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Questions and Answers
Which of the following metrics is a lead indicator related to the financial perspective within a Balanced Scorecard framework?
Which of the following metrics is a lead indicator related to the financial perspective within a Balanced Scorecard framework?
A company aims to improve its internal business processes to enhance customer satisfaction and shareholder value. Which outcome measure within the internal business process perspective would directly reflect this improvement?
A company aims to improve its internal business processes to enhance customer satisfaction and shareholder value. Which outcome measure within the internal business process perspective would directly reflect this improvement?
What primary aspect does the 'Learning and Growth' perspective of the Balanced Scorecard focus on within an organization?
What primary aspect does the 'Learning and Growth' perspective of the Balanced Scorecard focus on within an organization?
Which of the following is a key difference between Return on Investment (ROI) and Economic Value Added (EVA)?
Which of the following is a key difference between Return on Investment (ROI) and Economic Value Added (EVA)?
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In the context of the Balanced Scorecard, which perspective directly addresses the question of how well the company is leveraging its internal resources and processes to achieve efficiency and effectiveness?
In the context of the Balanced Scorecard, which perspective directly addresses the question of how well the company is leveraging its internal resources and processes to achieve efficiency and effectiveness?
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Which of the following is the correct formula for calculating Return on Investment (ROI)?
Which of the following is the correct formula for calculating Return on Investment (ROI)?
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A company aims to improve its ROI. Which of the following strategies would directly contribute to this goal?
A company aims to improve its ROI. Which of the following strategies would directly contribute to this goal?
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Which of the following describes 'investment turnover'?
Which of the following describes 'investment turnover'?
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What is a potential disadvantage of solely focusing on improving ROI in the short term?
What is a potential disadvantage of solely focusing on improving ROI in the short term?
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Which of the following is an advantage of using ROI as a performance measure?
Which of the following is an advantage of using ROI as a performance measure?
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Which of the following actions would NOT typically improve a company's Economic Value Added (EVA)?
Which of the following actions would NOT typically improve a company's Economic Value Added (EVA)?
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The Weighted Average Cost of Capital (WACC) is primarily used for what purpose?
The Weighted Average Cost of Capital (WACC) is primarily used for what purpose?
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A company's EVA is $500,000. Which of the following interpretations is most accurate?
A company's EVA is $500,000. Which of the following interpretations is most accurate?
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Which of the following is a key limitation of relying solely on Economic Value Added (EVA) as a performance measure?
Which of the following is a key limitation of relying solely on Economic Value Added (EVA) as a performance measure?
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Which of the following is a valid criticism of using only financial performance measures?
Which of the following is a valid criticism of using only financial performance measures?
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What is the primary purpose of a Balanced Scorecard (BSC)?
What is the primary purpose of a Balanced Scorecard (BSC)?
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Which of the following is NOT one of the four perspectives typically included in a Balanced Scorecard?
Which of the following is NOT one of the four perspectives typically included in a Balanced Scorecard?
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In the context of a Balanced Scorecard, what does the 'Internal Business Process' perspective focus on?
In the context of a Balanced Scorecard, what does the 'Internal Business Process' perspective focus on?
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A company is developing a Balanced Scorecard. What is the first step they should take?
A company is developing a Balanced Scorecard. What is the first step they should take?
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Under the customer perspective of the balanced scorecard, which outcome would not be classified?
Under the customer perspective of the balanced scorecard, which outcome would not be classified?
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Flashcards
Economic Value Added (EVA)
Economic Value Added (EVA)
A measure of the value created over a single accounting period by comparing return to cost of capital.
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC)
The average rate of return a company is expected to pay its shareholders, used in calculating EVA.
Improving EVA
Improving EVA
Ways to enhance EVA include increasing profitability or restructuring capital use effectively.
Limitations of EVA
Limitations of EVA
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Financial Performance Measures
Financial Performance Measures
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Balanced Scorecard (BSC)
Balanced Scorecard (BSC)
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Four Perspectives of BSC
Four Perspectives of BSC
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Financial Perspective (BSC)
Financial Perspective (BSC)
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Customer Perspective (BSC)
Customer Perspective (BSC)
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Stages of BSC Development
Stages of BSC Development
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Financial Objective
Financial Objective
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Lag Indicators
Lag Indicators
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Lead Indicators
Lead Indicators
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Internal Business Processes
Internal Business Processes
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Learning and Growth Perspective
Learning and Growth Perspective
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Return on Investment (ROI)
Return on Investment (ROI)
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Return on Sales
Return on Sales
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Investment Turnover
Investment Turnover
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Advantages of ROI
Advantages of ROI
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Study Notes
Intelligence
- Intelligence is the ability to connect knowledge.
- The highest form of intelligence is connecting all known knowledge with the Most Intelligent (God).
Performance Measurement System (PMS)
- PMS translates strategy into financial and non-financial measures across multiple perspectives.
- PMS is driven by organizational goals and strategic priorities.
- It identifies cause-and-effect relationships between various measures, including financial performance.
- PMS can be divided into financial and non-financial measures.
Effective Performance Management System (PMS)
- Effective PMS is crucial for successful organizational strategy implementation.
- PMS monitors organizational effectiveness in meeting goals and stakeholder requirements.
- Successful companies perform well financially and in terms of quality, flexibility, and value.
Characteristics of Effective PMS
- Keep it simple: Include only a few performance measures.
- Emphasize the positive: Express measures in positive terms.
- Recognize controllability: Employees are accountable for the measures under their control.
- Link to strategy: Connect measures to organizational goals.
- Include benchmarking: Compare performance against high external standards.
Financial Performance Measures
- The primary objective of a profit-making organization is to maximize shareholder wealth.
- Performance measures should be based on the value created by each organizational division.
- Commonly used measures: ROI, RI, and EVA.
Return on Investment (ROI)
- ROI measures the financial performance of an investment center.
- It calculates how effectively an investment center used its capital to generate profit.
- ROI = profit / invested capital
- Expanding on the formula: ROI = (profit/sales revenue) * (sales revenue/invested capital) = return on sales * investment turnover.
Return on Investment (ROI) – components
- Invested capital: The assets (plant, equipment, and buildings) available to generate profits for the investment center.
- Return on sales: The percentage of each sales dollar that remains as profit after expenses.
- Investment turnover: The number of sales dollars generated by every dollar of invested capital.
Return on Investment (ROI) – improving
- Increase return on sales: Increase selling prices, profits, sales volumes, or reduce expenses.
- Increase investment turnover: Increase sales revenue or reduce invested capital.
Return on Investment (ROI) – advantages
- Widely used to measure the performance of units and managers.
- Encourages focusing on generating profits given the assets required.
- Promotes an understanding of the relationship between revenues, costs, and assets.
- Can evaluate relative performance, even for business units of different sizes.
Return on Investment (ROI) – limitations
- Encourage short-term financial performance, sometimes at the expense of long-term performance
- Potentially encourage managers to defer asset replacement to maintain high ROI.
- Discourage investments in projects that would decrease the investment center's ROI.
Minimizing ROI behavioral problems
- Use ROI as one measure among others to focus on both short-term and long-term performance.
- Consider alternative ways to measure invested capital to prevent dysfunctional decisions
- Use alternative financial measures (like RI or EVA) to evaluate performance.
Residual Income (RI)
- RI is an investment center's profit remaining after subtracting an imputed interest charge.
- Imputed interest charge is based on the required rate of return expected.
- It depends on the organization's cost of capital (WACC).
- WACC is the average cost of funds from borrowing and equity.
Residual Income (RI) – advantages
- More likely to promote goal congruence compared to ROI.
- Considers the organization's required rate of return in measuring performance.
- Encourages investment in projects yielding positive residual income.
Residual Income (RI) – disadvantages
- Cannot assess the relative performance of different-sized businesses efficiently.
- Biased towards larger businesses due to its absolute dollar measure.
- Can potentially encourage short-term orientation.
Measuring Profit & Invested Capital
- Invested capital can be defined as total assets, total productive assets, or total assets minus current liabilities.
Asset Measurement
- Acquisition cost, carrying amount, or market value can be used.
- Advantages of carrying amount: Consistency with balance sheets (prepared for external purposes) and consistent with profit definitions.
- Advantages of acquisition cost: Choice of depreciation method is arbitrary, and carrying amount isn't reliable for ROI and RI.
- Depreciation can sometimes deter new equipment investment.
Measuring Profit
- Profit margin can be controlled by investment center managers.
- Suitable for assessing the performance of managers who influence profit.
- Profit margin attributable to the investment center is suitable when assessing investment performance specifically.
Economic Value Added (EVA)
- Shareholder value: Enhancing business worth from a shareholder perspective. This translates to increased profitability and share price dividends.
- EVA measures value creation during an accounting period and the difference between the business return and capital cost.
- EVA depends on net operating profit after tax, capital employed, and weighted average cost of capital (WACC).
- WACC is the weighted average of the costs of equity and debt. EVA and RI often both use WACC in their calculations.
Measures of Shareholder Value
- To improve EVA: Improve profitability without additional capital, borrow more when profits exceed borrowing costs, or pay off debt by selling assets.
- Limitations of EVA: Potentially for manipulation and short-term orientation (similar to ROI and RI).
Issues with Financial Performance Measures
- Financial measures focus too narrowly on a single performance perspective.
Non-Financial Measures. Balanced Scorecards.
- A tool to translate organizational mission, objectives, and strategies into performance measurements.
- Useful for implementing strategy, monitoring, and managing performance.
- Focused on multiple perspectives (customer, internal business processes, learning and growth, financial).
Four Perspectives of BSC
- Financial: Indicators of how effectively strategies and operations produce value for shareholders
- Customer: Indicators of whether strategies add value to customers. Indicators include customer profitability, market share and number of new customers; lead indicators include on-time delivery and number of defects
- Internal Business Processes: Indicators of whether internal business processes contribute to the achievement of a company's customer and financial objectives. Includes product cost, quality, time-based measures, and new product development
- Learning and Growth: Indicators of companies' infrastructure for future innovation and growth; focus on organizational capabilities for processes, including employees' abilities as well as information systems' capabilities and organizational climate
Stages in the development and use of BSC
- Establish mission, objectives, and strategic priorities.
- Develop specific objectives for perspectives (customer, internal business process, learning and growth).
- Choose performance measures for each perspective.
- Develop performance targets for each measure.
- Cascade the balanced scorecard goals, measures, and targets to organizational units.
- Monitor and manage performance against the targets.
Definition of Benchmarking
- Benchmarking is a process of comparing the business’s products, functions, and activities against other companies to identify improvement areas and implement continuous improvements.
Reasons For Benchmarking
- Efficient way to improve, eliminating trial-and-error processes
- Speeds up improvement implementation
- Compare business practices with world-class organizations to identify best practice
- Encourages a reassessment of current practices
- Changes perspectives of executives and managers
Stages in Benchmarking
- Identify the functions (or activities) to be benchmarked.
- Choose benchmark partners (companies with similar interests and technologies, competitors, or internal units from the same company)
- Collect and analyse data from benchmark companies
- Establish benchmarks
- Develop and implement plans to implement improvements
Forms of Benchmarking
- Internal Benchmarking: Comparing units within the same company, simplest to implement but does not compare to the best practices
- Competitive Benchmarking: Comparing a company against similar competitors by identifying strengths and weaknesses, improving areas for improvement
- Industry Benchmarking: Benchmarking against other organizations in the same industry to gain insights about market practices
- Best-in-class/Process Benchmarking: Benchmarking against the best performer or industry leaders
Advantages of Using BSC
- Comprehensive view of business operations beyond just finance
- Identifies opportunities for improvement
- Provides a mechanism for better alignment and communication across the organization
- Helps improve overall performance
Disadvantages of BSC
- Cause-and-effect assumptions may be too simplistic
- Timing differences between lead and lag indicators might create complications
- Expectations for improvement might be unrealistic
- Some benchmarking activities are better suited outside an organization
Other notes
- Some organizations use KPI's (Key Performance Indicators) and KPD's (Key Performance Drivers) for lag and lead indicators, respectively.
- Different businesses may have differing definitions for internal assets.
- Some companies use similar indicators across departments while others may find custom-tailored measurements for their specific needs.
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Description
This quiz covers the key concepts of Performance Measurement Systems (PMS) and their role in aligning organizational strategies. It explores the characteristics of effective PMS and how they contribute to organizational success through financial and non-financial measures. Test your understanding of how intelligence relates to effective performance management.
