PM - Budgeting and control

Performance Analysis

VARIANCE ANALYSIS:

It is crucial to consider variances alongside each other when using them for performance analysis, as an
adverse variance in one area might have also resulted in a favourable variance elsewhere.

Risk: Appraising management through variance analysis could result in some very demotivated members of
staff and the future performance of the business is likely to suffer.

Solution: By splitting variances into 'uncontrollable' and 'controllable' (planning and operational), management
can then be assessed based on the variances they can control, which seems fair and should result in a more
motivated workforce.

STANDARD COSTING:

Ensuring that the standard cost being used within the initial budget is correct is also crucial to ensure that:

1) The initial budgets are as accurate as possible;

2) Management is not being assessed against unrealistic targets, costs, and revenues.

If standard costs are to be used to appraise management, we need to ensure that the standards being set are:

1) Not too high. If they are too high, management will find it difficult to achieve them and they may be
deterred from even trying to achieve them;
2) Not too low. If the standard is too low and is easy to achieve, this is likely to mean that management will
not strive to achieve the best possible results. This can result in staff and management becoming
demotivated;
3) Attainable but challenging. If so, the management and staff can see that they can achieve the standards,
provided they work hard and work to improve the performance of their department.

JIT AND TQM:

In a just-in-time production process, materials are only acquired when an order is placed and the finished
goods are immediately shipped to the customer on completion to fulfill the order. There is no buffer stock and
costs are covered quickly through a direct sale to a customer.

Total quality management focuses on the customer and their needs, rather than relying on predetermined
levels of quality, wastage, and so on. There is a strong emphasis on the cost of producing high quality items and
on the idea that all areas of the business need to get things right the first time.

There is a direct link between this just-in-time process and total quality management:

There are a number of problems that arise if we try to combine standard costs and variance analysis with total
quality management and just-in-time processes:

1) Variance analysis only looks at a narrow range of costs and revenues and it does not pay any attention to
quality or customer satisfaction;
2) Standard costs only apply when we are producing high quantities of the same product over and over again;
3) There is too much emphasis on labour costs rather than machine costs, and given that most modern
manufacturing environments are highly automated, this isn’t appropriate;
4) Production overheads are the main cost associated with modern manufacturing and these are ignored in
standard costing;
5) Standard costing cannot cope with the ever changing costs, products, processes, and business
environments.
 PM - Performance Management
Performance Analysis in Not-For-Profit Organisations and the Public-
Sector

OBJECTIVES
The objectives of not-for-profit organisations are often non-quantifiable, so their impact is hard to measure.

Examples of the objectives of non-profit organisations include:

● Solve a problem or provide support for people in our society;

● Maximise clients’ satisfaction;

● Have job satisfaction among the volunteers and staff;

● Maximise revenues;

● Maximise the organisation's surplus; and

● Value for money (VFM).

It is difficult to measure the performance of an organisation with non-quantifiable objectives. A not-for-profit

organisation can also have many objectives because they have many stakeholders. This can result in:

● Difficulties assessing performance; and

● Objectives conflicting with each other.

The solution is for the organisation to prioritise their objectives and compromising between them.

PERFORMANCE MEASUREMENT
If the performance of not-for-profit organisations is not measured:

● Resources such as time and money would be misallocated; and

● Decisions for allocating funds would be subjective rather than objective.

Performance can be examined under the following headings:

 ● Economy – are the resources used the cheapest for what is needed?

● Efficiency – is the maximum output being achieved for the resources invested?

● Effectiveness – look and examine the results or the outputs of the project to ensure the objectives are
met.

To assess value for money (VFM) objectives the organisation can:

● Benchmark against other organisations;

● Use performance indicators to measure if value for money has been achieved; or

● Undertake an internal value for money audit.

PERFORMANCE INDICATORS
When assessing a not-for-profit, both financial and non-financial performance indicators should be used. A
performance indicator is a sign that the company is on target for achieving its objectives.

Examples of non-financial performance indicators include:

● Staff morale;

● Client satisfaction levels; and

● Client engagement.

How can the organisation improve on its performance?

Targets must be set, however, targets of not-for-profits are often qualitative. Qualitative targets are difficult to
set because of these reasons:

● There is often no scale to measure the target. How can you assess how much of an improvement there
is in the quality of life of somebody with a chronic illness?

● How are benefits and costs measured against each other and traded off against each other? For
example, does the cost of providing certain services equal the benefit of improving someone’s life?

● Timing – Benefits do not accrue overnight. Often the impact of not-for-profits will be seen over the years
that follow.

● The impact of external events.

When the targets have been set:

● Performance indicators are decided;

● Past performance is assessed using current performance indicators; and

● Current performance is assessed using current performance indicators.

LONG-TERM VIEW
The benefits of not-for-profit organisations are often not visible for many years. So a long-term view must be
adopted.To encourage this:

● Communicate to the public and the volunteers the long-term benefits of the expenditure; and

● Use performance indicators that reflect a long-term view.

 PM - Performance Measurement & Control
Balanced Scorecard

The balanced scorecard is a management technique for assessing and communicating the performance of the
business.

It focuses on both financial and non-financial performance indicators and provides a link between an
organisation’s strategy and its short-term operations and performance measurements across four perspectives:

1) Financial Perspective. It considers how the organisation can create value for its shareholders. It is
measured in terms of net profit margin, ROI or earnings per share;
2) Customer Perspective. It considers how the organisation appears to its customers. It might be assessed
by a reduction in the number of customer complaints, increase in the number of customer visits or increase
in the number of on-time deliveries;
3) Internal Perspective. The organisation must identify the internal business processes that are critical to the
implementation of its strategy. It is assessed in terms of reducing staff turnover, reducing the number of
mistakes or increasing the organisation’s IT capability;
4) Innovation Perspective. The aim here is constant learning and growth. Increasing staff training or
enhancing research and development expenditure might result in less staff mistakes (internal perspective),
increased customer satisfaction (customer perspective) increased organisation’s profit (financial
perspective).

Note: The balanced scorecard provides a valuable link between the short-term business operations and the
long-term goal or strategy of that business. It can be considered a dynamic and efficient tool used in delivering
the organisation’s strategy.
 PM - Performance Management
Performance Measures in the Private Sector and NFP and Public Sector

PERFORMANCE MEASURES
Performance measurement aims to establish how well a company or individual is doing in relation to a given
plan. It is a vital part of the planning and control process.

At a high-level, performance measures can be divided into two types:

1. Financial performance indicators: These measures will typically relate to figures from financial
statements (e.g., revenue, profits, return on capital, cash flows, etc.). The actual performance is usually
measured against a financial plan, a previous time period, a similar business, or an industry average.

2. Non-financial performance indicators: These measures will vary from one organisation to another but
can include measures around the quality of the goods or service provided, customer feedback, achieving
deadlines, or capacity utilisation for a manufacturing company.

Whether performance measures are financial or non-financial, there are several factors that organisations
should consider:

A. Any form of performance measurement will require some type of resource to collect and analyse the
information (e.g., staff time, equipment).

B. All measures must be measured in relation to "something". Overall, this will be the company’s objectives
and the plans that will cascade from those objectives.

C. The measures should be "fair". If managers are targeted or incentivised for achieving certain targets, the
measure should only include areas that the manager is responsible for and has direct control over.

D. A mixture of both long-term and short-term achievements should be measured. Too much emphasis on
short-term targets can lead to short-termism, where decisions are taken for the "here and now" with little
regard to the long-term future of a company.

Note: Once suitable performance measures have been identified, they should be monitored on a regular basis to
ensure that they are relevant and provide meaningful information.

Performance measures can be:

 1. Quantitative: These measures are expressed in numbers and by measurements. This will include all
financial performance measures and measures that are numerical (e.g., number of units, number of
hours, or cost per unit).

2. Qualitative: These measures are not numerical. However, they are subjective and judgemental, and
may relate to the quality of a product or service, customer loyalty, or employee morale.

FINANCIAL PERFORMANCE MEASURES FOR THE PRIVATE SECTOR

Financial performance measures for the private sector can be grouped into three categories:

1. Profitability ratios: This category includes the following ratios:

a. Gross profit margin: This ratio is calculated using the following formula:

Gross profit
Gross profit margin = ———————— x 100%
Sales revenue

To improve this measure, a company will need to either increase its revenue or decrease the
cost of sales. This measure can be used for comparisons against previous periods within the
same company, similar-sized companies within the same industry, or against an industry
average.

b. Net profit margin: This ratio considers all costs of the company, including administrative and
distribution costs. It is only meaningful when compared to previous periods within the same
company, or performance of similar-sized companies within the same industry. It is calculated
using the following formula:

PBT
Net profit margin = ———————— x 100%
Sales revenue

c. Return on capital employed (ROCE): The capital employed is the shareholder funds plus any
non-current liabilities. This is also the equivalent of the total assets less the current liabilities.
High return on capital employed ratios generally indicate a high rate of return for investors.
ROCE is calculated using the following formula:

PBT
ROCE = —————————— x 100%
Capital employed

d. Asset turnover: Asset turnover is a measure of how well a business is using its assets to
generate sales. The ratio is calculated as follows:

Revenue
Asset turnover ratio = —————————
Capital employed
 The asset turnover ratio is linked to the return on capital employed and the net profit margin in
the following way:

Return on capital employed = Net profit margin x Asset turnover

PBT
Return on capital employed = ————————— x 100%
Capital employed

Revenue
Asset turnover ratio = —————————
Capital employed

PBT
Net profit margin = —————
Revenue

e. Earnings per share (EPS): A company must be able to generate sufficient earnings in order to
firstly pay a dividend to the shareholder, and then re-invest any surplus back into the business to
support future growth. It is calculated as follows:

Profit after tax

EPS = —————————————————————
Weighted average number of ordinary shares

2. Liquidity and cash flow ratios: A company may be financially profitable, but it will struggle if it does not
have sufficient liquidity (i.e., cash to pay its debts). Liquid assets include cash, trade receivables,
deposits with the bank, and any short-term investments which can be readily converted into cash (e.g.,
shares). This category includes the following ratios:

a. Current ratio: This ratio gives an indication as to whether the organisation has enough cash to
meet its short-term liabilities over the coming year. A current ratio of one is the most desirable
current ratio value for most organisations. The ratio is calculated as follows:

Current assets
Current ratio = ——————————
Current liabilities

b. Quick ratio (acid test): This ratio is very similar to the current ratio, but it takes into account the
fact that the conversion of inventory into cash may take a long time. Ideally, this ratio should still
be greater than one for companies with a slow inventory turnover. For companies that have a
rapid inventory turnover, a quick ratio may be less than one without suggesting that the company
is having any cash flow difficulties.

Current assets - Inventory

Quick ratio = ——————————————
Current liabilities
 c. Receivables payment period: This measure allows a company to calculate the average length
of time it takes for customers to pay them. Close monitoring of this is essential for companies to
avoid a high receivables figure and cash flow difficulties. It is calculated as follows:

Trade receivables
Receivables payment period = —————————— x 365
Credit sales

d. Payables payment period: This measure allows a company to calculate the average length of
time it takes to pay its suppliers. From a cash flow perspective, companies will normally take full
advantage of any credit period offered. However, it is important for companies not to abuse the
agreed terms, as this could lead to loss of goodwill, and ultimately, a restriction on supply. The
ratio is calculated as follows:

Trade payables
Payables payment period = ————————— x 365
Cost of sales

e. Inventory turnover period. This measure indicates the average period that a company holds its
inventory. An increasing inventory days calculation suggests slow moving inventory, which can
lead to a build-up or excessive holdings. In addition to potential cash flow problems, too much
inventory can lead to loss through obsolescence or damage, and there may be associated
related costs such as warehousing and insurance. The ratio is calculated as follows:

Closing inventory
Inventory turnover period = —————————— x 365
Cost of sales

3. Gearing ratio: There are different ways that a company can be financed, and this is known as the
capital structure of a business. At a high level there are two options open to a business for long-term
finance:

a. They can raise capital from shareholders (equity); or

b. They can borrow funds (debt).

Gearing ratio looks at the relationship between the shareholders' funds (equity) and debt. Generally, any
ratio greater than 50% would denote that a company is highly geared. It is calculated as follows:

Non-current liabilities Debt

Capital gearing ratio = —————————————— x 100% = ————— x 100%
Ordinary shareholders' funds Equity

The higher the percentage of capital financed through debt, the higher the financial risk associated with
the company. It is important for companies to keep their debt under control, otherwise, banks or other
lenders would likely refuse to lend funds in the future.

NON-FINANCIAL PERFORMANCE MEASURES FOR THE PRIVATE SECTOR

Non-financial performance indicators are generally a useful guide to future financial performance, unlike
financial indicators. They vary significantly between different types of businesses, dependent on what is
important for the organisation.

As a general guide, non-financial performance measures could include:

● Quality of goods or service: This could be formulated by the number of rejects within the production
process, the number of customer returns, or warranty claims.

● Delivery: This could be calculated by the average time between taking and delivering an order.

● Reliability: This could be expressed as the percentage of equipment failures or "downtime".

● Innovation: This could be calculated as the number of new products launched over a given time period,
or the value invested in development of new products.

● Customer satisfaction: This may include the number of repeat orders, the number of new accounts
opened, the percentage of on-time deliveries, or the number of customer complaints as a percentage of
total sales volume.

● Employee morale: This can be measured by survey results.

Once all suitable performance measures have been identified, it is important to monitor them, analyse
performance, and identify any reasons for unexpected performance.

NOT-FOR-PROFIT ORGANISATIONS AND THE PUBLIC SECTOR

Not-for-profit organisations and the public sector are likely to have significantly different goals in comparison to a
private sector business as profit is not their primary goal and they do not have to be successful against the
competition.

Normally, performance will be judged in terms of input and output, which ties in with the value for money criteria
of economy, efficiency, and effectiveness:

1. Economy: This will focus on the inputs for an organisation and obtaining them at the lowest acceptable
cost possible for the level of service to be provided. Economy does not necessarily mean straightforward
cost cutting, as the resource needs to be of a suitable quality.

2. Efficiency: This means getting the greatest output possible for the level of inputs. Efficiency would mean
ensuring that the staff is fully utilised, equipment is fully operational and running to the maximum, and
inventory is not wasted.

3. Effectiveness: This is concerned with achieving the end result or objective. There is always a "trade-off"
between economy and effectiveness. Organisations usually have the ability to plan their inputs at a lower
cost. However, if the cost cutting is too severe, then the organisation will struggle to achieve its end
objectives.

Typically, management may be subjected to value for money audits to ensure services are being delivered in the
most economical, efficient, and effective way. The audits can be conducted by an internal audit department or
may be carried out by an outside specialist organisation.