MEASURING TOTAL BUSINESS UNIT

PERFORMANCE : BALANCE SCORE CARD

ACT4401
Department of Accounting and Finance
Year 04 Semester 01
LEARNING OBJECTIVES

• Describe three competitive strategies that a firm can adopt

to achieve sustainable competitive advantage and explain
how they influence performance management systems;

• Describe the balanced scorecard;

• Explain each of the four perspectives of the balanced

scorecard;

• Provide illustrations of performance measures for each of the

four perspectives;

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LEARNING OBJECTIVES

• Explain how the balanced scorecard links strategy

formulation to financial outcomes;

• Distinguish between lead and lag measures;

• Outline the benefits and criticisms of the balanced scorecard.

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PERFORMANCE MANAGEMENT FRAMEWORK

• Otley (1999) identifies five main sets of issues that need

to be addressed in developing a framework for managing
organizational performance.

• He suggests that these issues can be represented by the

following set of questions:

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PERFORMANCE MANAGEMENT FRAMEWORK

1. What are the key objectives that are central to the

organization’s overall future success and how does it go
about evaluating its achievement for each of these
objectives?

2. What strategies and plans has the organization adopted

and what are the processes and activities that it has decided
will be required for it to successfully implement these? How
does it assess and measure the performance of these
activities?

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PERFORMANCE MANAGEMENT FRAMEWORK
3. What level of performance does the organization need to
achieve in each of the areas defined in the above two
questions and how does it go about setting appropriate
performance targets for them?

4. What rewards will managers (and other employees) gain

by achieving these performance targets (or, conversely,
what penalties will they suffer by failing to achieve them)?
Because the human resources function is often responsible
for the rewards systems in many organizations, the linking of
rewards to performance targets tends not to be sufficiently
emphasized in performance management systems.
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PERFORMANCE MANAGEMENT FRAMEWORK
5. What are the information flows (feedback and feed-
forward loops) that are necessary to enable the organization to
learn from its experience and to adapt its current behaviour
in the light of that experience?

These feedback and feed-forward controls provide information

about the extent to which a company is achieving its key
strategic aims. This process can range from simple corrective
action through to the revision of a corporate strategy if it
becomes apparent that the current strategy is proving
ineffective.

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STRATEGY AND STRATEGIC POSITIONING

• A major aim of strategic performance management systems is

to facilitate strategy implementation.

• Porter (1985) suggests that a firm has a choice of three

generic strategies in order to achieve competitive advantage.
They are:
- cost leadership strategy,
- differentiation strategy,
- focusing strategy,

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STRATEGY AND STRATEGIC POSITIONING

• A cost leadership strategy, whereby an enterprise aims to

be the lowest cost producer within the industry thus
enabling it to compete on the basis of lower selling prices
rather than providing unique products or services.

• The source of this competitive advantage may arise from

factors such as economies of scale, access to
favourable raw materials prices and superior
technology (Langfield-Smith, 1997).

• Eg: Amazon

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 STRATEGY AND STRATEGIC POSITIONING

• A differentiation strategy, whereby the enterprise seeks

to offer products or services that are considered by its
customers to be superior and unique relative to its
competitors.

• Examples include the quality or dependability of the

product, after-sales service, the wide availability of the
product and product flexibility (Langfield-Smith, 1997).

• Eg: Apple

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STR ATE GY AN D STRATE GIC PO SITION IN G

• A focusing strategy, which involves seeking competitive advantage by

focusing on a narrow segment of the market that has special needs
that are poorly served by other competitors in the industry.

• A focusing strategy recognizes that differences can exist within

segments (e.g. customers and geographical regions) of the same
market.

• Competitive advantage is based on adopting either a cost leadership or

product differentiation strategy within the chosen segment.

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 PERFORMANCE EVALUATION

• Financial reports are useless to an organisation unless

they are used as a tool to identify strengths and
weaknesses and the causes behind them.

• The purpose of accounting is not to produce financial

reports; the real goal is to use that information to
improve financial decision making.

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 PERFORMANCE EVALUATION

• Therefore, performance evaluation is a big part of

accountancy, which includes things like variance, trend
and ratio analysis.

• The purpose in such activities is not to simply calculate

the variance or the ratio.

• The idea is to interpret and draw an educated conclusion

from it, which can then be used to facilitate the decision
making process.

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 FINANCIAL PERFORMANCE INDICATORS

Ratios are commonly used to assess performance, either:

a) Between one year and the next for a particular business or

division ; or

b) Between one business or division and another

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LIMITATIONS OF FINANCIAL STATEMENT FIGURES FOR RATIO
ANALYSIS

• Only provide historic data and as such ignore future action by

management. For example, if inventory days have increased due to stock
being reserved for a huge deal in the coming year, this will not be reflected.

• Only provide financial information. Non-financial information such as

that given in the notes to the accounts and the management discussion and
analysis section of the statements are not shown in ratios.

• Limited information to be able to identify trends over time. This can

be overcome if we use ratios over a number of years: if Arethra usually has
one strong year and then one weak year, the ratios we have seen could be
tolerable. If, by comparison, they have worsened every year over the last
five, then it's time to panic!
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LIMITATIONS OF FINANCIAL STATEMENT FIGURES FOR RATIO ANALYSIS

• Provide only summarized information and therefore lack the

detailed information required to get the overall view. This is in stark
comparison to the integrated reports we have previously looked at, which
seek to support financial information with a wide array of non-financial data.

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NON-FINANCIAL PERFORMANCE INDICATORS

We all know that money is important and historically financial performance

was considered the only true measure of an organisation. Now, while
financial metrics are obviously important and can offer a great deal of
information there are limitations:

• They consist of historical data only, whereas businesses generally like

to be forward thinking
• They can be manipulated through careful selection of accounting
policies
• They offer short term feedback only

For this reason many firms also employ non-financial performance

indicators (NFPIs), designed to measure progress towards long
term goals.
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NON-FINANCIAL PERFORMANCE INDICATORS

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NON-FINANCIAL PERFORMANCE INDICATORS

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NON-FINANCIAL PERFORMANCE INDICATORS

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ADVANTAGES OF NFPIS
• NFPIs are forward looking; giving management an idea of
future performance (this lies in contrast to financial
indicators, which are generally backward looking).

• Allows all areas of the business to be measured.

• Are easily understood by all personnel. Non-financial

managers will not understand financial ratios but will
understand things like customer satisfaction and staff
turnover very easily.

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ADVANTAGES OF NFPIS
• Gives a good indication of long-term performance, as
opposed to financial indicators which are mostly focused on
the short term.

• Cannot be easily manipulated through accounting

policies.

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DISADVANTAGES OF NFPIS
• NFPIs allow every aspect of the business to be measured,
which can cause information overload and take focus away
from the entity’s core goals.

• NFPIs could be set that do not meet ultimate business

goals. It is important that all NFPIs do end up are somehow
linked to financial performance in most businesses because
improving shareholder wealth is a key goal.

• The large amount of possible NFPIs means businesses can

‘over-evaluate’, spending time and resources on
measurements that provide little value to the decision
making process. 23
Need for a more holistic performance evaluation Method
: Balance Score Card

In order to overcome the limitations of using financial ratios alone,

Kaplan and Norton developed the balance scorecard, which outlines
four key areas in which company and divisional performance should
be measured.

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Definition and Concept

An approach to the provision of information to the management to assist with

strategic policy formulation and achievement. It emphasizes the need to

provide the user with a set of information which addresses all relevant areas of

performance in an objective and unbiased fashion. The information provided

may include both financial and non-financial elements and cover areas such as

profitability, customer satisfaction, internal efficiency and innovation.’

CIMA Official Terminology, 2005

OVERVIEW AND BRIEF HISTORY :
BALANCE SCORE CARD

• The basic idea of the Balanced Scorecard (BSC) is to focus the organization on
performance measures and implementing the current strategy. The BSC comprises
measures from financial, customer, internal processes and learning and growth
perspectives. The aim is to avoid focusing only on short term financial measures. The
BSC enables managers to focus their efforts and to understand the links between the
four key areas.
• The BSC technique was developed by Kaplan and Norton (1992, 1996) to combine
financial control measures with non-financial control measures. It is used for
implementing the mission and objectives of an organisation’s business strategy. The
purpose of the BSC is to enable effective monitoring and control of the business.
OVERVIEW AND BRIEF HISTORY :
BALANCE SCORE CARD

• Essentially, the BSC is a management system that enables an organisation to identify

and clarify its vision and strategy, and translate them into action. It provides feedback
around both the internal business processes and external outcomes to improve
continuously strategic performance and results.
BALANCE SCORE CARD QUADRANTS

The Balanced Scorecard consists of four interrelated quadrants, each containing measures for a
distinct perspective. These perspectives are:

1. financial
2. customer
3. internal processes
4. learning and growth.

These four perspectives are designed to cover the whole of the organisation’s activities, both
internally and externally, current and future.
BALANCE SCORE CARD QUADRANTS
FINANCIAL PERSPECTIVE:

The financial perspective is a key factor of any performance measurement system because
an organisation’s financial performance is fundamental to its success. Measures reflecting
financial performance include the number of debtors, creditors, cash flow, profitability
and return on investment. The main problems with financial measures are as follows.

• They are based on past data. Financial measures show what has happened but they may
not tell us what is currently happening. They are not necessarily a good indicator of
future performance.
• They are short termist and do not focus on the organisation’s long term financial
strategy.
CUSTOMER PERSPECTIVE:

These are measures that have a direct impact on customers. They could include time
taken to process a phone call, the number of customer complaints, results of customer
surveys or volume of repeat customers.

The customer and customer satisfaction have had a growing importance in business.
Businesses recognise that if customers are not satisfied, they will find other suppliers to
meet their needs.
BUSINESS PROCESS PERSPECTIVE:

These are measures of key business processes, such as time taken in production, re-
work costs or time to process an order.
These internal business focused measures allow the organisation to measure how well
the business is operating and whether its products and services meet customer
requirements.
LEARNING AND GROWTH PERSPECTIVE:

These are measures that highlight an organisation’s development and learning ability.
They might include the number of training days, the number of qualified staff or total
hours spent on staff training.
This perspective includes staff training and attitudes to organisational culture related to
both individual and corporate self-improvement. This quadrant recognises that in a
knowledge worker organisation, people are the greatest resource. Kaplan and Norton
focus upon the fact that 'learning' is more than 'training'.
BALANCE SCORE CARD & OVERALL BUSINESS
PERFORMANCE

The measures used in the BSC are mutually consistent and reinforcing. The BSC
should be viewed as more than a collection of disparate financial and non-financial
indicators. Instead it monitors a set of cause and effect relationships that lead to better
financial returns.

This is done by ensuring that a vertical vector runs through the four BSC perspectives,
as demonstrated in Figure 2 below, based on Kaplan and Norton (1996, p.31).
BALANCE SCORE CARD & OVERALL BUSINESS
PERFORMANCE
USES OF THE BALANCED SCORECARD

Kaplan and Norton found that companies are using the BSC to:

• clarify and update strategy

• communicate strategy throughout the company
• align unit and individual goals with strategy
• link strategic objectives to long term targets and annual budgets
• identify and align strategic initiatives
• conduct periodic performance reviews to learn about and improve strategy
STEPS IN DEVELOPMENT OF A BALANCED
SCORECARD

The steps in the process of developing a BSC are to:

1. Identify the key outcomes critical to the success of the organisation

2. Identify the processes that lead to these outcomes
3. Develop key performance indicators for these processes
4. Develop reliable data capture and measurement systems
5. Develop a mechanism for reporting these to the relevant managers and staff.
6. Enact improvement programmes to ensure that performance improves
APPLICATION : BALANCED SCORECARD

The BSC can be used in assisting the implementation of an organisation's strategy. The
process of developing the measures will make managers more aware of how their work
fits in with the strategy of the business. Managers should receive regular reports of their
performance against the BSC measures relevant to their area of work. Strategic level
management should receive regular information on the organisation’s overall performance
of BSC measures. This is to monitor whether the chosen strategy is being achieved and to
take appropriate action when necessary. Outside stakeholders could also have access to
BSC measures to help them form a fuller understanding of the organisation’s objectives.
BENEFITS OF A BALANCED SCORECARD
 It avoids management reliance on short-term or incomplete financial measures. It
ensures that senior management takes a balanced view about the organisation’s
performance.
 Using the BSC can assist in ‘driving down’ the corporate strategy to divisions and
functions by forcing management to develop success measures related to corporate
goals. Top level strategy and middle management level actions are clearly connected
and appropriately focused.
 It can help stakeholders to evaluate the organisation if measures are communicated
externally.
 The organisation’s performance reporting system (and the organisation itself) is much
more likely to focus on staying competitive in the long term and to realise value for
its stakeholders.
DRAWBACKS OF A BALANCED SCORECARD

 The BSC does not lead to a single aggregate summary control. The popularity of
measures such as Return on Investment (ROI) has been because they conveniently
summarise ‘how things are going’.
 Measures may give conflicting signals and confuse management. For example, if
customer satisfaction and financial indicators are both falling, do management
sacrifice one or the other?
 It involves substantial shifts in corporate culture to implement, such as the need to re-
focus on the long term. The organisation must also be recognised as a set of processes
rather than separate departments.
 The approach is not a quick fix. It takes considerable thought to develop an
appropriate scorecard.
Questions ….