Balanced Scorecard Striking the Right Balance

What is a Balanced Scorecard?

Strategic Management Tool

Performance Management Framework

The Balanced Scorecard was first introduced in the 1990s through the work of Robert Kaplan and David Norton of the Harvard Business School.

Measures support change, not monitoring

Framework for communicating strategy in operating terms

Concept for measuring whether the small-scale operational activities of a company are aligned with its large-scale objectives in terms of vision and strategy
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A question of balance?

Customer perspective Corrective activity Developmental activity Balancing compliance with added value Financial Measures Key performance ratios Financial health Balancing leading with trailing indicators Business Processes Time, cost, quality Balancing inputs and outputs

Balanced Scorecard

Learning and growth People measures Knowledge measures Balancing soft and hard indicators
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Benefits of Balanced Scorecard

Benefits of Balanced Scorecard

Strategic initiatives that follow "best practices" methodologies Leads to increased Creativity and Unexpected Ideas Helps align key performance measures with strategy at all levels Provides management with a comprehensive picture of business operations Facilitates communication and understanding of business goals & strategies Usable Results - Transforms strategy into action and desired behaviors Provides strategic feedback and learning Initiatives are continually measured and evaluated against industry standards Improved organization alignment The Balanced Scorecard provides an effective way of communicating priorities to all levels of organization, then all employees can see and understand how their work is related to the business and its success as a whole

Financial perspective of Balanced Scorecard

Financial Perspective

Meaning & importance of Financial Perspective

Financial perspective looks at how the businesss strategy is affecting the bottom-line By including this perspective it shows that Kaplan and Norton have not turned away from the need for financial data, but instead have incorporated it into a measurement and strategy model that includes a more holistic view of the organization's business strategies As per Kaplan and Norton, "Assertions that financial measures are unnecessary are incorrect []." In fact, those who do not integrate all four perspectives into their strategic vision may be doomed to failure

Typical parameters of a Financial Perspective

Return on Capital Employed

Net income

Return on Assets

Financial Perspective

Free Cash Flow

Operating Profit Margin

Current ratio

Break-even

Return on Capital Employed (ROCE)

ROCE is used as a measure of the Returns that a company is realizing from its capital employed It is used comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital Different authors use different definitions for ROCE. A common definition of ROCE is:

In the numerator we have Pretax Operating Profit or Operating Income. In the denominator is Capital Employed or Net Assets , which, in general, is the Capital Investment necessary for a business to function It is commonly represented as Total Assets Less Current Liabilities or Fixed Assets Plus Working Capital
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Return on Capital Employed (ROCE)

Name of Company A B

Profit (in $) 100 150

Sales (in $) 1,000 1,000

Profit Margin (%) 10 15

Capital Employed 500 1,000

ROCE (in %) 20 15

A has a ROCE of 20% [100/500] while B has an ROCE of only 15% [150/1,000] The ROCE measurements show us that Company A makes better use of its capital In other words, it is able to squeeze more earnings out of every dollar of capital it employs A high ROCE indicates that a larger chunk of profits can be invested back into the company for the benefit of shareholders The reinvested capital is employed again at a higher rate of return, which helps to produce higher earnings-per-share growth A high ROCE is, therefore, a sign of a successful growth company

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Net Income (NI)

Net income is equal to the income that a firm has after deducting costs and expenses from the Total Revenue Net Income post payment of applicable taxes is referred to as Profit After Tax (PAT) PAT can be distributed among holders of common stock as a dividend or held by the firm as retained earnings Often referred to as "the bottom line" since net income is listed at the bottom of the income statement In the U.K., net income is known as "profit attributable to shareholders" Net income or Net loss = Revenue Cost of goods sold Sales discounts Sales returns and allowances Expenses Minority interest Preferred stock dividend Net income is more meaningfully expressed on a per-share basis and Net Income per share (better known as "earnings per share," or EPS) is perhaps the most important measure of a company's success Net Income is a somewhat artificial figure that doesn't reveal the actual amount of cash the company generated from operations
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Net Income (NI)

Revenue Cost of Goods Sold General & Administrative Depreciation Interest Expense Interest Income Taxes Preferred Dividends

$1,000,000 $500,000 $300,000 $100,000 $5,000 $1,000 $10,000 $10,000

Using the formula and the information, we can calculate Companys Net Income as follows: $1,000,000 - $500,000 - $300,000 $100,000 - $5,000 + $1,000 - $10,000 $10,000 = $76,000 Note: The outcome of Net Income is greatly influenced by the accounting policies used by the Company.

It is important to understand that net income is not a measure of how much cash a company earned during a given period. This is because the income statement, and hence net income, typically includes a host of non-cash expenses such as depreciation and amortization.
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Cash Flow

A cash flow statement is a financial statement that shows a company's flow of cash The money coming into the business is called Cash Inflow and money going out from the business is called Cash Outflow The statement shows how changes in Balance Sheet and Income Accounts affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities

As an analytical tool, the statement of cash flows is useful in determining the shortterm viability of a company, particularly its ability to pay bills International Accounting Standard 7 (IAS 7) is standard that deals with cash flow statements International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB) The Institute of Chartered Accountants of India (ICAI) has decided to fully converge with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board for accounting periods commencing on or after April 1, 2011.
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Cash Flow

Cash flow information enables users to develop models to assess and compare the present value of the future cash flows of different enterprises The cash flow statement is a cash basis report on three types of activities: Operating activities, Investing activities, and Financing activities Cash Flow from Operating activities: Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the enterprise Examples of cash flows from operating activities are: cash receipts from the sale of goods and the rendering of services; cash receipts from royalties, fees, commissions and other revenue; cash payments to suppliers for goods and services; cash payments to and on behalf of employees; cash receipts and cash payments of an insurance enterprise, cash payments or refunds of income taxes cash receipts and payments relating to futures contracts, forward contracts, option contracts and swap contracts when the contracts are held for dealing or trading purposes
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Cash Flow

Cash Flow from Investing activities: Cash flows from investing activities represent the extent to which expenditures have been made for resources intended to generate future income and cash flows Examples of cash flows from Investing activities are: cash payments to acquire fixed assets (including intangibles) cash receipts from disposal of fixed assets (including intangibles); cash payments to acquire / cash receipts from disposal of shares, warrants or debt instruments of other enterprises and interests in joint ventures cash payments / receipts for futures contracts, forward contracts, option contracts and swap contracts

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Cash Flow

Cash Flow from Financing activities: The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise

Examples of cash flows from Financing activities are: cash proceeds from issuing shares or other similar instruments; cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings; and cash repayments of amounts borrowed

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Cash Flow

Methods of reporting cash flow: (a) the Direct Method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) the Indirect Method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows

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Break Even Analysis

The break-even point for a product is the point where total revenue received equals the total costs associated with the sale of the product (TR=TC) A break-even point is typically calculated in order for businesses to determine if it would be profitable to sell a proposed product Break-even quantity is calculated by: Total fixed costs / (selling price - average variable costs) Lets take an example: Assume that the selling price of a product is $2 each and the variable cost associated with producing and selling the product is 60 cents Assume that the fixed cost related to the product (the basic costs that are incurred in operating the business even if no product is produced) is $1000 In this example, the firm would have to sell [1000/(2.00 - 0.60) = 715] 715 units to break even At Break even point, TR = TC. Let P = Selling Price and Q = Quantity Sold. P*Q = TFC + V * Q Let V = Variable cost and TFC = Total Fixed cost P * Q V * Q = TFC (P V) * Q = TFC Q = TFC / (P V)
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Break Even Analysis - Limitations

Break-even analysis is only a supply side (ie.: costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices It assumes that Fixed Costs (FC) are constant It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales (i.e. linearity) It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period) In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant) Margin of Safety: In break-even analysis, margin of safety is how much output or sales level can fall before a business reaches its break-even point (BEP) Margin of safety = ((Budgeted sales - break-even sales) /Budgeted sales) x 100%

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Current Ratio

A financial ratio or accounting ratio is a ratio of selected values on an enterprise's financial statements Current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It is also known as "liquidity ratio", "cash asset ratio" and "cash ratio" It compares a firm's current assets to its current liabilities. It is expressed as follows: Current Ratio = Current Assets / Current Liabilities A Current Ratio of Assets to Liabilities of 2:1 is usually considered to be acceptable (ie., your assets are twice your liabilities) If Current Liabilities exceed Current Assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations If the current ratio is too high, then the company may not be efficiently using its current assets

Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices There is no world-wide standard for calculating the summary data presented in all financial statements, and terminology is not always consistent between companies, industries, countries and time periods
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Operating Profit Margin

The Operating Profit Margin can be expressed as = (Profit Margin) divided by (Total Revenues) It is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials, etc. Operating margin gives analysts an idea of how much a company makes (before interest and taxes) on each Rupee of sales The Operating Profit Margin indicates a firms effectiveness at controlling the costs and expenses associated with their normal business operations When looking at operating margin to determine the quality of a company, it is best to look at the change in operating margin over time and to compare the company's yearly or quarterly figures to those of its competitors If a company's margin is increasing, it is earning more per Rupee of sales The higher the margin, the better For example, if a company has an operating margin of 12%, this means that it makes INR 0.12 (before interest and taxes) for every rupee of sales
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Return On Assets - ROA

ROA gives an idea as to how efficient management is at using its assets to generate earnings Calculated by dividing a company's annual earnings** by its total assets, ROA is displayed as a percentage (** After Tax income) The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income The higher the ROA number, the better, because the company is earning more money on less investment For example, if one company has a net income of $1 million and total assets of $5 million, its ROA is 20%; however, if another company earns the same amount but has total assets of $10 million, it has an ROA of 10% Based on this example, the first company is better at converting its investment into profit If a company has no debt, then Return on Assets and Return on Equity figures will be the same
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Return On Assets - ROA

Companies such as telecommunication providers, car manufacturers and railroads are very asset-intensive, meaning they require big, expensive machinery or equipment to generate a profit Advertising agencies and software companies, on the other hand, are generally very asset-light There are two acceptable ways to calculate return on assets: Option 1: Net Profit Margin x Asset Turnover Option 2: Net income divided by Average Assets for the Period Under Option 1: To calculate Net Profit Margin divide the Net Income by the Total Revenue To calculate asset turnover, divide the Total Revenue by Avg. Assets for the period
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Parting thought.....

"Life is like riding a bicycle. To keep your balance you must keep moving." Albert Einstein

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