focuses onindividual tasks whereas managementcontrol is concerned with the sum of alltasks.






Measure performance Plan for the future Control the business Make decisions

What management accounting information helps managers to do(its objectives)

Management accounting information is used for score keeping, problemsolving and attention directing.

Forward looking Neutral (free from bias) Financial, non-financial, quantitative or qualitative

Features that characterise management accounting information inparticular

Relevant Complete Accurate Clear Usable with confidence Appropriately

communicated (to theright person using thecorrect method)

Manageable volume Timely Cost effective

Good information

Information requirements vary significantly across different types oforganisational structure (eg functional basis vs network organisation).





Open and closed systemsA closed system is isolated and shut off from theenvironment, is unaffected by the environment, andcannot influence the environment.

An open system is connected to and interacts withthe environment and is influenced by it.

Enterprise Resource Planning Systems (ERPS)Management accounting systems do not exist inisolation, but are part of the wider information systemsin an organisation; exemplified by ERPS.

ERPS are software systems designed to support andautomate the business processes of medium-sized andlarge organisations. They aid the flow of informationbetween business functions within an organisation, andcan manage connections to outside suppliers.

All departments that are involved in operations orproduction are integrated in one system. As a result,organisations are more agile in the way they useinformation, can process information better, and canintegrate it into business procedures and decision-making more effectively.

Performance management:Organisations should adopt an open systemsapproach to performance management

eg organisational performance could be affected bycompetitors actions. Also, performance often cannotbe attributed to one single issue, but needs to beviewed as the combined effect of many variables.



Lean management information systems Application of lean to MI systemsKey characteristics of lean systems:

Continuous improvement Increased productivity Improved quality Improved management

But note: to be successful, lean techniquesmust involve a commitment to adding value andeliminating waste. They cant be used simply asa justification for cost-cutting.

Lean can:

Enhance the value of data in the system:how it is organised, exchanged and retrieved

Add value to information through the way itis organised and presented (eg excludeunnecessary detail)

Enable information to flow to users moreefficiently.





The contingency approach to management accounting is based on the premise that there is no universallyappropriate accounting system applicable to all organisations in all circumstances. Efficient systems dependon awareness by the system designer of the specific environmental factors which influence their creation.

Predictability Competition Number of different product markets Hostility of competitors

Contingent factor - the environment

Size Interdependence of parts Degree of decentralisation Availability of resources

Contingent factor - organisationstructure

Nature of production process Complexity of production

process Task variety

Contingent factor - technology

Contingency approach



Impact of human behaviour.

Allocating responsibility Encouraging participation in decision making Devising ways of measuring and rewarding

behaviour that contribute to organisationalobjectives

Methods

Management accounting systems have to developways of overcoming the problems of humanbehaviour.

Issues for management accountants:

Dual process frameworkheuristic/holisticprocessing analytical/systematicprocessing

Ways of presenting information:

Written format Tables Graphs or charts Dashboards Interactive reports





Responsibility accountingRole of management accountant

Learn from managers of responsibility centreswhat information they need, in what forms andwhat intervalsDesign a system that enables this information tobe provided (using different responsibility centres(cost, profit and so on))

A system of accounting that segregates revenuesand costs into areas of personal responsibility inorder to monitor and assess the performance of eachpart of an organisation.

Any part of an organisation which is headed by amanager who has direct responsibility for itsperformance.Responsibility accounting is based on the

principle of controllability.

But in practice is it always possible to splitimpacts on performance into controllable anduncontrollable categories?

Responsibility accounting

Responsibility centre

Important to distinguish between division'sperformance and managers performance. Can onlyevaluate manager's performance on factors he orshe can control.


6: Management information, recording and processing and management reports

Topic List

Internal sources of information

External sources of information

Recording and processing methods,systems and data

Controls and security

Output reports

External information is vital for strategic planning andperformance feedback but is rarely directly input into themanagement accounting system.Internal information provides the input data for themanagement accounting system and is vital formanagement control and operational control. Control isdependent on the receipt and processing ofinformation.Also, the way in which information is presented is important.If the outputs from a management information system arenot accessible to the relevant people, the usefulness of theinformation is severely reduced.You are likely to encounter issues about controls andsecurity over data in your own workplace, but its worthreminding you about them here anyway.


Recording and processing methods, systems and data

Controls andsecurity

Output reportsExternal sourcesof information

Internal sourcesof information

Financial accounting records Systems of control over transactions

(eg inventory control systems) Payroll, production records, timesheets Staff (collected formally or informally)

Principal internal sources of managementaccounting information

Costs of the collection, processing and productionof internal data

Direct data capture costseg use of barcoding

Processing costseg inputting data to the MIS

Cost of inefficient use of informationeg information disseminated more widelythan needed

In todays competitive market, where the paceof change in information systems andtechnology is rapid, organisations must beflexible enough to adapt to change quickly andmust plan for expansion, growth and innovationwithin information systems.






6: Management information, recording and processing and management reportsPage 61

External information is used to different degreesdepending on the level and type of decision.

INTERNALEXTERNAL

Operational Tactical Strategic

Business directories Associations Government agancies Consumer panels Customers Suppliers Internet Databases Market research Data warehouses (internal + external sources)

Common external sources of information

External information can contribute to planning (eg market research informing sales budgets),decision-making (eg through competitor research)and control (eg from benchmarking.)

External information is used in the management accounting system depending on its quality. Quantitativedata is easier to use. Benchmarking uses external information to help set targets.






Costs associated with external sourcesDirect search costseg subscriptions to magazines

Indirect access costseg spurious accuracy

Management costseg wasted time on excessive processing

Infrastructure costseg maintenance of computer server

Time thefteg information overload

May not be entirely relevant Bias Accuracy should be questioned May not be available in correct form Can be expensive

Disadvantages

Note that the costs of market research can beconsiderable and that the internet can significantlyreduce search time and search costs.

Save time and money as secondary data ischeaper than primary

Advantages







. . . But: beware the dangers of information overload given the volume of potential information available.

Different types of business will require different recording and processing methods butthe methods used should suit the volume of data (eg batch processing at the end ofthe day for a small bookshop), the level of accuracy required and the speed with whichthe information is required (eg EPoS devices, and real-time inventory updating insupermarkets).

Spreadsheet packages WiFi Database packages Radio-frequency identification Software packages (RFID) E-mail systems ERPS Computer Telephony Electronic data interchange (EDI)

Integration (CTI)

IT developments which have influenced recording and processingsystems

Given that qualitative data issubjective and judgmental, itsrecording is likely to beproblematic. The number of salesmade is easy to record; thereasons why sales are lost is not.

Qualitative data

General rule: any information that isneeded should be recorded and storedin such a way that it can be readilyretrieved.






Controls required over the generation ofinternal information

In routine reportseg consistent format to ensureaccuracyIn ad-hoc reportseg ensure information does notalready exist in another formatOver distributing internal informationeg procedures manualsOver information held on serverseg passwordsOther controlseg email policy

Passwords Firewalls Logical access systems Encryption Database controls Authentication

inference controls Anti-virus and anti-spyware passwords software

Personnel security planning

Procedures to ensure the security of highly confidentialinformation that is not for external consumption


DashboardsDashboards are executive information systems which illustrate howa business is performing and help managers make better decisions,through showing current data, pictures, graphs and tables, therebyreducing the numbers (and size) of paper reports which have to beproduced.

Drill-down reportsDrill-down reports allow users to look at increasingly detaileddata about a situation.

Exception reportsOne way of reducing the amount of information being presented(thereby preventing overload) is through using exception reports.Reports are only triggered when a situation is unusual orrequires management action.






As the volume of data available tobusiness increase, it is important thatthey ensure this data is 'fit forpurpose.'

'Fitness for purpose' involves databeing accurate and relevant withoutbeing overwhelming.

Similarly it is important that outputreports are timely, accurate andtailored to the user.

Beware of the dangers ofinformation overload.!






Recap: Overview of management information systems

Feedback is crucial for control, eg through comparing actual results to plan, and identifying variances.

PROCESSING

STORAGE

OUTPUTINPUT

FEEDBACK


7: Performance hierarchy

Topic List

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

In this chapter we start looking at strategic performancemeasurement techniques and the issues relating tostrategic performance measurement.

Although we will look at some important aspects ofstrategy in this chapter, please remember that the focusof paper P5 is on performance (performancemeasurement, and performance management) ratherthan strategy itself.


Short term andlong term

Planning/controllingat different levels


Goals and objectivesMission statementsand vision

Describes the organisations basic function in society,in terms of the products and services it produces forits clients. Explains what the business is for.

MissionA formal statement of an organisations mission

Mission statement

Purpose Policies and standards of behaviour Strategy Values and culture

Elements of mission

VisionIf a mission answers the question What is thebusiness for?, a vision answers the question Whereis the business going?

A vision gives a general sense of direction to thecompany.

There is no standard format but mission statementsshould be brief, flexible, distinct and open-ended.

Business areas in which the organisation willoperate

Organisations reason for existence Stakeholder groups served by the organisation

Factors to incorporate in a mission statement



7: Performance hierarchyPage 69




Goals are derived from an organisations vision and mission. Operational goals can be expressed as quantified,SMART (Specific, Measurable, Attainable, Relevant, Time-bounded) objectives.

ExampleA mission might be to deliver a quality service, a goal to enhance manufacturing quality and an objective toreduce the number of defects to one part per million over the next year.

Corporate objectives Strategic objectives Subsidiary objectives

ExampleIf a primary objective is growthin profits, strategies by whichthe primary objective can beachieved (eg for growth in

sales) must be developed.

Unit objectives Ranking objectives

These primary objectivesconcern the organisation as awhole (eg profitability, industrialrelations) and are set as part ofthe corporate planning process.

These are specific to individualunits of an organisation.

These combine to ensure theachievement of the primarycorporate objective.

These are developed beneath strategicobjectives.To ensure co-ordination, the various functionalobjectives must be interlocked vertically,horizontally and over time.

Multiple objectives can clash so strategicmanagement must ensure goal congruence.






Hierarchy of objectives Social and ethical obligationsMission

Goals

Objectives

Strategy

Tactics

Operational plans

Increasingcoverageof aspects

of theorganisation

Each level of the hierarchy derives its objectives from the level above, so ultimately all are founded in the mission.Objectives therefore cascade down the hierarchy so that, for example, strategies are set to achieve objectives,and provide targets for tactics. Again, this highlights the importance of goal congruence across different levels.

To internal stakeholders (employees, management) To connected stakeholders (shareholders, customers,

suppliers, financiers) To external stakeholders (the community, government,

pressure groups)Whereas social responsibility deals with the organisationsgeneral stance towards society, and affects the activities theorganisation chooses to do, ethics relates more to how anorganisation conducts individual transactions.

Corporate codes of conduct contain statements setting outcompany values and responsibility toward stakeholders.



Objectives, CSFs and KPIs Objectives

Critical Success Factors (CSFs)

Key Performance Indicators (KPIs)

CSFs are the key factors and processes an organisation needs toexcel at in order to achieve its objectives.

KPIs measure how well an organisation is performing against itsCSFs.

Impact on information systems.

CSFs identify the areas of performance which managers need information about. Therefore it is important thatinformation systems can provide managers with this information (eg, the systems can provide information forKPIs.)






Postpone/abandon capital expenditure

Cut R&D expenditure

Reduce quality control

Reduce the level of customer service

Cut training costs/recruitment

Decisions which involve the sacrifice of longer-term objectivesfor short-term benefit

Make short-term targets realistic. Provide sufficient information to

allow managers to see what S/Ltrade-offs they are making.

Evaluate managerial performancein terms of contribution to long-term as well as short-termobjectives.

How to control short termism

Refers to the balance of organisational activities aiming to achieve long-term and short-term objectives whenthey are in conflict or where resources are scarce

S/L trade-off







Incremental improvements to currentactivities (eg cost reduction)

Combination of market penetration, marketdevelopment, product development anddiversification (Ansoffs matrix)

Withdrawing from a business (if it is loss-making); divestment

Acquisition Internally-generated (organic) growth

How to fill the gap$000

Planning gapThe planning gap is the gap between the forecast position from continuing with current activities, and theforecast of the desired position.






Level ControlsPlansCorporate/strategic Focused on overall performance

Influenced by external environment Set plans/targets for units/departments Sometimes qualitative Aggregate

Operational

Exercised by external stakeholdersand/or the market

Double-loop feedback (ie relatively freeto change targets)

Often feedforward elements Based on objectives about what to

achieve Specific Little immediate environmental influence Likely to be quantitative Detailed specifications Based on how something is achieved Short time horizons

Exercised internally by management orstaff in empowered teams

Immediate or rapid feedback Single loop feedback (ie little authority

to change plans or targets)

Operational performance is customer-facing (in services), specialised, more likely to be routine, limited inscope, characterised by short time horizons and easier to automate than some management tasks.


8: Scope of strategic performance measuresin the private sector

Topic List

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

The profit-making or private sector tends to favourfinancial performance measures whereas the publicsector favours non-financial indicators. There are fourmain groups of financial performance measures: growth,profitability, gearing and liquidity.

You also need to be clear about the distinction betweenshort-run and long-run performance measures.


Shareholders,survival and growth

Profitability Performance andshare value

Liquidity ComparisonsGearing

An organisation must make sustainable profits

Revenue Number of employees ROI Number of products Market share Cash flow

Other ways of measuring growth

Why are shareholders important? Survival and growthThe clearest measure of success for a business is continuedexistence and expansion.

Growth requires profits Growth produces profits Growth without profits no survival*

Problems in attaining goal congruenceare often due to difficulties in satisfyingdiffering objectives of the organisationsvarious stakeholder groups. Shareoptions are one way of aligningshareholder and managerial goals.

Profit-making organisations tend tofocus on financial performance ingeneral and on the interests ofshareholders in particular. The argumentfor this is that shareholders are the legalowners, the company belongs to themand so their interests are paramount.

* But beware there could be conflicts between a business strategy aimed at growth and a strategy aimed at survival.


ROCE




8: Scope of strategic performance measures in the private sectorPage 77

Calculated as (gross profit/turnover) 100%(where gross profit = sales cost of sales)Influenced by the level of fixed costsNot useful for comparing different industries

Earnings before interest, tax, depreciation andamortisation.It is a good proxy for cash flow from operations and so can beused as a measure of underlying performance.Tax and interest are not relevant to an organisationsunderlying success.Depreciation is not relevant to performance in a particular year.It is easy to calculate and understand.

EPSShows how well the shareholder is doing.Calculated as (profit after tax, MI, extraordinaryitems and pref div)/no of equity shares.Must be seen in context as on its own it does notimpart much information.Easily manipulated by changes in accountingpolicies/mergers/acquisitions (especially forbonuses).

Calculated as (PBIT/capital employed) 100%Capital employed = share capital and reserves +long-term liabilities and debt capitalROCE = profit margin asset turnover

Sales margin

EBITDA





NPV/IRR/MIRR.

Definition/valuation of assets.

Fair performance comparisons with othercentres.

It can give a false impression of improvingperformance over time.

It can discourage new investment.

Group target returns may be unsuitable forthe entire group.

Target returns can produce a lack of goalcongruence, short termism anddysfunctional decision making.

Problems with the use of ROI

Focus on future cashflows and allow for risk(through use of discount factors)

It is calculated as profit imputed interest (whereimputed interest is capitalemployed cost of capital).

It overcomes some of theproblems of ROI but it has its owndisadvantages.

ROI

RI

ROI is a form of ROCE used forinvestment centres.

It is calculated as (PBIT/operations management capitalemployed) 100%.

MIRR distinguishesbetween investmentphrase and returnphase of a project, toovercome the flawedassumption made inIRR that cash flowsare reinvested at theprojects IRR over thelife of the project.



Economic value added (EVA)EVA is similar to RI because it is an absoluteperformance measure calculated by subtractingan imputed interest charge from the profitearned by a company or division.

EVA = net operating profit after tax (NOPAT)less capital charge.

Capital charge = weighted average cost ofcapital net assets.

However, EVA looks to measure specificallyhow well companies are maximising thewealth of their shareholders. Argues thattraditional profit-based measurement do not dothis.

EVA is based an economic profit which is not thesame as accounting profit:

Value-building expenditure (eg advertising) isadded back to profit

Non-cash items are eliminated

One-off, unusual items are excluded

Charge for accounting depreciation is added back toprofit (under EVA) and a charge for economicdepreciation made instead.

Capital charge uses different bases for net assets.EVA usually uses replacement cost of assets.

Key differences between EVA and RI


GearingShareholders,survival and growth


Liquidity Comparisons

Measures of financial gearingPrior charge capital

Equity capital (incl reserves)

Prior charge capitalTotal capital employed

Financial gearingA high level of debt creates financial risk in a companys capital structure.

The company: if debts cant be paid it may be forced into liquidation. Suppliers: they are unlikely to recover in full the money they are owed. Shareholders: they can expect lower or non-existent dividends if high interest payments are made.

Financial risk from different points of view

Operating gearing

Gearing measures the relationship between shareholders capital plus reserves, and either prior charge capital orborrowings or both.

Operating gearing is concerned with the relationshipbetween the variable cost/fixed cost operating structureand profitability.Gearing ratio = contribution/PBIT






A company must be liquid so that it can meetits debts when they fall due.

A company can be profitable but at the sametime have cash flow problems.

Liquid funds consist of cash and short-terminvestments for which there is a ready market +fixed-term bank/building society deposits + tradereceivables + bills of exchange receivable.Some assets are more liquid than others.Non-current assets are not liquid assets.Liquid assets = all current assets or all currentassets with the exception of inventory.

Ratios to assess liquidity

Current assets current liabilities Should be greater than 1

Those for inventory and receivables give anindication of liquidity.

(Current assets inventory) current liabilities Can be less than 1 if inventory turnover is fast

Current ratio

Quick/acid test ratio

Turnover periods


Performance andshare value


Profitability Liquidity ComparisonsGearing

Calculated as:

Market value in cents or Total MV of equity__________________ _______________EPS in cents Total earnings

Reflects the markets appraisal of the shares future prospects

Assuming the P/E ratio will not vary much over time, if the EPSgoes up/down, the share price should move up/down too.

Internet companiesShort-run v long-run performance Managers have a personal interest in the long-term survival of thebusiness and shareholders want a long-term increase in their wealth frominvestment in the business. But managers performance is often measuredon short-term results and even investors are under pressure to maximisethe growth in the value of their portfolios in a particular period.

P/E ratio

Fuelled by what appeared to beunrivalled opportunities forgrowth and increasing returns toscale, share prices of internetcompanies rose dramaticallyduring 1999/2000.Despite exciting websites andhuge marketing expenditure,internet companies were madeor broken on issues of logisticsand distribution. Many wereunable to avoid the traditionalneed for profits and positive cashflow to survive.






Results of the same company over successive accounting periods

Different organisations in the same industry

They give some indication of progress but there areweaknesses in such a comparison.

The effect of inflation should not be forgotten.

The organisations progress needs to be put into thecontext of what other organisations have doneand/or special environmental/economic influences.

If they are in the same broad industry even thoughnot direct competitors, might still expect broadlysimilar performance in terms of growth.If they are direct competitors, comparisons could beparticularly useful. Which has better sales growth,or profit growth? Which has better liquidity or

working capital position?

Investors might want to know:Growth comparisonsROCE comparisonsP/E ratio and dividend yield comparisons

Between organisations in different industries

Allows comparisons at different levels to be madebetween firms and inside the firm.

Benchmarking


Notes


9: Divisional performance and transferpricing issues

Topic List

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

Ensure that you understand the organisational context oftransfer pricing ie why transfer prices are necessary andwhen they are set.

Then consider how prices are set. Also look at the widercontext eg taxes and EU legislation.


Divisionalisation Negotiatedtransfer prices

Multinationaltransfer pricing

Short supply ofintermediate products

Setting transfer prices

Dysfunctional decision making (abalance has to be kept betweendecentralisation of authority to provideincentives and motivation, andretaining centralised authority toensure goal congruence)

Increase in costs of activities commonto all divisions

Loss of control by top management

It can improve the decision-making process in two ways. Quality Speed

The authority to act to improve performance shouldmotivate divisional managers.

Top management are freed from detailed involvement inday-to-day operations and can devote more time tostrategic planning.

Divisions provide valuable training grounds for future

acca p5 - advanced performance management passcards 2013-1

Documents

strategic performance

divisional performance

performance hierarchy

management reports

bpp house

bpp learningmedia

strategic managementaccounting

published bybpp learning