Measuring performance
| by Ronnie Patton 27 Mar 2007 Diploma in Financial Management Relevant to Module A papers |
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It goes without saying that in a syllabus area entitled Performance Management, the topic of performance measurement will have particular significance. In fact, this topic is one of the four key topics in the Syllabus, and is then expanded in the Study Guide. Here, it comprises six of the study sessions, and therefore is an important area of the syllabus.
From this it follows that any candidate wishing to be successful in Module A will need to have a clear understanding of performance measurement. The purpose of this article is to provide candidates with an overview of the topic – allowing candidates to identify the outcomes that successful study will achieve. This will be done by looking at performance measurement in the context required by the syllabus and learning outcomes of the Performance Management study area within Module B.
What is performance measurement?
A surprising feature of a number of the leading textbooks on management accounting is that a review of the index or glossary of each textbook does not provide a useable definition of performance measurement. Rather the approach in most of the literature is to consider a number of techniques. This may lead candidates to the view that performance measurement is a purely ‘technical’ matter, and that what is required is an ability to ‘do the numbers’. It is my view that this is unsatisfactory. There is a strong argument that this technical perspective is unsatisfactory for a student who wishes to achieve a professional qualification in accounting as a prerequisite to a career in that profession. Such an argument is based on the premise that an accountant must understand the business and how it is affected by its environment, objectives and internal capabilities – and the way in which these matters influence how the organisation should be managed. It is this view that is driving a change in the terminology from ‘management accounting’ to ‘managerial accounting’, and leading to an increased emphasis on strategic management accounting, with its use of data which is not part of the traditional accounting system.
As I have noted in my examiner’s approach article, the Diploma in Financial Management is clearly not intended to lead to a professional accounting qualification, but rather, it is intended to assist non-accounting managers to become financially aware and financially literate. This means that although the techniques may be drawn from the available management accounting material, it is even more critical on the DipFM that successful candidates demonstrate an understanding of why managers need to measure performance and what they ought to measure, as a basis for the techniques.
This means that, in the absence of an agreed definition, there is no obvious starting point for the topic of performance measurement. However, there is general agreement on a number of keys points, which provide a context for the topic, and allow a definition to be developed. The key points can be summarised as:
- Performance measurement is an integral part of the management control system.
- The management control system includes planning and decision making.
- Planning will be influenced by strategic decisions and organisational objectives.
- The management control system will influence behaviour.
- Performance measurement will compare actual performance against a predefined and predetermined yardstick.
- Performance measurement will be carried out at different levels within the organisation (corporate, division, section, individual).
- Resource allocation will be influenced by performance measurement.
- Both financial and non-financial measures will be used in performance measurement.
From the above observations, the following definition can be derived:
‘Performance measurement is part of the planning and control cycle of an organisation. Based on corporate objectives, expected levels of achievement – expressed in both financial and non-financial terms – are set for sectors of the organisation and for individuals and compared to actual achievement to aid future decisions.’
This definition provides the context for performance measurement within the DipFM syllabus.
Why measure performance?
From the definition it can be seen that performance should be measured to ensure that the organisation is achieving its objectives. In a sense this provides a link across the entire syllabus of the DipFM. When the management of an organisation decides on the organisational objectives, they will do so on the basis of an analysis of the environment within which the organisation operates. Part of this analysis will be included in the risk management activities which form part of the syllabus for Module B. When the financial statements are published, these will be used by shareholders and others to make an assessment of the performance of the organisation.
Therefore, it is possible to argue that performance measurement is a vital activity, which effectively binds together all the activities of management. This may be a bold claim for a single part of a syllabus, but it contains at least an element of truth, and emphasises the need to view the topic as more than a collection of techniques.
What should be measured?
The definition indicates that performance measurement is not just about corporate performance. In many organisations, one element of performance measurement will relate to the assessment of the performance of individuals. This may be for decisions regarding bonus payments or career progression. It therefore follows that what should be measured is entirely dependant on the purpose of the particular performance measurement exercise.
This aspect of performance measurement has been tested regularly in the Module A project. This will continue to be the case, as this form of assessment provides opportunities for candidates to demonstrate the ability to form the management judgements referred to above – as well as the ability to select the appropriate performance measurement ‘tool’. This is a key skill for managers, and has sometimes been lacking in projects submitted by previous candidates. One particular example is the number of candidates who seem to assume that when the project requires ‘suitable measures of performance’ to be identified and discussed, this must always be done in the context of the balanced scorecard. Candidates should note that the balanced scorecard is one technique which may be used in a performance measurement system. It is, without doubt, an excellent technique and numerous organisations have found that adopting the technique has led to improved performance. However, it should be noted that it is not the technique itself which leads to improved performance. In fact it is the activities, analyses and behaviours that the balanced scorecard prompts that lead to improved performance. This is because introducing and using the balanced scorecard leads to an examination of how the organisation functions and what needs to be controlled to ensure success. The balanced scorecard might be described as a communication and behavioural tool, rather than a measurement tool. For example, Kaplan and Atkinson[Reference 1] quote Bob McCool, the executive vice president of Mobil Corporation’s US Marketing and Refining Division, regarding his experience of the balanced scorecard as follows:
‘It enabled us to teach the managers about strategy … to think across the organisation, not just in functional silos. It exposed the managers to issues outside their expertise and to understand the linkages they have with other parts of the organisation. People now talk about things outside their immediate responsibility. The scorecard has provided a common language, a good basis for communication.’
These comments are not meant to understate the importance and contribution of the balanced scorecard, but rather to place it in context, and to alert candidates to the need to move beyond the techniques.
By considering the strategy of the organisation and the corporate objectives that will be derived from that strategy, it should be possible to identify appropriate measures of performance. For example, the project for submission in May 2005 was based on the fashion retail chain New Look. One of the questions required candidates to:
‘Identify and explain the significance of a range of non-financial performance measures which can be used to monitor the performance of the company.’
It may be helpful to make two observations on this requirement. The first is that candidates were required to both ‘identify’ and ‘explain’. The need to explain was made specific in the requirement. Unfortunately, a number of candidates did not provide an explanation of the measures they identified. This is poor examination technique, as part of the requirement was ignored. It also demonstrates a lack of awareness of the context discussed above.
The context can be considered by reference to the fact that the suggested solution included available retail space and average store size as appropriate performance measures. These were justified (or explained) on the basis that the chief executive of the group had identified an increase in trading space as a key objective. The reason for this key objective is that the group is not an exclusive retailer, but relies on achieving a high volume of sales, based on a broad appeal. Therefore, more retail space will attract more customers, which should lead to more sales. The average store size was relevant as it allowed a balance between ‘flagship’ and ‘satellite’ stores, providing the broad appeal which the group seeks to achieve.
What is significant about these measures is that they are appropriate for that organisation as a result of its stated strategy and market position. Such objectives may not be appropriate for an exclusive retailer, such as a designer label. For that organisation, the attraction lies in the exclusive nature of the product and consequently having too many outlets may be detrimental to the business.
How should performance be measured?
It should be apparent from the discussion above that performance should be measured in a manner that is appropriate for the specific organisation. This will be a function of the strategy and the stated objectives of the organisation.
It may be helpful to note that any assessment in Module A will not be based on a candidate’s ability to develop a statement of organisational strategy. The strategy will normally be stated in the material provided. Where an assessment does require strategic objectives to be developed, the requirement will be to ensure that proposals are derived from the information provided – and that they are justified. As long as a reasonable justification is provided, marks will be awarded. Equally, it should be noted that marks will not be awarded if no justification is provided.
All of the above means that performance should be measured using a combination of financial and non-financial measures.
Another important issue for candidates to note is that the basis of any performance measure must be clearly specified. How widely accepted measures such as ‘market share’ will be measured should be defined. Such definition indicates an understanding of the context in which the organisation operates. A useful, and widely used, basis for performance measures is that they should be ‘SMART’ (specific, measurable, achievable, realistic, time-bound). The need for measures to be measurable can often lead to a performance measurement system being biased towards financial measures. Candidates are therefore encouraged to make a deliberate effort to include qualitative measures – but to ensure that these are defined.
Drury[Reference 2] defines qualitative measures as ‘those factors that cannot be expressed in monetary terms’. From this it follows that ‘qualitative’ does not mean ‘non-numeric’, although it can often be difficult to decide how to convert a ‘qualitative’ issue into a numerical scale.
The example of customer satisfaction from the project based on New Look may help to illustrate this. It goes without saying that customer satisfaction is an important qualitative objective for any organisation. However, what this actually means needs to be clarified. In the suggested solution, the measure is defined as ‘customers in the last month who had bought products in the last six months’. This is not by any means the only way in which customer satisfaction could be measured, but it is relevant and it meets the criteria of being specific (returning customers), measurable (number of customers), realistic (it focuses on a key issue for the business – customers), time bound (within six months). It does not address the requirement to be achievable as this would require specific knowledge of the business. However it follows that ongoing measurement would seek to encourage a continuous improvement in the level of performance achieved. Thus any candidates who made sensible suggestions as to the required level of performance would have been awarded marks.
What techniques could be used?
The purpose of this article is to place performance measurement in context, rather than to examine specific techniques, which will be discussed in future articles. However, candidates should note that much of the discussion in this article refers to the opportunity for expanded analysis provided by the project. When performance measurement is assessed in the exam, a demonstration of the ability to apply a technique will usually be required. Such a question will invariably include the need to discuss how the results of a technique should be applied, but such discussion will naturally be limited by the time constrained nature of an exam.
Candidates should therefore ensure that they understand the purpose, method of calculation, and application of the techniques specifically referred to in the Syllabus and Study Guide. Key points for performance measurement:
- consider the context
- select measures related to objectives
- justify your measures
- specify your measures
- include non-financial/qualitative measures.
Ronnie Patton is examiner for Module A
References
1 Kaplan, R S and Atkinson, A A, Advanced Management Accounting, Prentice Hall, 1998.
2 Drury, C, Management and Cost Accounting, sixth edn, Thompson, 2004.