hhofma3e_ch24_inst

Report
Chapter 24
1
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Explain why and how companies decentralize
Explain why companies use performance
evaluation systems
Describe the balanced scorecard and identify
key performance indicators for each
perspective
Use performance reports to evaluate cost,
revenue, and profit centers
Use ROI, RI, and EVA to evaluate investment
centers
2
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1
Explain why and how companies decentralize
3
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CEO,
Top
Controller,
Sales Mngr.
Plant Mngr.
CFO,
Vice Pres.
Mid-Level
Supervisors
Front Line/Supervisory
Foremen
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Catch
Global Competition
Speed & efficiency
Flat vs. vertical hierarchy
Market centric management
Requires decentralization of
management
How do we measure the
performance of each segment?
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Advantages:
Frees top management time
Supports use of expert knowledge
Improves customer relations
Provides career path training
Improves motivation and retention
Disadvantages:
Duplication of costs
Problems achieving goal congruence
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A responsibility center is a part or subunit of an
organization whose manager is accountable for specific
activities (recall from Chapter 22)
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2
Explain why companies use performance
evaluation systems
9
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Decentralized organizations need a system to
communicate goals to segment managers
Primary goals:
Promoting goal congruence and coordination
No one is apathetic except in the pursuit of somebody else’s goals
Communicating expectations
Visibility to management and workforce makes things clear
Benchmarking
These expectations provide objective, measureable, expectations
Providing feedback
Objective feedback promotes management to performance
Motivate segment managers
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Traditional systems revolved almost entirely around
financial performance
Ultimate goal of a company is to generate profit
Financial measures follow performance, don’t create it
“Just win” mentality leads to trouble
Measure causes of performance to build lasting success
Management needs lead indicators
Find out what causes success, and measure that
Strong indicators of future success, not just past success
Top management needs signals that assess and predict
performance over longer periods of time
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3
Describe the balanced scorecard and identify key
performance indicators for each perspective
13
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A major shift in corporate performance measurement
Recognizes that financial measures are only one type
of measure among many
Uses key performance indicators (KPI)
Select ones that drive/cause/lead performance
Well aligned with mission-centric management
Management needs to consider other critical factors:
Customer satisfaction
Operational efficiency
Employee excellence
AND of course, financial performance
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How do we look to shareholders?
Ultimate goal is to generate income for owners
Strategy revolves around increasing the company’s
profits, for example:
Increasing revenue growth
Introducing new products, gaining new customers, and
increasing sales
Increasing productivity/profitability
Reducing costs and using the company’s assets more
efficiently
KPIs:
Sales revenue growth
Gross margin growth
Return on investment
17
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How do customers see us?
Top priority for long-term success
Customer satisfaction critical to achieving the company’s
financial goals
Typical customer concerns:
Product price
Product quality
Sales service quality
Product delivery time
KPIs:
Customer satisfaction
Market share and increasing number of customers
Repeat customers
Rate of on-time deliveries
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What business processes must we excel in to satisfy
customer and financial objectives?
Three factors critically affect customer satisfaction:
Innovation—must continually improve existing products
and develop new products
Operations—lean and effective internal operations,
product efficiency and product quality
Post-sales service—service customers after the sale
Sample KPIs:
The number of new products developed or
new-product development time
The number of units produced per hour and defect rate
The number of warranty claims received, average repair
time, and average wait time
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How can we continue to improve and create value?
Measures employee skills, knowledge, motivation, and
empowerment
Employee capabilities–skilled, positive culture ,and
up-to-date technology
System capabilities–insightful information systems, strong
internal processes, and efficient finances
Corporate culture–supports communication, change, and
growth
KPIs:
Hours of employee training, employee satisfaction and
turnover, and number of employee suggestions implemented
Percentage of employees with access to customer data and
percentage of processes with real-time feedback
Employee turnover rate
20
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Four Teams of victims:
Case 1
Case 2
Case 3
Case 4
List possible “Gaming” approaches by people trying to achieve
the new goal.
Create a balanced scorecard basket of measures considering your
experience above & explain why it will align behavior with the
well being of all involved.
Financial Customer Internal processes Learning/Growing
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22
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5
Use ROI, RI, and EVA to evaluate
investment centers
32
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Managers are responsible for:
Maximizing earnings
Minimizing assets utilized to minimize financing required
How can we measure to two counter goals?
Basic: Use a ratio to compare the two items
ROI = Return ÷ Investment
Complex: Use residuals to assess earnings
Performance measures:
How much operating income the division is generating
How efficiently the division is using its assets
KPIs
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ROI compares Profits to Investment
required, thereby helping maximize
earnings per dollar invested
ROI is size-independent, easily comparing
small to large divisions.
ROI carries an odd side effect that
sometimes leads managers to
decline profitable projects.
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Income earned by the segment
ROI =
Operating income
Average total assets
Cash, accounts receivable, inventory,
plant and equipment, and other
productive assets. (L+OE)
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Royal Division reports the following:
Operating income
Average total assets
Sales
ROI =
$ 30,000
$ 200,000
$ 500,000
$30,000
$200,000
= 15%
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Three ways to improve ROI . . .
 Increase
Sales
ROI =
Reduce
Expenses
 Reduce
Assets
Operating income
Average total assets
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ROI = Profit margin  Asset turnover
=
Operating income
Sales
x
Sales
Average total assets
=
Operating income
Average total assets
This expanded equation allows a quick view of two
determinates of Return on Investment:
Profit Margin: Does a healthy portion of sales make it to
the bottom line? Expense control. Pricing power.
Asset Turnover: Are our assets used efficiently to generate
sales volume? Lean assets. Strong sales.
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Royal division reports the following:
Operating income
$ 30,000
Average total assets
$ 200,000
Sales
$ 500,000
ROI
=
ROI
=
ROI =
15% =
Profit margin
Operating income
Sales
$30,000
$500,000
6%

Asset turnover
x
Sales
Average total assets
x
$500,000
$200,000
x
250%
Royal division Boosts operating income to $50,000 by cutting expenses. New ROI?
ROI =
$50,000
$500,000
x
25% =
10%
x
40
$500,000
$200,000
250%
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Royal division reports the following:
Operating income
$ 30,000
Average total assets
$ 200,000
Sales
$ 500,000
ROI
=
ROI
=
ROI =
15% =
Profit margin
Operating income
Sales
$30,000
$500,000
6%

Asset turnover
x
Sales
Average total assets
x
$500,000
$200,000
x
250%
Royal division Boosts operating income to $50,000 by Raising Sales $333,333. New ROI?
ROI =
25% =
41
$50,000
$833,333
6%
x
x
$833,333
$200,000
417%
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Royal division reports the following:
Operating income
$ 30,000
Average total assets
$ 200,000
Sales
$ 500,000
ROI
=
ROI
=
ROI =
15% =
Profit margin
Operating income
Sales
$30,000
$500,000
6%

Asset turnover
x
Sales
Average total assets
x
$500,000
$200,000
x
250%
Royal division Boosts ROI to 25% by eliminating non-productive assets
ROI =
25% =
42
$30,000
$500,000
6%
x
x
$500,000
$120,000
? #2
? #1
417%
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Royal division reports the following:
Operating income
$ 30,000
Average total assets
$ 200,000
Sales
$ 500,000
ROI
=
ROI
=
ROI =
15% =
Profit margin
Operating income
Sales
$30,000
$500,000
6%

Asset turnover
x
Sales
Average total assets
x
$500,000
$200,000
x
250%
Benchmarking Royal Division’s performance against company standards
25% =
ROI =
43
8%
$44,000
$550,000
x
313%
x
$550,000
$175,718
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Complete JUST THE ROI questions, 1, 2, and the typo-filled 3 for
problem 24-21A on page 1185.
We will do the other sections of this problem as we work through it.
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A division with a higher ROI is performing
better
more likely to receive extra funds, putting more
assets under the control of the more successful
managers
Lower ROE divisions may be under more
operational scrutiny, or divestment pressure
Drawback to using ROI
Tempts management to choose only projects that meet or
exceed current ROIs
Rejecting profitable projects may be harmful to the company
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As division manager your pay includes a bonus based on
your division’s ROI -- the higher your ROI, the bigger
your bonus.
The company wide ROI stands at 15% -- your division has
a much higher ROI at 20%.
You rather like your enormous bonus checks.
You have an opportunity to add a new product line in your
division that will produce an ROI greater than 15%, but
lower than your division’s ROI.
What is this new product line going to do to
your division’s ROI?
To your bonus?
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
This KPI better aligns incentives with business goals
Compares segment profits with profits at the required
rate of return
Positive–income exceeds target rate of return
Negative–income does not meet target rate of return
General formula:
Applicable formula:
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CM Income Statement
Sales
Variable expenses
Contribution Margin
Fixed expenses
Net operating income
Assets
ROI (NOI ÷ Assets)
Drink It In Corp. Coffee segment
Cofee segment
Coffee segment
Proposal
with proposed
status Quo
ONLY
changes
10,000,000
6,000,000
4,000,000
3,200,000
800,000
2,000,000
1,200,000
800,000
640,000
160,000
12,000,000
7,200,000
4,800,000
3,840,000
960,000
4,000,000
1,000,000
5,000,000
20%
16%
19%
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Gee . . .
I thought we were
supposed to do what
was best for the
company!
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
RI Measures operating
income above the minimum
acceptable operating
income as established by
the target ROI
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
CM Income Statement
Sales
Variable expenses
Contribution Margin
Fixed expenses
Net operating income
Drink It In Corp. Coffee Segment
Coffee Segment
Coffee Segment
Proposal
with proposed
Status Quo
ONLY
changes
10,000,000
6,000,000
4,000,000
3,200,000
800,000
2,000,000
1,200,000
800,000
640,000
160,000
12,000,000
7,200,000
4,800,000
3,840,000
960,000
4,000,000
1,000,000
5,000,000
Require NOI at 12% minimum (12%*assets)
480,000
120,000
600,000
Residual income (Actual earning - Mimimum earnings)
320,000
40,000
360,000
Assets
VS ROI
20%
16%
19%
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Benefits:
Promotes goal congruence better than ROI,
minimizes gaming
Incorporates management’s minimum required rate
of return
Advantages:
Divisions will be motivated to take the action that
top management desires
Can use different target rates of return for divisions
with different levels of risk
Disadvantages:
Complex, we fear change
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Special type of Residual income calculation
Looks at residual income through the eyes of the
company’s primary stakeholders
Investors (Owners)
Creditors (Bondholders)
Uses a weighted-average cost of capital, instead of
Non-investor perspective basis for calculating
minimum ROI
Considerations:
After-tax income available to stakeholders
Very appropriate for whole company analysis
Omit assets committed to paying current liabilities
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Compare the EVA equation with the RI equation
Both calculate whether any operating income was
above and beyond expectations
Differences:
EVA uses after-tax operating income (income
available to stakeholders)
EVA reduces average total assets by current
liabilities (funds not available for generating
income)
Replace management’s target rate of return with
WACC (rate of return expected by stakeholders)
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The following are focus areas of the
final exam. This is not an exhaustive
list of every single questions, but a
targeting of where 80% of your
studying time should be spent to
master core concepts:
Relevant cost decision making:
apply concepts E20-10
Capital investment
NPV focus, P21-28A
Budgeting
Focus on operating expense
and cash budget
Responsibility centers E22-21
Flex budgeting E23-15
Variance Analysis DM/DL focus,
E23-19
Performance evaluation P24-21A
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As companies grow, they often decentralize by
geographic area, product line, customer base,
business function, or some other characteristic.
Decentralization frees top management’s time by
delegating decision making, supports the use of
expert knowledge, improves customer relations,
provides training for managers, and improves
employee motivation and retention. Disadvantages of
decentralization include possible cost duplications
and difficulty achieving goal congruence among
decentralized divisions.
69
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Performance evaluation systems provide top
management with a framework for maintaining
control over the entire organization once it is
decentralized. Such systems should help
management promote goal congruence, provide a
tool for communications, motivate unit managers,
provide feedback, and allow for benchmarking.
These measures should not revolve around just
financial performance measures, however.
70
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The balanced scorecard focuses performance
measurement on progress toward the company’s
goals in each of the four perspectives. In designing
the scorecard, managers start with the company’s
goals and its strategy for achieving those goals and
then identify the most important measures of
performance that will predict long-term success.
Some of these measures are lead indicators, while
others are lag indicators. Managers must consider the
linkages between strategy and operations and how
those operations will affect finances now and in the
future.
71
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Responsibility accounting performance reports
capture the financial performance of cost, revenue,
and profit centers. They compare actual amounts to
budgeted amounts to determine variances. Then,
management investigates to identify if the cause of
the variance was controllable or uncontrollable.
Management can then make decisions to take
corrective actions for controllable variances.
72
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To evaluate an investment center’s financial
performance, companies need summary
performance measures—or KPIs—that include both
the division’s operating income and its assets.
Commonly used KPIs for evaluating an investment
center’s financial performance are return on
investment (ROI), residual income (RI), and
economic value added (EVA). Each of these
financial KPIs must be considered in conjunction
with KPIs that come from all four of the balanced
scorecard perspectives.
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means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.
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