CIMA E3Course Notes

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CIMA E3 Course Notes

Chapter 12
Strategic Review And Control

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Strategic Review And Control

After a period of time, often yearly, it is important to review the progress

of the strategies adopted to ensure they are moving the organisation
towards its objectives. This review process is vital if the organisation is
going to achieve the objectives long term.
If the current approach is working, the organisation can continue forward in
the same way. They may even look to improve the approach going forward
having learnt from the periods activities and taking into account any
environmental or internal changes that have occurred.
If the current approach is not working, then new strategies will need to be
adopted if the organisation is still going to achieve its long term objectives.
It may even be necessary to change the objectives.
The taking of action as a result of the review process is called control.

2.

Performance Measurement

Performance measurement is the review of actual performance, typically

through comparing against objectives, previous years results or those of
other organisations or departments.

Traditional financial performance measures

Traditionally organisations measured performance of the whole organisation
and their business units using financial performance measures such as:
a)
b)
c)
d)

Profit
Return on investment: Profit/Investment
Residual income: Profit - (Cost of capital x Investment)
Costs incurred

Financial performance measures remain a very important way of measuring

performance. Ultimately, financial performance links into increasing
shareholder wealth, which is probably the main objective of most
organisations.

Dysfunctional behaviour and traditional performance measures

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Financial performance targets are often set and measured annually. This
short term target setting and performance measurement period can result in
decisions being taken which do no encourage good long term performance.
Considering an organisation where bonuses are paid to its directors based on
annual return on investment and the directors do not intend to stay past the
end of the current year, the following table provides an overview of how
they could manipulate the performance measure to maximise personal gain,
while negatively affecting the firm in the long term.

How directors could maximise their

bonus by manipulating ROI

Negative long term consequences

Reduce staff numbers to the minimum

Poor customer service and product
necessary to provide a basic service
quality. Long term, customers will
yet still achieve high sales. Short
move to competitors.
term costs will be saved.
Staff dissatisfaction - they leave high long term recruitment and
retraining costs.

Stop all staff training beyond basic

skills training to save costs.

Poorly skilled staff - poor quality and

service

Stop all R&D expenditure to cut costs.

No new products in the future. Poor

long term profitability.

Buy cheap materials.

Poor quality products - long term

warranty claims rise, and customers
use competitors in the future.

Minimise quality control and quality

Poor quality products - long term
procedures to save costs and speed up warranty claims rise, and customers
production
use competitors in the future.
Make no new purchases of machinery.
Keeps investment low, and increases
ROI.

Inefficiencies in production. Poorer

quality products. Poor long term
profits.

Stop machine servicing to cut costs.

Costs will rise long term as repair

costs rise significantly.

Minimise after sales service. Meet

legal obligations only.

Poor customer service Long term

customers will move to competitors.

Dramatically increase prices of on-sell People must buy in the short term but
services/products - e.g. new batteries are unlikely to buy long term
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Have a sales orientated approach.

Stop focusing on meeting customer
needs and focus more on getting the
sale. (e.g. make promises about
products that can not be met)

Poor customer service Long term

customers will move to competitors.

Accruing this years expenses to next

year, while aiming to bring forward
next years sales into this year

Gives an unfair view of profit to banks

and shareholders, who make poor
investment decisions

Increasing stock levels, so that some

of this years expenses are carried
over to next year within the stock
figure, thus increasing profits

Gives an unfair view of profit to banks

and shareholders, who make poor
investment decisions

Shareholder value analysis (SVA)

An alternative measure of financial performance in shareholder value
analysis. The aim is to produce a measure which focuses primarily on
shareholder needs.
Ultimately the value of a company depends on the present value of all
future cashflows of a business discounted at the cost of capital. There are 7
key variables which affect this calculation and as such these become the key
variables which the organisation must manage if they are going to deliver
shareholder value. These 7 drivers of shareholder value are:

Revenue
Operating Margin
Tax Rate
Incremental Capital Expenditure
Investment in Working Capital
Cost of Capital
Length over with competitive advantage can be expected

Based on these seven components, all functions of a business plan and show
how they influence shareholder value. A prominent tool for any department
or function to prove its value are so called shareholder value maps that link
their activities to one or several of these seven components. So, one can
find "HR shareholder value maps", "R&D shareholder value maps", and so on.
The 7 drivers of shareholder value also show how short term profit
maximisation does not necessarily increase shareholder value, particularly
since many of the short term measures noted above, reduce the length of
the period of competitive advantage thus reducing the overall shareholder
value seen over the long term. Hence shareholder.
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As such shareholder value analysis provides a better single measure of

overall performance than traditional financial measures.

Economic value added (EVA)

The economic value added provides a measure of performance similar to
residual income but adjusted in a way that is very hard to manipulate by
managers.
The key differences are:

profit and capital employed figures are adjusted so that items such
as spending on R&D, training and brand building advertising are
moved out of costs and into investment, little to be gained by
managers reducing investment in key items of long term
performance.

accruals and prepayments are converted into cash amounts so that

EVA represents a cash based profit figure which removes any
benefit that might be gained by manipulating accounting measures
such as accruals.

Economic value added is:

Net Operating Profit After Tax (Economic Capital Employed x Cost of capital)

Where:
Net operating profit after tax (NOPAT) is:
cash based profit adding back accruals and including prepayments and any
other accounting based measures such as changes in provisions
Less
Cash spend on items of long term value (such as long term advertising,
development, staff development, operating leases that are effectively
finance leases)
Economic Capital Employed is:

Capital Employed
Plus
Items of long term value taken out of profit

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One key problem that remains with EVA is asset harvesting which is the
retention of aging assets to avoid investing in new capital. This keeps
capital employed low and EVA higher.
Overall though EVA provides a more meaningful, cash based measure of
performance that is much harder to manipulate by managers.

3.

Balanced Scorecard

To overcome possible short-termism Kaplan and Norton developed the

balance scorecard which outlined four key areas in which company and
divisional performance should be measured to focus on both the short and
long term needs of the organisation.
The 4 perspectives and suitable performance measures in each are:

Customer perspective
Focusing on the customer and meeting their needs.
Possible measures:

Customer satisfaction - per a customer satisfaction survey

Number of returns
Number of customers moving to the competition.
Call waiting time / service time
Delivery time
% of deliveries on time.

Internal business perspective

Focusing on the way the business works and operates with a particular focus
on productivity and efficiency.
Measures include:

Time per unit

Number of defective products
Cost per unit
Material wastage rates

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Innovation and learning perspective

Focusing on innovating in product and processes, and developing and
learning for the future. Learning is more than just training, but includes any
kind of organisational improvements made.
Measures include:

No of new products developed

Sales from new products
Development time of new products
R & D spending
Amount spent per employee on training
Number of qualified staff
Number of training programmes available

Financial
Financial performance remains vital to the organisations success, as it gives
an indicator of shareholder wealth and ability to survive long term, and so
must also be balanced against the other factors.
Measures include:

Profits
Return on investment
Residual income
Costs (variance analysis)
Sales

Linked to strategy
In each category the organisation must follow through from the business
strategy, to ensure they are focused on the long term direction of the
business.
Clear objectives should be set under each category according the SMART
criteria (Specific, Measureable, Achievable, Relevant and Timebound),
measured at the end of the period, and lessons learnt from actual results to
help to improve performance in future periods and keep the organisation on
track to achieve its strategic goals.

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Performance pyramid

The performance pyramid, from Lynch and Cross, provides an alternative

approach to a creating a range of balanced performance measures all linked
to the achievement of the business vision.

Vision
Measures

Objectives
Market

Financial

Business Units

Customer Flexibility Productivity

Quality

Delivery

Cycle Time

Waste

Business Systems

Departments

Operations
Internal

External

Measures are selected under nine dimensions of performance Quality,

Delivery, Cycle time, Waste, Customer, Flexibility, Productivity, Market and
Financial. The aim is that the objectives lower in the pyramid, if achieved,
should contribute to achieving the objectives at the next level up, so for
example good quality and on-time delivery will ensure customers are
satisfied, which will in turn lead to good market share and financial
performance.
The performance objectives should be driven from the vision of where the
business wants to be in the future, so that if all the objectives are achieved
the company is moving towards its long term vision.

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Benchmarking

What is benchmarking?
Benchmarking is the comparison of performance and business processes to
the best in the industry or best practices from other industries, with the aim
of learning from those practises to improve performance in the future.
Benchmarking can involve different types of performance comparison
including with:

Other organisations in the same industry (external or competitive

benchmarking)

a business function or process(e.g. finance) with similar divisions of

other (usually non-competing) organisations (functional or process
benchmarking)

similar divisions within the organisation itself e.g. two similar retail
outlets (internal benchmarking).

Procedure
The following is an example of a typical benchmarking methodology:
1. Identify areas to be benchmarked usually areas where performance
needs to be improved.
2. Map current processes and measure current performance levels in
that area
3. Identify organisations which are leaders in this area
4. Decide who and how to benchmark performance, including (where
relevant) agreeing with the preferred organisation to undertake
benchmarking and how to do this.
5. Surveys and data collection of target organisations processes
includes performance measurement and process mapping information
6. Compare performance and identify process differences
7. Decide on changes needed and implement change
8. Review progress and control
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What are the difficulties when benchmarking?

A key difficulty with benchmarking is how to successfully get relevant
information about competitor performance. Financial performance may be
able to be obtained through company accounts, the companies product can
be purchased to trial and test it, but ultimately a competitor is unlikely to
exchange important information about internal processes and results.
Functional benchmarking can overcome this problem by exchanging
information with non-competing organisations.
In addition, even where information is available, for instance in company
accounts, it can be hard to make meaningful and fair comparisons due to
differences in the businesses or business process, and so data needs to be
very carefully analysed.
There are also problems with there being too many measures, so staff lose
focus on achieving any one. Measures can also be conflicting, making
decision making difficult as the manager tries to balance their wide variety
of targets (e.g. higher quality may result in higher costs reducing profits).

6.

Critical Success Factors

What are critical success factors?

Critical success factors are the areas in which the organisation has to do
well if they are to remain competitive and profitable. Critical success
factors should flow directly from the organisations strategy, so for example
an organisation growing through a strategy of buying lots of other companies
will need to excel at effectively merging the joint operations.
No more than 4-5 critical success factors are usually defined for each
organisation so they are focused on the key points.

Key performance indicators

Critical success factors can be used as a way to identify the key areas for
performance measurement the key performance indicators. For the
acquisitive company, to measure the CSF of effectively merging the joint
operations, you might measure:

% of key staff retained.

Cost savings attained in acquired company
Sales/profit growth in joint business

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Employee satisfaction before and after acquisition

Customer satisfaction before and after acquisition

Each of these provides vital information that the organisation must collect,
so for example if they are not doing so already they must measure employee
satisfaction, perhaps through conducting employee surveys, both in their
own company and in the companies being acquired.

7.

Internal Control

What is internal control?

Internal control is defined as a process affected by an organization's
structure, work and authority flows, people and management information
systems, designed to help the organization accomplish specific goals or
objectives.
It is a means by which an organization's resources are directed, monitored,
and measured. It plays an important role in preventing and detecting fraud
and protecting the organization's resources, both physical (e.g., machinery
and property) and intangible (e.g., reputation or intellectual property such
as trademarks).
Under the COSO Internal Control-Integrated Framework, internal control is
broadly defined as a process, effected by an entity's board of directors,
management, and other personnel, designed to provide reasonable
assurance regarding the achievement of objectives in the following
categories:
a) Effectiveness and efficiency of operations;
b) Reliability of financial reporting; and
c) Compliance with laws and regulations.

What are internal control systems?

An internal control system is the system of controls applied to the
organisation as a whole to help to prevent organisational risks.
According to the UKs Turnbull report (which later formed part of the
Combned code) An internal control system encompasses the policies,
processes, tasks, behaviours and other aspects of a company that, taken
together:
- facilitate its effective and efficient operation by enabling it to respond
appropriately to significant business, operational, financial, compliance and
other risks to achieving the companys objectives. This includes the
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safeguarding of assets from inappropriate use or from loss and fraud, and
ensuring that liabilities are identified and managed;
- help ensure the quality of internal and external reporting. This requires
the maintenance of proper records and processes that generate a flow of
timely, relevant and reliable information from within and outside the
organisation; help ensure compliance with applicable laws and
regulations, and also internal policies with respect to the conduct of
business.

Strategic level control

At the organizational level, internal control objectives relate to the
reliability of financial reporting, timely feedback on the achievement of
operational or strategic goals, and compliance with laws and regulations.

Operational control
At the specific transaction level, internal control refers to the actions taken
to achieve a specific objective (e.g., how to ensure the organization's
payments to third parties are for valid services rendered. Internal control
procedures reduce process variation, leading to more predictable outcomes.

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