Modern Tools for Performance Measurements

8/2/2019 Modern Tools for Performance Measurements

1/9Electronic copy available at: http://ssrn.com/abstract=2017435

MODERN TOOLS FOR PERFORMANCE MEASUREMENTS

Modern Tools for Performance

Measurements

Amirsaleh AzadinaminDoctorate of Finance Candidate

Swiss Management Center (SMC) University

December 11, 2011


2/9Electronic copy available at: http://ssrn.com/abstract=2017435


Abstract

This paper looks upon new methods, standards, and performance measurements that are required

of companies in todays competitive market environment. Older and traditional methods seem to

fail in measuring performance with the market structure that currently rules the market. The

essence of these measurements are being modifies and they are being pushed to go from

accounting-based toward a rather economic-oriented framework. New economic-based

measures, such as economic value added (EVA), are replacing the more traditional measures

such as earning-per-share. Activity-based costing (ABC), the Balanced Scorecard, and Economic

Value Added (EVA) are the three frameworks discussed throughout this paper as the new

measures.


3/9


The Need to Adapt to the Current Environment

In an attempt to keep up with the competitive mood of todays business environment,

many organizations have been pushed to adapt new standards, including some new performance

measurements. In face of todays complex and competitive business environment, many

traditional performance measurements need to be modified or changed for a company to remain

competitive. It is worth mentioning that this change in the business environment has created the

need for a new way to render these measurements. The changing environment has also caused

organizations to re-examine their traditional evaluation measures, as well as the design of

management compensation packages. These changes modified the essence of measurements,

pushing them to go from accounting-based toward an economic-oriented framework. New

economic-based measures, such as economic value added (EVA), are replacing the more

traditional measures such as earning-per-share. Shinder and McDowell (1999) discuss some of

the new measures that are becoming increasingly popular in the process of improving corporate

measurements. Activity-based costing (ABC), the Balanced Scorecard, and Economic Value

Added (EVA) are the three frameworks discussed throughout this paper.

Activity Based Costing

Shinder and McDowell (1999) describe activity-based costing (ABC) as a method where

deficiencies and shortcomings of the traditional system are presented, and solutions using new

measurements are offered. The traditional system solely considers the direct operational cost

mentioned in the financial statements, like labor and machinery, but fails to consider other forms

of expenses that company bears, for instance a cost resulting from a time delay in receiving

inventory.


4/9


ABC systems have been around since the mid-1980s. When implemented properly, they

can provide managers with more accurate product-cost data that can be used to make

more informed decisions about process improvements, pricing, and managing customer

relationships. The overall goal of an ABC system is to allocate indirect (support) costs in

such a way that the resulting cost information reflects more accurately the resource

demands/resource consumption of an organizations cost objects (products, services, and

customers). (Stout & Propri, 2011, p. 2)

New system takes into account elements that were traditionally never fully or even

partially implemented. Activity-based costing not only considers the cost of doing a task, but it

also considers the cost of not doing a task. For instance, the costs of waiting for inventory or

machine downtime are the sort of costs that do not show on financial statements. Having

information about those specific activities, managers can lower the actual cost of doing business,

which is why activity-based costing is a more efficient system. Activity-based costing can be

specifically beneficial in service sector, where there is no product per se, and the actual product

is servicing the customer. Drucker (1995) explains the reasoning behind this as the following:

Service companies cannot start with the cost of individual operations, as manufacturing

companies have done with traditional cost accounting. They must start with the

assumption that there is only one cost: that of the total system. And it is a fixed cost over

given any time periodthe cost per customer in any major area of banking is a fixed

cost. Thus it is the yield per customer both the volume of services a customer uses and

the mix of those services that determines cost and profitability. (p. 56)

ABC is a system that illuminates not only the cost of products, but also for each service

or customer by analyzing each activity that goes into the production process or servicing a


5/9


6/9


indicators are not sufficient to indicate the health of the business. Shinder and McDowell (1999)

also shed some light on how new measures relate to the strategy of the organization:

Each organization will emphasise different measures depending on their strategy.

Management is, in effect, translating their strategy into objectives that can be measured.

The scorecard is a collection of data that helps a manager understand performance. The

measures help managers balance their focus between current and future performance.

Leading variable are future performance indicators, and lagging variables are historic

results. Financial variables are typically lagging variables, telling managers how they

have done (p. 2).

Some indicators such as the training cost, a lagging characteristic, are very efficient

predictions of future business since they greatly influence the customer satisfaction and repeated

business. Shinder and McDowell (1999) further explain that the balanced scorecard usually

contains four categories, which include financial performance, customers, internal processes, and

learning and growth, in which each category will have between two to five measures of its own.

The measurements also vary based on different strategies that the company follows. Shinder and

McDowell (1999) explain these measures further and how they could vary based on strategies

chosen and followed by the organization:

If the business strategy is to increase the market share and reduce operating cost, the

measures may include market share and cost per unit. Another business may choose

financial indicators that focus on price and margin, willingly forgoing market share for a

high-priced niche product (p. 3).

So, the objectives, measures, targets, and initiatives for each of the four categories could

vary accordingly to the strategic path chosen by the business.


7/9


The balanced scorecard is a great tool for managers in tracking factors that affect

performance. If placed in a proper framework and accurately supervised by managers, there is a

fruitful purpose in following it and that is adding value to the company, which leads to the next

topic, the economic value added (EVA).

Economic Value Added

EVA is a measure in determining the value creation in an organization. EVA illuminates

the true financial performance of the business as it subtracts all costs from the accounting profit.

The EVA measure was created by Stern Stewart in order to address challenges companies face in

the area of financial performance by measuring profits after the expected return of shareholders

is subtracted, which indicates economic profitability (Shinder & McDowell, 1999). Burksaitiene

(2009) states that EVA was created by Stern Stewart consulting organization after Residual

Income (RI) was refined. Burksaitiene (2009) continues that based on the meaning of economic

profit, Stern Stewart & Co. developed the concept of the EVA model. The basic difference between the

notions of economic value andRIconcerns the method for calculating profits and invested capital (p.

711).

Adjustments were made in traditional conventional profit measures as well as accounting

methods in creating EVA, and following that path, historic accounting indicators were replaced

by a measure of economic profit and real asset values. New measures also help managers reshape

their priorities by monitoring value added, and ultimately control and supervise the invested

capital in a more efficient manner as part of a bigger financial management system

(Burksaitiene, 2009). Teker et al. (2009) emphasize that EVA concept, or Economic Profit as it

is often called, will avoid problems caused by trade marking, and it will help in the creation of

shareholder value as it has become recognized as the ultimate economic purpose of corporations.

Various metrics are used for various purposes. As the balanced scorecard is used to illuminate


8/9


the objectives of a strategy-driven company, EVA is also used as a single most valuable

measure, as well as a common language, to illuminate the economic value added to the business,

with the difference that EVA is the single metric used to weight all managerial performance.

Using EVA as a single metric will also removes all confusion as to what measures managers

must look for. This also causes managers, and effectively businesses, to operate more effectively

because managers come to realize that this is how success is measured.

Concluding Remarks

All three frameworks discussed here are new measurement techniques. It is worth

mentioning that adding performance measurement techniques will not increase the performance

of the business unless they are implemented by managers accordingly. Activity-based costing

and economic value added will help managers understand the true cost of operation and the true

profit of the business respectively. The balanced scorecard is also a great framework in raising

awareness on the priorities of the company, and in leading the company to align its strategies

with future performance targets. The balanced scorecard can assist organizations in creation of

value, as it sets targets for leading variables. It will help managers obtain a vivid picture on how

they can dedicate to creation of value in the organization. This could be solely done based on

indications obtained from the balanced scorecard framework. However, the information that is

extracted from these measurements is only part of the effort in reaching goals, proper

implementation being the other factor. But without information, decision frameworks, and

performance measures, it is rather hard for managers to act accordingly. Having proper

information and developing right strategies based on those measures will provide the opportunity

for motivated managers to produce great results.


9/9


References

Ahmad, Z., Ahmad, Z., Ahmad, I., & Nawaz, M. (2010). Balanced scorecard: Is it a spontaneous

Performance measurement tool?Interdisciplinary Journal Of Contemporary Research In

Business, 2(2), 99-107.

Burksaitiene, D. (2009). Measurement of value creation: Economic value added and net present

value.Economics & Management, 709-714.

Drucker, P. (1995, Jan. - Feb.). The information executives truly need.Harvard Business

Review, 73, 54-62.

Shinder, M., & McDowell, D. (1999). ABC, the balanced scorecard and EVA.Evaluation, 1(2),

1-5.

Stout, D. E., & Propri, J. M. (2011). Implementing time-driven activity-based costing at a

medium-sized electronics company.Management Accounting Quarterly, 12(3), 1-11.

Teker, D., Teker, S., & Snmez, M. (2011). Economic value added performances of publicly

owned banks: Evidence from Turkey.International Research Journal Of Finance &

Economics, (75), 133-137.

Documents

Modern Tools for Performance Measurements