Divisional Performance

Measurement
 Performance Measurement is a key tool used
by an entity through which achievement of
Introducti goals/targets will be evaluated. To assess
whether goals have been achieved, an
on evaluation is conducted using measures
deemed appropriate for such an evaluation.
In measuring the performance, it (generally)
compares with a benchmark such as previous
achievement, expectation and/or competitors
achievement
.Both people (employees) and organization
(as a whole) will be motivated by the
achievement of goals. Generally, entitys
goals are expressed through the mission.

Mission is a common path to achieve long

term unique goal of every corporation. (why
do we exist?)
  Performance measurement is the performance based
management process which is flowing from the
organizational mission and the strategic planning
process. Divisional performance measurement
includes the objective and subjective assessments of
What is the performance sub-units of an organization such as
Divisional divisions or departments. Divisional performance
Performance measurement are effective in ensure that a strategy of
organization is successfully implemented by monitor
Measurement? a divisions effectiveness in satisfying its own
predetermined goals or stakeholder desires.
Divisional performance measures may be based on
non-financial as well as on financial information.
 “Divisional performance
measurement includes the objective and
Definition subjective assessments of the performance
sub-units of an organization such as divisions
or departments”.
 Localize decision making. This improve
timelines of and access to information.
Importance of Improve commitment and motivation of
divisional managers responsible for each unit.
performance Provide inputs to strategic long-term
measurement planning of whole organization.
Assign responsibility & authority to
divisional managers.
It increases the over all employees efficiency
 It helps to optimum utilisation of resources
It reduce unnecessary Costs incurred in
particular division
It improves over all profitability of an
organisation
It improves healthy competition between a
different divisions
It helps to achieve the organisation mission and
vision
Advantages and disadvantages of decentralization
in a sizable organization,
‣ Understand how transfer pricing methods affect
the performance of independent units.
Determine the optimal transfer price between the
selling division and buying division.
 The Performance Measurement system of
an entity generally aligns with its
Effective structure. That is, each division, group or
Performance segment identifies its contribution to the
overall goal of the entity, and is evaluated
Measurement on the basis of this contribution.
Key Business Centres;
Cost Centre-Responsible for the production of
goods/services at minimum cost.
Revenue Centre- Solely responsible for
generating target level ofrevenue.
Profit Centre-Responsible for evaluate &
control cost inputs and outputs of revenue
through which attain required level of profitability.
Investment Centre - Responsible for the
Investment activities such asinvestment in assets,
deposits.
 The responsible managers performance is
Effective assessed on the divisions overall
contribution to the entitys goal.
performance
When evaluating the divisional
measurement performance, it should clearly identify the
(conducted) controllable and non-controllable cost and
revenue.
The preparation of divisional performance
report designed to;
Evaluate the performance of each
division.
Provide guidance for the pricing of goods
& services.
Evaluate the level of investment in each
division.
Evaluate the overall
efficiency/effectiveness of each division.
Financial
Performance The evaluation of performance with respect to
evaluation / the investment center is based on the economic
Measurement return relative to the invested resources.
Following key indicators used to evaluate
the performance.
Return on Investment (ROI)
Residual Income (RI)
Economic Value Added (EVA)
 Nowadays, most of companies concentrate on
the return on investment (ROI) of a division
that is profit as a percentage in direct relation
Return on to investment of division which instead of
focusing on the size of a division’s profits.
investment ROI addressed divisional profit as a
(ROI ) percentage of the assets employed in the
division. Assets employed can be defined as
total divisional assets, assets controllable by
the divisional manager, or net assets.
 In this context, return on investment
calculated as a ratio of net divisional
profit (before tax) to the net assets (at
book values) employed n the division.
This is calculated with the help of the
following formula:
Formula
  Easy to use & understand.
 Direct link between profit & investment help
managers.
 Can casily link profit at income statement and
investment in balance sheet at any given time.
Advantages
 Better Measure of Profitability
of ROI
 Achieving Goal Congruence
 It may be used for inter firm comparisons,
provided that the firms whose results are being
compared are of comparable size and of the
same industry.
 The following problems arise in defining
in the computation of profit and capital
involved:
Should capital employed be valued at net
Disadvantage or gross book value?
s of ROI Should capital employed be valued at
historic or current cost?
Should capital employed include or
exclude intangible assets?

Is the profit arrived at before or after
deducting tax?
Is the profit arrived at after deducting
uncontrollable or controllable allocated
head office expenses?
ROI is a percentage measure, not a
measure of absolute values.
Doesn’t consider size and type of the
divisions.
Easily can manipulate by the managers.
  As an alternative to ROI, the performance of
a division can be measured by means of
residual income method.
 The residual income (RI) technique deducts
a charge for the use of assets from divisional
profits, and bases this charge on companies
Residual cost of capital.
income  It is an operating profit or income of a
division less the imputed interest on the
assets used by the division.
 In other words, interest on the capital
invested in the division is treated as cost and
any surplus is the residual income.
This criterion is relevant when managers
of divisions are autonomous and
accountable for his performances and
makes his own decisions on capital
investment.
 Residual income is the excess of net
earnings over the cost of capital.
A typical divisional residual income
statement is shown in Table
 RI=Profit – Capital charges (Out of
capital)
 (Capita
charges=Required rate of return*
Formula investment)

RI = Profit before tax - (required

rate of return x investment)
 It maximises the overall value and
growth of the firm and increase
shareholders wealth by accepting
investments which give a rate of return in
Advantages excess of the cost of capital
of Residual
Divisional managers become aware of the
income opportunity cost of funds and the accept
those investment which give a rate of
return then the rate of imputed interest
IT avoides taking sub optimal decision
because investments are not rejected by
divisional managers merely because they
lower their target ROI
Goal congrance overall and objective of
the firm is more likely to be achieved by
using residual income rather than ROI as a
technique of performance evaluation
 It is difficult to have satisfactory
definition of income and investment
Disadvantage It may be difficult to get the rate of
imputed interest because it depends on
s of RI factors like risk, demand and supply ,
capital etc…
Residual income is an absolute measures
of performance because it is expressed in
rupees. It will not provide a proper basis
for evaluation of organisational
performance which is affected by size of
the organisation.ROI being a relative
measure expressed in percentage is a
better technique of organisational
performance as compared to the Residual
income.
There may be difficulties in defining the
net operating income and the value of the
Divisional investments
Identifying controllable and uncontrollable
factors at a divisional level may be difficult
they can be problems in calculating an
accurate cost of capital