THE BUILDING BLOCK MODEL

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2 CHAPTER 10 PERFORMANCE EVALUATION THE BUILDING BLOCK MODEL This model is particularly suited to service industries. Fitzgerald and Moon divide performance measurement into three areas: 1. Standards. 2. Rewards. 3. Dimensions. Dimensions Financial performance Competitiveness Quality Flexibility Resource utilisation Innovation Standards Ownership Achievability Equity Rewards Clarity Motivation Controllability Service industries In general services differ from manufacturing since they are: Intangible. Simultaneous. Perishable. Heterogeneous. By Roy Goh 297

3 CHAPTER 10 PERFORMANCE EVALUATION 1. Standards This refers to the targets that are set within the organisation. These should be: High enough to motivate. Be owned by the employees (through participation in target-setting). Be seen to be equitable. 2. Rewards This refers to what the organisation (and the employee) is trying to achieve. The organisation s objectives should be clearly understood. Employees should be motivated to work towards these objectives. Employees should be able to control areas over which they will be held responsible. 3. Dimensions This refers to how performance will be measured. The areas are: Financial Competitive performance Quality of service Flexibility Resource Utilisation Innovation. By Roy Goh 298

4 CHAPTER 10 PERFORMANCE EVALUATION PERFORMANCE MEASUREMENT IN A NOT FOR PROFIT ORGANISATION AND THE PUBLIC SECTOR In simple terms the basic objective of a not for profit is to provide a service without making a loss, a profit or surplus simply being either a timing issue or a means to an end. The wider issue is that the organisation is providing a service of social or moral worth. We can attempt to measure this service. Objectives of a not for profit entity The objective for such an organisation will differ widely from one organisation to another. They may include one or more of the following: Client satisfaction Employee satisfaction (particularly when volunteers are a substantial part of the workforce) Maximisation of surplus (perhaps to assist in growth or protect against loss of future funding) Growth Usage of facilities (for example library services) Maintenance of capability (for example a fire service or army). The key to remember in the exam is that for every not for profit organisation there will be multiple objectives that have to be addressed as opposed to a profit making organisation where profit is the key aim in relation to satisfying the owners or shareholders. Problems of performance measurement of a not for profit entity 1. Multiple objectives As seen above most organisations will have competing objectives. The difficulty arises when attempting to identify the relative importance of the objectives. 2. Measurement of services provided The nature of many services is that they are more qualitative than quantitative. When measuring such outputs it is often very difficult to get meaningful aggregate measures of performance. 3. No profit motive Measures such as ROI and RI cannot be used to gain an overall measure of performance. 4. Identification of cost unit The cost unit is likely to be relatively complex and there is likely to be more than one cost unit. For example what is a cost unit for a hospital/ there are likely to be multiple such cost units being used by a single patient. By Roy Goh 299

5 CHAPTER 10 PERFORMANCE EVALUATION VALUE FOR MONEY (VFM) Value for money is a framework by which not for profit organisations can be measured. It separates the performance of the business into three areas the three E s: 1. Effectiveness 2. Efficiency 3. Economy 1. Effectiveness (an output measure) This may be described as how well the organisation meets its objectives. Perhaps an easier way of understanding it would be to see how well the output of services match the client need. 2. Efficiency (the relationship between input and output) This describes how well resources are utilised; it measures the output of services for a given level of resource or input. 3. Economy (an input measure) This considers the cost of sourcing the input resources. The aim being to minimise the costs of the input for a given standard and level of resource. The key to VFM The key to VFM is to understand that performing in a single area is not sufficient, instead the organisation must achieve in relation to all three aspects in order to provide value for money. By Roy Goh 301

6 CHAPTER 10 PERFORMANCE EVALUATION Web Co (Dec 2012 Q3) Web Co is an online retailer of fashion goods and uses a range of performance indicators to measure the performance of the business. The company s management have been increasingly concerned about the lack of sales growth over the last year and, in an attempt to resolve this, made the following changes right at the start of quarter 2: Advertising: Web Co placed an advert on the webpage of a well-known online fashion magazine at a cost of $200,000. This had a direct link from the magazine s website to Web Co s online store. Search engine: Web Co also engaged the services of a website consultant to ensure that, when certain key words are input by potential customers onto key search engines, such as Google and Yahoo, Web Co s website is listed on the first page of results. This makes it more likely that a customer will visit a company s website. The consultant s fee was $20,000. Website availability: During quarter 1, there were a few problems with Web Co s website, meaning that it was not available to customers some of the time. Web Co was concerned that this was losing them sales and the IT department therefore made some changes to the website in an attempt to correct the problem. The following incentives were also offered to customers: Incentive 1: A free Fast Track delivery service, guaranteeing delivery within two working days, for all continuing customers who subscribe to Web Co s online subscription newsletter. Subscribers are thought by Web Co to become customers who place further orders. Incentive 2: A $10 discount to all customers spending $100 or more at any one time. The results for the last two quarters are shown below, quarter 2 being the most recent one. The results for quarter 1 reflect the period before the changes and incentives detailed above took place and are similar to the results of other quarters in the preceding year. Total sales revenue Net profit margin Total number of orders from customers Total number of visits to website Conversion rate visitor to purchaser The percentage of total visitors accessing website through magazine link Website availability Number of customers spending more than $100 per visit Number of subscribers to online newsletter Quarter 1 Quarter 2 $2,200,000 $2,750,000 25% 16 7% 40,636 49, , ,714 40% 35% % 95% 95% 4,650 6,390 4,600 11,900 By Roy Goh 302

7 CHAPTER 10 PERFORMANCE EVALUATION Required: Assess the performance of the business in Quarter 2 in relation to the changes and incentives that the company introduced at the beginning of this quarter. State clearly where any further information might be necessary, concluding as to whether the changes and incentives have been effective. (20 marks) By Roy Goh 303

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11 CHAPTER 10 PERFORMANCE EVALUATION Preston Financial Services (Pilot Q4) The following information relates to Preston Financial Services, an accounting practice. The business specialises in providing accounting and taxation work for dentists and doctors. In the main the clients are wealthy, self-employed and have an average age of 52. The business was founded by and is wholly owned by Richard Preston, a dominant and aggressive sole practitioner. He feels that promotion of new products to his clients would be likely to upset the conservative nature of his dentists and doctors and, as a result, the business has been managed with similar products year on year. You have been provided with financial information relating to the practice in appendix 1. In appendix 2, you have been provided with non-financial information which is based on the balanced scorecard format. Appendix 1: Financial information Turnover ($ 000) Net profit ($ 000) Average cash balances ($ 000) Average debtor / trade receivables days (industry average 30 days) Inflation rate (%) Appendix 2: Balanced Scorecard (extract) Internal Business Processes Error rates in jobs done Average job completion time Customer Knowledge Number of customers Average fee levels ($) Market Share Learning and Growth Percentage of revenue from non-core work Industry average of the proportion of revenue from non-core work in accounting practices Employee retention rate. Current year Previous year days 3 22 days 3 Current year Previous year 16% 10% 7 weeks 10 weeks Current year Previous year % 20% Current year Previous year 4% 5% 30% 60% 25% 80% Notes 1. Error rates measure the number of jobs with mistakes made by staff as a proportion of the number of clients serviced 2. Core work is defined as being accountancy and taxation. Non-core work is defined primarily as pension advice and business consultancy. Non core work is traditionally high margin work By Roy Goh 304

12 CHAPTER 10 PERFORMANCE EVALUATION Required: (a) Using the information in appendix 1 only, comment on the financial performance of the business (briefly consider growth, profitability, liquidity and credit management). (8 marks) (b) Explain why non financial information, such as the type shown in appendix 2, is likely to give a better indication of the likely future success of the business than the financial information given in appendix 1. (5 marks) (c) Using the data given in appendix 2 comment on the performance of the business. Include comments on internal business processes, customer knowledge and learning/growth, separately, and provide a concluding comment on the overall performance of the business. (12 marks) (25 marks) By Roy Goh 305

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17 CHAPTER 10 PERFORMANCE EVALUATION Ties Only (Dec 2007 Q2) Ties Only is a new business, selling high quality imported men s ties via the internet. The managers, who also own the company, are young and inexperienced but they are prepared to take risks. They are confident that importing quality ties and selling via a website will be successful and that the business will grow quickly. This is despite the well recognised fact that selling clothing is a very competitive business. They were prepared for a loss-making start and decided to pay themselves modest salaries (included in administration expenses in table 1 below) and pay no dividends for the foreseeable future. The owners are so convinced that growth will quickly follow that they have invested enough money in website server development to ensure that the server can handle the very high levels of predicted growth. All website development costs were written off as incurred in the internal management accounts that are shown below in table 1. Significant expenditure on marketing was incurred in the first two quarters to launch both the website and new products. It is not expected that marketing expenditure will continue to be as high in the future. Customers can buy a variety of styles, patterns and colours of ties at different prices. The business s trading results for the first two quarters of trade are shown below in table 1 Table 1 Sales less Cost of Sales Gross Profit less expenses Website development Administration Distribution Launch marketing Other variable expenses Total expenses Loss for quarter Quarter 1 Quarter 2 $ $ $ $ 420, ,000 (201,600) (340,680) 218, , , ,500 20,763 60,000 50,000 (351,263) (132,863) 90, ,640 33,320 40,800 80,000 (394,760) (55,440) Required: (a) Assess the financial performance of the business during its first two quarters using only the data in table 1 above. (12 marks) (b) Briefly consider whether the losses made by the business in the first two quarters are a true reflection of the current and likely future performance of the business. (4 marks) By Roy Goh 306

18 CHAPTER 10 PERFORMANCE EVALUATION The owners are well aware of the importance of non-financial indicators of success and therefore have identified a small number of measures to focus on. These are measured monthly and then combined to produce a quarterly management report. The data for the first two quarters management reports is shown below: Table 2 Quarter 1 Quarter 2 Website hits* 690, ,492 Number of ties sold 27,631 38,857 On time delivery 95% 89% Sales returns 12% 18% System downtime 2% 4% * A website hit is automatically counted each time a visitor to the website opens the home page of Ties Only. The industry average conversion rate for website hits to number of ties sold is 3 2%. The industry average sales return rate for internet-based clothing sales is 13%. Required: (c) Comment on each of the non-financial data in table 2 above taking into account, where appropriate, the industry averages provided, providing your assessment of the performance of the business. (9 marks) (25 marks) By Roy Goh 307

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22 CHAPTER 10 PERFORMANCE EVALUATION Bridgewater Co (June 2008 Q3) Bridgewater Co provides training courses for many of the mainstream software packages on the market. The business has many divisions within Waterland, the one country in which it operates. The senior managers of Bridgewater Co have very clear objectives for the divisions and these are communicated to divisional managers on appointment and subsequently in quarterly and annual reviews. These are: 1. Each quarter, sales should grow and annual sales should exceed budget 2. Trainer (lecture staff) costs should not exceed $180 per teaching day 3. Room hire costs should not exceed $90 per teaching day 4. Each division should meet its budget for profit per quarter and annually It is known that managers will be promoted based on their ability to meet these targets. A member of the senior management is to retire after quarter 2 of the current financial year, which has just begun. The divisional managers anticipate that one of them may be promoted at the beginning of quarter 3 if their performance is good enough. The manager of the Northwest division is concerned that his chances of promotion could be damaged by the expected performance of his division. He is a firm believer in quality and he thinks that if a business gets this right, growth and success will eventually follow. The current quarterly forecasts, along with the original budgeted profit for the Northwest division, are as follows: Sales less: Trainers Room hire Staff training Other costs Forecast net profit Original budgeted profit Annual sales budget Teaching days Q1 $ Q2 $ Q3 $ $ Total $ Required: (a) Assess the financial performance of the Northwest division against its targets and reach a conclusion as to the promotion prospects of the divisional manager (8 marks) By Roy Goh 308

23 CHAPTER 10 PERFORMANCE EVALUATION The manager of the Northwest division has been considering a few steps to improve the performance of his division. Voucher scheme As a sales promotion, vouchers will be sold for $125 each, a substantial discount on normal prices. These vouchers will entitle the holder to attend four training sessions on software of their choice. They can attend when they want to but are advised that one training session per quarter is sensible. The manager is confident that if the promotion took place immediately, he could sell 80 vouchers and that customers would follow the advice given to attend one session per quarter. All voucher holders would attend planned existing courses and all will be new customers. Software upgrade A new important software programme has recently been launched for which there could be a market for training courses. Demonstration programs can be bought for $1,800 in quarter 1. Staff training would be needed, costing $500 in each of quarters 1 and 2 but in quarters 3 and 4 extra courses could be offered selling this training. Assuming similar class sizes and the usual sales prices, extra sales revenue amounting to 20% of normal sales are expected (measured before the voucher promotion above). The manager is keen to run these courses at the same tutorial and room standards as he normally provides. Software expenditure is written off in the income statement as incurred. Delaying payments to trainers The manager is considering delaying payment to the trainers. He thinks that, since his commitment to quality could cause him to miss out on a well deserved promotion, the trainers owe him a favour. He intends to delay payment on 50% of all invoices received from the trainers in the first two quarters, paying them one month later than is usual. Required: (b) Revise the forecasts to take account of all three of the proposed changes. (7 marks) (c) Comment on each of the proposed steps and reach a conclusion as to whether, if all the proposals were taken together, the manager will improve his chances of promotion. (6 marks) (d) Suggest two improvements to the performance measurement system used by Bridgewater Co that would encourage a longer term view being taken by its managers. (4 marks) (25 marks) By Roy Goh 309

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28 CHAPTER 10 PERFORMANCE EVALUATION Pace Company (Dec 2008 Q1) Pace Company (PC) runs a large number of wholesale stores and is increasing the number of these stores all the time. It measures the performance of each store on the basis of a target return on investment (ROI) of 15%. Store managers get a bonus of 10% of their salary if their store s annual ROI exceeds the target each year. Once a store is built there is very little further capital expenditure until a full four years have passed. PC has a store (store W) in the west of the country. Store W has historic financial data as follows over the past four years: Sales ($ 000) Gross profit ($ 000) Net profit ($ 000) Net assets at start of year ($ 000) The market in which PC operates has been growing steadily. Typically, PC s stores generate a 40% gross profit margin. Required: (a) Discuss the past financial performance of store W using ROI and any other measure you feel appropriate and, using your findings, discuss whether the ROI correctly reflects Store W s actual performance. (8 marks) (b) Explain how a manager in store W might have been able to manipulate the results so as to gain bonuses more frequently. (4 marks) PC has another store (store S) about to open in the south of the country. It has asked you for help in calculating the gross profit, net profit and ROI it can expect over each of the next four years. The following information is provided: Sales volume in the first year will be 18,000 units. Sales volume will grow at the rate of 10% for years two and three but no further growth is expected in year 4. Sales price will start at $12 per unit for the first two years but then reduce by 5% per annum for each of the next two years. Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices on goods for resale will remain constant for the four years. Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in years three and four. Store S requires an investment of $100,000 at the start of its first year of trading. PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on these assets. By Roy Goh 310

29 CHAPTER 10 PERFORMANCE EVALUATION Required: (c) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store S over each of its first four years. (9 marks) (d) Calculate the minimum sales volume required in year 4 (assuming all other variables remain unchanged) to earn the manager of S a bonus in that year.(4 marks) (25 marks) By Roy Goh 311

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