Chapter 14 Cost Allocation, Profitability
mission statement
expresses an organization's purpose and should identify how the organization will meet targeted customers' needs through its products or services
short-run objectives
focus on the effective and efficient management of current operating, investing, and financing activities
process quality yield
good units/total units
Employee Stock Ownership Plan (ESOP)
investments are made in the employer's securities
long-term objectives
involve resource investments and proactive efforts, such as customer satisfaction, quality, delivery, price, service, and sustainability to enhance competitive position
leading indicators
reflect causes, measurements for improving performance should involve tracking leading indicators
Performance measures should exist for all elements that are critical to an organization's success in a competitive market
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management should strive to increase throughput by engaging in one or several of the following methods:
1. Decreasing NVA activities 2. Increasing total unit production and sales 3. Decreasing the per-unit processing time 4. Increasing process quality yield
short-term financial performance measures for management
1. Divisional profits 2. Cash Flow 3. Return on Investment 4. Residual Income 5. Economic Value Added (EVA)
quality measures (NFM) (exhibit 14.12)
1. Prevention 2. Appraisal 3. Internal Failure 4. External Failure
ROI, RI, and EVA have three primary limitations
1. Reflects the use of accounting income 2. Relates to the asset investment base used; asset investment can be difficult to properly measure and assign to center managers 3. The measures direct attention to how well an investment center performed in isolation rather than relative to companywide objectives; such a focus can result in resource sub optimization so that the firm is not maximizing its operational effectiveness and efficiency
general criteria should be considered in designing a performance measurement system:
1. The measures should be established to assess progress toward the organizational mission and its related goals and objectives 2. The persons being evaluated should be aware of the measurements being used and have had some input in developing them 3. The persons being evaluated should have the appropriate skills, equipment, information, and authority to be successful under the measurement system 4. Feedback of accomplishment should be provided in a timely and useful manner 5. They system should be flexible enough to adapt to new conditions in the organization's environment
appropriate nonfinancial metrics are those that:
1. can be clearly articulated and defined 2. are relevant to the objective 3. can trace responsibility 4. rely on valid data 5. have target objectives 6. have established internal and/ or external benchmarks
The balanced scorecard should reflect the organization's mission and strategy and typically includes performance measures from four perspectives:
1. financial 2. internal business 3. customer 4. learning and growth
definitions of effective and efficient may relate to:
1. historical organizational performance 2. competitive benchmarks 3. stakeholder expectations
To succeed, an entity or an investment center must meet two requirements:
1. long-run profitability 2. continuous liquidity
two additional factors should be considered in the actual determination of throughput:
1. organizations should not count units, services, or work performed as truly being throughput unless they would be deemed acceptable for purchase by customers 2. because a firm's primary goal is to earn income, only goods or services that are actually sold should be considered throughput
ROI can be increased through various management actions including:
1. raising sales prices if demand will not be impaired 2. decreasing expenses 3. decreasing investment in assets, especially nonproductive ones
improved throughput means a greater ability to :
1. respond to customer needs and demands 2. reduce production costs 3. reduce inventory levels, and therefore, the NVA costs of moving and storing goods
internal process measures should reflect concern for
1. streamlined production 2. high quality 3. minimization of product complexity 4. reduction/elimination of negative environmental impacts
For an organization to be successful, managers must devise appropriate information systems to track and gauge the effective and efficient use of organizational resources. Two conditions must exist to make such determinations:
1. the terms effective and efficient must be defined 2. measures consistent with those definitions must be formulated
research has indicated that pay-for-performance is increasing in large organizations for four primary reasons:
1. to better align activities with business strategies 2. to create better linkages between corporate and individual performance 3. to improvement organizational or team performance 4. to ensure market competitiveness
carbon footprint
NFPM, which reflects the total of all greenhouse gas emissions created by that organization's activities during a specified time
lead time
a NFPM related to customer service is lead time, which reflects how quickly customers receive their goods after placing their orders
Economic Value Added (EVA)
a measure that has been developed to more directly align managerial interests with common stockholders' interests, EVA measures the profit produced above the cost of capital EVA=After-tax profits - (Cost of Capital % X Market value of invested capital)
lagging indicators
both the financial measures and the score are reflections of past decisions, reflect effects or outcomes
quantitative measures
are of two types: 1. financial 2. nonfinancial
qualitative measures
are often objective
expatriates (expats)
are parent-company and third-country nationals assigned to a foreign subsidiary or foreign nationals assigned to the parent company
return on investment (ROI)
is a ratio relating income generated by an investment center or organization to the resources (or asset base) used to produce that income ROI= Income/Assets Invested
Residual Income
is the profit earned that exceeds an amount "charged" for funds committed to the center. The "charged" amount is equal to a specified target rate of return multiplied by the asset base and is comparable to an imputed rate of interest on the divisional assets used. Residual Income= Income-(Target Rate X Asset Base)
Profit Margin
is the ratio of income to sales and indicates what proportion of each sale dollar is NOT used for expenses (and, thus, becomes profit)
learning and growth measures of the BSC:
lead customer perspective measures and should focus on using the organization's intellectual capital to adapt to changing customer needs or influence new customer needs and expectations through product or service innovations
customer measures of the BSC:
lead financial perspective measures and should indicate how the organization is faring relative to customer issues of speed (delivery time), quality, service, and price (both at and after purchase)
throughput calculation:
manufacturing cycle efficiency X process productivity X process quality yield = throughput OR (value-added processing time/Total time) X (Total Units/VA processing time) X (good units/total units) = throughput
Asset Turnover
measures asset productivity and shows the number of sales dollars generated by each dollar of assets
external performance measures
must signal an organization's ability to satisfy its customers, investors/creditors, and other stakeholders
balanced scorecard
provides a set of measurements that "complements financial measures of past performance with measures of the drivers of future performance"
values statement
reflects the organization's culture by identifying fundamental beliefs about what is important to the organization; mission and values statements are two of the underlying bases for setting organizational goals (abstract targets to be achieved) and objectives (quantified targets with expected completion dates)
The performance measurement system
should be designed to encourage behaviors that will result in outcomes that generate organizational success
internal process measure of the BSC:
should focus on organizational actions designed to meet customer needs and expectations
financial measures of the BSC:
should reflect stakeholder-relevant issues of profitability, organizational growth, and market price of stock
As the difference between the market value of invested capital (total equity and interest-bearing debt) and the book value of assets increases...
so do the relative benefits of using EVA rather than RI as a performance measure
Du Pont model
the ROI formula can be restated to provide useful information about two individual factors that compose the rate of return: 1. Profit Margin 2. Asset Turnover ROI=Profit Margin X Asset Turnover= (Income/Sales) X (Sales/Assets)
divisional profits
the segment margin of profit or investment center is frequently used to measure divisional performance; actual and budgeted margins are compared, and variances are computed to determine the points
cash flow
the statement of cash flows provides information about the sources and uses of cash from operating, investing, and financing activities; it is useful when managing cash outflow commitments, adapting to adverse changes in business conditions, and assessing new cash commitments; assists managers in judging the reliability of the entity's earnings
process productivity
total units produced/VA processing time
nonfinancial performance measures
use information contained in the cost management, rather than the financial accounting, system; NFPMs are based on nonmonetary details, such as time, quantities, and ratios
throughput (NFPM):
which reflects the movement of inputs through a process to become outputs, provides a measure of productive activity for firms