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PERFORMANCE EVALUTION TERM PAPER

1. Introduction
Performance can be defined as achievements of the organization in relation with its set
goals. Here achievement can include accomplishment of an individual or a group of
individuals that forms a team in achieving the overall goal of the organization. Basically
performance includes both economic as well as behavioral measuring factors.

Performance evaluation is a process of checking whether the organization objectives are


met in a given period. There should be specific period to which the evaluation is sought.
This will involve evaluation of the individuals in terms of their annual KPIs, evaluation of
the teams under a certain manager and the evaluation of the organization as a whole. The
evaluation will always involve going through plans, actual achievements and a comparison
of the two to establish any variations from plans.

2. Financial Performance Measures


For any organization to run smoothly there should be enough funds to ensure all activities
of the organization are carried without any problem. This will only be possible if proper
management of funds is made. Finance is one of scarce resources which need proper
management by any manager. This will ensure proper allocation of funds for a better
performance of an organization. Financial performance measures are determined by
calculating a set of financial ratios. This gives a picture of how the organization doing
financially. It can be used to compare itself with other similar organizations in the same
industry or it can compare its performance in different periods in time also know as trend
analysis. Financial performance measures are categorized into those which determine
performance in terms of the profitability comparison, and those which are cost based.

2.1.The Profitability Performance Measures


Profitability performance is mainly measured by how best is the company make use of
the resources efficiently in profit generation. In this area we will look at the ratios which
can be used to measure efficient use of assets and management of organization
operations. Most widely used ratios in this area are explained below;
2.1.1. Profit Margin
In measuring company’s performance we need to pay attention to the profit
margin which is determined as a ratio of net income and sales revenue earned
during a certain period. It is given as a percentage of the net income earned to
the total sales revenue earned on the same period.
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑷𝒓𝒐𝒇𝒊𝒕 𝑴𝒂𝒓𝒈𝒊𝒏 = 𝑺𝒂𝒍𝒆𝒔

All things being constant a relatively high profitability margin is obviously


desirable. Also in some cases a low profit margin might not be a bad thing.
Because profit increase maybe a result of decrease in expenses or decrease in
selling price. So a low profitability it is not necessary means the organization
had large expenses but might be due to a decreasing a selling price and
depending in the volume of sales that an organization makes will lead to a low
profit margin. (Ross, 2008)
2.1.2. Return on Asset (ROA)
This is a measure of how the usage of asset contributed in the net profit of an
organization. Return on assets is given by the following ratio
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑨𝒔𝒔𝒆𝒕 = 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔

2.1.3. Return on Equity (ROE)


This measures how the stockholders fared during the year under evaluation.
Since the goal of any firm is to increase or maximize stockholders value, ROE
is considered a bottom line measure of performance. It is given as a percentage
of net income earned during the year and the total equity of the organization.
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑬𝒒𝒖𝒊𝒕𝒚 =
𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚
The ROE measure the return in the net worth of the organization. In case when
the ROE exceeds that of ROA it is an indication that the organization is using
financial leverage. Ideally looking at the ROE we can express it in the following
form
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆 𝑨𝒔𝒔𝒆𝒕𝒔
𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑬𝒒𝒖𝒊𝒕𝒚 = 𝒙
𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚 𝑨𝒔𝒔𝒆𝒕𝒔
𝑨𝒔𝒔𝒆𝒕𝒔
This gives 𝑹𝑶𝑬 = 𝑹𝑶𝑨 𝒙 𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚
But the Assets to Equity ratio is known as the equity multiplier which can be
obtained from the simple accounting equation as shown below.
𝑨𝒔𝒔𝒆𝒕𝒔 𝑻𝒐𝒕𝒂𝒍 𝑫𝒆𝒃𝒕𝒔
𝑬𝒒𝒖𝒊𝒕𝒚 𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒊𝒆𝒓 = =𝟏+
𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚 𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚
The formula derived above for ROE is known as the Du Pont Identity. It tells us
the ROE is affected by three things the operating efficiency as obtained by profit
margin, asset use efficiency as measured by the total asset turnover and the financial
leverage as measured by the equity multiplier. The weakness on either the operating or
asset use efficiency will be translated into a weak ROE.

2.2. The Cost Based Financial Performance Measures


The cost base financial performance measures includes ratios which measures both
short term and long term solvency of the firm. Solvency means the ability of the firm
to meet its obligations as and when they fall due. Solvency of a firm can be divided
into short term solvency and long-term solvency. The following ratios will be used to
measure short term solvency of a firm
2.2.1. Current Ratio
It is extremely essential for any firm to be able to meet its obligations as they
fall due. This ratio measures the ability of the firm to meet its current
obligations. It is calculated as a ratio of total current assets to total current
liabilities. An organization must ensure it doesn’t suffer low liquidity as this
might lead to poor credit worthiness, lost of creditors’ confidence and might
cause its liquidation. Also excessive liquidity is not advised as keeping because
the firm’s funds will be tied up on current assets. A 2:1 ratio is considered
satisfactory.
2.2.2. Quick Ratio
Also known as acid-test ratio establishes the relationship between the quick
assets to current ratio. Quick assets are the most liquid assets of an organization.
Liquidity means the easy at which an asset can be transformed into cash without
significance lose of value.(Pandey, 2010). This ratio therefore is obtained as a
ratio of Total current assets less inventories:current liabilities. A quick ratio of
1:1 is considered satisfactory for a firm.

2.2.3. Cash Ratio


Now since cash is the most liquid asset it is desired to measure the relationship
between cash and cash equivalents to current liabilities. There however should
be no worries for a firm with low cash ratio as long as it has reserve borrowing
power.

2.2.4. Net Working Capital Ratio


Some firm also uses the net working capital ratio to measure the liquidity of the
firm. Net working capital(NWC) is obtained as a difference between current
assets and current liabilities. This is calculated as a ratio to net assets (NA) i.e.
NWC:NA.
2.2.5 Long term solvency
Short term solvency measures the ability of the firm to pay its short term debts. The
interest of long-term debt providers like banks are much interested with long-term
capability of the firm. To judge the long-term financial position of a firm, the
financial leverage or capital structure ratios will be used (Pandey, 2010). The
manners in which assets are financed have a number of implications to the firm.
Financed can be financed by equity or debt. However, debt is more risky in the firm
view point of the firm than equity. The firm has legal obligations to pay interests to
debt holders irrespective of the profit made or losses incurred by the firm. When a
firm uses debt to increase shareholder’s return is called financial leverage.
Sometimes this might work against the firm, if the cost of debt is higher than the
firm’s overall return then there will be reduction in shareholders return. Therefore
in evaluation of financial performance is important to measure the financial risk
associated with the firm’s usage of debt to shareholders advantage (Ross, 2008).
Generally the long-term solvency of the firm will always tell by how much a firm
rely its operations from the debts than its share of equity.
3. Non Financial Performance Measures
Non financial performance measures are any quantitative measure of either an individual’s
or an entity’s performance that is not expressed in monetary units. This includes any ratio-
based performance measure in that a non-financial performance measure that is ratio-based
omits any monetary metric in either the numerator or denominator of that ratio (Financial
Times, 2018). Common examples here includes measures of customer or employee
satisfaction, quality of products or services, percentage that a firm owns in the market, and
the number of new products or services introduced during a period. The level of innovation
also can be used as a non financial performance measure.
3.1.Employee Engagement and Satisfaction
Focusing on employee satisfaction allows you to create a workforce of engaged, loyal
employees. With increased employee morale often come better attendance and effort.
By aiming to improve the workplace for your employees, you show them that you care
about more than simply making money. Specific objectives related to employee
satisfaction include giving staff greater responsibility, rewarding exceptional work,
creating a positive work environment, promoting teamwork and communicating openly
with your employees (Frost, 2018)
3.2. Quality
The quality of work produced by your company affects your reputation and amount of
business you receive. Whether you sell a product or a service, you want every sale from
your company to be top-notch. Consistency is another key factor in the quality of a
company. When you offer consistently high-quality products or services, your
company gains a positive reputation that potentially leads to more business and repeat
customers. Create standards for the items you produce or sell. Establish guidelines for
the services you provide, particularly if you have multiple employees providing the
service (Frost, 2018).

3.3. Customer Service


Along with a quality product or service, aim to provide your customers with a positive
experience every time they interact with your business. Making your customers feel
valued encourages them to give your company additional business in the future.
Improved customer service is possible through employee training and high
expectations. Monitor your employees' interactions with customers. Surveys and
informal conversations with employees help you assess the level of customer service
you currently provide and areas in need of improvement (Frost, 2018).
3.4. Public Relations

Another non-financial area for goals is your company's public image. Improving the
way the general public views your company can mean increased business and stronger
relationships with the community. Potential objectives include maintaining a
professional image, establishing a positive social media presence and giving back to
the community. Donating time and money to charitable organizations helps establish
your company as a fixture in the community (Frost, 2018).

4. Evaluation of Results Based on Business Objectives

The goal of any business is maximization of shareholder’s value. To maximize


shareholder’s value managers need to plan, organize, lead and control all activities of the
business. In doing so consistently a positive result will be expected as everything in the
business will be well planned and sought before it is executed. In evaluation of business
performance based on its objectives one should consider both financial and non-financial
performance measures as they both link in increasing overall business profitability.
Managers should make sure they control to reduce adverse variances.

5. The Balanced Score Card

Although financial measures are important for evaluation purposes as discussed above, we
have seen that nonfinancial measures are also important in evaluation of performance.
Therefore a company should use a mix of both financial and non-financial measures when
evaluating performance. The balanced scorecard is a balanced set of measures that
organizations use to motivate employees and evaluate performance. These measures are
typically separated into four perspectives outlined in the following (Kaplan, 2018)

Table1. Balanced Scorecard Measures


Internal Business
Financial Learning and Growth Customer
Process
Gross margin Hours of employee Customer satisfaction
Defect-free rate
ratio training (survey)
Employee satisfaction Number of customer
Return on assets Customer response time
(survey) complaints
Receivables
Capacity utilization Employee turnover Market share
turnover
Inventory New product Number of employee Number of returned
turnover development time accidents products

Source: Kaplan, 2018

Measures established across the four perspectives of the balanced scorecard are linked in a way
that motivates employees to achieve company goals. For example, if the company wants to
increase the defect-free rate and reduce product returns, effective employee training and low
employee turnover will help in achieving this goal. The idea is to establish company goals first,
then create measures that motivate employees to reach company goals.

6. Value for Money Technique

According to Kaplan Bank (2018), Value for money (VFM) is often quoted as an objective in Not
for Profit Organizations (NFP), i.e. have they gained the best value from the limited funds
available. In assessing performance using the VFM technique a firm should look at the following:

 Through benchmarking an activity against similar activities in other organizations. This


will help to assess the comparability of the activity to similar activity.
 By using performance indicators/ measures
 Through conducting VFM studies (possibly in conjunction with other institutions)

 By seeking out and then adopting recognized good practice where this can be adapted to
the institution's circumstances
 Through internal VFM audit work
 Through retaining both documents that show how an activity has been planned to build in
VFM, and evidence of the good practices adopted
 By examining the results or outcomes of an activity.

7. Stakeholders Based Performance measures


Organizations have stakeholders. Therefore, in developing and implementing strategies
every organization should consider those groups who can affect and are affected by an
organization’s objectives (Freeman, 1983). The term ‘stakeholder’ in a business context
can be defined as “those groups without whose support the organization would cease to
exist” (Freeman, 1983). This word can also be defined as “any group or individual who
can affect or are affected by the achievement of the organization’s objectives” (Barringer
and Harrison, 2000). Stakeholders are important to organization because they affect the
organization’s ability to achieve its objectives, and they require something in return for
helping the organization to achieve its objectives. These include suppliers for product
supply, customers of products or services, the community, government, employee,
prospective investors, and others. The opinion of these groups will help the organization to
adjust to ensure better performance in achieving the overall business objectives. The views
of customers can be used to give feedback on organizations customer’s relations problems.
A proper employee engagement ensures better employee performance and overall
performance.

8. Managing People and Change

Organization is not complete without people. Employees are one of the key drivers of
performance of the organization. However, like any other resource, human resources need
a proper management and evaluation. If human resources are not well managed the
company will lose valuable time which could have been used to stile the firm to a right
direction. For a better performance work organization human resources need to be engaged
in the workplace. Managers need to ensure human resources are involved in key areas of
organization drive. This will create a sense of belongingness and motivates employees to
perform better. To ensure employees perform better there should be predetermined set of
performance indicators that can be used as a benchmark on human resources performance
appraisal on yearly basis.

9. Transfer Price and Performance Evaluation

Transfer prices are almost unavoidably needed whenever an organization is divided


departments or divisions. The movement of goods and/or services between division or
departments will sometimes involve additional cost in it. The monetary value of the good
moved between departments is the transfer price. This price may have profound effect on
reported performance. According to ACCAGlobal, (2018) the following will be the effect
of transfer pricing on performance measurement

9.1.Performance evaluation
The success of each division, whether measured by return on investment (ROI) or
otherwise will be changed. These measures might be interpreted as indicating that a
division’s performance was unsatisfactory and could tempt management at head office
to close it down a certain department while it is not.
9.2.Performance-related pay
If there is a system of performance-related pay, the remuneration of employees in each
division will be affected as profits change. If they feel that their remuneration is
affected unfairly, employees’ morale will be damaged and this will impact the
organization negatively.
9.3. Make/abandon/buy-indecisions
If the transfer price is very high, the receiving division might decide not to buy any
components from the transferring division because it becomes impossible for it to make
a positive contribution. That division might decide to abandon the product line or buy-
in cheaper components from outside suppliers.
9.4.Motivation
Everyone likes to make a profit and this ambition certainly applies to the divisional
managers. If a transfer price was such that one division found it impossible to make a
profit, then the employees in that division would probably be demotivated. In contrast,
the other division would have an easy ride as it would make profits easily, and it would
not be motivated to work more efficiently.
9.5.Investment Appraisal
New investment should typically be evaluated using a method such as net present value.
However, the cash inflows arising from an investment are almost certainly going to be
affected by the transfer price, so capital investment decisions can depend on the transfer
price.
9.6.Taxation and Profit Remittance
If the divisions are in different countries, the profits earned in each country will depend
on transfer prices. This could affect the overall tax burden of the group and could also
affect the amount of profits that need to be remitted to head office. Generally transfer
prices can have a profound effect on group performance because they affect divisional
performance, motivation and decision making.

10. Performance Measurement in Tanzania Standards News Papers (TSN)

Tanzania Standard News paper is a media house which is owned by the government of the
United Republic of Tanzania. Like any for profit organization performance at TSN is
measured by looking at both financial and non financial measures.

REFERENCES

Barringer, B.R., Harrison, J.S. (2000) ‘Walking a Tightrope: Creating Value Through
Interorganizational Relationships’ Journal of Management, Vol. 26, No.3, pp.367-
403

Freeman, R.E. (1983) ‘Strategic Management: a Stakeholder Approach’ in Lamb, R (ed.)


Advances in Strategic Management, Vol.1, pp.31-60

Frost, S (2018) accessed on 30th January 2018 from


http://smallbusiness.chron.com/list-nonfinancial-performance-objectives-
35524.html
Kaplan, S and Norton, D, (2018). Accessed on 29th January 2018 from
https://saylordotorg.github.io/text_managerial-accounting/s17-05-nonfinancial-
performance-measu.html
Ross, S, et al (2008). Fundamentals of Corporate Finance, 8th Edition, Mc Graw-Hill, New
Delhi.
Pandey, I (2010). Financial Management; 10th Edition, Vikas Publishing House, Delhi