1. Financial Key Performance
Indicators
Module 9 - Finance for Non-Finance

2. Accounting based
Performance
Measurement

3. Objectives
1. Define responsibility accounting, and
After studying this
describe four types of responsibility centers.
chapter, you should
2. Tell why firms choose to decentralize.
be able to:
3. Compute and explain return on investment
(ROI) and economic value added (EVA).
4. Explain the role of balance scorecard in a
evaluating firm performance.

4. Responsibility accounting is a system that
measures the results of each responsibility
center according to the information managers
need to operate their centers.
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5. Types of Responsibility Centers
Cost center: A responsibility center in
which a manager is responsible only
for costs.
Revenue center: A responsibility
center in which a manager is
responsible only for sales.
Continued

6. Types of Responsibility Centers
Profit center: A responsibility center
in which a manager is responsible for
both revenues and costs.
Investment center: A responsibility
center in which a manager is
responsible for revenues, costs, and
investments.

7. ACCOUNTING INFORMATION USED TO MEASURE
PERFORMANCE
Capital
Cost Sales Investment Other
Cost center x
Revenue center Direct cost x
only
Profit center x x
Investment center x x x x

8. Return on Investment
Operating income
ROI =
Average operating assets
Beginning net book value +
Ending net book value
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9. Comparison of ROI
Electronics Medical Supplies
Divisions Divisions
2003:
Sales $30,000,000 $117,00,000
Operating income 1,800,000 3,510,000
Average operating assets 10,000,000 19,500,000
ROI 18 % 18 %
$1,800,000
$10,000,000

10. Comparison of ROI
Electronics Medical Supplies
Divisions Divisions
2004:
Sales $40,000,000 $117,00,000
Operating income 2,000,000 2,925,000
Average operating assets 10,000,000 19,500,000
ROI 20 % 15 %
$2,000,000
$10,000,000

11. Margin and Turnover
ROI = Margin x Turnover
Operating Income Sales
Sales
Average operating assets

12. MARGIN AND TURNOVER COMPARISONS
Electronics Medical Supplies
Division Division
2003 2004 2003 2004
Margin 6.0% 5.0% 3.0% 2.5%
Turnover x 3.0 x 4.0 x 6.0 x 6.0
ROI 18.0% 20.0% 18.0% 15.0%

13. Advantages of ROI
1. It encourages managers to
focus on the relationship
among sales, expenses,
and investments.
2. It encourages managers to
focus on cost efficiency.
3. It encourages managers to
focus on operating asset
efficiency.

14. Disadvantages of ROI
1) It can produce a narrow
focus on divisional
profitability at the expense
of profitability for the
overall firm.
2) It encourages managers to
focus on the short run at the
expense of the long run.

15. Economic value added (EVA) is after-
tax operating profit minus the total
annual cost of capital.
EVA = After-tax operating income – (Weighted
average cost of capital x Total capital
employed)
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16. There are two steps involved in
computing cost of capital:
1. Determine the
weighted average cost
of capital (a
percentage figure)
2. Determine the total
dollar amount of
capital employed
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17. Weighted Average Cost of Capital
Suppose that a company has two sources of
financing: $2 million of long-term bonds paying
9 percent interest and $6 million of common
stock, which is considered to be of average risk.
If the company’s tax rate is 40 percent and the
rate of interest on long-term government bonds
is 6 percent, the company’s weighted average
cost of capital is computed as follows:

18. Weighted Average Cost of Capital
Amount Percent x After-Tax Cost = Weighted Cost
Bonds $2,000,000 0.25 0.009(1 –0.4) = .054 0.0135
Equity 6,000,000 0.75 0.06 + 0.06 = .120 0.0900
Total $8,000,000 0.1035
Thus, the company’s
weighted average is
10.35 percent.

19. EVA Example
Suppose that Mahalo, Inc., had after-tax
operating income last year of $900,000. Three
sources of financing were used by the company:
$2 million of mortgage bonds paying 8 percent
interest, $3 million of unsecured bonds paying
10 percent interest, and $10 million in common
stock, which was considered to be no more or
less risky than other stocks. Mahalo, Inc. pays
a marginal tax rate of 40 percent.
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20. Weighted Average Cost of Capital
Weighted
Amount Percent x After-Tax Cost = Cost
Mortgage
bonds $ 2,000,000 0.133 0.048 0.006
Unsecured
bonds 3,000,000 0.200 0.060 0.012
Common
stock 10,000,000 0.667 0.120 0.080
Total $15,000,000
Weighted average cost of capital 0.098

21. EVA Example
Mahalo’s EVA is calculated as follows:
After tax operating income $900,000
Less: Cost of capital 784,000
EVA $116,000
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22. Behavioral Aspects of EVA
A number of companies have discovered that
EVA helps to encourage the right kind of
behavior from their divisions in a way that
emphasis on operating income alone cannot.
The underlying reason is EVA’s reliance on the
true cost of capital.

23. Behavioral Aspects of EVA
In many companies, the responsibility for
investment decisions rests with corporate
management. As a result, the cost of capital is
considered a corporate expense. If a division
builds inventories and investment, the cost of
financing that investment is passed along to the
overall income statement and does not show up
as a reduction from the division’s operating
income.
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24. The Balanced Scorecard translates
an organization’s mission and
strategy into operational objectives
and performance measures for four
different perspectives:
 The financial perspective
 The customer perspective
The
Balanced  The internal business
Scorecard
process perspective
 The learning and growth
perspective

25. Strategy, according to Robert Kaplan and
David Norton, is defined as
“. . . choosing the market and customer
segments the business unit intends to serve,
identifying the critical internal and business
processes that the unit must excel at to
deliver the value propositions to customers
in the targeted market segments, and
selecting the individual and organizational
capabilities required for the internal,
customer, and financial objectives.”

26. Vision and Strategy
Financial Customer Process L and G
Objectives
Strategy-
Measures
Translation
Process
Targets
Initiatives

27. Financial Increase Sales Increase Profits
Increase Increase
Customer Market Customer
Share Satisfaction
Reduce
Process Redesign Defective
Products Units
Infra- Quality Testable Strategy
structure Training Illustrated

28. Summary of Objectives and Measures:
Financial Perspective
Objectives Measures
Revenue Growth:
Increase the number of new Percentage of revenue
products from new products
Create new applications Percentage of repeat
customers
Develop new customers and Percentage of revenue from
markets new sources
Adopt a new pricing strategy Product and customer
profitability

29. Objectives Measures
Cost Reduction:
Reduce unit product cost Unit product cost
Reduce unit customer cost Unit customer cost
Reduce distribution channel cost Cost per distribution channel
Asset Utilization:
Improve asset utilization Return on investment
Economic value added

30. Summary of Objectives and Measures:
Customer Perspective
Objectives Measures
Core:
Increase market share Market share (percentage of
market)
Increase customer retention Percentage of repeat
customers
Increase customer acquisition Number of new customers
Increase customer satisfaction Ratings from customer
surveys
Increase customer profitability Customer profitability

31. Objectives Measures
Performance Value:
Decrease price Price
Decrease postpurchase costs Postpurchase costs
Improve product functionality Ratings from customer
surveys
Improve product quality Percentage of returns
Increase delivery reliability On-time delivery percentage
Aging schedule
Improve product image and Ratings from customer
reputation surveys

32. Actual Conversion Cost per Unit
Standard costs per minute = $1,600,000/400,000
= $4 per minute
Actual cycle time = 60 minutes/10 units
= 6 minutes per unit
Actual conversion costs = $4 x 6
= $24 per unit
Theoretical Conversion Cost per Unit
Theoretical cycle time = 60 minutes/12 units
= 5 minutes per unit
Theoretical conversion
costs = $4 x 5
= $20 per unit

33. Summary of Objectives and Measures:
Process Perspective
Objectives Measures
Innovation:
Increase the number of new Number of new products vs.
products planned
Increase proprietary products Percentage of revenue from
proprietary products
Decrease new product Time to market (from start
development time to finish)

34. Objectives Measures
Operations:
Increase product quality Quality costs
Output yields
Percentage of defective units
Increase process efficiency Unit cost trends
Output/input(s)
Decrease process time Cycle time and velocity
MCE
Postsales Service:
Increase service quality First-pass yields
Increase service efficiency Cost trends
Output/input(s)
Decrease service time Cycle time

35. Summary of Objectives and Measures:
Learning and Growth Perspective
Objectives Measures
Increase employee capabilities Employee satisfaction ratings
Employee turnover percentage
Employee productivity
(revenue/employee)
Hours of training
Strategic job coverage ratio
(percentage of critical job
requirements filled)

36. Objectives Measures
Increase motivation and Suggestions per employee
alignment Suggestions implemented per
employee
Increase information systems Percentage of processes with
capabilities real-time feedback
capabilities
Percentage of customer-facing
employees with on-line
access to customer and
product information

37. Examples of Key Performance Indicators
Examples of Key Performance Indicators
Key Results Areas Key Performance Indicators
Return/profit Return on investment
Percentage of return on sales
Net profit before taxes (dollars)
Percentage of gross margin (by product line)
Productivity Dollars of sales per employee
Units per month (by product line)
Output per work-hour
Output per employee
Overtime as percentage of payrool
Downtime
Turnaround time
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38. Examples of Key Performance Indicators (2)
Examples of Key Performance Indicators
(continued)
Key Results Areas Key Performance Indicators
Employee development Training investment as percentage of sales
Number of employees on degree plan
Cross-training plan
Number of backups per position
Number of employees with implemented
development plan
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39. Examples of Key Performance Indicators (3)
Examples of Key Performance Indicators
(continued)
Key Results Areas Key Performance Indicators
Quality assurance Percentage of first-time acceptance
Yield
Cost of rework, scrap
Percentage of error-free completions
(per
shift, per employee)
Percentage of recidivism (in law
enforcement)
Cross-functional Percentage of on-time completions
Integration Number of unresolved conflicts
Average lead time on support
requests 39

40. Examples of Key Performance Indicators (4)
Examples of Key Performance
Indicators (continued)
Key Results Areas Key Performance Indicators
Research and Number of new product ideas
approved for
development development
Projected dollar value of approved
product ideas
Number of new applications for
current products/services
Cost of R&D investment: ratio to
total budget
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41. Examples of Key Performance Indicators (5)
Examples of Key Performance Indicators
(continued)
Key Results Areas Key Performance Indicators
Organizational Favorable mentions in media
Image Public information programs
Involvement in community
Interorganizational cooperative efforts
Legislative relations Response time to legislators
Inquiries handled favorably
Funding approved
Major programs approved
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42. How to Set Targets
¢ Past performance trends per historical data.
¢ Performance levels of similar organizational units at a
comparable level that facilitates benchmarking.
¢ Best practices across the agency, the public sector or
the private sector. Must be at a pre-existing high level
of performance before you use this approach.
¢ For newly launched services, may have to establish a
baseline per a prototype test and extend out from this
point forward.
¢ For major strategic shifts, may have to set directly per
the plan itself without regard for hard data.
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43. Checklist for Setting Targets
¢ Targets match up with measurements, one to one.
¢ Targets require improving current levels of
performance.
¢ Targets are a stretch, but achievable: they may require
improvements to existing processes.
¢ Targets are quantifiable so that the target
communicates if the expected performance was met.
¢ Long-term targets are established before short-term
targets.
¢ Financial/Budget related targets are established before
non-financial targets.
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44. Initiatives should enable strategic execution
Initiatives Goals or Objectives
Value Mapping Project Improve identification and delivery of all
agency services across the full stakeholder
spectrum
Employee Rotation Program Improve the employee turnover and
satisfaction scores
Web Self Service Portal Reduce agency costs and streamline our
services for more direct service delivery
Common Knowledge Center Expand the overall knowledge base so that
inter-functions can learn from one another
Customer Survey and Develop a more systematic process across
Analysis Tool Program the entire agency to better connect to our
customers
Shared Service Center Reduce reworks and overlaps between our
Tracking System seven shared service centers
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45. Going from Output to Outcome
When you first launch your Initiative, you probably want to use an Output Measurement. Once the
Initiative is up and running, change your measurement to an Outcome to see if the Initiative is
really having strategic impact.
Initiative Output Outcome
Measurement Measurement
Lean Process / Six Number of Projects Overall reductions in errors,
Sigma Defined by Region reworks, and cycle times
Activity Based Costing % of Service Center Reductions in identified re-
/ Management Outlets with ABC Models activities per process study
(ABC/M) in place for Allocation
Costs
Employee % of Employees who Higher skill levels of
Competency Models have a Competency employees using the models
Model in place
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46. What is KPI in graphic?
Input KPI
KPI2
After
Before
Before After Output
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47. Sale per ringgit Advertising
Advertising Sales/advertising
KPI2
After
Before
Before After Sales
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48. Thank you
Question please
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