Performance Measurement Overview
The management accountant’s job is to help the organisation do better in the future, and to do that we must first measure how well it is doing now. This chapter introduces performance measurement: the mission statement, goals and objectives, critical success factors (CSFs) and key performance indicators (KPIs).
It then explains why performance measures must be appropriate – linked to objectives, controllable and clearly defined – and how responsibility accounting gives each manager the authority, the responsibility and the measures that match the part of the business he or she controls. Chapters 11 and 12 then look at financial and non-financial measures in detail.
1 Introduction
The lecture illustrates sections 2 to 4 with a well-known fast-food chain; these notes use a made-up restaurant chain, FreshBite, for the same points. Sections 5 and 6 (appropriate performance measures and responsibility accounting) are in the written notes only, so read them carefully.
This chapter introduces the idea of performance measurement and its importance for the management accountant.
Measuring performance tells managers how well the business is doing at the moment and what needs to improve. Some measures are financial – for example, has profit gone up or down compared with last year? Others are non-financial – for example, is the quality of our products or our service good enough, and is it improving? Poor quality may not hurt this year’s profit, but if customers keep returning goods, sales will fall in the future.
2 The mission statement
This statement expresses the overall purpose of the organisation.
It will generally contain four elements:
Element | What it sets out |
A purpose | Why the company exists |
A strategy | The range of activities in which the business intends to compete, and how it intends to compete |
Policies and standards | Guidelines which help staff decide what to do to carry out the strategy |
Values | The beliefs and moral principles which lie behind the firm’s culture |
FreshBite runs a chain of quick-service restaurants. Its mission statement reads:
“FreshBite’s vision is to be the best quick-service restaurant in every town where we trade. Being the best means serving good-quality food quickly, in clean restaurants and at fair prices, so that every customer leaves happy.”
The first sentence states its purpose. The second sets out what it will compete on – quality, speed of service, cleanliness and value – and the values it wants its staff to promote.
A mission statement is only a general statement of what the company exists for. It is not specific enough to measure, so the next step is to set goals and objectives.
3 Goals and objectives
Having decided on the company’s mission, it is then necessary to have goals and objectives.
Goals are statements of general intentions, whereas objectives are more specific.
Example | |
A goal | To improve profits |
An objective | To increase the profit by 20% within 2 years |
An objective is specific enough to be measured: in two years’ time either the profit has risen by 20% or it has not. In the same way, FreshBite might have the goal “to serve customers quickly” and the objective “to serve every customer within five minutes of ordering”.
4 Critical success factors and key performance indicators
Having decided on the objectives of the business, it is important that we measure how well they are achieving these objectives.
There are two parts to this. First they must decide what are the critical success factors (CSFs) – the performance requirements that are most fundamental to being successful. A business could list dozens of things it would like to do well; the CSFs are the few (perhaps five or six) that really matter if it is to succeed. They differ from one business to another.
For example, two of FreshBite’s CSFs could be quality and speed of service.
Secondly, they must then decide how they are going to measure their performance in these areas. For this they need key performance indicators (KPIs) – aspects to which they can actually put numbers, that indicate whether they are doing better or worse. Targets can then be set for each KPI.
For example, FreshBite might decide to measure quality by asking customers to complete a form scoring the quality from 1 to 5, and then recording the average score. It could measure speed of service by keeping records of the time taken to serve each customer and recording the average service time in minutes.
Business | Critical success factor | Possible key performance indicator |
Quick-service restaurant | Speed of service | Average time from order to service (target: under five minutes) |
Quick-service restaurant | Quality | Average customer score for quality (1 to 5) |
Quick-service restaurant | Cleanliness | Score at each restaurant’s hygiene inspection |
Online or mail-order retailer | Speed of delivery | Percentage of orders delivered within three days |
As you will see in the following chapters, it is important that a company has a range of KPIs – both financial (measuring, for example, profitability) and non-financial (measuring, for example, quality).
5 The need for appropriate performance measures
Performance measures help managers to plan, to control and to evaluate performance, so that the objectives are achieved and improvement is encouraged. But a measure only helps if it is appropriate. People tend to work towards whatever they are measured on, so a poor measure can make performance worse: a branch manager judged only on keeping costs down may cut staff and let the quality of service fall.
A good performance measure:
is linked to the objectives and CSFs of the organisation, so that a manager who improves the measure is also helping the organisation (this is called goal congruence)
relates to things the manager can control or at least influence (see section 6)
is clearly defined and understood by the people being measured, and is calculated the same way each period so that results can be compared
is measurable from reliable information that does not cost more to collect than it is worth
suits the type of business – a factory, a bank and a hospital need different measures
No single measure is enough. Financial measures (chapter 11) mostly report what has already happened. Non-financial measures (chapter 12) such as quality and customer satisfaction often show what is likely to happen to profit in the future, so an organisation needs both.
6 Responsibility accounting
In all but the smallest organisations, the business is divided into parts, each run by a manager. Responsibility accounting is a system of accounting that divides the organisation into responsibility centres and reports the costs, revenues and (where relevant) assets of each centre to the manager responsible for it. Each manager is then judged on the results of his or her own centre.
Responsibility accounting rests on three ideas:
Meaning | |
Authority | The right to make decisions and to use the organisation’s resources – for example, to hire staff, to order materials or to set selling prices |
Responsibility | The duty to achieve results, and to account for them; the manager is answerable for the performance of the centre |
Controllability | How far a manager can influence a cost, a revenue or an asset. A manager should be held responsible only for the items he or she can control |
Authority and responsibility should match. It is unfair, and demotivating, to hold a manager responsible for results he or she has no authority to affect. A manager given authority with no responsibility, on the other hand, has no reason to use it well.
Responsibility centres
The type of centre depends on what the manager has authority over:
Responsibility centre | The manager is responsible for | Typical measures |
Cost centre | Costs only | Actual costs against budget (cost variances); cost per unit |
Revenue centre | Revenues only | Actual sales revenue against budget |
Profit centre | Costs and revenues (and so profit), but not the capital invested | Profit; profit margins |
Investment centre | Costs, revenues and the capital invested (non-current assets and working capital) | Profit compared with the capital invested – for example, return on capital employed (chapter 11) |
A production department is usually a cost centre; a sales region is usually a revenue centre; a retail branch that sets its own prices and controls its own costs may be a profit centre; a division whose manager can also decide to buy new assets is an investment centre.
Controllable and uncontrollable costs
A controllable cost is a cost that can be significantly influenced by a particular manager within a given period – for example, the quantity of materials used in the department, overtime the manager authorises, or local advertising the manager commissions. An uncontrollable cost is one the manager cannot influence – for example, an apportioned share of head-office costs, or depreciation of equipment that head office chose to buy.
Every cost is controllable by someone at some level of the organisation: head-office costs are controllable by the directors, but not by a department manager. Over a long enough period most costs become controllable. The question is always: controllable by whom, and over what period?
A responsibility report should therefore separate the costs the manager controls from those he or she does not. Uncontrollable costs may be shown for information, but the manager’s performance is judged on the controllable ones.
The monthly report for the Machining department of a manufacturer (a cost centre) is set out as follows:
Budget $ | Actual $ | Variance $ | |
Controllable costs | |||
Direct materials | 40,000 | 42,500 | 2,500 A |
Direct labour | 30,000 | 29,000 | 1,000 F |
Maintenance | 5,000 | 5,600 | 600 A |
Total controllable costs | 75,000 | 77,100 | 2,100 A |
Uncontrollable costs (for information) | |||
Apportioned head-office costs | 12,000 | 13,000 | 1,000 A |
Depreciation of machinery bought by head office | 8,000 | 8,000 | – |
Total costs | 95,000 | 98,100 | 3,100 A |
The department manager is answerable for the $2,100 adverse variance on controllable costs. The extra $1,000 of head-office costs was decided elsewhere, so it should not count against the manager, even though it is part of the department’s total cost.
Tamworth Group has four managers:
The manager of the Lagos factory decides how materials, labour and machines are used to make the group’s products. Selling prices are set by the sales team and all spending on new machines is decided by head office.
The sales manager for the Kenya region is set a target for sales revenue and is judged on the revenue the region earns. She has no say over the cost of the goods she sells.
The manager of the Karachi shop sets local selling prices, decides staffing levels and orders the shop’s inventory. Spending on new shop fittings is decided by head office.
The managing director of the Malaysian subsidiary sets prices, controls costs and decides how much to invest in new non-current assets and in working capital.
The Lagos factory manager’s monthly cost report includes: direct materials used; overtime premium on overtime the manager authorised; an apportioned share of head-office rent; depreciation of machines bought by head office; and maintenance of machines, which the manager orders.
Required:
State the type of responsibility centre run by each of the four managers.
State which of the five costs in the factory manager’s report are controllable by the factory manager, and which are not.
Show answerHide answer
7 Test your knowledge
Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.
Performance Measurement Overview
12 questionsAnswer the questions one at a time. Your progress is saved so you can leave and come back.
Open chapter practice