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ACCA

PAPER P5
ADVANCED PERFORMANCE MANAGEMENT
PASSCARDS
FOR E X A M S U P TO J U N E 2 0 1 4

Professional Paper P5 Advanced Performance Management

First edition 2007, Seventh edition September 2012 ISBN 9781 4453 9672 9 e ISBN 9781 4453 9233 2 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Published by BPP Learning Media Ltd, BPP House, Aldine Place, 142-144 Uxbridge Road, London W12 8AA www.bpp.com/learningmedia Printed in the United Kingdom by Ricoh Ricoh House Ullswater Crescent Coulsdon CR5 2HR

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media. BPP Learning Media Ltd 2012

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Preface

Contents

Welcome to BPP Learning Medias ACCA Passcards for Professional Paper P5 Advanced Performance Management. 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 ACCA Passcards 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 plan identifies 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, try to go through the Passcards again! You will then be well on your way to passing your exams. Good luck!

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Preface

Contents

1 2 3 4 5 6 7 8 9

Introduction to strategic management accounting Performance management and control of the organisation Business structure, IT developments and other environmental and ethical issues Changing business environment and external factors Performance management information systems Management information, recording and processing and management reports Performance hierarchy Scope of strategic performance measures in the private sector Divisional performance and transfer pricing issues

Page 1 17 23 39 49 59 67 75 85

10a 10b 11

12 13 14 15 16

Strategic performance measures in not-for-profit organisations Non-financial performance indicators The role of quality in management information and performance measurement systems Performance measurement: strategy, reward and behaviour Alternative views of performance measurement and management Strategic performance issues in complex business structures Predicting and preventing corporate failure Current developments, issues and trends

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105 121 131 141 147 153

1: Introduction to strategic management accounting


Topic List
Planning, control, decision making and management information Corporate planning Planning and control: strategic and operational Multinational aspects SWOT analysis Benchmarking

This chapter introduces strategic management accounting and how it fits into the planning and control process of an organisation. The chapter also explains how organisations set strategic plans and control their outcomes. There is an explanation of some of the techniques used to do this and some of the factors that affect strategic planning.

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Strategic planning
The process of deciding on the objectives of the organisation, on changes in these objectives, on the resources used to attain these objectives, and on the policies that are to govern the acquisition, use and disposal of the resources.

Characteristics of strategic information 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 noncurrent assets, required levels of company profit

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

Management control
The process by which managers ensure that resources are obtained and used effectively and efficiently in the accomplishment of the organisations objectives. It is sometimes called tactics or tactical planning.

Characteristics of management accounting information


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, is often quantitative and commonly expressed in money terms Cash flow forecasts Variance analysis reports Staffing levels Source of information likely to be endogenous (from within the organisation)

Management accounting information for strategic 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

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1: Introduction to strategic management accounting

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Management control and strategic planning compared Example


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

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.

Performance management
Activity designed to improve an organisations performance and ensure that its goals are being met

Performance management systems


Plans, with set guidelines and targets, to help organisations measure how efficiently goals are being met, and to identify areas where performance can be improved

Organisation has to establish its goals and objectives before it can assess whether they are being met. Once performance targets have been set, an organisation can measure whether its goals and targets are being achieved.

Often linked to employee reward programmes so employees are rewarded for helping an organisation reach its goals. Performance measurement is an important control in an organisation.

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1: Introduction to strategic management accounting

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Operational control/planning
The process of ensuring that specific tasks are carried out effectively and efficiently.

Example
Strategic plan Senior management decide sales should increase by 5% pa for at least five years. Management control decision Sales quotas are assigned to each sales territory. Operational control decision Managers of sales territories specify weekly targets for each sales representative.

Characteristics of operational control


Short-term and non-strategic Occurs in all aspects of an organisations activities and needed for day to day implementation of plans Often carried out at short notice Information likely to have an endogenous source, to be detailed transaction data, quantitative and expressed in terms of units/hours Includes customer orders and cash receipts

Management control v operational control


Operational control decisions are more narrowly focused, carried out within a shorter time frame and taken by managers less senior in the organisation. Operational control focuses on individual tasks whereas management control is concerned with the sum of all tasks.

Anthony hierarchy
Strategic planning

Performance management systems should have clear links between performance measures at the different hierarchical levels of the organisation. Means all departments and divisions will be working towards the same ultimate goal. Illustrated by performance pyramid (see chapter 13).

Managment control

Operational control

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1: Introduction to strategic management accounting

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Overall strategic stance

and/or
MISSION
Why the business exists at all What the business is

Businesss underlying values

Strategic analysis
ENVIRONMENTAL ANALYSIS
eg PEST factors, competitive forces, turbulence

GOALS
The relevance of the mission to different stakeholders

Often the same. Terms used interchangeably.

OBJECTIVES
How the mission can be achieved Desirable outcomes of corporate activity

CORPORATE APPRAISAL
eg Strengths, Weaknesses, Opportunities, Threats; Gap analysis

POSITION AUDIT
Companys internal resources and facilities: current performance, comparatives

Strategic choice

CORPORATE STRATEGIC CHOICE

1 2 3

Options generation Options evaluation Choice

Strategic implementation
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STRATEGY IMPLEMENTATION
eg Marketing strategies, production strategies

REVIEW & CONTROL


Assess actual performance in the light of plans etc

TACTICS

ACTUAL PERFORMANCE

1: Introduction to strategic management accounting

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Levels of strategy
Corporate Strategy Covers 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 level eg product pricing; personnel and recruitment Operational strategies are crucial in implementing corporate and business level strategies successfully.

Business level Strategy

Operational/functional Strategies

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Linking strategy and operations


The achievement of long-term goals will require strategic planning which is linked to shortterm operational planning ... If there is no link between strategic planning and operational planning the result is likely to be unrealistic plans, inconsistent goals, poor communication and inadequate performance measurement.

Strategic planning and control versus operational planning and control


Strategic
Broad brush targets Whole organisation External input External focus Future orientated, feedforward control Potential for double loop feedback (ie opportunity to change the plan) Long term

Operational
Detailed Activities of department Mainly internal information Internal focus, on actual procedures More concerned with monitoring current performance against plan Mainly single loop feedback (performance must change, not the plan) Short term
1: Introduction to strategic management accounting

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Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Strategic control
The key to strategic control is ensuring that the right things get measured. False alarms motivate managers to improve areas where there are few benefits to the organisation Gaps are important areas that are neglected (eg customer satisfaction) Different measures apply to different industries

To encourage the measurement of the right things, organisations can institute formal or informal systems of strategic control. Formal systems require the identification of milestones of performance (strategic objectives).

Desirable features of strategic performance measures Focus on what matters in the long term Identify and communicate drivers 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

Guidelines for a strategic control system Linkages Diversity Criticality Change Competitive advantage

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

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
Problems of performance measurement

Differences between domestic and international businesses

Establishing realistic standards Determining controllable cash flows Currency conversion Bases of comparison
Examples of problems when setting objectives

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

Cultural factors (eg international has fragmented, diverse markets) Economic factors (eg international has multiple (unstable?) environments) Competitive factors (eg little information about many more competitors in international business) Political factors (often significant in international businesses) Technological factors (eg training problems in international businesses)
1: Introduction to strategic management accounting

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

SWOT analysis
A critical appraisal of the strengths and weaknesses, opportunities and threats in relation to the internal and external environmental factors affecting an organisation, in order to establish its condition prior to the preparation of a long-term plan.

How SWOT can guide strategy formulation


Internal to the company Strengths Matching Conversion Conversion Opportunities Threats Weaknesses

SWOT and performance management


Identify weaknesses which need to be addressed Identify key aspects of performance (CSFs) which need to be measured (through KPIs) Help set targets (eg to take advantage of opportunities) Determine information needs (eg to report on KPIs).

Exist independently of the company

Match strengths with market opportunities

Convert weaknesses into strengths and threats into opportunities

Planning, control, decision making and management information

Corporate planning

Planning and control: strategic and operational

Multinational aspects

SWOT analysis

Benchmarking

Benchmarking
The establishment, through data collection, of targets and comparators, which will allow relative levels of performance (and particularly areas of underperformance) to be identified. By adopting identified best practices, it is hoped that performance will improve.
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Internal

Types of benc hmarking

Functional Competitor Non-competitor

Comparing one operating unit or function with another in the same industry Comparing an internal function with the best external practitioners, regardless of industry Gathering information about direct competitors using, for example, reverse engineering Particularly relevant for not-for-profit organisations. Compare against organisations in the same industry although they are not competitors. Disadvantages 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.
1: Introduction to strategic management accounting

Advantages Provides basis for establishing standards of performance Sets targets that are achievable Can be a spur to innovation

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-term targets within the framework of the longer-term strategic plans (covered in Chapter 1). Some of the contents of this chapter are brought forward from earlier studies and will provide background to exam problems on higher-level budgeting issues. Not-for-profit organisations and their specific budget issues are considered, before use look at the concept of beyond budgeting which tries to address some of the problems faced in traditional budgeting.

Budgeting

Not-for-profit organisations

Beyond budgeting

Uses of budgeting
Ensures organisations objectives are 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

As a budget has different purposes, it might mean different things to different people. Forecast Yardstick Target Means of allocating resources

Prior knowledge
You should know the detail behind 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

Alternative budget systems Incremental Flexible Zero based Rolling Activity based

Strengths and weaknesses


Incremental budging Pros
Easy to prepare Can be flexed to actual levels Encourages slack Doesnt look to improve performance Assumes 3Es in place

Cons

Pros

Zero-based budgeting

Cons
Time consuming Needs training Needs a participative approach

Pros

Rolling budget

Cons
Time consuming Not necessary in a stable environment Managers may not see value of continuous updating

Responds to changes in environment Reviews cost behaviourclosely Improves efficiency of resource allocation

Reduces uncertainty in an unstable environment Most recent plans used Budgets always several months ahead

Flexible budgeting Pros Identifies spare capacity Cons Prone to error if standards incorrect Irrelevant in a mainly fixed cost environment Pros Identifies critical success factors

ABB

Cons Time consuming Difficult to identify responsibility and

Looks at activity in depth

accountability for activities

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2: Performance management and control of the organisation

Budgeting

Not-for-profit organisations

Beyond budgeting

Not-for-profit organisation
An organisation whose ... prime goal is not assessed by Bois economic measures.

Funding
Funding comes from government rather than users and is a political decision. So no clear link between providing more service and funding. Poor performance can lead to higher levels of funding

Planning
The political system affects planning. Changes in priorities and funding can be imposed at will. Limited control is offered over funding.

Budgeting in public sector


Characterised by incremental, short-term (one year) bid budgets.

Budgeting

Not-for-profit organisations

Beyond budgeting

Beyond Budgeting
Beyond Budgeting is a set of guiding principles that propose abandoning traditional budgets in favour of an alternative general management model based on decentralised decision making, personal responsibility, maximising value and adaptability to change.

Criticisms of traditional budgeting (Hope and Fraser) Add little value Waste valuable management time Can result in dysfunctional behaviour Conflict between communicating corporate goals and financial control Often based on bargaining and not the best model of resource consumption

Two fundamental concepts underlie the Beyond Budgeting approach: Adaptive management processes Devolved organisation and decision making
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Incompatible with a drive towards continuous improvement Insufficient external focus

2: Performance management and control of the organisation

Budgeting

Not-for-profit organisations

Beyond budgeting

Traditional budgeting and beyond budgeting compared


Factor
Time frame Basis of rewards Strategic planning Resource allocation Co-ordination Performance reports

Traditional budgeting
Short-term focus Focus on individual departments and divisions; self-interest Company-led approach to strategic management To operating units or departments Link functional budgets to one another Primarily based on historical, financial indicators

Beyond Budgeting
Longer-term focus Organisation viewed as one team. Focus on learning and innovation. Customer-led approach to strategic management Allocated to strategic initiatives rather than departments Determined by requirements to meet customer needs Multifaceted, multi-level information. Forward looking as well as historical.

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 are structured and how they co-ordinate their resources. We also look at how data systems and MIS provide information on changes happening in the organisation. Then we look at stakeholders, their roles and effect on the organisation. Finally, we consider ethics, which is a vital component of modern organisational behaviour.

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Business structure
Organisations vary in the way they arrange their activities. Differences in organisational structure affect information needs and how performance is measured.

Information needs
Functional form

Performance measurement
Economies of scale Hard to identify results for individual products or markets People don't understand how business works as a whole Freedom to set standards by divisional managers Tendency for centre usurp divisional profits Divisional performance not direclty assessed by markets. Outsourcing of personnel and assets is common Functions and services shared between organisations

Vertical flow
Functions tend to be isolated

Divisional form

Autonomy lower down the organisation Formal communication between centre and divisions Use of transfer prices to set performance standards Lateral communication Information and advice rather than instructions and commands Levels of information need: operational, financial, management information

Network form

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Business process re-engineering


The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical contemporary measures of performance such as cost, quality, service and speed. A process is a collection of activities that takes one or more kinds of input and creates an output.

Principles of BPR which influence systems development Processes should be designed to achieve a desired outcome (rather than focus on existing tasks). Personnel who use output from a process should perform the process. There is no differentiation between information gathering and information processing. Geographically-dispersed resources should be treated 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.

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

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Business process re-engineering


Performance measurement
Measures must be built around processes not departments. This may affect the design of responsibility accounting systems. There will be a need to identify where value is being added. ABC might be used to model the business processes. Complexity of the reporting system will depend on organisational structure. New variance analyses may need to be developed.

Implications of BPR for accounting systems

Reporting Activity Structure Variances

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Business integration
All aspects of a business must be aligned to secure the most efficient use of the organisations resources to achieve its objectives effectively.

McKinsey 7S model
The McKinsey 7S model describes the links between the organisations behaviour and the behaviour of individuals within it.
STRUCTURE

Hard
STRATEGY SYSTEMS SHARED VALUES SKILLS STAFF STYLE

Four particular aspects of linkage highlighted in the P5 syllabus: People Operations Strategy Technology
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Soft

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

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Linkage between people, operations, strategy and technology

People

People implement the strategy and enable the organisation to pursue its mission: human resources; motivation

Strategy

People must be trained to use technology effectively

s ble na ons y e pti log ic o d no ateg rsue ch Te w str be pu ne to

Strategy is made or broken at operational level

Technology

Technology facilitates operations

Operations: Most people work here

THE CUSTOMER INTERFACE

People issues
Quantity Skills level Motivation Deployment

Strategy issues
Direction Implications for resources

Technology issues
Equipment Work organisation Information

Operations issues
Procedures Empowerment Customer relations Quality

Value chain
The value chain is another model for looking at business integration. It provides an overall perspective of the activities of the business, which might easily be seen in isolation in functional departments. The ultimate value a firm creates is measured by the amount customers are willing to pay for its products/services above the cost of carrying out value activities.

To be successful, an organisation needs to ensure that the characteristics of all of its activities are consistent with each other.

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

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

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

Mixture of financial and non-financial information. Teams carry out activities but may not know the financial implications. Transparency and immediacy. Teams need information quickly if they are to work flexibly. Common data definitions. These are necessary to 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 the activities in which it is involved.

Impact of empowerment on mana g ement accounting systems

Information must be disseminated throughout the organisation rather than handed down through the hierarchy. Employees need to be given responsibility and the authority to make decisions within defined parameters. Rather than issue orders, managers must be able to create conditions in which the organisation can prosper and front line staff must be able to deliver appropriate customer service.

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Consideration of Information needs for manufacturing business

Characteristics that distinguish services from manufacturing Perishability Intangibility Inseparability/simultaneity Variability/heterogeneity No transfer of ownership

Cost behaviour Quality Time

Innovation Valuation

Information for service businesses

Small service businesses, whose expenses are The information required may vary mainly overheads, provide a model in miniature of depending on whether the the requirements of activity based costing (ABC). organisation offers mass services or personal services. Service industries in particular rely on their staff and so management information must include Operational information is likely to intangible factors such as how customers feel be largely qualitative. about the service, as well as the key drivers of service costs (eg repeat business, churn rate).
3: Business structure, IT developments and other environmental and ethical issues

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Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Remote input of data


A number of data capture techniques allow staff to input data to the organisations system whether or not they are in the office. Laptop computers Bar coding and EPoS devices Via sharing of data Groupware Intranets Extranets

Instant access to data


Via distribution of data Word processing Electronic schedules Desktop databases Web publishing Voicemail E-mail

Office automation systems

Software that can be used by collaborative work groups (messaging, views of an information database, 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 to exchange information.

Databases Database management systems (DBMS) Data warehouses Datamining Enterprise resource planning (ERPS)
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Provide comprehensive files of data for a number of different users. Avoid data redundancy and wastage of space, and reduce errors/inconsistencies from multiple data input. Software systems which organise the storage of data in a database in the most appropriate way.

Contain data from a range of internal and external sources. Query and reporting tools facilitate management reporting and analysis. Software which looks for different (sometimes previously unknown) patterns in groups of data (eg retail companies can find customers with common interests). 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 the Balanced Scorecard.
3: Business structure, IT developments and other environmental and ethical issues

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Management information system (MIS)


A system to convert data from internal and external sources into information and to communicate that information, in an appropriate form, to managers at all levels in all functions to enable them to make timely and effective decisions for planning, directing and controlling the activities for which they are responsible.
Essential characteristics of an MIS Definition of functions of individuals and their areas of 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

Consequences of MIS development without formal planning Not all information will be collected and processed (but will be kept in managers heads). Information will not be disseminated to appropriate managers. Communication of information will not be timely. Consequences of a poor MIS Dissatisfaction among employees who believe they should be told more Lack of understanding of what targets to achieve are Lack of information about how well work is being carried out

Management accounting systems 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
Examples of impact of increasing competition More competition requires better competitor intelligence Faster response means information must be produced quickly and be up to date Examples of impact of increasing globalisation Increasing competition as above Behavioural impact on management accounting system of operating in different markets
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Modelling systems Decision support systems Expert systems Executive information systems

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Stakeholders
Groups or individuals whose interests are directly affected by the organisations activities

Stakeholder mapping
Stakeholders interests are likely to conflict. Stakeholder mapping helps the organisation to establish its priorities and set up its system of corporate governance.

Example
Internal Connected External Employees, management Owners, investors, suppliers, customers, lenders Government, local communities, pressure groups, unions

Level of interest High Low Low Power High C D A B

A: Minimal effort B: Keep informed; little direct influence but may influence more powerful stakeholders C: Treat with care; often passive but capable of moving to segment D; keep satisfied D: Key players strategy must be acceptable to them, at least

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

Ethics are ideas about right and wrong that set standards for conduct. Ethics are important to business because society considers such things important. There are also rules of professional conduct to consider. Ideas of right and wrong 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.

Ethical stance
The extent to which an organisation will exceed its minimum obligation to stakeholders.(Johnson, Scholes & Whittington) Short-term stakeholder interest: obey the letter of the law Long-term stakeholder interest: behave ethically to enhance image and reduce pressure for regulation Multiple stakeholder obligations: the expectations of other groups of stakeholders may be considered, as well as any right they may have Shaper of society: ensuring society benefits from actions is more important than financial and other stakeholder interests (eg for public sector organisations)
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Ethical dilemmas
Conflicting views of the organisations responsibilities create ethical dilemmas for managers at all levels. 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.

Corporate ethics

Has three contexts: interaction with society, effects of routine operations, behaviour of the individuals.

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

Business structure/information

Business process re-engineering

Business integration

Teamwork and empowerment

Data and MIS

Stakeholders and ethics

Stakeholders and business performance Shareholders Employees and management


Organisations should seek to align the interests of their staff with those of the organisation (eg through reward systems) Shareholders often take a short-term view of their involvement in an organisation.

Consumer groups
Consumerism reflects the increased importance and power of consumers. Highlights that consumer satisfaction is likely to be crucial to long-term profitability.

Suppliers
Can influence the cost and quality of goods and services

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

4: Changing business environment and external factors

Topic List
Changing business environment Risk and uncertainty Factors to consider when assessing performance Government regulation

In this chapter, we look at the economic, fiscal and environmental factors which affect strategic management. Businesses need to consider the risks and uncertainty from these external factors in their strategic decision-making, and we also look at some aspects of risk and uncertainty in this chapter.

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

Changing competitive environment


Manufacturing organisations Then Pre 1970s, there was little international competition, costs were passed on to customers, minimal efforts were made to maximise efficiency/reduce costs/improve management practices. Pre 1980s, many were government-owned monopolies or protected by highly regulated, non-competitive environments. Cost increases were covered by increasing prices. Cost systems were not deemed necessary. Organisations could rely on years of high demand for products. Now There is massive international competition, and global networks for acquiring raw materials and distributing high quality, low-priced goods. Privatisation and deregulation has resulted in intense competition, an increasing product range and a need for sophisticated costing systems. Competitive environment, technological innovation and discriminating and sophisticated customer demand require continual product redesign and quick time to market.

Service organisations

Product life cycles

Changing customer requirements


Successful organisations make customer satisfaction their priority. New management approaches Continuous improvement Employee empowerment Total value chain analysis

Changing manufacturing systems Traditional manufacturing systems Jobbing industries Batch processing Mass/flow production Recent developments Group technology/repetitive manufacturing Dedicated cell layout Manufacturing processes must be sufficiently flexible both to accommodate new product design and to satisfy the demand for greater product diversity.
4: Changing business environment and external factors

Key success factors

Cost efficiency Quality Time Innovation

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Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

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


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

Production management strategies


The traditional approach to determining materials requirements is to monitor the level of inventories constantly so 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 for assemblies/subassemblies of which it forms a part). Modern computer techniques integrate such relationships into the inventory ordering process.

Advanced manufacturing technology (AMT)


helps them to do this. Computer-aided design (CAD) Computer-aided manufacturing (CAM) Flexible manufacturing systems (FMS) Electronic data interchange (EDI)

Production management strategies linked to AMT


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

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

Risk and uncertainty


Strategic planning deals with future events: the future cannot be predicted. Strategic planning is therefore susceptible to risk and uncertainty, much of which is exogenous. Types of 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)
Page 43 4: Changing business environment and external factors

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

Expected values
The expected value (EV) of a decision is calculated as EV = px where p = the probability of an outcome occurring, and x = the value (profit or cost) of that outcome.

Decision-makers attitudes to risk can also influence the way they analyse potential business decisions. Decision-makers have to consider the potential upsides and downsides of a particular course of action. Their attitude to risk can determine the decisionmaking 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 preference
Decisions will be influenced by stakeholders appetites for risk and their attitude to risk.

Risk seeker

Risk neutral

Risk averse

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

The main factors in the macro-environment which can affect an organisation's performance can be identified using PEST analysis

The level of competition in an industry affects the industrys 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

Political Economic Socio-cultural Technological


Collectively, these factors represent opportunities and threats an organisation could face

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4: Changing business environment and external factors

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

Examples
Economic Inflation Legal Political EU Cultural Consider local economic trends interest and exchange rates and inflation Is inflation driving up wage rates or being caused by pay settlements? Consider the impact of employment law or industry regulators. Is government policy affecting competition? Are incentives being offered to locate in a particular area? Think about product standards and labour costs. These can affect the motivation and satisfaction of employees, the adaptability of the organisation and its image.

Business cycle Is the economy booming or in recession? When comparing performance across different countries, consider problems such as distance and remoteness of divisions from HQ, transfer pricing difficulties, currency exchange rate fluctuations and variation in management and worker skills.

Changing business environment

Risk and uncertainty

Factors to consider when assessing performance

Government regulation

Types of organisation under government regulation

Types of regulations by regulators Regulation of supply Regulation of quality Regulation of prices Purpose of regulations Promote competition Protect customer welfare Use private cash to enhance quality Reduce public spending Ensure government subsidies are well spent
4: Changing business environment and external factors

Business Free at delivery Public good Privatised utility Privatised utility with competition

eg Royal Mail operates on a commercial basis in the UK eg NHS in the UK National security eg Water firms in the UK are still, effectively, monopolies eg British Telecom in the UK

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Notes

5: Performance management information systems


Topic List
Accounting information needs Management accounting information Management accounting systems

This chapter introduces management accounting and information systems, and how they could be used to measure performance. Remember that we looked at strategic planning, management control and operational control information in Chapter 1. A variety of topics are considered, including the type of organisation and the objectives of management accounting information.

Accounting information needs

Management accounting information

Management accounting systems

Management accounting information can be used to support strategic planning, control and decision making. Strategic management accounting differs from traditional management accounting because it has an external orientation and a future orientation.

Examples of strategic management accounting 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

Management control
The process by which managers ensure that resources are obtained and used effectively and efficiently in the accomplishment of the organisations objectives. It is sometimes called tactics or tactical planning.

Characteristics of management control 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, is often quantitative and commonly expressed in money terms Cash flow forecasts Variance analysis reports Staffing levels Sources of information likely to be endogenous (from within the organisation)
5: Performance management information systems

Management control decisions need to support an organisations strategic plans.

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Accounting information needs

Management accounting information

Management accounting systems

Operational control/planning
The process of ensuring that specific tasks are carried out effectively and efficiently.

Example
Strategic plan Senior management decide sales should increase by 5% pa for at least five years. Management control decision Sales quotas are assigned to each sales territory. Operational control decision Managers of sales territories specify weekly targets for each sales representative.

Characteristics Short-term and non-strategic Occurs in all aspects of an organisations activities and needed for day to day implementation of plans Often carried out at short notice Information likely to have an endogenous source, to be detailed transaction data, quantitative and expressed in terms of units/hours Includes customer orders and cash receipts

Management control v operational control


Operational control decisions are more narrowly focused, carried out within a shorter time frame and taken by managers less senior in the organisation. Operational control focuses on individual tasks whereas management control is concerned with the sum of all tasks.

Accounting information needs

Management accounting information

Management accounting systems

Good information Relevant Complete Accurate Clear Usable with confidence Appropriately communicated (to the right person using the correct method) Manageable volume Timely Cost effective

What management accounting information helps managers to do (its objectives) Measure performance Control the business Plan for the future Make decisions

Management accounting information is used for score keeping, problem solving and attention directing. Features that characterise management accounting information in particular Forward looking Neutral (free from bias) Financial, non-financial, quantitative or qualitative Information requirements vary significantly across different types of organisational structure (eg functional basis vs network organisation).

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5: Performance management information systems

Accounting information needs

Management accounting information

Management accounting systems

Open and closed systems


A closed system is isolated and shut off from the environment, is unaffected by the environment, and cannot influence the environment. An open system is connected to and interacts with the environment and is influenced by it.

Enterprise Resource Planning Systems (ERPS)


Management accounting systems do not exist in isolation, but are part of the wider information systems in an organisation; exemplified by ERPS. ERPS are software systems designed to support and automate the business processes of medium-sized and large organisations. They aid the flow of information between business functions within an organisation, and can manage connections to outside suppliers. All departments that are involved in operations or production are integrated in one system. As a result, organisations are more agile in the way they use information, can process information better, and can integrate it into business procedures and decisionmaking more effectively.

Performance management:
Organisations should adopt an open systems approach to performance management eg organisational performance could be affected by competitors actions. Also, performance often cannot be attributed to one single issue, but needs to be viewed as the combined effect of many variables.

Lean management information systems


Key characteristics of lean systems: Continuous improvement Increased productivity Improved quality Improved management But note: to be successful, lean techniques must involve a commitment to adding value and eliminating waste. They cant be used simply as a justification for cost-cutting.

Application of lean to MI systems


Lean can: Enhance the value of data in the system: how it is organised, exchanged and retrieved Add value to information through the way it is organised and presented (eg exclude unnecessary detail) Enable information to flow to users more efficiently.

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5: Performance management information systems

Accounting information needs

Management accounting information

Management accounting systems

Contingency approach
The contingency approach to management accounting is based on the premise that there is no universally appropriate accounting system applicable to all organisations in all circumstances. Efficient systems depend on awareness by the system designer of the specific environmental factors which influence their creation.
Contingent factor - the environment Contingent factor - organisation structure Contingent factor - technology

Predictability Competition Number of different product markets Hostility of competitors

Size Interdependence of parts Degree of decentralisation Availability of resources

Nature of production process Complexity of production process Task variety

Impact of human behaviour.


Management accounting systems have to develop ways of overcoming the problems of human behaviour.

Issues for management accountants: heuristic/holistic processing Dual process framework analytical/ systematic processing Ways of presenting information:

Methods Allocating responsibility Encouraging participation in decision making Devising ways of measuring and rewarding behaviour that contribute to organisational objectives
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Written format Tables Graphs or charts Dashboards Interactive reports

5: Performance management information systems

Accounting information needs

Management accounting information

Management accounting systems

Responsibility accounting Role of management accountant


Learn from managers of responsibility centres what information they need, in what forms and what intervals Design a system that enables this information to be provided (using different responsibility centres (cost, profit and so on)) Responsibility accounting is based on the principle of controllability. But in practice is it always possible to split impacts on performance into controllable and uncontrollable categories?

Responsibility accounting
A system of accounting that segregates revenues and costs into areas of personal responsibility in order to monitor and assess the performance of each part of an organisation.

Responsibility centre
Any part of an organisation which is headed by a manager who has direct responsibility for its performance. Important to distinguish between division's performance and managers performance. Can only evaluate manager's performance on factors he or she 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 and performance feedback but is rarely directly input into the management accounting system. Internal information provides the input data for the management accounting system and is vital for management control and operational control. Control is dependent on the receipt and processing of information. Also, the way in which information is presented is important. If the outputs from a management information system are not accessible to the relevant people, the usefulness of the information is severely reduced. You are likely to encounter issues about controls and security over data in your own workplace, but its worth reminding you about them here anyway.

Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

Costs

of the collection, processing and production of internal data

Principal internal sources of management accounting information Financial accounting records Systems of control over transactions (eg inventory control systems) Payroll, production records, timesheets Staff (collected formally or informally) In todays competitive market, where the pace of change in information systems and technology is rapid, organisations must be flexible enough to adapt to change quickly and must plan for expansion, growth and innovation within information systems.

Direct data capture costs


eg use of barcoding

Processing costs
eg inputting data to the MIS

Cost of inefficient use of information


eg information disseminated more widely than needed

Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

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

Common external sources of information

INTERNAL
Operational Tactical

EXTERNAL
Strategic

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

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

External information is used in the management accounting system depending on its quality. Quantitative data is easier to use. Benchmarking uses external information to help set targets.
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Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

Costs

associated with external sources

Disadvantages May not be entirely relevant Bias Accuracy should be questioned May not be available in correct form Can be expensive Note that the costs of market research can be considerable and that the internet can significantly reduce search time and search costs. Advantages Save time and money as secondary data is cheaper than primary

Direct search costs


eg subscriptions to magazines

Indirect access costs


eg spurious accuracy

Management costs
eg wasted time on excessive processing

Infrastructure costs
eg maintenance of computer server

Time theft
eg information overload

Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

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

General rule: any information that is needed should be recorded and stored in such a way that it can be readily retrieved.

IT developments which have influenced recording and processing systems Spreadsheet packages Database packages Software packages E-mail systems Computer Telephony Integration (CTI) WiFi Radio-frequency identification (RFID) ERPS Electronic data interchange (EDI)

Qualitative data
Given that qualitative data is subjective and judgmental, its recording is likely to be problematic. The number of sales made is easy to record; the reasons why sales are lost is not.

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

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

Controls

required over the generation of internal information

Procedures to ensure the security of highly confidential information that is not for external consumption Passwords Logical access systems Database controls inference controls passwords Personnel security planning Firewalls Encryption Authentication Anti-virus and anti-spyware software

In routine reports
eg consistent format to ensure accuracy

In ad-hoc reports
eg ensure information does not already exist in another format

Over distributing internal information


eg procedures manuals

Over information held on servers


eg passwords

Other controls
eg email policy

Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

As the volume of data available to business increase, it is important that they ensure this data is 'fit for purpose.' 'Fitness for purpose' involves data being accurate and relevant without being overwhelming. Similarly it is important that output reports are timely, accurate and tailored to the user.

Dashboards
Dashboards are executive information systems which illustrate how a business is performing and help managers make better decisions, through showing current data, pictures, graphs and tables, thereby reducing the numbers (and size) of paper reports which have to be produced.

Drill-down reports
Drill-down reports allow users to look at increasingly detailed data about a situation.

Beware of the dangers of information overload.

Exception reports
One 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 or requires management action.

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6: Management information, recording and processing and management reports

Internal sources of information

External sources of information

Recording and processing methods, systems and data

Controls and security

Output reports

Recap: Overview of management information systems

INPUT

PROCESSING

OUTPUT

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

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 performance measurement techniques and the issues relating to strategic performance measurement. Although we will look at some important aspects of strategy in this chapter, please remember that the focus of paper P5 is on performance (performance measurement, and performance management) rather than strategy itself.

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

Mission
Describes the organisations basic function in society, in terms of the products and services it produces for its clients. Explains what the business is for. Elements of mission
Purpose Strategy Policies and standards of behaviour Values and culture

Mission statement
A formal statement of an organisations mission There is no standard format but mission statements should be brief, flexible, distinct and open-ended.
Factors to incorporate in a mission statement

Vision
If a mission answers the question What is the business for?, a vision answers the question Where is the business going? A vision gives a general sense of direction to the company.

Business areas in which the organisation will operate Organisations reason for existence Stakeholder groups served by the organisation

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

Goals are derived from an organisations vision and mission. Operational goals can be expressed as quantified, SMART (Specific, Measurable, Attainable, Relevant, Time-bounded) objectives. A mission might be to deliver a quality service, a goal to enhance manufacturing quality and an objective to reduce the number of defects to one part per million over the next year.

Example

Corporate objectives
These primary objectives concern the organisation as a whole (eg profitability, industrial relations) and are set as part of the corporate planning process.

Strategic objectives
These combine to ensure the achievement of the primary corporate objective.

Subsidiary objectives
These are developed beneath strategic objectives. To ensure co-ordination, the various functional objectives must be interlocked vertically, horizontally and over time.

Example
If a primary objective is growth in profits, strategies by which the primary objective can be achieved (eg for growth in sales) must be developed.

Unit objectives
These are specific to individual units of an organisation.
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Ranking objectives
Multiple objectives can clash so strategic management must ensure goal congruence.
7: Performance hierarchy

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

Hierarchy of objectives
Mission Goals Objectives Strategy Tactics Increasing coverage of aspects of the organisation

Social and ethical obligations


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 organisations general stance towards society, and affects the activities the organisation chooses to do, ethics relates more to how an organisation conducts individual transactions. Corporate codes of conduct contain statements setting out company values and responsibility toward stakeholders.

Operational plans 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.

Objectives, CSFs and KPIs


Objectives Critical Success Factors (CSFs) Key Performance Indicators (KPIs)
CSFs are the key factors and processes an organisation needs to excel at in order to achieve its objectives. KPIs measure how well an organisation is performing against its CSFs.

Impact on information systems. CSFs identify the areas of performance which managers need information about. Therefore it is important that information systems can provide managers with this information (eg, the systems can provide information for KPIs.)
Page 71 7: Performance hierarchy

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

S/L trade-off
Refers to the balance of organisational activities aiming to achieve long-term and short-term objectives when they are in conflict or where resources are scarce Decisions which involve the sacrifice of longer-term objectives for short-term benefit Postpone/abandon capital expenditure Cut R&D expenditure Reduce quality control Reduce the level of customer service Cut training costs/recruitment How to control short termism Make short-term targets realistic. Provide sufficient information to allow managers to see what S/L trade-offs they are making. Evaluate managerial performance in terms of contribution to longterm as well as short-term objectives.

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

Planning gap
The planning gap is the gap between the forecast position from continuing with current activities, and the forecast of the desired position. How to fill the gap
$000

Incremental improvements to current activities (eg cost reduction) Combination of market penetration, market development, product development and diversification (Ansoffs matrix) Withdrawing from a business (if it is lossmaking); divestment Acquisition Internally-generated (organic) growth

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7: Performance hierarchy

Mission statements and vision

Goals and objectives

Short term and long term

Filling the planning gap

Planning/controlling at different levels

Level
Corporate/strategic

Plans
Focused on overall performance Influenced by external environment Set plans/targets for units/departments Sometimes qualitative Aggregate 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

Controls
Exercised by external stakeholders and/or the market Double-loop feedback (ie relatively free to change targets) Often feedforward elements Exercised internally by management or staff in empowered teams Immediate or rapid feedback Single loop feedback (ie little authority to change plans or targets)

Operational

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

8: Scope of strategic performance measures in 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 favour financial performance measures whereas the public sector favours non-financial indicators. There are four main groups of financial performance measures: growth, profitability, gearing and liquidity. You also need to be clear about the distinction between short-run and long-run performance measures.

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

Why are shareholders important?


Problems in attaining goal congruence are often due to difficulties in satisfying differing objectives of the organisations various stakeholder groups. Share options are one way of aligning shareholder and managerial goals. Profit-making organisations tend to focus on financial performance in general and on the interests of shareholders in particular. The argument for this is that shareholders are the legal owners, the company belongs to them and so their interests are paramount.

Survival and growth


The clearest measure of success for a business is continued existence and expansion. Growth requires profits Growth produces profits Growth without profits

no survival*

An organisation must make sustainable profits

Other ways of measuring growth


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

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

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

Sales margin
Calculated as (gross profit/turnover) 100% (where gross profit = sales cost of sales) Influenced by the level of fixed costs Not useful for comparing different industries

EPS
Shows how well the shareholder is doing. Calculated as (profit after tax, MI, extraordinary items and pref div)/no of equity shares. Must be seen in context as on its own it does not impart much information. Easily manipulated by changes in accounting policies/mergers/acquisitions (especially for bonuses).

EBITDA
Earnings before interest, tax, depreciation and amortisation. It is a good proxy for cash flow from operations and so can be used as a measure of underlying performance. Tax and interest are not relevant to an organisations underlying success. Depreciation is not relevant to performance in a particular year. It is easy to calculate and understand.
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ROCE
Calculated as (PBIT/capital employed) 100% Capital employed = share capital and reserves + long-term liabilities and debt capital ROCE = profit margin asset turnover

8: Scope of strategic performance measures in the private sector

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

ROI
ROI is a form of ROCE used for investment centres. It is calculated as (PBIT/ operations management capital employed) 100%.

Problems with the use of ROI Definition/valuation of assets. Fair performance comparisons with other centres. It can give a false impression of improving performance over time. It can discourage new investment. Group target returns may be unsuitable for the entire group. Target returns can produce a lack of goal congruence, short termism and dysfunctional decision making.

NPV/IRR/MIRR.
Focus on future cash flows and allow for risk (through use of discount factors) MIRR distinguishes between investment phrase and return phase of a project, to overcome the flawed assumption made in IRR that cash flows are reinvested at the projects IRR over the life of the project.

RI
It is calculated as profit imputed interest (where imputed interest is capital employed cost of capital). It overcomes some of the problems of ROI but it has its own disadvantages.

Economic value added (EVA)


EVA is similar to RI because it is an absolute performance measure calculated by subtracting an imputed interest charge from the profit earned by a company or division. EVA = net operating profit after tax (NOPAT) less capital charge. Capital charge = weighted average cost of capital net assets. However, EVA looks to measure specifically how well companies are maximising the wealth of their shareholders. Argues that traditional profit-based measurement do not do this.
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Key differences between EVA and RI EVA is based an economic profit which is not the same as accounting profit: Value-building expenditure (eg advertising) is added back to profit Non-cash items are eliminated One-off, unusual items are excluded Charge for accounting depreciation is added back to profit (under EVA) and a charge for economic depreciation made instead. Capital charge uses different bases for net assets. EVA usually uses replacement cost of assets.

8: Scope of strategic performance measures in the private sector

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

Financial gearing
A high level of debt creates financial risk in a companys capital structure. Financial risk from different points of view 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.
Gearing measures the relationship between shareholders capital plus reserves, and either prior charge capital or borrowings or both.

Measures of financial gearing


Prior charge capital Equity capital (incl reserves) Prior charge capital Total capital employed

Operating gearing
Operating gearing is concerned with the relationship between the variable cost/fixed cost operating structure and profitability. Gearing ratio = contribution/PBIT

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

A company must be liquid so that it can meet its debts when they fall due. Liquid funds consist of cash and short-term investments for which there is a ready market + fixed-term bank/building society deposits + trade receivables + 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 current assets with the exception of inventory. A company can be profitable but at the same time have cash flow problems.

Ratios to assess liquidity Current ratio


Current assets current liabilities Should be greater than 1

Quick/acid test ratio


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

Turnover periods
Those for inventory and receivables give an indication of liquidity.
8: Scope of strategic performance measures in the private sector

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Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

Short-run v long-run performance


Managers have a personal interest in the long-term survival of the business and shareholders want a long-term increase in their wealth from investment in the business. But managers performance is often measured on short-term results and even investors are under pressure to maximise the growth in the value of their portfolios in a particular period.

Internet companies
Fuelled by what appeared to be unrivalled opportunities for growth and increasing returns to scale, share prices of internet companies rose dramatically during 1999/2000. Despite exciting websites and huge marketing expenditure, internet companies were made or broken on issues of logistics and distribution. Many were unable to avoid the traditional need for profits and positive cash flow to survive.

P/E ratio
Calculated as: Market value in cents __________________ EPS in cents or Total MV of equity _______________ Total earnings

Reflects the markets appraisal of the shares future prospects Assuming the P/E ratio will not vary much over time, if the EPS goes up/down, the share price should move up/down too.

Shareholders, survival and growth

Profitability

Gearing

Liquidity

Performance and share value

Comparisons

Results of the same company over successive accounting periods


They give some indication of progress but there are weaknesses in such a comparison. The effect of inflation should not be forgotten. The organisations progress needs to be put into the context of what other organisations have done and/or special environmental/economic influences.

Different organisations in the same industry


If they are in the same broad industry even though not direct competitors, might still expect broadly similar performance in terms of growth. If they are direct competitors, comparisons could be particularly useful. Which has better sales growth, or profit growth? Which has better liquidity or working capital position?

Between organisations in different industries


Investors might want to know: Growth comparisons ROCE comparisons P/E ratio and dividend yield comparisons
8: Scope of strategic performance measures in the private sector

Benchmarking
Allows comparisons at different levels to be made between firms and inside the firm.
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Notes

9: Divisional performance and transfer pricing 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 of transfer pricing ie why transfer prices are necessary and when they are set. Then consider how prices are set. Also look at the wider context eg taxes and EU legislation.

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

There are two common ways of structuring organisations.

Functionally Divisionally Disadvantages of divisionalisation Dysfunctional decision making (a balance has to be kept between decentralisation of authority to provide incentives and motivation, and retaining centralised authority to ensure goal congruence) Increase in costs of activities common to all divisions Loss of control by top management

In general, a divisional structure will lead to decentralisation of the decision-making process. Advantages of divisionalisation It can improve the decision-making process in two ways. Quality Speed The authority to act to improve performance should motivate divisional managers. Top management are freed from detailed involvement in day-to-day operations and can devote more time to strategic planning. Divisions provide valuable training grounds for future members of top management.

Measuring divisional performance


Measure ROI Pros Can compare divisions of different sizes Aggregation is easy Can compare investments with different risk characteristics Cons Short-term perspective Lack of goal congruence Valuation of assets Does not account for different risk Cant compare divisions directly Valuation of assets Doesn't relate size of divisional income to size of investment Short-term perspective Depends on historic data Adjustments to data Comparison of like with like
9: Divisional performance and transfer pricing issues

RI

EVA

Real wealth for shareholders Less distortion by accounting policies Absolute value

Page 87

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

Aims of transfer pricing Promote divisional autonomy Equitable divisional performance measurement Overall corporate profit maximisation

Transfer prices based on market price


Where a perfect external market exists and unit variable costs and selling prices are constant, the ideal transfer price (ie the opportunity cost of transfer) will be one of the following. External market price External market price less savings in selling costs

Transfer prices based on opportunity costs


Transfer price per unit = standard variable cost in the transferring division + opportunity cost to the organisation as a whole for supplying the unit internally.

How to set transfer prices


1 2
Recognise the levels of output, external sales and internal transfers that are best for the company as a whole. Arrive at a transfer price that ensures all divisions maximise their profits at this same level of output (ie there should not be a more profitable opportunity for individual divisions).

Transfer prices based on cost


If there is no external market, the transfer price has to be based on cost. 1 Standard or actual? The use of standard costs is fairer because if actual costs are used the transferring division has no incentive to control its costs it can pass on its inefficiencies to the receiving division. The transferring division does not cover its fixed costs (although this problem can be overcome by central decisions or by some form of dual pricing or twopart charging system). The transferring division makes no profit. What margin will all parties perceive as fair?

Variable cost?

3 4

Full cost? Full cost plus?

Goal congruent decisions will be made if the transfer price is set in the range where: variable cost in the transferring division net marginal revenue in the receiving division
Page 89 9: Divisional performance and transfer pricing issues

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

One resource in short supply


If only one resource is in short supply you can use the technique of ranking options according to contribution per unit of scarce resource. G produces two products, P1 and P2. Both products use material M. Material M can be obtained from D Division of G or from E, an external supplier. Both sources of supply can also sell M on the external market. The best policy is to transfer internally-produced M to product P2 production. Externally-bought M should be used to make P1.
Cost of material M External selling price per kg Production capacity (kg)

Example
D Division $6 $13 5,000 P1 3 $ 40.00 10.00 _____ 30.00 6.00 _____ 24.00 _____ _____
8.00 _____ _____ 30.00 16.00 _____ 14.00 _____ _____ 4.66 _____ _____

E . Unknown $16 7,000 P2 2 $ 32 8 ___ 24 6 ___ 18 ___ ___

Kg of material M needed per unit Selling price Conversion costs Contribution before material costs Transferring material from D Division Contribution Contribution per unit of scarce resource ( 3 or 2) Contribution before material costs Buying material from E Contribution Contribution per unit of scarce resource ( 3 or 2)

9 ___ ___ 24 16 ___ 8 ___ ___ 4 ___ ___

A range of limiting factors


In such circumstances you need to be able to formulate (but not solve) a linear programming model.

1 Work out contribution or profit from each product. 2 Formulate objective function. 3 Define constraints.

Shadow price and transfer prices


The opportunity cost of the scarce resource The amount of benefit foregone by not having the extra resource The maximum extra amount it would be worth paying to obtain one extra unit of the scare resource
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Shadow prices replace opportunity cost in the transfer price formula (transfer price = variable cost of the intermediate product + opportunity cost of making the transfer) when there are constraints on production.
9: Divisional performance and transfer pricing issues

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

Negotiated transfer prices


When authority is decentralised to the extent that divisional managers negotiate transfer prices with each other, the agreed price may be finalised from a mixture of accounting arithmetic, politics and compromise. Possibility 1: Market value minus reduction to allow for internal nature of the transaction Possibility 2: For a near-finished product, market value of the end product minus an amount for finishing work Disputes about transfer prices are likely to arise, however, and head office may either impose a price which maximises company profits or may ensure negotiations continue until a transfer price is agreed. Less decentralisation of authority More imposition by head office of its own decisions

Less effective in motivating divisional managers

Divisionalisation

Setting transfer prices

Short supply of intermediate products

Negotiated transfer prices

Multinational transfer pricing

Factors affecting transfer prices in multinationals


Exchange rate fluctuations Taxation in different countries Import tariffs Exchange controls The value of transfers is affected. Manipulation of profits is possible by raising/lowering transfer prices. It is possible to minimise costs by minimising transfer prices. Restrictions on the transfer of profits can be overcome if head office provides goods/services to the subsidiary and charges exorbitantly high prices. A government might insist on fair market value as a transfer price. Transfer pricing can be used to enable divisions to match/undercut local competitors.

Anti-dumping legislation Competitive pressures

Transfer pricing is often abused by multinational organisations to evade tax payments.

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9: Divisional performance and transfer pricing issues

Notes

10a: Strategic performance measures in not-for profit organisations


Topic List
Not-for-profit organisations Performance measurement The public sector and politics Value for money
Increasingly there is little difference between performance measurement in profit-seeking and not-for-profit seeking organisations: The commercial sectors new focus on customers and quality has much in common with the aims of non-profit seeking organisations. Conversely, non-profit seeking organisations (particularly parts of the public sector) have been forced to face up to elements of competition and market forces.

Not-for-profit organisations

Performance measurement

The public sector and politics

Value for money

Not-for-profit organisation
An organisation whose attainment of its prime goal is not assessed by economic measures, although in pursuit of that goal it may undertake profit-making activities

Objectives Difficult to define Often have multiple objectives (and hence difficult to decide which is overriding) Difficult to judge if non-quantitative objectives have been met Public sector organisations have limited control over both the level of financing they receiving and hence, to an extent, the objectives they can achieve.

Examples
Many different kinds of organisation with differing legal status such as charities, statutory bodies and public utilities

Not-for-profit organisations

Performance measurement

The public sector and politics

Value for money

Commercial organisations generally have market competition and the profit motive to guide the process of managing resources economically, efficiently and effectively. Non-profit seeking organisations cannot by definition be judged primarily by profitability and in this respect do not generally have to be successful against competition in the same way that commercial organisations do. Problems with performance measurement

Why assess performance?


To make efficient resource allocations To assess effectiveness and efficiency To make comparisons For government and/or providers of funds
Solutions

Multiple objectives How to measure outputs Lack of profit measure Difficulty in defining a cost unit for services provided Financial constraints Political, social and legal considerations
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See value for money

Assess performance in terms of inputs and outputs Use judgement Make comparisons eg benchmarking Quantitative measures

10a: Strategic performance measures in not-for profit organisations

Not-for-profit organisations

Performance measurement

The public sector and politics

Value for money

Traditional difficulties in measuring performance in the public sector

Purposes of regulation

It cannot be judged by success against competition or by profitability. Different stakeholders hold different expectations of public sector organisations. Long-term organisational objectives v short-term political gains. Performance measures are difficult to define.

Performance indicators
Publication of performance indicators try to overcome these difficulties and enable interested parties to secure control of public sector resources.

Promote competition Protect/enhance customer welfare Tap into private sector cash to improve quality Reduce public spending

League tables: provide a readily-available data source for user of public services by ranking not-for-profit organisations on a range of measures, such as exam pass rates (for schools) or mortality rates (for hospitals). But is there a danger that league tables lead to tunnel vision or sub-optimisation?

Not-for-profit organisations

Performance measurement

The public sector and politics

Value for money

Value for money


Economy
Spending money frugally Attaining the appropriate quantity/ quality of inputs at lowest cost Getting out as much as possible for what goes in The relationship between inputs and outputs Getting done, by means of economy and efficiency, what was supposed to be done The relationship between an organisations outputs and its objectives

Example 1
Dishwasher ECONOMY More clean plates per $ of operation EFFICIENCY More clean plates per cycle EFFECTIVENESS Plates as clean as they should be

Efficiency Effectiveness

Example 2
Building a new school INPUTS Costs of building the school OUTPUTS (results of an activity) School building itself IMPACTS (effects of outputs in terms of achieving objectives) Effect of new school on education in the area
10a: Strategic performance measures in not-for profit organisations

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Notes

10b: Non-financial performance indicators

Topic List
NFPIs Qualitative issues

So far we have looked at performance mainly in terms of financial performance. However, qualitative and non-financial measures of performance are becoming increasingly popular in organisations as they seek to capture more comprehensive data about different aspects of performance.

NFPIs

Qualitative issues

If organisations focus solely on financial performance indicators, other important goals and factors may get overlooked. Non-financial measures can deal more directly with customer requirements, competitors and other longer-term strategic goals than measures looking at financial performance. Examples of non-financial performance measures: Area Service quality Production Marketing effectiveness Personnel Example Number of complaints Number of repeat bookings Output per employee Number of defects requiring reworking Treads in market share Number of customers Brand awareness Staff turnover Training time per employee

In practice, managers should look at a combination of financial and non-financial indicators. Two approaches which explicitly combine financial and non-financial performance indicators are:

1 2

Balanced scorecard (financial; customer; internal business; learning perspectives) Results and determinants analysis: Results (competitive performance; financial performance) Determinants (Quality of service; flexibility; resource utilisation; innovation)

Advantages of NFPIs Can be provided quickly Easy to calculate Easier for non-financial managers to understand and use More suitable given recent changes in cost structures and manufacturing and competitive environments

NFPIs in relation to employees


Traditional performance measurement systems do not measure skills, morale and training of the workforce.

NFPIs in relation to product/service quality


In a TQM environment, NFPIs should cover three areas. Measuring quality of incoming supplies Measuring work done as it proceeds Measuring customer satisfaction Quality of service and customer satisfaction can be assessed using customer surveys.

Disadvantages of NFPIs Financial aspect cannot be ignored Risk of manipulation Pursuit of detailed operational goals may blind managers to overall strategy
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10b: Non-financial performance indicators

NFPIs

Qualitative issues

Issues in interpreting qualitative data


Based on peoples opinions and judgements; therefore subjective. How much are they influenced by personal preference and taste? How is qualitative data recorded and processed? Use of scoring systems in surveys to capture data (eg ranking customer satisfaction on scale of 1 to 5.)

Impact of subjectivity can be reduced by looking at trends in performance rather than one-off metrics.

What impact does branding have on peoples opinions and judgements?

But these can still be subjective

11: The role of quality in management information and performance measurement systems
Topic List
Modern Japanese techniques Terminology ISO 9000:2000 and 2008 standards The quality management system Information systems development Qualities of good information Six sigma

This chapter examines modern approaches to quality management. Delivering consistent and satisfactory quality is a vital feature of successfully implementing a strategy.

Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Total Quality Management (TQM)


The process of focusing on quality in the management of all resources and relationships within the organisation

Measuring and controlling quality


1 2 3

Quality assurance (supplier guarantees quality) Inspection of output (at various key stages) Monitoring customer reaction

Two basic principles of TQM


Getting things right first time, on the basis that the cost of correcting mistakes is greater than the cost of preventing them from happening in the first place Continuous improvement the belief that it is always possible to improve, no matter how high quality may be already

Employees and quality


Workers are empowered and encouraged to become multiskilled. Workers are encouraged to take responsibility for their work.

Internal customers and suppliers


To satisfy external customers expectations, the expectations of internal customers at each stage of the overall operation must be satisfied. Internal customers are therefore linked in quality chains.

JIT systems
Traditional responses to the problems of improving manufacturing capacity and reducing unit costs of production Longer production runs Economic batch quantities Fewer products in the product range More overtime Reduced time on preventative maintenance, to keep production flowing Just-in-time systems challenge such traditional views. Although often described as a technique, JIT is more of a philosophy since it encompasses a commitment to continuous improvement and a search for excellence in the design and operation of the production management system.
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Aims of JIT Minimise warehousing and storage costs. Eliminate waste by maintaining control over quality of inventories input to the production process. Reduce the amount of raw materials and WIP carried as working capital through more effective production planning. Reduce the amount of finished goods held as working capital.

11: The role of quality in management information and performance measurement systems

Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Elimination of waste, involvement of all staff and continuous improvement are the three key elements of the JIT philosophy. JIT techniques and methodologies
Work standards Flexibility in responsibilities Equality of all staff Autonomy Development of personnel Quality of working life Creativity Design for manufacture Use several, small, simple machines Work floor layout and work flow Total productive maintenance Set-up reductions Total people involvement Visibility JIT purchasing

A kanban control system controls the flow of materials between one stage of a process and the next. Problems with JIT Can be difficult to predict patterns of demand Makes the organisation vulnerable to disruptions in the supply chain Difficult to operate over a wide geographical spread

Life cycle costing


Traditional management accounting systems tend to report costs at the physical production stage of the life cycle only and do not accumulate costs over the entire life cycle, assessing product profitability on a periodic basis instead. Life cycle costing tracks and accumulates costs and revenues over the entire product life cycle, from the design stage, through development to market launch, production and sales, to the eventual withdrawal from the market. This means that a products total profitability can be determined.

Target costing
The target costing process
Determine currentlyachievable cost Determine product concept Establish target price

Establish desired profit margin

Set target cost Calculate cost gap

Try to close the gap


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Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Kaizen costing
Focuses on obtaining small incremental cost reductions during the production stage of the product life cycle using various tools such as value analysis and functional analysis

Kaizen costing process


Used for ... Focus is on ...

Standard costing v Kaizen costing


cost control standard costs based on static conditions every 612 months cost reduction actual costs assuming dynamic conditions monthly

Standards/cost reduction targets are set ... Costs are controlled ... Employees are ...

using variance analysis the cause of problems

by implementing continuous improvement the source of solutions

Continuous improvement (CI)


The ongoing process which involves a continuous search to reduce costs, eliminate waste, and improve the quality and performance of activities which increase customer value or satisfaction.

Essential factors for CI


Commitment from senior management Opportunity for all employees to contribute Information about the organisations environment Employees awareness of their role Management of the performance and contribution of employees Good communications Recognised quality management systems and standards Measurement and evaluation of progress against key

Basic concepts of CI
Quality (defined by the needs of both internal and external customers) Process improvements (through technology and innovative ideas) Team work (in the form of quality circles and group problemsolving activities)

performance indicators and benchmarks

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11: The role of quality in management information and performance measurement systems

Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Cost of quality
The difference between the actual cost of producing, selling and supporting products/ services and the equivalent cost if there were no failures during production/usage

Cost of prevention Costs incurred prior to or during production in order to prevent substandard or defective products/services from being produced Cost of appraisal Costs incurred in order to ensure that outputs produced meet required quality standards Cost of internal failure Costs arising from inadequate quality which are identified before the transfer of ownership from supplier to purchaser Cost of external failure Costs arising from inadequate quality discovered after the transfer of ownership from supplier to purchaser

Examples
Cost of prevention Training in quality control Cost of appraisal Inspection of goods inwards Cost of internal failure Losses due to lower selling prices for sub-quality goods Cost of external failure Cost of customer service section

Traditional view of quality costs


The costs of conformance (cost of achieving specified quality standards) is a discretionary cost incurred with the intention of eliminating non-conformance costs (cost of failure to deliver the required standard of quality). The cost of non-conformance can only be reduced by increasing the cost of conformance. The optimal investment in conformance costs is when total costs of quality reach a minimum (which may be below 100% quality conformance).

Alternative view of quality costs


It is inappropriate to think of an optimal level of quality at which some failures will occur, and the inevitability of errors is not something that an organisation should accept. It is better to spend more on prevention as this will eventually lead to lower total quality costs, because appraisal, internal and external failure costs will be reduced. The emphasis should be on getting things right first time and designing in quality to the product or service. Cost of quality reports Such reports show how much is being spent on each of the categories (prevention, appraisal etc.) They indicate how total cost can be reduced by more sensible division of costs between the categories. Non-financial measures (eg number of warranty claims) may be more appropriate for lower-level managers.
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Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Some definitions
Quality is the degree to which a set of inherent characteristics fulfils requirements (ISO definition) A quality management system (QMS) is the organisational structure of responsibilities, activities, resources and events that together provide procedures and methods of implementation to ensure the capability of an organisation to meet quality requirements. Quality assurance is the part of quality management focused on providing confidence that quality requirements will be fulfilled. Quality assurance is therefore concerned with the things that make quality control systems and activities effective. Quality control is the part of quality management focused on fulfilling quality requirements. Quality certification is an externally provided, objective acknowledgement that the QMS is adequate in its provisions and its operation.

Exam focus point


Note the distinction between quality control and quality assurance: quality control is primarily about detecting errors whereas quality assurance is about preventing them.

Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

The ISO 9000:2000 and 2008 series consists of four primary standards.
1 2

ISO 9000:2005 is fundamentals and terminology. ISO 9001:2000 and 2008 specifies essential features of quality management systems.

3 4

SO 9004:2009 provides guidelines for performance improvement. ISO 19011 covers quality auditing standards

In addition, ISO 14001 relates to environmental management systems, covering issues such as: use and source of raw materials, waste, noise, energy use, and emissions. 4 important principles in ISO 9000:2000:
1 2 3 4

Quality management should be customer-focused Quality performance should be measured both in terms of process performance and customer satisfaction Quality management should be improvement driven Senior management must demonstrate commitment to improving management systems.
11: The role of quality in management information and performance measurement systems

Page 115

Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

QMS should incorporate the 8 quality management principles in ISO 9001:2005.


1 2 3 4 5 6 7 8

Customer focus Leadership Involvement of people Process approach (managing related activities and resources as integrated processes) Systems approach to management (managing groups of related processes as integrated systems) Continual improvement Factual approach to decisions Mutually beneficial supplier relations

A quality manual is a document specifying the quality management system of an organisation. (ISO 9000:2005) The quality manual contains practical details and instructions and provides quality assurance to external stakeholders. It will contain a wide range of material and must be kept up to date. Policies relating to quality The organisation structure that relates to quality management Full details of quality procedures Quality policies formally define the organisations approach to quality. They may include a mission statement, a corporate policy statement and process specific polices. A quality process is a set of activities which transform inputs into outputs. A quality procedure is the specified way to carry out a quality process There are two types of quality process: core business processes and supporting processes. Both must be fully documented.
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Modern Japanese techniques

Terminology

ISO 9000:2000 and 2008 standards

The quality management system

Information systems development

Four aspects of quality are particularly important in software. 1 Functionality it performs the tasks expected of it
2 3 4

Reliability keeps working, and produces reliable outputs Usability is easy to use effectively Build quality flexibility, expandability, portability between platforms, ease of maintenance

Low quality in IS development produces systems that are difficult to use, maintain and enhance. This leads to costs (correcting defects etc), a loss of user confidence, and a reduction in business efficiency.

Qualities of good information

Six Sigma

As well as ensuring it has good quality information systems, an organisation also has to ensure it produces good quality management information. 'Good' management information is information which adds to management's understanding of performance or of an issue, and thereby helps them control their business.

Qualities of good information

A C C U R A T E

ccurate omplete ost-beneficial (ie benefits from it outweigh costs of producing it) ser-targeted elevant uthoritative (eg sources are reliable) imely asy to use

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11: The role of quality in management information and performance measurement systems

Qualities of good information

Six Sigma

Six Sigma is a quality management system that grew out of statistical quality techniques. It has developed into a widely applicable system for process improvement. The overall aim is a very high and consistent standard of quality output. It tends to take the form of specific improvement projects that follow a standard five phase pattern (DMAIC).
1 2 3 4

Define customer requirements establish precise customer requirements Measure existing performance concentrate on things that are important to the customer, that the customer is not satisfied with, and that can be improved Analyse the existing process produce a list of problem causes and areas for improvement Improve the process creativity and planning are required. Consider cost and resource consequences of any plans. Control the new process a continuing management role consider cost of monitoring

Key themes in Six Sigma include: Genuine focus on the customer Data- and fact-drive management (rather than intuition)

Processes as being crucial to success Proactive management Perfectionism (combined with a tolerance of failure)

12: Performance measurement: strategy, reward and behaviour


Topic List
Appraisal and performance management Reward management Accountability Benefits and problems Reward schemes Management styles

If people know that their performance is being measured this will affect the standard of their performance, particularly if they know they will be rewarded for achieving a certain level of performance. In this respect, appraisals and reward management are practical aspects of management that can have a direct impact on performance.

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Appraisal wider aspects


Instrument of control Aspirational model of HRM? Psychological contract

Performance management
Integrates HRM with strategy using cybernetic model of feedback and control
1

Practical aspects
Judgement VS Development Development needs Pay Current progress Promotion Opportunities Responsibility Supports performance Uncomfortable for improvement all concerned

Goals set (derived) from overall strategy 2 Performance measured and compared with target

3 4

Control actions taken (to correct shortfall) Goals adjusted in light of experience

Approach to measuring performance


Inputs or personal qualities. Accuracy in assessing traits depends on skilled psychometry. Managers often introduce subjective bias. Results and outcomes. Measurement against quantified work targets and competence frameworks can work well. Supports quality management programmes and BPR. Behaviour-anchored rating scales provide examples of a range of behaviours for each aspect of performance Behaviour observation scales: appraisees are scored on actual frequency of performing such activities.

Effects
Criticism has negative effect on performance Praise has little effect Specific goals improve performance Participative goal-setting helps results

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Reward
Reward is all of the monetary, nonmonetary and psychological payments that an organisation provides for its employees in exchange for the work they perform. (Bratton) Rewards are EXTRINSIC (derive from the job context) or INTRINSIC (derive from the job content) For example, PAY is an extrinsic reward and may be divided into three categories base pay (reward for time spent), performance pay (to incentivise and encourage teamwork) and indirect pay (benefits).
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Reward and the organisation Reward system should support overall strategy Reward is a vital part of the psychological contract between employer and employee It influences the success of recruitment and retention policies It must conform with the law Rewards must be affordable (for organisation) Reward system affects motivation and performance management

Bratton: Model of reward management based on 5 elements:


1 2 3 4 5

Strategic perspective Reward objectives Reward options Reward techniques Reward competitiveness

Strategic perspective
Reward policy and practice must support overall strategy and be linked to the cascade of subordinate goals and objectives.

12: Performance measurement: strategy, reward and behaviour

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Reward objectives Support recruitment and retention. Must be competitive externally, equitably structured internally, and must compensate for poor working conditions, if they exist. Motivation. Reward system should motivate employees to higher levels of performance. Despite prevalence of incentive and performance related pay, its effectiveness is still disputed. Compliance. Pay system signals valued behaviour and workplace expectations. Reward options Base pay. Related to value of work overall as estimated, measured or set by the market. Performance pay. Rewards performance, learning or experience. Can support teamworking and commitment to organisational goals. Profit sharing supports overall organisational performance. Indirect pay. Benefits of various kinds (eg health care, pensions, car allowance). Can resemble base pay (eg subsidised canteen) or performance pay (eg sales staff benefits based on performance). Share options. Provide the right to purchase shares in a company at a specified exercise price after a specified period of time. Can encourage directors to be more concerned with longer-term success of the company, not just short-term performance.

Reward techniques The reward system must achieve internal equity so that the overall structure is fair. These are 3 techniques that help. Job analysis. Produces a detailed description of the tasks, responsibilities and context of a job. Also useful in quality schemes, redesign and adoption of e-business. Job evaluation. Determines relative worth of jobs. However is hampered by subjective judgement, politics and the qualities of the current job holder. Performance appraisal. Discussed earlier potential issues with judgement vs. development. Reward competitiveness In reality, pay levels will be subject to external factors The local labour market Pressure for cost efficiency Legislation, such as minimum wage rules
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Pay levels in practice Will be affected by: Survey data Need for flexibility Government influence

Relative power of trade unions Economic conditions Subjective judgement (by managers)

12: Performance measurement: strategy, reward and behaviour

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Ideally performance measures should reward behaviour that maximises the corporate good (in both long term and short term). But: Management/staff will concentrate only upon what they know is being measured. Good performance that satisfies managements/staffs own sense of what is important will not necessary work towards the corporate good (problem of goal congruence). Problems in measuring managerial performance Segregating managerial performance from the economic performance of the department/ division Including in performance measures only those items directly controllable by the manager in question It is easy to assess a manager as an employee (eg days absent) but ability as a manager requires assessment in relation to area of responsibility.

But: There are different degrees of controllability. There are reasons for holding managers accountable for factors beyond their control.

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Accountability
1
Hard accountability (financial and quantitative information) which covers three areas Counting (converting activities and outcomes into numbers) Ensuring that numbers are accounted for (how and why an outcome occurred) Being held accountable (for accounting and for the underlying circumstances)

Steps to accountability
1 2 3 4
Choose and publicise accepted performance measures. Identify the benefits of the measures. Identify and understand problems in their use. Consider how to counter perceived problems.

Accountability and controls


Three broad categories of control mechanisms:

Soft accountability (the human impact on the system and its role in shaping, evaluating and implementing goals)

1 2 3

Action (or behavioural) control Personnel and cultural control Results (or output) control
12: Performance measurement: strategy, reward and behaviour

Page 127

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Benefits of performance measures Clarify organisational objectives Develop agreed measures of activity Greater understanding of processes Facilitate comparison of the performance of different organisations Facilitate target setting (for the organisation and managers) Promote accountability of the organisation to its stakeholders

Problems of performance measurement Tunnel vision measure customer satisfaction Sub-optimisation quantify all objectives Myopia a long-term perspective among staff Measure fixation constant review of the performance measurement system Misrepresentation flexible use of measures Misinterpretation audit of data used Gaming involvement of staff at all levels Ossification constant review of performance measurement system

These problems highlight the issue of congruence between the goals of individuals and the goals of the organisation.

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Benefits of linking reward schemes and performance Provides an incentive to achieve good performance Attracts and keeps valuable employees Use of share schemes motivates managers to act in the organisations longterm interests (increase market value) Creates an organisation focused on continuous improvement Makes employees aware of what creates organisational success

Problems associated with reward schemes Encourage dysfunctional behaviour Schemes to combat short-termism may not motivate Employees will concentrate on what is measured Higher output achieved at the expense of quality Undervalue intrinsic rewards Lack of goal congruence

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12: Performance measurement: strategy, reward and behaviour

Appraisal and performance management

Reward management

Accountability

Benefits and problems

Reward schemes

Management Styles

Styles of management Hopwood


Styles of management
Effects Involvement with costs Job-related tension Manipulation of accounting reports Relations with supervisor Relations with colleague Budgetconstrained High High Extensive Poor Poor Profitconscious High Medium Little Good Good Nonaccounting Low Medium Little Good Good

Importance of context The context in which management styles are used can be as important as the style which is used. eg: Budget-constrained style may be appropriate in a business with cash flow problems, or a mature business where management have to focus on cost control. Profit-conscious style may be more appropriate for a business in its growth phase, where longer term performance objectives are more important than short term profit. Non-accounting style can often be appropriate for public sector or not-for-profit organisations, where financial parameters are less important than non-financial ones.

13: Alternative views of performance measurement and management

Topic List
Balanced scorecard Performance pyramid Building blocks Performance prism Activity-based management Value-based management

In this chapter we look at six models or techniques which can be used to measure performance. These models offer a contrast to the approaches for measuring financial performance we looked at in earlier chapters. However, note that the P5 syllabus requires you to evaluate these models rather than just describing them. What are the strengths and weaknesses of the different models? (Refer back to Chapter 13 of the Study Text if you need to remind yourself of these.)

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

Key features Covers all relevant areas of performance Looks internally and externally Related to the key elements of an organisations strategy Links financial and non-financial measures Balanced, thereby preventing improvement in one area at the expense of another Problems Conflicting measures Selection of measures Lack of familiarity with certain perspectives Inability to interpret in terms of all four perspectives

Perspectives and examples of goals and measures Financial perspective Survive Cashflow Prosper Increased market share Customer perspective Responsive supply On-time delivery Quality % of returns Internal processes perspective Manufacturing excellence Cycle time Design productivity Engineering efficiency Innovation and learning perspective Time to market New product introduction v competition Technology leadership Time to develop next generation of products

Strategic maps
Could be used to help implement the scorecard more successfully: (a) (b) (c) (d) (e) (f) Identify objectives. Identify the key objectives of the organisation Value creation. In the light of these key objectives, determine the main ways the organisation creates value Financial perspective: Identify financial strategies to support the overall objectives and strategy Customer perspective. Clarify customer-orientated strategies to support the overall strategy Internal processes. Identify how internal processess support the strategy and help to create value Innovation and learning. Identify the skills and competences needed to support the overall strategy and achieve the objectives.

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13: Alternative views of performance measurement and management

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

The sequence of these stages also suggests there is a hierarchy among the different perspectives. The financial perspective is the highest level perspective, and the measures and goals from the other perspectives should help an organisation achieve its financial goals.

Perspectives
Financial Customer Internal business Innovation and learning

Measures
ROCE: Shareholder value Relationships and loyalty; timeliness of service Quality, efficiency and timeliness processes Employee skills

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

The performance pyramid links the overall strategic view of management with day to day operations.

1 2 3

At corporate level, financial and market objectives are set and actioned by ... ... strategies developed at the strategic business unit level, which in turn are supported by ... ... specific criteria at the operational level

Objectives for external effectiveness and internal efficiency are achieved through measures at the three levels.
Page 135 13: Alternative views of performance measurement and management

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

Performance measurement in service business can be difficult due to characteristics of: Simultaneity Perishability Heterogenity Intangibility No transfer of ownership Building block model was devised as a way of measuring performances in service businesses.

Dimensions
Quality of service Resource utilisation Flexibility Innovation Financial performance Competitive performance

Improvement of determinants leads to improvement of results

Standards
Ownership Achievability Equity

Rewards
Clarity Motivation Controllability

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

Performance Prism
Aims to unify various explanations of organisational performance. There are five facets, which affect performance:

1 2 3 4 5

Stakeholder satisfaction organistion has identified key stakeholders and what they want Strategies to be pursued to ensure value delivered to stakeholders by satisfying their needs and wants Processes required to deliver strategies Capabilities required to operate and enhance the processes Stakeholder contribution what contributions are required from stakeholders in order to maintain and develop capabilities?

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13: Alternative views of performance measurement and management

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

Aspects of ABM Cost reduction (by controlling/reducing cost driver incidence) and process improvement Activity analysis Value-added and non-value added Core/primary, support and diversionary/discretionary

Design decisions (provide cost driver information to ensure the production of low cost products meeting customers requirements) Cost driver analysis Unit level costs Batch level costs Product/process level costs Organisational/facility costs

Continuous improvement (eliminate non-value-added activities) Performance evaluation Volume measures Time measures Quality measures Cost driver rates

Balanced scorecard

Performance pyramid

Building blocks

Performance prism

Activity-based management

Value-based management

Value-based management (VBM)


The value of a company is measured by its discounted cash flows. VBM extends this idea to align all strategic, operational and management processes. Organisations should set goals, targets and performance measures based on discounted cash flow.

Value driver
Any variable affecting the value of the company. Three types are Generic Grass roots Business unit

Management processes
There are four management processes that run in order. 1 Organisation develops a strategy to maximise value

Value mindset
Management are aware that their ultimate financial objective is maximising value.

2 3 4

Strategy becomes performance targets Then action plans and budgets to meet these targets Performance measures and incentive systems to monitor performance to target

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13: Alternative views of performance measurement and management

Notes

14: Strategic performance issues in complex business structures

Topic List
Strategic models Performance management and business models

In this chapter, we will look at three models that can be used to plan and assess business performance. While they can be useful to organisations, the models also have their drawbacks, so make sure you are clear about these too. The chapter finishes by considering performance management issues in different business structures. We look at joint ventures, strategic alliances and the supply chain. What issues for performance management do these different types of structure have?

Strategic models

Performance management and business models

Porters Five forces


The level of sustainable profit in an industry is determined by five forces

Boston Consulting Group Portfolio matrix


Analysis of market growth and relative market share gives four categories of product during lifecycle and four strategies Product Strategy Stars Cash cow Question marks Dogs Build Hold/harvest Build/harvest Divest/hold

Threat of new entrants Threat from substitute products Bargaining power of buyers Bargaining power of suppliers Rivalry between existing competitors

Caution
Defining market can be difficult Assumes market structures are relatively static, but they may not be.

Caution
Defining market can be difficult Collection of data needed Classifications too simplistic Links between products ignored

Ansoffs growth vector matrix


Identifies possible strategies which could be used to close profit gaps identified in gap analysis.
Matrix analyses product and market in a two-way grid and so options for growth are identified

Market penetration Product development Market development Diversification

: current product, current market : new product, existing market : existing product, new market : new product, new market

Lowest risk Highest risk

Caution
Defining market can be difficult Model is broad brush and strategic in focus, so can lack precision

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14: Strategic performance issues in complex business structures

Strategic models

Performance management and business models

Joint ventures
Performance management issues
JV partners may have different goals Ensuring smooth co-ordination and control amongst venture partners Sharing information and intellectual property Establishing trust between venture partners

Multinationals
Performance measurement issues from comparing subsidiaries in different countries: Establishing realistic standards Establishing controllable cash from and profits Impact of currency conversion rates Procedures used to obtain performance information (eg style and frequency of reports, common language and currency)

Strategic alliances
Issues
Success depends on communication and collaboration rather than formal goals and objectives Number of stakeholder organisations contribute to success

Virtual organisations
Performances management issues
Controlling and monitoring performance of remote workers (eg timeliness, quantity and quality of goods or service delivered) Importance of establishing service level agreements.

Supply chain management


Looks at the supply chain as a whole, and ways the organisations in the supply chain collaborate to produce value for the end customer. Move away from traditional arms' length supplierpurchaser relationship to develop stronger relationships between organisations in the supply chain. Use of technology in supply chain 'seamless' supply chain, and closer relationship between producers and consumers. (eg collaboration with consumer on product design; and joint development projects). Impact on business models? Value chain: customer = external to value creation process. But now customer = integrated into value creation process.

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14: Strategic performance issues in complex business structures

Notes

15: Predicting and preventing corporate failure

Topic List
Business failure Performance improvement strategies Organisation lifecycle and survival

The chapter looks at some of the models you could apply to asses whether a business is facing failure, and also looks at some of the performance improvement strategies which can be used to try to prevent corporate failure. Measures of failure can be financial and nonfinancial. You also need to look at the long-term lifecycle of the business as this affects decisions on whether to invest or divest products and divisions.

Business failure

Performance improvement strategies

Organisation lifecycle and survival

Most instances of corporate failure could have been predicted. There have been several analyses of the indications of impending doom. A scores (Argenti) 1. Defects Autocratic chief executive CEO also chairman Passive, imbalanced board Lack of strong FD Poor management team No budget control No cashflow forecasts No costing system Poor response to change; eg out-dated product or processes 2. Mistakes High gearing Overtrading Failure of big project 3. Symptoms Deteriorating financial indicators Creative accounting Non-financial signs (eg lack of cleaning, rumour, high staff turnover) Declining morale

Z score (Altman)

Z=1.2X1+1.4X2+3.3X3+0.6X4+1.0X5 X1 = working capital/total assets X2 = retained earnings/total assets X3 = EBIT/total assets X4 = Market value of equity/Book value of total debt X5 = Sales/total assets Z score below 1.8 indicates a strong possibility of insolvency Z score above 3.0 suggests financial safety.

Declining companies
Slatter identifies four stages in the crisis 1. Crisis denial. Managers are complacent. They ignore warning signs or do not understand them. 2. Hidden crisis. Crisis signs are explained away by managers to protect their positions. 3. Disintegration. Action is taken too late and too little. Management becomes more autocratic. 4. Collapse. Effective action becomes impossible. There are power struggles and able managers leave.

The Icarus paradox (Miller)


Strategic drift can follow success if the organisation becomes over-confident. The business model comes to revolve around what worked in the past, hampering innovation and reducing flexibility. Strategy rests on unchallenged assumptions and drifts away from environmental fit. It can be difficult to distinguish core competences from obsolete assumptions.
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Business failure

Performance improvement strategies

Organisation lifecycle and survival

Slatter: 10 symptoms of corporate decline: 1 2 3 4 5 6 7 8 9 10 Decrease in company's profitability Decrease in sales volume Increase in gearing Decrease in liquidity Restrictions on dividend policy Financial engineering Top management fear Frequent changes in senior management Falling market share Evidence of lack of planning

Other signs Difficulties indicated in chairmans report Adverse press coverage New legislation Increased competition Worsening economic situation Note: Failure can be caused by internal factors (eg lack of innovation; inappropriate marketing strategy) or external factors (eg recession; industry lifecycle) or a combination of both.

Business failure

Performance improvement strategies

Organisation lifecycle and survival

Ross and Kami: 10 commandments for avoiding business failure 1 2 3 4 5 You must have a strategy You must have controls The Board must participate Avoid one-man rule Management in depth 6 7 8 9 10 Keep informed of, and react to, change Customer is king Do not misuse IT Do not manipulate accounts Organise to meet employees needs

3 stages in turning a company round Contraction to cut the cost base while maintaining revenue Reinvestment in capability and efficiency Rebuilding with an emphasis on innovation
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Business failure

Performance improvement strategies

Organisation lifecycle and survival

The life cycle and long-term survival


Although not all products inevitably go into decline, organisations need to be aware of life cycle issues, so that their products generate enough cash to allow for investment in new products. Stages of lifecycle: Introduction Growth Maturity Decline Ideally organisations should have a number of different products at different stages in the life cycle New products at introduction/ growth stages, which will mature and generate cash (Question marks in BCG matrix) Mature products already generating cash for new investment (Cash cows) Products in decline to be harvested (Dogs) Importantly though, critical success factors, KPIs and information needs also vary through the life cycle.

16: Current developments, issues and trends

Topic List
Environmental management accounting Changing role of management accountant Public sector performance Contemporary issues

This final chapter covers current developments and emerging issues in performance management (section F of the syllabus.) We look at a range of discrete topics here but they could all easily be examined in your P5 exams. One of the key capabilities P5 candidates are expected to demonstrate is their ability to identify and assess the impact of current developments in management accounting and performance measurement on measuring, evaluating and improving organisational performance.

Environmental management accounting

Changing role of management accountant

Public sector performance

Contemporary issues

Environmental management accounting


The generation and analysis of both financial and non-financial information in order to support internal environmental management processes. Traditional management accounting Underestimates cost of poor environmental behaviour Underestimates benefits of improvements Distorts and misrepresents environmental issues Classifies environmental costs as general overheads EMA attempts to make all relevant, significant costs visible so that they can be considered in business decision making using: Input/output analysis Flow cost accounting ABC Life cycle costing Poor management decision making Managers are unaware of these costs, have no information with which to manage them and no incentive to reduce them. Product pricing Budgeting Investment appraisal Setting performance targets

for the purposes of

Environmental management accounting

Changing role of management accountant

Public sector performance

Contemporary issues

Traditional view of the management accountant


Separation from operational aspects of the organisation to allow independence and objective judgement.

Trigger for change

Technology
Access to IT and MIS across the organisation

Management structure
Shift in responsibility for budgeting to operational management who prepare and monitor their own budgets.

Competition
Competitive economic situation has led to strategic focus and commercial orientation.

Modern view of the management accountant


Hybrid accountant with accounting knowledge and in-depth awareness of operational/commercial processes of the organisation. Increasingly integrated into the operations of the organisation.
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Environmental management accounting

Changing role of management accountant

Public sector performance

Contemporary issues

Issues to consider
Benchmarking and league tables Can motivate organisations to improve performance. But how reliable are league tables, what measures to use? Could lead to concentration on achieving specific benchmarks whilst neglecting others Are league tables looking at organisation as a whole (strategic view) or looking at individual operational issues? Potential conflict between strategic and operational focus? who to compare against, validity of comparisons VFM, efficiency and effectiveness, qualitative measures. But which areas of performance are selected for measurement? Wide range of stakeholders, each with different (possibly conflicting) objectives.

Level of comparison

Private sector comparators Targets

Environmental management accounting

Changing role of management accountant

Public sector performance

Contemporary issues

Four main performance issues requiring management attention Linking performance to strategy Setting performance standards and targets Linking rewards and performance Considering benefits and problems of performance measures Source: The pyramids and pitfalls of performance measurement, ACCA student Accountant 2005

Performance measures chosen should: Measure effectiveness of all processes Measure efficiency of resource utilisation Include mix of qualitative and quantitative methods Look at both long-term at shortterm performance Be flexible and adaptable to changing business environment.

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