P5

Advanced Performance
Management
Okey Umeano ACCA FRM

Aim
To apply relevant knowledge and skills and to
exercise professional judgment in selecting and
applying strategic management accounting
techniques in different business contexts, and to
contribute to the evaluation of the performance
of an organization and its strategic development

Core Areas

Strategic planning and control

External influences on organisational performance
Performance measurement systems and design
Strategic performance measurement
Performance evaluation and corporate failure
Current developments and emerging issues in
performance management.

Planning & Control

Planning is about:
- where an organization wants to be, and
- how it will get there
Control is concerned with monitoring the
achievement of objectives and suggesting
corrective action.

The Performance Hierarchy

Mission
Strategic plans and objectives
Tactical plans and objectives
Operational plans and targets

Strategic Management Accounting

The Strategic planning process includes
strategic analysis, strategic choice, and strategic
implementation.

Strategic management accounting

- provides information on the financial aspects of
strategic planning using information from internal and
external sources, monitoring performance in line with
organisational objectives.

 Critical Success Factors (CSF)s are areas

in which the business must do well to
achieve its objectives
The achievement of CSFs is measured by
establishing Key Performance Indicators
(KPIs).

Tools used in strategic analysis

Benchmarking use of a best-in-class yardstick
to compare performance.
Things to know:
- types of benchmarking
- the process
- benefits and problems of benchmarking
SWOT analysis
Gap analysis
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Environmental Influences
External Analysis
- can be analysed using PESTEL and Porters 5forces.
Impact of Stakeholders & Stakeholder conflict
- Mendelows matrix
- managing conflicting objectives by
prioritisation, negotiation and satisficing,
sequential attention, side payments and
exercise of power
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Environmental Influences contd.

Impact of ethical issues
- corporate social responsibility (CSR)
Impact of government policy
- fiscal and monetary policy
- legislation and regulation
- competition policy
Risk and uncertainty
- tools for incorporating risk and uncertainty:
1. scenario planning
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Environmental Influences contd.

2. computer simulations
3. sensitivity analysis
4. expected values
5. maximin, maximax, and minimax regret
Expected Values
- Calculated by multiplying the value of each
possible outcome (x), by the probability of that
outcome (p), and summing the results.
EV = px
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Environmental Influences contd.

Maximin, Maximax, and Minimax Regret
The risk tolerance of management will determine
which of the 3 will be used.
Maximin rule- selects the alternative that maximises
the minimum payoff achievable pessimist.
Maximax rule- selects the alternative that maximises
the minimum payoff achievable optimist.
Minimax regret- selects the strategy that minimises
the maximum regret (opportunity loss from
making the wrong decision) sore loser.
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Environmental Influences contd.

Classwork maximin,etc

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Approaches to Budgets
A budget is a financial plan prepared for a
specific time period.
Purposes of budgeting include planning,
control, communication, co-ordination,
evaluation, motivation, authorisation, delegation.

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Approaches to Budgets contd.

Methods of Budgeting

Note: Know all the methods, their advantages/disadvantages.

a. Fixed budget budget prepared at a single level of

activity.

b. Flexible budget budget prepared with the cost

behaviour of all cost elements known and
classified as either fixed or variable. May be
prepared at a number of activity levels and can be
flexed.

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Approaches to Budgets contd.

c. Incremental budget starts with the previous periods
budget or actual results, and adds (or subtracts) an
incremental amount to cover inflation and other known
changes.
d. Zero-based budget (ZBB) requires each cost element
to be specifically justified, as though the activities to
which the budget relates were being undertaken for the
first time.
e. Rolling budget one that is kept continuously up to date
by adding another accounting period (e.g. month or
quarter) when the earliest period has expired.
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Approaches to Budgets contd.

f. Activity-based budget uses principles of activity based
costing to estimate the firms future demand for
resources and hence can help the firm to acquire these
resources more efficiently.
Beyond budgeting
This is a leadership philosophy that relates to an alternative
approach to budgeting which should be used instead of
traditional annual budgeting.

Budgeting in Not-For-Profit Organisations

Considerations include: no profit motive, non-quantifiable
benefits, no revenue generated, multiple stakeholders,
objectives.
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Approaches to Budgets contd.

Forecasting
Recall the methods from F5:
- high-low method
- regression analysis
- time series analysis
- the learning curve model
Wrights Law as output doubles, the average time per
unit falls to a fixed percentage of the previous average
time.
The learning curve effect is calculated using: y=axb
where: y= average time per unit/batch; a= time for the first unit/batch
x= output in units/batches;
b= log r (r = rate of learning)
log 2

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Approaches to Budgets contd.

Classwork

Ammy Ltd. wants to estimate the labour costs of a new product.

The product, DSC, will have a life of 12months. Sales are
budgeted to be 110,000 in the year, in batches of 100 units.
An 75% learning curve will apply for the first 500 batches,
after which a steady state production time will apply, with the
labour time per batch after the first 500 batches being equal to
the 500th batch. The labour cost of the first batch was
measured at $1,800. This was for 300hours at $6 per hour.
Required: Calculate the labour cost for production of DSC.
Note: At a learning rate of 75%, learning factor b is -0.415.
Limitations: For the learning curve effect to work; there must
be no breaks in production, the product should be new, and
the process should be complex, labour-intensive, and
repetitive.
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Changes in Business Structure

Business Integration
- means that all aspects of the business must be aligned to
secure the most efficient use of the organisations
resources so that is can achieve its objectives effectively.
- Four aspects that need to linked include:
people, operations, strategy, and technology.
- Tools that can be used here include Porters Value Chain
and the McKinseys 7s model.

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Business Process Re-engineering

This is 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 spread. BPR is aimed at improved
customer satisfaction.

Staff Empowerment
- the delegation of certain aspects of business
decisions to those lower down in the hierarchy.
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Information
Important Issues
Sources: Internal and External
Costs of information
Quantitative & Qualitative data
Qualities of good information ACCURATE
accurate, complete, cost<benefit,
understandable, relevant, adaptable to
user needs, timely, easy to use.
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Behavioural Aspects of Performance Management

Performance Measures & Human Resource Mgt (HRM)
HRM is the strategic and coherent approach to the
management of the people working in an organisation,
who individually and collectively contribute to the
achievement of its objectives for sustainable competitive
advantage.

Theories of HRM:
a. The Vroom expectancy model
force = valence x expectancy
b. Agency theory

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Behavioural Aspects of Performance Management

Important Issues:
- Relationship between performance management and
performance measurement
- Performance measurement and reward systems
Methods of Reward:
1. Basic pay
2. Performance-related pay
3. Benefits

- Wrong signals and inappropriate action

misrepresentation, gaming, misinterpretation, shorttermism, measure fixation, tunnel vision, suboptimisation, ossification.
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Behavioural Aspects of Performance Management

Management styles of performance appraisal- Budget constrained style
- Profit-conscious style
- Non-accounting style

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Financial Performance Measures in

the Private Sector
The primary objective of profit-seeking organisations is
maximisation of shareholder wealth. This further broken
down into profit, survival, and growth.
Growth can be identified in the following ways:
Financial: profitability, revenue, return on investment, cash
flow

Non-Financial: market share, number of employees,

number of products
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Financial Performance Measures in the Private Sector

-

ROCE
- EPS
EBITDA
- NPV
IRR
- MIRR
Liquidity & Gearing Ratios

ROCE is a measure of profitability

ROCE =
Net profit
x 100
Capital employed
Merits
Demerits
-Easily understood by shareholders.
-Figures are readily available.
-Measures how well a business is
using investors funds

-Research shows poor correlation

between ROCE and shareholder value.
-Care must be taken to compare like
with like
-Can be gamed using certain
accounting treatments.

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Financial Performance Measures in the Private Sector

EPS is a measure of the profit attributable to each
ordinary share.
EPS =
profit after tax less preference dividends
weighted average number of ordinary shares outstanding
Classwork:
ABC Ltd. share capital is as follows:
ordinary shares ($1 each)
6% preference shares

$2,000,000
$ 500,000

ABCs profits before tax were $1,800,000. Tax rate is 32%.

Required:
Calculate ABCs EPS.
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Financial Performance Measures in the Private Sector

EPS contd.
Merits
-Easily understood by shareholders.
-Figures are readily available.

-Calculation precisely defined, avoiding

ambiguity.

Demerits
-Research shows poor correlation
between EPS and shareholder value.
-Can be gamed using certain
accounting treatment.

EBITDA
Earnings before interest, tax, depreciation and amortization
Merits
Demerits
-Easy to calculate and understand.
-It is a proxy for cash flow from
operations

-Ignores changes in working capital

and its impact on cash flow
-Can be gamed using certain
accounting treatment.
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Financial Performance Measures in the Private Sector

Liquidity ratios:
- Current ratio
- Quick ratio (acid test)
- Raw material period
= (ave. value of raw materials/purchases) x 365
- WIP period = (ave. value of WIP/cost of sales) x 365
- Receivables period = (ave. receivables/sales) x 365
- Payables period = (ave. payables/purchases) x 365

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Financial Performance Measures in the Private Sector

Gearing ratios:
- Gearing = (long-term debt/shareholder funds) x 100% or
- Gearing =
long-term debt
x 100%
long-term debt + shareholder funds
Interest cover = PBIT/interest charges

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Financial Performance Measures in the Private Sector

Ways to reduce short termism:
- Use both financial and non-financial measures
- Switch from a budget-constrained style to a profitconscious or non-accounting style
- Use share options
- Use bonuses linked to profits
- Use NPV to appraise investments
- Reduce decentralisation
- Use value-based techniques.

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Divisional Performance Appraisal and Transfer Pricing

Problems associated with a divisional structure:

- Co-ordination difficulties
- Goal congruence
- Inter-dependence of divisions
- Head office costs
- Transfer prices
- Controllability
Types of divisions
- Cost centre incurs costs, no revenue stream
- Profit Centre incurs costs, has revenues, manager
has no investment authority
- Investment Centre has costs, revenues, and
investment authority

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Divisional Performance Appraisal and Transfer Pricing

- Return on Investment (ROI)

ROI =
PBIT
x 100
capital employed
ROI is the divisional equivalent of ROCE.
Decision rule: If ROI > cost of capital (required return),
accept the project.
Advantages
1. Widely used & accepted

Disadvantages

1. May lead to dysfunctional

decision making
2. Relative measure can be 2. Different accounting
used for divisions of diff sizes policies can distort comparisons
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Divisional Performance Appraisal and Transfer Pricing

Residual Income
PBIT
less imputed interest (capital employed x cost of capital)
RI

x
(x)
x

Decision Rule: accept the project if RI is positive

Advantages
1. Reduces problems of ROI

Disadvantages

1. Difficult to decide right cost

of capital
2. Divisional managers are made 2. Not relative and so sizeaware of the cost of financing
dependent

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Divisional Performance Appraisal and Transfer Pricing

Economic Value Added (EVA)

EVA = NOPAT less (capital employed x WACC)
Advantages
1. Should not lead to dysfunctional behaviour because it
is consistent with NPV.
2. Based on cash flows, and so, less distorted by chosen
accounting policies.
Disadvantages
1. Many assumptions
2. Ignores items such as brands and goodwill
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Divisional Performance Appraisal and Transfer Pricing

Classwork:
Division XYZ of a company has a PBIT of $25m. This PBIT
is after a $5m charge for the launch of a new product
expected to have a life of 5 years.
XYZs non-current assets (NCAs) are valued at $75m and
net current assets $28m. The replacement cost of
NCAs is estimated to be $80m.
The companys WACC and tax rate are 10% and 30%,
respectively.

Required: Calculate XYZs WACC.

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Divisional Performance Appraisal and Transfer Pricing

Models used in divisional performance appraisal

Ansoffs matrix:

Existing Products
Protect/Build

New Products
Product devt.

Existing Markets

Mkt. developmnt Diversification

New Markets

Relative market share

High
Low

BCG matrix:

Star

Problem child

High
Market
Growth
Cash cow

Dog

Low

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Divisional Performance Appraisal and Transfer Pricing

Transfer Pricing: 3 scenarios

Scenario 1: perfectly competitive market for product/service
Transfer price = market price less any cost saving due to
transfer (e.g. packaging & carriage costs)
Scenario 2: the selling division has surplus capacity
Transfer price = marginal cost (less any savings), so long
as the total is less than the external purchase price
Scenario 3: the selling division has no surplus capacity
Transfer price = marginal cost (less any savings) + lost
contribution from other product, so long as the total is
less than the external purchase price
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Divisional Performance Appraisal and Transfer Pricing

Treatment of fixed costs: In transfer pricing, standard

costs are best used and fixed costs are treated as
lump sums. This is to prevent the selling division from
transferring the cost of slack to the buying division.
In summary, fairness has to be maintained in fixing
transfer prices.

Classwork:

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Performance Management in
Not-For-Profit Organisations (NFPO)
Problems associated with performance
measurement in NFPOs
1.

Non-quantifiable costs and benefits

- no readily available scale exists
- time scale problems
- how to trade off cost & benefits measured differently
- externalities
solution = cost-benefit analysis

2.

Assessing the use of funds

solution = assess value for money
use the 3Es in the VFM assessment

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Performance Management in
Not-For-Profit Organisations (NFPO)
3. Multiple and diverse objectives
Solution = problem can be overcome by prioritizing
objectives or making compromises between
objectives.
4. Impact of politics on performance measurement

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Non-financial performance indicators

and corporate failure
Know typical NFPIs for
-

Competitiveness
Activity
Productivity
Quality of service
Customer satisfaction
Quality of working life
Innovation
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Non-financial performance indicators

and corporate failure
Models for evaluating financial and non-financial
performance
- Balanced Scorecard
- Performance pyramid
- Building Block Model

44

Balanced Scorecard:
- Customer perspective
- Financial perspective
- Internal business process
- Innovation & learning
Within each of these perspectives a business
should seek to identify a series of goals (CSFs)
and measures (KPIs).

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Performance Pyramid
Corporate
Vision

Market
Customer

Financial

Divisions/SBUs

Business operating
systems

Flexibility

Satisfaction

Productivity
Cycle

Quality

Delivery

External effectiveness

time

Departments
Waste

Internal efficiency

- One drawback of the performance pyramid is that it does tend to

concentrate on two groups of stakeholders shareholders and customers.
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Building Block Model

Dimension
Competitiveness
Financial performance
Quality of service

Flexibility
Resource utilization
Innovation

Standards

Measures

Ownership

Clarity

Achievability

Motivation

Fairness

Controllability

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Corporate Failure
Reasons for corporate failure:
- Failing to adapt to changes in the environment
- Strategic drift
Assessing the likelihood of failure:
Red flags- poor cash flow
- lack of financial controls
- internal rivalry
- general economic conditions
- loss of key personnel
- lack of new production/service introduction
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Corporate failure prediction models

Altmans Z-score:
z-score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
where:
X1 = working capital/total assets
X2 = retained earnings/total assets
X3 = EBIT/total assets
X4 = market value of equity/total liabilities
X5 = sales/total assets
Decision rule:

Less than 1.81 :- impending failure

1.81 2.99 :need further investigation
3.0 and above:- financially sound
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Argentis A score
- Defects management weaknesses
- Mistakes high gearing, overtrading, failure of
big project
- Symptoms of failure deteriorating ratios or
creative accounting
Decision rule: If the overall score is more than 25, the
company has many of the signs preceding failure and is
therefore a cause for concern.
Know:
Limitations of qualitative & quantitaive models for predicting
corporate failure.
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Current developments in
performance management

Six sigma
Kaizen costing
Target costing
Just-in-time
Total quality management
Quality assurance, control and management
- Quality-related costs prevention, internal & external
failure costs, and appraisal costs

Performance prism
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