Financial and non-financial methods of performance measurement

Introduction

Performance measurement evaluates how well managers, divisions and the organisation achieve their goals. It compares actual results with targets so that good performance is rewarded and weak performance corrected. Measures are grouped as financial and non-financial.

Financial measures

1. Variance analysis against budgets and standards: for cost centres. Example: the assembly shop's labour cost is ₹40,000 above standard for the output achieved.
2. Profit and contribution: for profit centres. Example: a branch's controllable profit against budget.
3. Return on investment (ROI) = Operating profit ÷ Capital employed × 100: for investment centres. Example: a division earning ₹30 lakh on ₹2 crore of assets has ROI of 15%.
4. Residual income (RI) = Operating profit − (Capital employed × Required rate of return). Example: with a 12% required return, the division above earns RI of ₹30 lakh − ₹24 lakh = ₹6 lakh.
5. Economic value added (EVA): net operating profit after tax less a charge for all the capital employed, at the weighted average cost of capital.
6. Ratios: gross and net profit margin, asset turnover, cost per unit, sales growth, earnings per share.

Limitations: they are historical, can encourage short-term thinking, and miss quality, customers and innovation.

Non-financial measures

1. Customer measures: customer satisfaction scores, complaints, repeat customers, market share. Example: a mobile-service provider tracks the number of complaints per thousand subscribers.
2. Quality measures: defect rates, returns, rework, warranty claims. Example: a factory tracks defects per million parts.
3. Operational and process measures: on-time delivery, cycle time, capacity utilisation, productivity per worker. Example: an online retailer tracks the percentage of orders delivered within two days.
4. Employee measures: staff turnover, training hours, absenteeism, employee satisfaction.
5. Innovation and learning: new products launched, share of sales from new products.
6. Environmental and social measures: energy use, emissions, safety incidents.

Choosing between ROI and residual income

ROI is easy to understand and allows comparison of divisions of different sizes, but a manager judged on ROI may reject a project that earns more than the required rate of return yet less than the division's present ROI, because it would lower the average. Residual income avoids this by charging capital at the required rate, so any project earning above that rate raises residual income, though it favours large divisions in comparisons.

Using both together

The balanced scorecard of Kaplan and Norton combines four perspectives, financial, customer, internal business process, and learning and growth, so that managers do not improve financial results at the expense of long-term performance. Non-financial measures often lead financial ones: better quality and service today produce higher profit tomorrow.