The article “Coming up short on Non-financial Performance Measurement” by Christopher

D. Ittner and David F. Larcker throws light on various common mistakes made by different

companies in coming up with their non-financial performance measures as follows:

Not linking measures to strategy

Not validating the links

Not setting the right performance targets

Measuring Incorrectly

The article talks about the extensive research done in studying the non-financial performance

measures implemented by various companies. It also highlights a number of practices which

allow firms to realize the genuine promise of non-financial performance measures. The

article finally advocates some well-established series of steps which can be employed to

realize the full promise of non-financial performance measures as follows:

Develop a Causal model

Pull together the data

Turn data into information

Continually refine the model

Base actions on the findings

Assess the outcomes

Performance measures are vital to any business system as they indicate how well the system

is doing and provides chance to make appropriate and timely decisions and plans. These

measures can be both financial and non-financial. Generally most of the entrepreneurs focus

primarily on the financial performance measures of a business system as they directly speak

the monetary language. However recent studies show that non- financial performance

measures compliment the financial performance measures and help to accurately measure the

efficiency, capability and effectiveness of a business system.

A traditional business system mainly believes that the sales, profit margins and cash flow are

the lifeblood of any business and so they pay very little attention to the non-financial

performance measures.

Lean business systems focus not only on better financial results but also on continuous

improvement and to minimize waste as much as possible. These systems focus on creating a

“value” to the customer and thus always attempt to optimize their processes.

Traditional Financial Indicators of a firm’s performance:

Lack of a precise and timely knowledge of the current financial position can lead to business

failure and have other consequences for the directors/owners. A Firm’s Financial Statements:

Income Statement, Balance Sheet, Cash flow statement. These statements are compared over

time periods (Horizontal analysis) or within a time period (Vertical analysis) to interpret the

financial health of the firm. A number of ratios and percentages are commonly used for

analyzing these financial statements. They are as following:

1. Liquidity Ratios

Current Ratio

Quick Ratio

2. Profitability Ratios

Profit Ratio

Earning Power

Return on Investment on Assets

Return on Common Equity

3. Asset Ratios

Inventory Turnover

Days of Receivables outstanding

4. Debt Ratios

Debt to Assets

Debt to Net worth

5. Security Ratios

Earnings per Share

Price Earnings

Book Value

Pay Out

Yield

Profit, market share, cash flow are also some other important financial performance metrics.

Traditional Non -Financial Indicators of a firm’s performance:

The original purpose of non-financial performance measures was to fill out the picture

provided by traditional financial accounting. Non-financial Indicators of performance can

help firms to come up with a stronger long term strategies.

The main drawback of any financial performance metric is that it indicates a firm’s

performance after a financial period. Hence they are mostly considered as lag indicators.

However non-financial performance indicators can play a dominant role as indicators of

future financial performance of a firm.

A firm’s financial performance can be measured more frequently by employing some non-

financial metrics like

number of enquiries made

number of customers per day

average sales value

number of quoted jobs lost

customer satisfaction/employee satisfaction

number of new products

Employee turnover and so on.

Manufacturing Scenario: Traditional Vs. Lean

Traditional manufacturing organizations view achieving profits as achieving economies of

scale by focusing on full machine/labor utilization and large production batch sizes. However

Lean Manufacturing organizations try to maximize product flow (based on customer order

rate) by minimizing overproduction, excess inventory, unnecessary motion etc. Hence it is

obvious that traditional performance measurements do not support a lean environment.

Key Performance measures of a Lean System provide excellent balance between long term

strategic measures and short term financial measures. These can be aligned well with the

daily work goals and plans.

Financial Performance Measures of a Lean Manufacturing System:

Profits

ROA(E)

Increase in Revenue

Hard Cost and Soft Cost Savings

Cost Shifting

Non-Financial Performance Measures of a Lean Manufacturing System:

Shop floor employee involvement in lean initiatives

Inventory turns

Equipment down time

On-time delivery

Scrap

Rework

Setup times

Labor productivity

Throughput time

Manufacturing cycle efficiency

Product Quality

Manufacturing Cycle time

Overall Equipment efficiency (OEE)

Build to schedule

First time through Capability (FTT)

Rolled Throughput Yield (RTY) etc.

Financial vs Non- financial Measures

As compared to financial measures, nonfinancial measures are seen by the manufacturing

managers as providing the greatest encouragement for risk taking and innovation and also are

more effective at curtailing short-termism and gamesmanship. Non – financial measures are

not seen as significantly different from financial measures in their contribution to operational

and strategic decision making and their capacity to align intra- and interdepartmental

objectives. Financial measures are generally considered to be more sensitive to factors

outside control than non-financial measures.

Conclusion

To develop a successful performance measurement system, managers must clearly

understand the interests of the stakeholders (customers, employees, and investors), the

strategic objectives of the company, and every aspect of the company's business processes.

Only then can they be assured that the performance measurement system includes the right

factors, both financial and nonfinancial. Long-term commitment to the system is required to

assure that the factors are measured, understood, and used. The result can be a performance

measurement system that is clearly linked to strategy, is dynamic, and is action-oriented.

References:

1. Article - “Coming up short on Non-financial Performance Measurement” by

Christopher D. Ittner and David F. Larcker.

2. Text book (ISE 200) – Applied Economic analysis for Technologists, Engineers &

Managers – Michael S. Bowman (2nd

edition)

3. ISE 251 Lecture Notes – Lean in Administrative, Technical and Professional work.

4. http://www.switzer.com.au/the-experts/joe-kaleb-tax-expert/financial-performance-

indicators-for-businesses/

5. http://www.mep.purdue.edu/successes/articles/Performance_Measurement_for_Lean.

aspx

6. http://www.slideshare.net/leanhank/lean-key-performance-metrics

7. A Research paper “Lean Manufacturing, Non-Financial Performance Measures, and

Financial Performance” by Rosemary R. Fullerton and William F. Wempe. Link

found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1318393

8. http://www.imanet.org/PDFs/Public/MAQ/2006_Q2/2006MAQ_spring_vanderstede.

pdf

9. http://college.cengage.com/accounting/resources/students/readings/stivers.htm