INTRODUCTIONPerformance Evaluation dealswith measurement and monitoring of management budgets and targets againstactual results to establish how well the organization and its staffs arefunctioning as whole and as individual.Performance Evaluation canrelate to short term objectives e.g. Cost Control or long term objectives e.g.Customer Satisfaction.
The short term objectives will enable the organizationto monitor progression towards the ultimate long term objectives and to enable performanceof employees to be measured along the way.However the objectives or goals to measure performance may varydepending on the type of the organization that is being operated. Example;-a) A Profit Making Organization the overall goals is forshareholders wealth maximization, therefore such company will monitor theProfitability and Market share compare to competitors.
b) For Non Profit Making Organization e.g. Government; theoverall objectives is to provide better services to the public.Performance measurement aims to establish how well an organization orits personnel is doing. It is about how organizations measure the quality oftheir activities and services, and is a vital part of the control process.
As amanagement accountant, you have to be able to identify a suitable performancemeasure for a department, a person or an organization.Performance measure is termed as a key performance indicator (KPI). KPIcan be separated into Financial Performance Indicators and Non-FinancialPerformance Indicators.SUITABLE FINANCIAL PERFORMANCEMEASURESAn organization should set asuitable financial performance measures in order to monitor the achievement ofeach objectives. These suitable performance measures may include;(a) Strategic – Measurement of overallprofitability of the organization and return made on investing surplus funds.Return on Investment (ROI), Return on Sales etc.
(b) Tactical – Comparison of actual costsand revenues with the budgeted costs and revenues for each business division ordepartment. Actual profit with the budgeted produced monthly.(c) Operational – Measurement of day to daytargets such as meeting production requirements, meeting sales targets andreducing wastage. Quality of rejects, number of customer complaints produceddaily.
EXTERNAL FACTORS AFFECTINGPERFORMANCE MEASUREMENTExternal factors may be an important influence on the ability of theorganization to achieve objectives. Particularly, market condition andgovernment policy are the factors that the organization’s management will notbe able to control and will need to be carefully monitored to ensure forecastsremain accurate.Economics and MarketconditionsThe economics and market conditions may led to the deteriorated orimprovement of the management performance. Also the action of competitorssometimes may be considered, for example; demand of the company’s products maydecrease if a competitor reduces its prices or launches a successfuladvertising campaign.
Government regulation The government regulation has a direct impact to the management’sperformance by introducing regulations or by having agencies that monitororganization activity may led to the deteriorated or improvement of themanagement performance. Example, Fines and Quota – maximum quota are set tolimit production or importation and if exceed fines are imposed. E.g.
thegovernment has set the quota on importation of sugar so that to protect localindustries, by exceeding the authorized quantity then fines are imposed. If the organization isaffected by government regulation then the performance measures should betaken. The measurement and evaluationof financial performance are central to control the affairs of an organization.Performance measurement can be sub-divided into financial measures andnon-financial measures.FINANCIAL PERFORMANCE MEASURESFinancial measures used tomonitor revenues and costs and overall management of funds in the organization.These measures focus on information available from Income statement andStatement of financial position of an organization.It can be used to records the performance of Cost centres, Profitcentres and Investment Centres within a responsibility accounting system but itcan also be used to assess the overall performance of the organization. Profitability MeasuresThe primary objective ofProfit Making Organization is to maximize profitability.
A business needs togenerate profits to be able to provide returns to investors and to be able togrow and made expansion of its operation by re-investing into the business. The major ratios used to monitor the achievements of this objective are;a) Return on Capital Employed (ROCE)= Earnings before interestand tax x 100% Capital Employed b) Return on Sales (ROS)= Net profit x 100% Sales c) Gross Profit Margin= Gross profit x 100% Sales d) Return on shareholder’s equity (ROE)= Earnings after tax x100%Total shareholder’s funds LiquidityMeasuresAn organization can beprofitable but at the same time may face liquidity problems. The liquiditymeasures ability of the company to meet short term obligation as the fall due.There are two major liquidity ratios that used to measure ability of thecompany to meet short term financial obligation.a) Current ratio= Current Assets Current Liabilities The ratio that being equal or exceed 2:1 is desirablebut the expected ratio varies depending on the type of the industry.
E.g.Banking Industry should be more liquidity as the customer may demand his savingat any time. b) Acid test (Quick ratio)= Liquid Assets Current liabilities The liquid Assets are those current assets that arenear to cash money or quick to pay liability by cash without losing theoriginal value. Liquid assets are total current assets excluding Inventoriesand Prepayments. If the ratio is 1:1 or above then the liquidity position ofthe company is said to be desirable. Activity MeasuresActivity measures theefficiency of the company to generate returns.
It looks on how well a businessmanages to convert statement of financial position items into cash.a) Assets Turnover= Total Assets Sales Revenue It measures the contribution of assets to generaterevenue. It answers the question; Does the company’s assets managed efficientlyto generate revenue. b) Inventories Days= Average Inventories x365 Days Cost of sales Measure number of days hastaken to sale the inventories. c) Receivables Days= Average Receivables x365 Days Credit sales Risk MeasuresIt is important for the company to manage risks as it managesprofitability, liquidity and efficiency. How ‘geared’ a company is can bedetermined to assess financial risk. Gearing/Leverage indicates how well thecompany will be able to meet its long term debts.
a) Debt Ratio= Total Debts x 100% Total Assets b) Debt to Equity Ratio= Total Debts x 100% Total Shareholder’s funds NONFINANCIAL PERFORMANCE MEASURESAlthough profit cannot be ignored as the first objectives of ProfitMaking Organization, critical success factors (CSFs) and Key PerformanceIndicators (KPIs) should not focus only on profit alone. The view is that arange of performance indicators should be used and these should be a mix offinancial and non financial measures.Exampleof Non Financial Performance Measures includes;a) Measurements of customers’ satisfaction e.
g. returningcustomers, reduction in complaints.b) Resource utilization e.g. the machine being operatedfor all available hours and producing outputs as efficiently as possible.c) Measurements of quality e.g.
reduction of conformanceand non-conformance costs. The large variety in types ofbusinesses means that there are many Non financial performance indicators. Eachbusiness will have its own set of non financial performance indicators thatprovides relevant measures of the success of the business. However nonfinancial performance measures can be grouped together into two broad groups;1) Productivity2) Quality Productivity A productivity measure is a measure of efficiency of an operation; it isalso referred to as resource utilization.
It relates the goods or servicesproduced to the resources used, and therefore ultimately the cost incurred toproduce the output. The most productive operation is one that produce themaximum output for any given set of resources inputs or alternatively uses theminimum inputs for any given quantity or quality of output.Typeof Productivity MeasuresProductivity measures are usually given in term of labour efficiency.However productivity measures are not restricted to labour and can also beexpressed in terms of other resource input of the organization such as themachine hours used for production.Productivitymeasures often analyzed using three control ratios;a) Production – Volume Ratio This ratio assesses the overallproduction relative to the budget. A ratio is excess of 100% indicates thatoverall production is above budgeted levels and below 100% indicates ashortfall compared to budget.Formula: = Actual Output Measured in Standard Hours x 100% Budgeted Production Hours b) Capacity RatioThis provides information interms of hours of working time that has been possible in the period.
A ratio inexcess 100% indicates that more hours have been worked than were in the budget andbelow 100% fewer hours have been worked than in the budget.Formula: = Actual Production Hours Worked x 100% BudgetedProduction Hours c) Efficiency RatioThis is useful indicator ofproductivity based on output compared with inputs. A ratio in excess 100%indicates that the workforce have been more efficient than the budget predictedand below 100% less efficient than in the budget predicted.
Formula: = Actual Output Measured in Standard Hours x 100% ActualProduction Hours Worked QualityQuality is an issue whethermanufacturing products or providing a service. Poor quality products orservices will leads to a loss of business and damage to the businessesreputation. Targets of an appropriate level need to be set. Example of NonFinancial Performance Indicators that could be used to monitor quality bothfrom an internal and external perspective include:a) Customer complaintsb) Speed of deliveryc) Accuracy of deliveryd) Staff absencese) Overtime workingf) CleanlinessEVALUATION OF RESULTS BASED ONBUSINESS OBJECTIVESBusiness ObjectivesBusiness objectives should bein line with the mission statement of the organization.
The major business objectives of most oforganizations include;a) Profitabilityb) Survivalc) Customer Satisfactiond) Employees Retentione) Maximization of Shareholder ValueAn organization may develop various strategies to achieve businessobjectives. At the time that objectives are identified, the following stage isto break down each objective into action plans. Action plans must be small andmanageable projects so that they can be accomplished in time.
Evaluation of Business ResultsEvaluation of performance ofany organization is the fundamental practice to assist in early identificationof potential problems and used to determine both positive and negative trendsin company’s operations. When the evaluation process is completed then themanagement needs to focus on improving business performance to ensure that thebusiness is in line with the recommendations from the evaluation. Generally, the financialbusiness results can be measured by;a) Profitability measuresb) Cash flow, liquidity and solvency measuresc) Efficiency measuresd) Risk measures Actiontaken by management to achieve business objectiveBased on the evaluation ofbusiness results, the management may be required to take action to achievetheir objectives. This is mostly required especially where objectives arechanging.
Normally, taking action is not as easy as in theories. Therefore thefirst step the management has to ensure that the approaches used is in theright place. They should know what they want to achieve and how will beachieved. Other steps to be followed include:i. Setting goals and deadlinesii.
Structuring time frame to achieve the goal, andiii. Being flexible to adopt changesTHE BALANCED SCORECARD METHODTo ensure an effective systemof performance appraisal a business should use a combination of financial andnon financial measures. One of the major developments in performancemeasurement techniques that have been widely adopted is the balanced scorecard.The concept of BalancedScorecard was developed by Kaplan and Norton in 1994 at Harvard.
BalancedScorecard is the device for planning that enables managers to set the range ofbudgets linked with appropriate objectives and performance measures. It definesthe mission, outlining the strategies to achieve the mission, understanding themajor customer requirement, defines the internal business process and assessingthe organizational infrastructure needed to achieve the objectives.The balanced scorecard is a useful approach for a complete strategicperformance evaluation is to include both financial and non financial factorsfor the organization. It measures an organization’s performance in four (4)major key areas;-a) Customer SatisfactionThis is an attempt to measures the customers view of the organization bymeasuring customer satisfaction.b) Financial PerformanceThis focuses on satisfying shareholders value. Appropriate performancemeasures include; Return on Capital Employed (ROCE) and Return on Shareholders’Funds.c) Internal Business ProcessThis aimed to measure the organization’s output in term of technicalexcellence and customer needs.
d) Learning and GrowthThis focuses on the need forcontinual improvement of existing products and techniques and developing newones to meet customers’ changing needs. Sources: Lean Management Programme: A managementSystem Built for Purpose (lean.org.za)EVALUATION ON THE USES OFVALUE FOR MONEY (VFM) TECHNIQUES IN PERFORMANCE MANAGEMENTGenerally value for money (VFM) signifies the following three elementsrelating to the internal operations of an organization and its use for money;a) Economy (Input)This implies the principle of prudence.
b) Efficiency (Process)This is concerned with the relationship between the input and output ofgoods, services or other outcomes.c) Effectiveness (Output)This is concerned with the relationship between the planned outcomes andactual outcomes of projects, programmes or other activities.It is very important to notethat, regardless of the type and nature of the organization, the basicassessment techniques of Economy, Efficiency and Effectiveness remain the same.These three measures may sometimes conflicts each other but may also complementeach other. STAKEHOLDER BASED MEASURES OF PERFORMANCE THAT MAY BE USED TOEVALUATE SOCIAL OR ENVIRONMENTAL PERFORMANCE OF THE BUSINESSStakeholders are the peoplewho have an interest on the operation of a particular company. Any decisionsmade by the organization are likely to affect their interest either positivelyor negatively.
The major stakeholders of any organization include;i. Board of Directorsii. Existing and Prospective Shareholdersiii. Money Lendersiv. Customers v. Competitors, andvi. Suppliers Stakeholders based measure ofperformanceThe stakeholders’ approach ofdeveloping the model of performance measurement captures strategic planningissues.
They can determine the organization’s performance through measures likeBalanced Scorecard, Economic Value Added (EVA), Shareholder Value Added (SVA)and the environmental and social reporting of such organization. How the transfer prices candistort the performance evaluation of divisions and decision madeTransfer pricing is the set of mechanisms which is used to attach pricesto the goods or services which are traded between two divisions of the samecompany. The transfer price is the price one division charges for a product orservices supplied to another division of the same organization. The goods whichare transferred in this way are called the intermediate product.In order to make performanceevaluation of the divisions useful, the ‘Selling Division’ should be creditedwith the revenue for the products and services transferred.
By the same amountthe ‘Buying Division’ needs to be charged with the expense of using the goodsor service supplied by the ‘Selling Division’. Where interdivisional transfersrepresent a large part of the total sales or purchases of a division, transferpricing is a very important issue. Any small change in the transfer price ofthe product transferred may result into large changes in profits for thedivision concerned.The performances of divisionalmanagers are often assessed according to the profits generated by the division concerned.Accordingly, setting transfer price can become a sensitive issue betweendivisional managers to make decisions which are in the interest of theirdivision but which are not in the interest of the business as a whole.
Effect of Transfer pricingmethods on the divisional performance1. Cost-Based MethodUnder this method, management needs to be careful in determine theefficiency of the transferor division. If the transferor division works lessefficiently, this inefficiently will be transferred to the transferee divisionand will ultimately affect its performance.2.
Market Price MethodThis method achieve most of the objectives of transfer pricing such asgoals congruence, divisional autonomy etc. This method does not favour anydivision. The transfer division has the freedom either to sell the product tothe transferee division or in the external market. On other hand, thetransferee division has the freedom either to purchase from outside or from thetransferor division.3.
Negotiated Price MethodUnder this method, divisionwhich have good bargaining skills will be at an advantage. Accordingly, thismethod does not present a rational transfer price and leads to distortedperformance levels for the division involved in the transfer of products.