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Transcript of Copyright © 2008 Prentice Hall All rights reserved 12-1 Performance Evaluation and the Balanced...
Copyright © 2008 Prentice Hall All rights reserved12-1
Performance Evaluation and the Balanced Scorecard
Chapter 12
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Objective 1
Explain why and how companies decentralize
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Decentralized Operations
• Operations are split into divisions
• Advantages: Frees top management time Supports use of expert knowledge Improves customer relations Provides training Improves motivation and retention
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Decentralized Operations
• Disadvantages: Duplication of costs Problems achieving goal congruence
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Responsibility CentersResponsibility Center
Manager is responsible for…
Examples
Cost Center Controlling Costs Production line at Dell computer
Revenue Center Generating Sales Revenue
Midwest sales region at Pace Foods
Profit Center Producing profit through generating sales and controlling costs
Product line at Anheuser-Busch
Investment Center Producing profit and managing the division’s invested capital
Company divisions such as Walt Disney World Resorts
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Objective 2
Explain why companies use performance evaluation systems
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Goals of Performance Evaluation Systems
• Promoting goal congruence and coordination
• Communicating expectations
• Motivating Unit Managers
• Providing feedback
• Benchmarking
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Limitations of Financial Performance Measures
• Management needs both: Lag indicators Lead indicators
• Tendency to focus on short-term achievements
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Objective 3
Describe the balanced scorecard and identify key performance
indicators for each perspective
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Balanced Scorecard
• Measure company’s activities in terms of its vision and strategies
• Financial and operational performance measures are considered
• Link company goals to key performance indicators
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COMPANY GOALSCOMPANY GOALS
CRITICAL FACTORS(customer satisfaction, operational efficiency, employee excellence, financial profitability)
CRITICAL FACTORS(customer satisfaction, operational efficiency, employee excellence, financial profitability)
KEY PERFORMANCE INDICATORS (KPIs)(market share, yield rate, employee training
hours, revenue growth)
KEY PERFORMANCE INDICATORS (KPIs)(market share, yield rate, employee training
hours, revenue growth)
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Four Perspectives
• Financial perspective
• Customer perspective
• Internal business perspective
• Learning and growth perspective
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Financial Perspective
• How do we look to shareholders?
• Strategy to increase company profits Increase revenue growth Increase productivity
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Customer Perspective
• How do customers see us?
• Strategy for customer satisfaction Product price Product quality Sales service quality Product delivery time
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Internal Business Perspective
• At what business processes must we excel to satisfy customer and financial objectives?
• Three factors: Innovation Operations Post-sales service
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Learning and Growth Perspective
• Can we continue to improve and create value?
• Three factors: Employee capabilities System capabilities Company’s climate for action
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E12-17 Sketch the Balanced Score Card
E12-17 Sketch the Balanced Score Card
1. Financial Perspective: “How do we look to
shareholders?”
3. Internal Business Perspective: “At what
business processes must we excel?”
4. Learning and GrowthPerspective: “Can we
continue to improve and create value?”
2. Customer Perspective: “How do customers see
us?”
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1. Financial Perspective
3. Internal Business Perspective
4. Learning and GrowthPerspective
2. Customer Perspective
Revenue Productivity
Price
Quality
Sales service
Delivery time
Innovation Operations Postsales service
Employee Capabilities
System Capabilities
Climate for Action
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E12-19: Classify KPI’s by Balanced Scorecard Perspective
a. Customer perspectiveb. Learning and growth perspectivec. Financial perspectived. Internal business perspectivee. Learning and growth perspectivef. Internal business perspective g. Customer perspectiveh. Internal business perspective
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E12-19: Continued
i. Customer perspectivej. Financial perspectivek. Internal business perspectivel. Learning and growth perspectivem. Internal business perspective n. Financial perspectiveo. Internal business perspectivep. Customer perspective
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E12-19: Continued
q. Learning and growth perspective
r. Financial perspective
s. Customer perspective
t. Internal business perspective
u. Internal business perspective
v. Learning and growth perspective
w. Internal business perspective
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Objective 4
Use performance reports to evaluate cost, revenue, and profit centers
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Performance Reports
• Report financial performance of responsibility centers Cost center: focus on flexible budget variance Revenue center: focus on flexible budget
variance and sales volume variance Profit center: focus on flexible budget
variance• Includes allocated charges from service
departments
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E12-21: Complete and Analyze a Performance Report
Racer-Subunit X Actual
Flexible budget
Flexible budget
variance%
Variance
Direct materials $28,100 $26,000
Direct labor 13,500 14,000
Indirect labor 26,000 23,000
Utilities 12,000 11,000
Depreciation 25,000 25,000
Repair & Maint 4,300 5,000
Total $108,900 $104,000
$2,100 U 8.08% U
500 F 3.57% F
3,000 U 13.04% U
1,000 U 9.09% U
0 0
700 F 14.00% F
4,900 U 4.71% U
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Objective 5
Use ROI, RI, and EVA to evaluate investment centers
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Investment Centers
• Financial evaluation must measure: Income generated Effective use of center’s assets
• Performance measures: Return on investment (ROI) Residual income (RI) Economic value added (EVA)
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Return On Investment (ROI)
Operating income ÷ Total assets
OrOperating income
SalesSales
Total assetsX
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ROI
Operating incomeSales
SalesTotal assets
X
Sales margin =Operating income
Sales
Capital turnover =Sales
Total assets
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ROI
Advantages:
• Expanded equation provides additional information
• Can be used to compare across divisions and with other companies
• Useful for resource allocation
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E12-23: Compute Each Division’s ROI
Professional:
$173,000 ÷ $420,000 =
41.19%
Residential:
$62,000 ÷ $188,000 =
32.98%
ROI = Operating Income ÷ Total Assets
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E12-23: Compute Each Division’s Sales Margin and Interpret Results
Professional:
$173,000 ÷ $1,030,000
16.80%
Residential:
$62,000 ÷ $555,000
11.17%
Sales Margin = Operating income ÷ Sales
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E12-23: Calculate Each Division’s Capital Turnover
Professional:
$1,030,000 ÷ $420,000
2.4524
Residential:
$555,000 ÷ $188,000
2.9521
Capital Turnover = Sales ÷ Total Assets
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E12-23: Expanded ROI Formula
Professional:
16.80% x 2.4524
41.20%
Residential:
11.17% x 2.9521
32.97%
ROI = Sales margin x Capital turnover
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Residual Income
• Compares division’s operating income with minimum operating income expected, given the size of the division’s assets Positive – income exceeds target rate of
return Negative – income does not meet target rate
of return
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RI
Operating income – minimum acceptable income
Minimum acceptable income =
target rate of return x Total assets
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RI
Advantages:
• Promotes goal congruence better than ROI
• Incorporates management’s minimum required rate of return
• Can use different target rates of return for divisions with different levels of risk
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E12-24: Calculate Each Division’s RI
Professional:
$173,000 - ($420,000 x 25%) = $68,000
Residential
$62,000 - ($188,000 x 25%) = $15,000
Residual Income =
Operating income – Minimum acceptable incomeAre the divisions meeting or exceeding
management’s minimum
required rate of return? If yes, what does this
mean?
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Economic Value Added
After-tax operating income –
[(Total assets – Current liabilities) x WACC%]
WACC% – weighted average cost of capital
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E12-24: Calculate Each Division’s EVA
Professional:
($173,000 x 70%) – [($420,000 - $150,000) x 15%]
$80,600
Residential
($62,000 x 70%) – [($188,000 - $68,000) x 15%]
$25,400
EVA = (After-tax operating income) –
[(total assets – current liabilities) x WACC%]Have the divisions
created wealth for their
stockholders and long term creditors? How
can you use EVA to answer this question?
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EVA
Advantages:
• Considers wealth created just for investors and long-term creditors
• Promotes goal congruence
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Limitations of Financial Performance Measures
• Measurement issues – how to define “total assets”
• Short-term focus
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End of Chapter 12