Business Management Chapter 7

Prepared by: Jamal

PERFORMANCE APPRAISAL & ANALYSIS

Survival and Growth: It depends upon making profit Areas of Growth: Revenue, Profitability, Return on Investments, Market Share, No of employees, No of products, cash flows etc Inflation: Inflation make hinder to achieve and sustain the profitability. Consequences of Inflation: Difficult to pass on increase in cost in competitive market where customer resists price increase For exporter, the cost of good increase for foreign buyer unless exchange rate falls Controlling Inflation: Exercise buyer power over supplies and negotiate to reduce the material prices Use material effectively Labour pay rate should be competitive but keep as low as possible Labour efficiency must match the competition Expenses should be rigorously controlled The timing of price increase should monitored carefully Inflation can conceal poor performance if company is using historical cost convention. NPV Technique to Control Investment: Discounted cash flows can be used to assess the performance of capital investment. Long term planning, capital expenditure decision should be based on an evaluation of future cash flow discounted at an appropriate cost of capital to an NPV. (Refer example on page no 145) Contribution Margin Technique: CM is the difference b/w sales volume & the variable cost of those sales, either absolute term or per unit. Contribution centre is profit centre where expenditure is calculated on a marginal cost basis. Contribution and Strategic Decisions: Product Market Issues: It emphasis on two things: The no of product required to break even The no of product required to generate adequate return over the life of the investment BE Analysis can be very useful in appraising and controlling strategy. Following factors effecting BE model. Probability of achieving the desirable level of market penetration Favorable or unfavorable condition in the market How competitors react or allow profitable entry Feasibility of cost and quality condition Availability of funds, skills, required manpower etc Return on Investment: Divisional Performance Many large Org are divided into strategic business units SBUs, which is a separate section responsible for planning, developing, producing and marketing its own product and services. Return on investment shows how much profit has been made in relation to amount of capital invested.

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Business Management Chapter 7

Prepared by: Jamal

Main Reasons to Use ROI: Financial Reporting: Data identifiable from financial statements Aggregation: Can be measure for separate division or org as a whole. Measurement Problem: Different profit centre has diff depreciated fixed assets without regular replacement, so its ROI will increase year by year. Fixed asset of diff ages may be depreciated in diff ways. Inflation and technological changes effects the ROI of diff centers. The Target Return for a Group of Companies: Set target return for the group as a whole or for each SBUs No investments project in an SBU if target return not achieve Problems: Investments are appraised DCF where as actual performance will probably be measured on the basis of ROI Target return ignores allowance \ provisions for different risk of diff SBUs Practically an identified target return may be unsuitable to many SBU in a group. (Refer example 5.19) There may be issues and conflicts b/w SBUs in short term and long term decision and the org Residual Income: (RI) It is a pre tax profit less an imputed interest (borrowing cost) charged for invested capital. Advantages of RI: I. RI will increase when; Investments earning above the cost of capital are undertaken Investment earning below the cost of capital are eliminated II. RI is more flexible since a different cost of can be applied to investment with different risk characteristics Disadvantages: Does not facilitate comparison b/w investment centre nor does it relate size of a centre income to the size of investment. Benchmarking: It is the establishment of targets through date gathering of comparators, the performance is compared at each relative level and areas of underperformance identified. Types of Benchmarking: Internal Benchmarking: A method of comparing one operating unit or function with another with another within the same industry. Functional Benchmarking: Internal functions are compared with those of the best external practitioner of those functions, regardless of the industry they are in. Also known as Operational or generic benchmarking Competitive benchmarking: Information is gathered about direct competitors through techniques like reverse engineering. Strategic Benchmarking: A type of competitive benchmarking aimed at strategic action and org change. Stages of Benchmarking: a) Gain senior management commitment

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Business Management Chapter 7

Prepared by: Jamal

b) c) d) e) f) g) h)

Set objectives and determines the areas to benchmark Establish key performance measures Select org to study Measure own and others performance Compare performances Design and implement improvement program Monitor improvement

Levels of Benchmarking; Levels Resources Competence in Separate Activities Competence in Linked Activities

Through Resource audit Analyzing activities

Examples Qt & qlt of resources like manpower Sales call per sales man etc

Analyzing over all performance Market share , profitability, productivity

Advantages: Position audit Focus on improvement in key areas Sharing information can be used for innovation Involvement of all employees and management The result should be improved performance eg cost cutting, delivering value etc Disadvantages; It concentrate on doing things right rather than doing right thing Yesterday solution to tomorrow problem It is copying / catching up exercise rather than development of anything distinctive It depends upon accurate info about comparator companies It is not cost free and can divert management attention It can be hindrance and threat, sharing info with other companies can be burden & security risk.

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