DIVISIONAL PERFORMANCE

MANAGEMENT
Centralised Organizational Structure
When major activities of a company are few & closely interrelated
then centralised organization structure is more easily managed.
All activities within a company are placed under the control of
departmental heads.
These are p(roduction, marketing, finance, HR and admin,
procurement and research and development.
Pricing, product mix and output decisions will be made by
central management
functional Organization none of the members of the 5 departments
is responsible for more than a part of the processes.


Production dept. is responsible for manufacturing of products at
minimum cost & of standard quality & on time delivery.
Marketing dept is responsible for making sales at market price
Purchasing dept is responsible for purchasing supplies & so on but
no one is responsible for the total profit of the company
. Revenue & cost including cost of investment are combined
together at CEO level, which is classified as an investment centre
Marketing function is revenue centre & rest of the dept are cost
centres.


2. PRE-REQUISITES FOR SUCESSFUL
DIVISIONLIZATION
FUNCTIONAL AND DIVISONLIZED ORGANIZATIONAL STRUCTURE

suited to companys engage in several dissimilar activities.
It is difficult for top management to be intimately acquainted with
all the diverse activities of various segments of the busines
It is appropriate to divide a company into separate segments or
divisions and to allow managers to operate with a great deal of
independence will lead to the decision making process for instance
divisional managers will normally be free to set selling prices, in
which market to sale ,make product mix ,setting credit
terms,advertising ,output decisions and select suppliers(this may
include buying from other divisions within the company or from
outsiders)


Each divisional manager is responsible for all of the operations
relating to particular product

Manager responsible for generating revenues, controlling cost and
earning a satisfactory return on the capital invested in their operations
To meet the true requirements of a divisionalises profit centre a
division should be able to save majority of its output to outside
customers & free to choose the sources of supply.
The autonomous division is that managers might not pursue goals
that are in the best interest of the company as a whole.
Consider financial performance measures that will motivate
pursue those goals that will best benefit the company as a whole


3. PROFIT CENTRES AND INVESTMENT
CENTRES

Investment Centres:
authority to make decisions on source
of supply & choice of markets & make
capital expenditure decisions. Division
is known as an investment centre.



Profit Centre:

A manger can't control investments & is responsible for the profits earned
from the fixed assets assigned to him by the corporate head quarters the
segment is known as profit centre.
The divisional managers have profit loss responsibility

Transfer prizes are assigned to the product transfer between the divisions.

Separate profits can be reported for each division but manager have
limited authority for sourcing and prizing decisions
A divisonlized profit center should be able to sale the majority of its
output to outside customers and free to choose the source of supplies.
Cost Centre:
used to describe a responsibility centre in a
conventional isational structure where a
manager is responsible for cost but not profit.


4. Disadvantages:

Divisions take actions which will increase their divisional profits at the expense of
the profits of other divisions.

Not achieving over all Organization goals of the company may lead to a reduction
in total company profits.

Cost of activities that are common to all divisions like finance, administration, IT,
HR may be greater for a divisionalised structure than for a centralised structure
because for each division seperate services are required.

Top management loses control, However, good performance evaluation together
with appropriate MIS top management able to control decentralised operation.


21. ADVANTAGES OF
DIVISIONALIZATION

Decision can be made by the person who is familiar with the situation and make
more informed judgments than central management,
Decision can be made on the spot by the manager who are familiar with the
product lines and production process.
Improve motivation and efficiency and will increase not just at the divisional
management level but throughout the whole division,
Free top management from detail involvement in day to day operations and
enables them to devote more efforts to strategic plans.
Excellent training oppurtunities for future members of top management by
enabling them to acquire skills and experience.
provide greater freedom to the manager thus, making their activities more
challenging.

managers of profit centres feel great job satisfaction than the managers of cost
centres.

Top management are not involved in day to operations which makes them devoted
to more effort & strategic planning.
DISADVANTAGE DIVISIONALIZATION
Divisions may compete with each other, manager take action
which will increase their own profits at the cost of other divisions
Lead to affect the overall company goals and reduction in
total company profits.
Top management assess additional benefits will exceed the
additional cost.
Cost of common activities to a divisionalized structure is
greater than a centralized structure. centralized accounting
function may be less costly as compare to separate accounting
function for each division.


5. Economic Performance Of The Division:
To evaluate divisional managerial performance then
only those items directly controllable by him should be
included in the profitability major.
All allocation of indirect cost i.e. central service &
administration cost which can't be controlled by the
divisional manager. So, exclude such cost.

Such cost can only be controlled by the central service
managers. So, they should be held accountable.


6. Division Profit Measures:
1.Return on investment
ROI is the most widely used financial measure of divisional performance
ROI is similar to ARR.
ROI express divisional profit as a % of the assets employed in the division
Net operating income is income before interest and taxes EBIT (earnings before interest and tax
. Operating assets include cash, accounts receivable, inventory, plant and equipment
Non operating assets include land held for future use, an investment in another company
Average of the operating assets between the beginning and the end of the year.
Most companies use the net book value to calculate average operating assets.
An assets net book value decreases over time as the accumulated depreciation
increases.Consequently, ROI increases
Replacing old equipment with new equipment increases book value of assets and
decreases ROI.
An alternative is gross cost of the asset, constant over time because depreciation is ignored;

Corporate management will see whether the returns earned on the capital
investment in a division exceeds the division's opportunity cost of capital.
Margin and turnover are very important concepts.
Margin is ordinarily improved by increasing sales or reducing operating expenses,
ROI. can be compared to the returns of other investment centers in the
organization,
it is subject to the following:
Manager take actions that increase ROI in the short run but harm the company in
the long run such as cutting back on research and development
Manager may reject investment opportunities that are profitable for the whole
company but that would have a negative impact on the managers performance.
Committed costs may be relevant in assessing the performance of the business
segment but difficult to fairly assess the performance of the manager.

Residual income
To overcome disadvantages of ROI the residual income approach
can be used
It is defined as a controllable contribution less a cost of capital
charge on the investment controllable by the divisional manager.
Residual income measure the managerial performance of
investment centre.
Managers will be encouraged to protect their interests and also to
act in the best interest of the company.
Residual income measure risk adjusted capital cost to be
incorporated where as the ROI ignores.
Residual income suffers from the disadvantage of being absolute
measures for example , a large division is more likely to earn a
larger residual income than a small division
In the case of profit centers, managers are not authorized to make
capital investment decisions .Therefore R I is not calculated

In case of investment centre or profit centre mangers
can significantly influence the investment in the
working capital ,ROI appears to be an un satisfactory
method and residual income is preferable
Residual income of division x will increase and that of
division Y will decrease.
If both managers accept the project, the manager of
division X would invest where as the manager of
division Y would not and these decisions are in the best
interest of the company as a whole
Residual income encourage both managers to make
the correct asset disposal decision

7. TRACEABLE FIXED COST:
Only the traceable fixed costs are charged to particular
segments. If a cost is not traceable to a segment, then it is
not assigned.
A traceable fixed cost of a segment is a fixed cost that is
incurred because of the existence of the segment if the
segment were eliminated, the fixed cost would disappear.
Examples of traceable fixed costs include:
The salary of the Fritos product manager at PepsiCo is a
traceable fixed cost of that segment
The maintenance cost for the building in which Boeing 747s
are assembled is a traceable fixed cost of that segment.

Inappropriate Methods for Assigning Traceable Costs among
Segments
In addition to omitting costs, many companies do not correctly
handle traceable fixed expenses on segmented income statements.
First, they do not trace fixed expenses to segments even when it is
feasible to do so.
Second, they use inappropriate allocation bases to allocate
traceable fixed expenses to segments.
Costs that can be traced directly to a specific segment should be
charged directly to that segment and should not be allocated to
other segments.
For example, the rent for a branch office of an insurance company
should be charged directly to the branch office rather spread
throughout the company

COMMON FIXED COST:
Is a fixed cost that supports the operations of more than
one segment, but is not traceable in whole or in part to any
one segment. Even if a segment were eliminated, there
would be no change in a true common fixed cost.
For example: The salary of the CEO of General Motors is a
common fixed cost of the various divisions of the company.

. The cost of the receptionists salary at an office shared
by a number of doctors is a common fixed cost of the
doctors. The cost is traceable to the offi ce, but not to
individual doctors.
.

ARBITRARY ALLOCATION OF FIXED COST:
For example, some companies allocate selling and administrative expenses
on the basis of sales revenues.
Thus, if a segment generates 20% of total company sales, it would be
allocated 20% of the companys selling and administrative expenses as its
fair share..
For example, sales should be used to allocate selling and administrative
expenses only if a 10% increase in sales will result in a 10% increase in
selling and administrative expenses.
Costs should be allocated to segments if it is highly correlated with the
real cost driver).
Nestle, Switzerland , has been working to overcome inefficiencies
resulting from its decentralized management structure.
For example, each candy and ice cream factory was ordering its own
sugar Nestle hopes to significantly reduce costs and simplify
recordkeeping by centralizing its raw materials purchases
SEGMENT MARGIN:
Segment margin is obtained by deducting traceable fi xed cost from the contribution margin.
It represents the margin available after a segment has covered all of its own costs.
Best judge of the long-run profitability of a segment it considers those costs that are caused by the
segment.
If a segment cant cover its own costs, then it should be dropped

COST ASSIGNED TO A SEGMENT:
From research and development, to product design, manufacturing, marketing, distribution, and
customer service, are required to bring a product or service to the customer.
The distinction between traceable and common fi xed costs is crucial because traceable fixed costs
are charged to segments and common fixed costs are not
Many organizations now integrate financial measures such as ROI and residual income in a
coordinated system of performance measures known as a balanced scorecard. 529 Balanced

Segmented income statements provide information for evaluating the profitability and
performance of divisions, product lines, sales territories, and other segments of a company.

25. ALTERNATIVE DIVISIONAL PROFIT MEASURES
Where a division is a profit centre, depreciation is not a
controllable cost since the manager does not have
authority to make capital investment decisions.
Depreciation is a controllable expense for an investment
centre in respect of those assets that are controllable by
the divisional manager.
Controllable contribution is the most appropriate measure
of a divisional manager performance because it measures
the ability of managers to use the resources under their
control effectively
It should be evaluated relative to a budget performance so
that market conditions can be taken into account.

26.CONTROLLABLE AND UNCONTROLLABLE COST
Depreciation of divisional assets and head office finance and legal staff assigned to
providing services for specific divisions would fall into this category, these
expenses can be avoided if a decision were taken to close the division.
EXAMPLE:
Suppose manager of division X has an asset that generates a return of 19% and the
manager of division Y has asset that yield a return of 12%
The manager of division X can increase ROI by disposing off the assets where as
the ROI of division Y will decline if the asset is sold.
Asset disposal appropriate where assets earn a return less than the cost of capital
Assets in division X should be kept and divisions Y asset sold
Both managers can increase their ROI by making decisions that are not n the best
interest of the company.


29. ADDRESSING THE DIVERSE FUNCTIONAL CONSEQUENCES OF SHORT TERM FINANCIAL
PERFORMANCE MEASURES
The prime objective of a company is to maximize the share holder value
In the stock exchanges ,the share prize are derived considering the companys performance as
a whole and not at the segmental level .
Using ARR as performance measures can encourage managers to become short term
oriented decisions i.e. is by rejecting profitable long term investment
By not making investment in profitable products they can reduce current period cost.
Manager can boost their performance measure in a particular period by destroying customer
and employee good will
For instance, force employees to work excessive towards the end of measurement period so
that maximum goods can be sold .to maximize short term profitability.This effect quality of
goods, customer satisfaction, future sales and de-motivation and increased labour turn over
Where two divisional managers have same amount of investment and produce same ROI it
does not mean that their performance is the same
One manager may have build up customer good will by offering excellent service and also
paid great attention to training education research and development
While another may not have given these items any consideration


DISTINGUISHING BETWEEN THE MANAGERAL AND ECONOMIC PERFORMANCE OF
THE DIVISION
A manager may be assigned to an aligned division to improve performance
and succeed in improving the performance of the division but the division still is
unprofitable due to industry factors such as over capacity and a decline market.
The future of division might be uncertain but manager promoted due to good
performance
Conversely a division report significant profits but due to management
deficiencies, the performance may still be un satisfactory provided favorable
economic environment is taken into account
To evaluate the divisional manager than only those items directly
controllable by the manager should be included in the performance measure.
Allocation of indirect cost including central administration cost which cannot
be controlled by the divisional manager, such cost not to be included in
performance measure. These costs can only be controlled where they are
incurred.


A balanced scorecard is an integrated system of performance measures
designed to support an organizations strategy.
The various measures in a balanced scorecard should be linked on a
plausible cause-and-effect basis from the very lowest level up through the
organizations ultimate objectives.
A theory about how specific actions taken by various people in the
organization will further the organizations objectives.
The theory should be viewed as tentative and subject to change if the
actions do not in fact result in improvements in the organizations financial
and other goals.
If the theory changes, then the performance measures on the balanced
scorecard should also change.
The balanced scorecard is a dynamic measurement system that evolves as
an organization learns more about what


In profit centre depreciation is not a controllable cost since manager has
no authority to make capital investment.
Depreciation should be controllable expense for an investment centre in
respect of assets, controlled by the manager

Controllable contribution is appropriate major since it major the ability of
a manager to use the resources under their control.

Where a manager is not bound to receive services from within the
company the expense is clearly controllable

Where division has no choice but to accept head office cost. This can be
regarded as non controllable over heads.

Those overheads that are attributable to a division and which would be
avoided if the division was closed are deducted from the controllable
contribution to drive the true divisional contribution
If the division is independent it would have to incur the cost of these
services performed by the head office as well because division would have
to incur if treated as a separate company

Companies may prefer to use divisional net profit when comparing the
economic performance of a division with the similar companies


Factors influencing companies to allocate the
cost of shared resources to divisions are
attributed to the following:
-To show total cost for operating a division.
- Such cost incurred and must be charged to
division.
- would incur such cost if they were
independent unit bear full business risk as being
the part of the company

27.RETURN ON INVESTMENT (ROI)
A situation where division A earn a profit $1 million and division B a profit of $2million. Can we
conclude that division B is more profitable than division A.?
The answer is no
Since we should consider whether are returning a sufficiently high return on the capital invested in
he division.
Suppose that 4 million capitals are invested in division A and 20 million in division B.
DIVISION AS ROI is 25% and for B is 10%.
The corporate management will see the return earned on a particular division exceed the division
opportunity cost of capital (i.e. returns available from the alternative use of the capital.)
Suppose the return available on similar investment to that in division B is 15% than the
performance B is questionable. If profitability cannot be improved ROI suggest that division A is
very profitable.
Another feature of the ROI is that it can be used a common denominator for comparing the returns
of dissimilar businesses such as other divisions with in the group or outside competitors.
It is widely used for many years in all types of organizations so that most managers understand
and consider it to be of considerable importance
Despite widely used there are a number of problems exists when this measure is used for example
divisional ROI can be increased by actions that will make the as a whole verse of and conversely
actions that decrease the divisional ROI but make the company as whole better off.
In other evaluating divisional managers on the basis of ROI may not encourage goal objective

The following example

Division x Division y
Investment project
available $10MILLON $10MILLION
Controllable contribution $2 MILLION $1.3
MILLION
Return on the proposed
project 20% 13%
ROI of divisions at
present 25% 9%
Cost of
capital 15% 15%
Sol

Solution
Manager of division X would be reluctant to invest 10million
because return on the project is 20% and this would reduce the
existing ROI of 25%.
The manager of division Y would wish to invest 10million because
the return on the proposed project of 13% is in excess of the
present return of 9% and it would increase the division overall ROI.
The managers of both divisions would make decisions that would
not be in the best interest of the company.
The company accepts projects where return is in excess of the cost
of capital of 15%.
In this case manager of division X reject a potential return of 20%
and the manager of division Y accept a non-potential return of 13%
Managers may the incorrect assets disposal decision.