Performance Measurement

Written by Drew Coles CIMA chartered Management Accountant

Performance measurement written on white board
Performance measurement allows you to gain insights into how your business is performing and competing in the industry. By assessing actual business performance, we will be able to examine whether business is growing, whether new products are flourishing or whether there is an issue to be resolved. Data from prior periods and monthly from one period to the next should be used to assess. There should also be a comparison against a concrete budget set at the beginning of the period.
By creating these performance measurement capabilities, the business will be able to use tools such as gap analysis to ensure business goals and objectives are met.
objectives setting with arrow showing improving Performance

Objectives setting process

The first step to be able to assess business performance is to set objectives for the period. This should be carried out before the period starts and should identify what the business wants to achieve in the period. Objectives set should be closely linked to the overall corporate strategy. For instance, objectives could be to reduce costs by a certain percentage in the next period or to increase the total number of sales or to diversify into different markets. Objectives should be SMART specific, measurable, achievable, realistic and time based.

blue budget word under construction

Budgets and their role in performance measurement

Budgets are an important tool to assess business performance over a period. There several types of budgets a business can set, these include the purchasing, sales and cash budget which feed into a master budget. The budget should be closely matched with the objectives and plans set out for the next period. The main purpose of the budgets is to quantify these objectives in numerical terms. It should also be noted that the budget should be used as a guide to compare actual performance in which the business can then use feedforward and feedback control to close gaps in performance. As a budget is forecast there needs to be a certain amount flexible judgement needed when assessing performance.
It should also be noted when assessing performance that fixed costs and costs out of the control of managers should not be assessed. For instance, a fixed charge for the use a shared service centre on a business unit should not be used in assessing a manager’s performance.
There are a number of ways a budget can be set which include the following:

  • Zero based budgeting – when the company creates a budget from scratch for the next period. This ensures there is no slack in the budget and that unwanted costs are excluded. The downside is the amount of time required to create a new budget every period.

  • Incremental budgeting – The business will use the last years budget or company performance and add a percentage increment to account for inflation and trends. The downside of this method is that any unwanted spend is carried on into future periods.

Performance measurement using KPI’s

To assess and measure performance key performance indicators (KPI) need to be set. To be of real use KPI’s should be compared to previous periods and from one period to the next to establish trends and highlight issues. KPI’s can measure profitability, liquidity, costs and return on investments therefore they play a vital role in performance measurement.
Profit measurement
Profit measurement is one of the most important performance measure. The following key performance indicators can be used, Net profit margin, gross profit margin and operating profit margin. These measures allow the company to analyse trends, for instance a company may have a steady gross profit margin throughout the year, if one period falls this variance can be analysed and the cause rectified for future periods.
Cost measurement
The business can focus its analysis on costs during the period using the following KPI, Cost of sales against revenue, operating costs against revenue and overheads against revenue. These costs will be displayed as a percentage to revenue. As above if there is an average cost percentage or a budgeted KPI actual costs can be compared and issues highlighted.
Return on investment measurement
Return on investments
Return on capital employed ROCE is a effective KPI to measure the return on investment in the business. It uses the profit generated and capital invested in the company to produce a measure displayed as a percentage.
Other KPI's
There are several KPI's not mentioned here, to assess performance the most important aspect is to use the ones which are most beneficial to your type of business and the industry in which you operate.
Another point worth noting is they are interconnected. For instance, a drop in operating profit margin will cause a fall in ROCE and so on.

Key performance indicator on a white board

Reviewing performance

Variance analysis
Variance analysis should be used to display the actual performance to budgeted, prior periods and years. This will allow the company to analyse the negative and positive variances and try to minimise the negative and repeat positive outcomes.
Accounting systems
Most accounting systems will allow the company to enter its budgeted figures for the next period. This will allow the business to download reports in pdf or excel format in order to generate further analysis. In order to allow a comprehensive analysis good management accounts are necessary every period in order to create the correct detail in the accounting systems and then to produce a detailed comprehensive report highlighting performance.
Periodic Reviews
The management accounts and a brief analysis should be created and reviewed monthly. This will include a variance analysis report, profit and loss report, balance sheet and commentary on performance. This should be distributed to senior management.
A quarterly or six-month management review should also be implemented. This will include all the reports mentioned above for the specific period with the inclusion of forecasted figures to ensure the company will reach its budgeted objectives and targets. If it looks as though the company will not achieve its targets gap analysis should be used to put in a plan of action to improve the figures.
At year end the actual performance for the year should be assessed against budget and prior years using KPI displayed in a variance analysis report. It will be beneficial for management to put ideas across on how they think the period went and how they could improve in future periods. This will include how the budget was set, whether the targets were realistic and whether more investment is required.

Clock showing its time for review

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