Financial vs non-financial performance (BSC)

Lecture Overview

  • Lecture Title: Financial vs Non-Financial Measures of Performance

  • Part 1

  • Institution: Glasgow Caledonian University (GCU)

Financial Measures of Performance

  • Key Financial Metrics:

    • Cost

    • Revenue

    • Profit

    • Return on Capital Employed (ROCE)

    • Liquidity measures (e.g., current ratio)

    • Capital structure measures (e.g., gearing)

    • Market ratios (e.g., Earnings Per Share (EPS), Price/Earnings (P/E) ratio)

Benefits of Profitability Focus

  • Advantages of using profitability as a single performance measure:

    • Simplicity in focus and decision-making with a single objective.

    • Allows for quantitative analysis.

    • Encourages focus on elements that contribute to profit: costs, income, productivity, customer satisfaction.

    • Simplifies decentralization with a defined corporate goal, promoting goal congruence.

    • Facilitates manager motivation through profit-linked bonuses.

Criticisms of Financial Indicators (FIs)

  • Limitations of relying solely on financial indicators:

    • Many FIs lag behind actual performance, resulting in delayed signals for action.

    • A need for leading indicators to drive financial performance in the short term.

    • Frequent focus on short-term operational issues at the expense of long-term strategy development.

    • Lack of integration in performance systems to connect short-term results with long-term goals.

Further Criticisms of Financial Indicators

  • Issues with financial measures include:

    • "What you measure is what you get" - management may prioritize achieving set targets.

    • Traditional FIs like ROCE and EPS may offer misleading signals, either intentionally or unintentionally, particularly short-term.

    • Difficulty influencing FIs and their understanding at lower management levels.

    • Perception that FIs suit the industrial era's focus on production and resource management.

Evolution of Societal Focus

  • Society has shifted through three main revolutions:

    • Agricultural Age

    • Industrial Age: Focused on volume, scale, and fixed overhead recovery.

    • Information Age: Emphasizes innovation, service, quality, speed, and knowledge sharing.

New Management Priorities

  • Transition seen in management focus:

    • Financial Management

    • Financial Capital

    • Intellectual Capital

    • Knowledge Management

    • Market Capitalization: shift from 50% (Industrial Age) to 90% (Third Age).

Characteristics of Effective Performance Measures

  • Performance measures should:

    • Be aligned with the type of organization (public vs. profit-making) and industry (production vs. service).

    • Reflect organizational objectives and be specific, understandable, and promote harmony within divisions.

    • Address internal and external factors and consider all stakeholder groups, extending beyond financiers and customers to employees.

Non-Financial Indicators

  • Quote by Albert Einstein:

    • "Not everything that can be counted counts, and not everything that counts can be counted."

Research Observations

  • Traditional measures may not suffice in contemporary, changing environments.

  • Successful measurement systems have characteristics like:

    • Clarity and understanding by all managers.

    • A balanced mix of financial and non-financial indicators.

    • Strong connections between strategic objectives and operational measures.

    • Frequent performance communication among all employees (KPMG findings).

U.S. Financial Services Survey Findings

  • Many firms express dissatisfaction with measurement systems.

  • Concerns raised include excessive emphasis on traditional financial measures at the expense of value drivers like customer and employee satisfaction, innovation, and quality.

Performance Measurement Necessities

  • Overview of performance measurement:

    • Need for integrations to align performance measurement with organizational strategy.

    • Measurement should promote positive future outcomes while reflecting past performance (Charles Bloomfield).

The Balanced Scorecard

  • Developed by Kaplan and Norton, the Balanced Scorecard integrates four perspectives:

    • Customer Perspective: How should we appear to customers?

    • Internal Business Perspective: Which internal processes must we excel at?

    • Learning and Growth Perspective: How will we sustain our ability to change and improve?

    • Financial Perspective: How should we appear to shareholders?

Scorecard System Implementation

  • Each perspective requires:

    • Definition of objectives.

    • Establishing measures to track progress.

Balanced Scorecard Features

  • Key features include:

    • Comprehensive performance monitoring across relevant areas.

    • Consideration of both financial and non-financial factors.

    • Focus on both medium/long-term strategies and short-term goals.

    • Integration of leading and lagging indicators and emphasis on key performance indicators (KPIs).

Implementation of SMART Goals

  • Effective performance measures must be:

    • Specific

    • Measurable

    • Achievable

    • Realistic

    • Time-bound

Customer Perspective Analysis

  • Key questions:

    • Why is customer perspective crucial?

    • How do customers view the organization?

Internal Business Perspective Analysis

  • Focus on which internal processes need improvement to satisfy customers and shareholders.

Learning and Growth Perspective Analysis

  • Key inquiry:

    • What innovations and changes are necessary for future success?

Financial Perspective Analysis

  • Important questions to consider:

    • What does success look like from a financial standpoint?

Implementation Guidelines for Balanced Scorecard

  • Steps for implementation based on Anthony (1998):

    • Define strategy.

    • Develop measures reflecting strategy.

    • Embed measures in management information systems.

    • Regularly review measures to foster feedback and adjustment cycles.

Strategy to Performance Measures

  • Connection between organizational strategy and performance measures illustrating how to gauge improvements across various perspectives.

Review of the Approach

  • Perspectives are interlinked; for example:

    • Improving profits through methods that may impact learning and innovation perspectives.

    • Investments in training may reduce short-term profits but enhance future customer satisfaction.

Critique of Balanced Scorecard

  • Noteworthy criticisms:

    • Potential bias towards shareholders.

    • Lack of recognition for employee contributions and social/environmental impacts.

    • Need for further specification of performance measures and coordination of metrics across perspectives.

Exercise

  • Task: Develop a Balanced Scorecard for ABC Hotels, considering its single model of "no-frills" value and service.

Financial Perspective Objectives for ABC Hotels

  1. Reduce unfilled room rate by 3% through discounts for longer stays.

  2. Control fixed overhead costs within a 3% increase.

  3. Manage variable costs to not exceed 50% of room rates.

Customer Perspective Objectives for ABC Hotels

  1. Increase market share by 5%.

  2. Achieve 50% customer return rate for a second stay.

  3. Attain 90% customer satisfaction regarding service quality.

Internal Business Perspective Objectives for ABC Hotels

  1. Improve customer satisfaction by enhancing checkout times.

  2. Reduce laundry service cycle to 3 days from 4.

  3. Implement one innovative practice.

Learning and Growth Perspective Objectives for ABC Hotels

  1. Ensure 60% staff participation in vocational training programs.

  2. Encourage staff to align personal goals with organizational objectives.

  3. Improve internal communication through a weekly newsletter.

Next Steps

  • Complete seminar questions.

  • Read relevant articles on the Balanced Scorecard.