Chapter 18: Performance Evaluations

Question 1

What is performance measurement?

Answer 1

-Performance measurement is about tracking how well people or departments are achieving their goals, and whether they are helping the organization succeed overall. This has four key pillars:
1) Central component of management control systems
2) Motivates managers/employees to acheive organizational goals
3) Goal Congruence
4) Moral Hazard

Question 2

What are the external measures of performance management?

Answer 2

-The external financial measures of performance management are stock prices and fundraising.
-The non-financial measures of performance management are customer satisfaction, market shares, graduation rate, and employment rate.

Question 3

What are the internal measures of performance management?

Answer 3

-The internal financial measures of performance measurement will be measured in 1 year, and they include ROI, RI, EVA, and ROS.
-The non-financial measures of performance management include defect rates, # of new patents(journal papers), manufacturing lead time, and retention rate.

Question 4

What are the 3Es of performance measurement in Not-For-Profit organizations?

Answer 4

1) Economy: This means spending wisely, buying the right things at the right price.
2) Efficiency: This means getting the most output for the resources we use.
3) Effectiveness: This means doing the right things, focusing on outputs and outcomes.

Question 5

What is the formula of ROI and DuPont?

Answer 5

-ROI Formula=(Net operating) Income/Investment
-DuPont Formula=(Revenues/Investment)((Net Operating) Income/Revenues)
-Dupont Formula=TATOROS
or
-Dupont Formula=TATO*Profit Margin

Question 6

What are the advantages and disadvantages of ROI or DuPont formula?

Answer 6

-The advantages are that it’s the most popular approach; can be compared with opportunities inside or outside the company; highlights benefits of reducing investment(idle cash, inventory, fixed assets); increase income (decrease costs); use assets to generate more revenue(decrease investment); and it is used in markets where revenue growth is limited and investment levels are held fixed; and helps to evaluate overall aggregate performance.
-The disadvantages are that it may cause dysfunctional effects, encouraging managers to invest only when the ROI on the new investment exceeds the existing ROI, a goal congruent problem.
-Final number expressed as a percentage.

Question 7

What is the formula for RI? What are it’s advantages and disadvantages?

Answer 7

-RI=Income-(RRR*Investment)
-It’s advantages are that goal congruence is more likely to be achieved; imputed costs represents opportunity costs or return foregone from alternate use of funds; helps to evaluate overall aggregate performance; and pre-tax income is easier to use.
-It’s disadvantages are that it does not take into account of the tax effects and cost of capital; and it may favour large dividsion in ranking performance.
-Final number represented as an absolute amount in $.

Question 8

What is the formula for Economic Value Added (EVA)? What are it’s advantages.

Answer 8

The formula for EVA=NOPAT-[WACC*(TA-CL)]
-TA=Total Assets
-CL=Current Liabilities
-The advantages of EVA are goal congruence will be more likely to be acheived; value will be created if after tax operating income exceeds the cost of investing the capital; it takes into account tax effects; and it allows the cost of capital to be incorporated into decisions at the subunit level.

Question 9

What is the formula for Return on Sales? What are it’s advantages?

Answer 9

-The formula for return on sales is ROS=Net Operating Income/Revenues
-The advantages of return on sales are that it is simple and intuitive; it helps boost ROI; and it focuses on operational profitability.

Question 10

What are the issues and inconsistencies that can arise when calculating performance measures such as ROI, RI, and EVA?

Answer 10

-Financial measures can be based on different income definitions, and each one tells a different story.
1) Pre-Tax (Operating) Income is often used in ROI and DuPont Analysis
2) After-Tax (Operating) Income is also NOPAT.
-There are also different ways to define investment, and the choice affects financial ratios like ROI and EVA.
1) Total Assets (Available vs Employed)
2) Long-term Assets+(Net) Working Capital
3) Shareholder’s Equity
4) Historical Cost vs Current Cost
5) Gross Book Value vs Net Book Value