Performance measures
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Topic: Performance measures,
Essex is an industrial company with three divisions. Both the Midland Division and the North Division are long established. Senior managers are concerned that these divisions have a high percentage of products that are near the end of their product life-cycle. Forecast sales increases over the next 5 years is expected to be in the region of 4-5% per annum.
The East Division was acquired in 1999 and senior managers are optimistic that this division has very good growth potential. Most of the senior managers at this division have experience of working at the other divisions.
Since 1999 the head office has ranked all divisions according to return on investment (ROI) and residual income (RI). All managers believe that the rankings are important for future promotions and career development.
A small number of other performance measures are also used by managers. These include
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1.
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Non-productive time: Non-productive direct labour hours (percentage of total hours paid). Non-productive time includes time wasted as a result of production delays or material shortages.
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2.
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Customers: Customer complaints (percentage of total number of customers)
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3.
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Lead time: Time from order to delivery
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These performance measures were agreed by all managers in 1999. At the time it was thought that managers should focus on only a small number of measures.
2002
The managers at the divisions provided the following information for the head office.
Selected data from the budgeted Management Accounts to 31 December 2002
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Midland Division
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Northern Division
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East Division
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£
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£
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Sales
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1,580,000
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1,560,000
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1,112,000
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Cost data
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Controllable cost of goods sold
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650,000
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620,000
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380,000
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Non -controllable cost of goods sold
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116,000
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115,000
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100,000
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Controllable Selling general & Administrative overheads
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370,000
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400,000
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370,000
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Non-controllable Selling general & Administrative overheads
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250,000
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250,000
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162,000
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Total costs
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1,386,000
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1,385,000
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1,012,000
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Capital employed
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Total investment
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1,400,000
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1,440,000
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850,000
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Controllable investment
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1,200,000
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1,111,000
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800,000
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Sales growth 2003
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4.80%
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5.20%
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28.00%
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Sales growth 2004
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4.30%
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5.10%
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37.00%
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1,580,000
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1,560,000
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1,112,000
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Other measures
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Midland Division
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Northern Division
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East Division
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Non-productive time: Non-productive direct labour hours (percentage of total hours paid).
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2001
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4%
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4%
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6%
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2002
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4.1%
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3.8%
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7.5%
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Customer complaints (percentage of total number of customers)
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2001
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1%
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1.2%
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5%
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2002
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1.1%
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1.1%
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6%
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Lead time: Time from order to delivery
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2001
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10 days
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9 days
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15 days
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2002
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11 days
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9 days
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18 days
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The head office has estimated that the group cost of capital is 10%
Ranking divisions in 2000
In 2000 the data on controllable and non-controllable costs and investments will be used to rank divisions.
Questions
Question 1
Based on the data provided comment on the relative financial performance of the two divisions and discuss how the ranking of the divisions changes if controllable and non-controllable costs and capital employed are analysed.
Question 2
Evaluate the choice of performance measures for the 3 divisions
Question 3
Identify and evaluate the difficulties faced by managers when measuring capital employed for a division.
Question 4
Discuss how using ROI can result in managers making poor investment decisions.
Question 5
Discuss the particular problems multinational companies have when evaluating the performance of divisions.
Answers
(a) See spreadsheet
(b) What assets are included - how are they valued
What assets are not controllable
What assets are idle
Should liabilities be included or excluded
Gross book value or net book value or market value
Cost of getting information for market values
(c) Behavioural problems
Examples of division with high ROI rejects good investment because ROI not quite as good. Lowers overall ROI
Company with low ROI accepts investment which improves overall ROI but gives return below cost of capital.
(d) Currency translation – manager uses local currency but head office wants results in home currency.
Changes is exchange rate can make manager look good or bad.
Problems of criticising manager for decline in exchange rate
Cultural and language barriers – limits to number of foreign managers!
Income taxes
Complicated reporting requirements
Volume of reports
Relative inflation
Legal differences can complicate evaluation
Import duties / tariffs
Management charges
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