Introduction 

Performance measurement and target-setting are important to the growth process. While many small 

businesses can run themselves quite comfortably without much formal measurement or targetsetting, for growing businesses the control these processes offer can be indispensable.

The benefits of performance measurement

Knowing how the different areas of your business are performing is valuable information in its own 

right, but a good measurement system will also let you examine the triggers for any changes in 

performance. This puts you in a better position to manage your performance proactively.

One of the key challenges with performance management is selecting what to measure. The priority 

here is to focus on quantifiable factors that are clearly linked to the drivers of success in your 

business and your sector. These are known as key performance indicators (KPIs). See the page in 

this guide on deciding what to measure.

Bear in mind that quantifiable isn't the same as financial. While financial measures of performance 

are among the most widely used by businesses, nonfinancial measures can be just as important.

For example, if your business succeeds or fails on the quality of its customer service, then that's 

what you need to measure - through, for example, the number of complaints received. For more 

information about financial measurement, see the page in this guide on measurement of your 

financial performance.

The benefits of target-setting

If you've identified the key areas that drive your business performance and found a way to measure 

them, then a natural next step is to start setting performance targets to give everyone in your 

business a clear sense of what they should be aiming for.

Strategic visions can be difficult to communicate, but by breaking your top level objectives down 

into smaller concrete targets you'll make it easier to manage the process of delivering them. In this 

way, targets form a crucial link between strategy and day-to-day operations.

FINANCIAL PERFORMANCE MEASURES

Financial performance exists at different levels of the organisation. This page is mostly concerned 

with measuring the financial performance of the organisation as a whole, and of measuring the 

performance of key projects. Further measures are used as part of the particular problem of 

divisional performance appraisal.

Traditionally, financial performance measures are split into the following categories:

- Profitability 

- Liquidity / working capital 

- Gearing 

- Investor ratios 

Profitability measures 

Return on capital employed (ROCE) 

ROCE is a key measure of profitability. It shows the net profit that is generated from every $1 of 

assets employed

An increase in ROCE could be achieved by: 

- Increasing net profit, e.g. through an increase in sales price or through better control of costs. 

- Reducing capital employed, e.g. through the repayment of long term debt. 

The ROCE can be understood further by calculating the net profit margin and the asset turnover:

ROCE = net profit margin × asset turnover

Gross profit margin 

This is the gross profit as a percentage of turnover

A high gross profit margin is desirable. It indicates that either sales prices are high or that production 

costs are being kept well under control.

Net profit margin 

This is the net profit (turnover less all expenses) as a percentage of turnover

A high net profit margin is desirable. It indicates that either sales prices are high or that all costs are 

being kept well under control.

Asset turnover 

This is the turnover divided by the capital employed. The asset turnover shows the turnover that is 

generated from each $1 of assets employed

A high asset turnover is desirable. An increase in the asset turnover could be achieved by:

- Increasing turnover, e.g. through the launch of new products or a successful advertising 

campaign. 

- Reducing capital employed, e.g. through the repayment of long term debt.

EBITDA 

EBITDA is:

- earnings before interest, tax and depreciation adjustment or 

- earnings before interest, tax, depreciation and amortisation. 

The two versions are entirely interchangeable

Liquidity measures 

The main reason why companies fail is poor cash management rather than profitability so it is vital 

that liquidity is managed.

A company can be profitable but at the same time encounter cash flow problems. Liquidity and 

working capital ratios give some indication of the company's liquidity.

Current ratio 

This is the current assets divided by the current liabilities

The ratio measures the company's ability to meet its short term liabilities as they fall due.

A ratio in excess of 1 is desirable but the expected ratio varies between the type of industry

A decrease in the ratio year on year or a figure that is below the industry average could indicate that 

the company has liquidity problems. The company should take steps to improve liquidity, e.g. by 

paying creditors as they fall due or by better management of receivables in order to reduce the level 

of bad debts.

Quick ratio (acid test) 

This is a similar to the current ratio but inventory is removed from the current assets due to its poor 

liquidity in the short term

The comments are the same as for the current ratio.

Inventory holding period 

This indicates the average number of days that inventory items are held for.

An increase in the inventory holding period could indicate that the company is having problems 

selling its products and could also indicate that there is an increased level of obsolete stock. The 

company should take steps to increase stock turnover, e.g. by removing any slow moving or 

unpopular items of stock and by getting rid of any obsolete stock.

A decrease in the inventory holding period could be desirable as the company's ability to turn over 

inventory has improved and the company does not have excess cash tied up in inventory. However, 

any reductions should be reviewed further as the company may be struggling to manage its liquidity 

and may not have the cash available to hold the optimum level of inventory.

Receivables (debtor) collection period

This is the average period it takes for a company's credit customers / debtors / receivables to pay 

what they owe.

An increase in the receivables collection period could indicate that the company is struggling to 

manage its debts. Possible steps to reduce the ratio include

- Credit checks on customers to ensure that they will pay on time 

- Improved credit control, e.g. invoicing on time, chasing up bad debts. 

A decrease in the receivables collection period may indicate that the company's has improved its 

management of receivables. However, a receivables collection period well below the industry 

average may make the company uncompetitive and profitability could be impacted as a result.

Payables (creditor) period

This is the average period it takes for a company to pay for its purchases.

An increase in the company's payables period could indicate that the company is struggling to pay 

its debts as they fall due. However, it could simply indicate that the company is taking better 

advantage of any credit period offered to them.

A decrease in the company's payables period could indicate that the company's ability to pay for its 

purchases on time is improving.However, the company should not pay for its purchases too early 

since supplier credit is a useful source of finance.

Gearing ratios 

In addition to managing profitability and liquidity it is also important for a company to manage its 

financial risk. The following ratios may be calculated:

Financial gearing 

This is the long term debt as a percentage of equity

A high level of gearing indicates that the company relies heavily on debt to finance its long term 

needs. This increases the level of risk for the business since interest and capital repayments must be 

made on debt, where as there is no obligation to make payments to equity.

The ratio could be improved by reducing the level of long term debt and raising long term finance 

using equity. 

Interest cover 

This is the operating profit (profit before finance charges and tax) divided by the finance cost.

A decrease in the interest cover indicates that the company is facing an increased risk of not being 

able to meet its finance payments as they fall due.

The ratio could be improved by taking steps to increase the operating profit, e.g. through better 

management of costs, or by reducing finance costs through reducing the level of debt.

Other investor ratios 

Investors will be interested in all of the above measures, along with the following:

Earnings Per Share (EPS) 

EPS is a measure of the profit attributable to each ordinary share

Dividend cover 

This is the net profit divided by the dividend

A decrease in the dividend cover indicates that the company is facing an increased risk of not being 

able to make its dividend payments to shareholders

Dividend yield 

- Dividend yield = (Dividend per share/Current share price) × 100% 

This is one way of measuring the return to shareholders but ignores any capital growth / loss.

Earnings yield 

This is another one way of measuring the return to shareholders but, as with dividend yield, ignores 

any capital growth / loss.

Shareholder value 

As discussed above, profit based measures have a poor correlation with shareholder value. Measures 

that have a closer correlation include the following:

- Discounted cash flow based approaches such as NPV, IRR and MIRR

- Economic value added (EVA)

NON-FINANCIAL MEASURES OF PERFORMANCE

Non-Financial Performance Indicators (NFPIs) and business performance 

Introduction 

There are a number of areas that are particularly important for ensuring the success of a business and 

where the use of NFPIs plays a key role. These include:

- the management of human resources 

- product and service quality 

- brand awareness and company profile. 

The management of human resources 

Traditionally the main performance measure for staff was cost (a FPI). However, businesses have 

started to view staff as a major asset and recognise that it is important to attract, motivate and retain 

highly qualified and experienced staff. 

As a result, NFPIs are now also used to monitor and control staff. These can include the following:

- staff turnover 

- absentee rates / sick days 

- % of job offers accepted 

- results of job satisfaction surveys 

- competence surveys 

Product and service quality 

Problems with product or service quality can have a long-term impact on the business and they can 

lead to customer dissatisfaction and loss of future sales.

A product (or service) and its components should be critically and objectively compared both with 

competition and with customer expectation and needs, for example: 

- Is it good value?

- Can it really deliver superior performance? 

- How does it compare with competitor offerings? 

- How will it compare with competitor offerings in the future given competitive innovations? 

Product and service quality are usually based on several critical dimensions that should be identified 

and measured over time. Performance on all these dimensions needs to be combined to give a 

complete picture. For example: 

- an automobile firm can have measures of defects, ability to perform to specifications, 

durability and ability to repair 

- a bank might be concerned with waiting time, accuracy of transactions, and making the 

customer experience friendly and positive 

- a computer manufacturer can examine relative performance specifications, and product 

reliability as reflected by repair data. 

Brand awareness and company profile 

Developing and maintaining a brand and/or a company profile can be expensive. However, it can 

also enhance performance. The value of a brand/company profile is based on the extent to which it 

has:

- high loyalty 

- name awareness 

- perceived quality 

- other attributes such as patents or trademarks. 

NFPIs may focus on areas such as customer awareness and consumer opinions.

Difficulties in using and interpreting qualitative information 

Particularly at higher levels of management, non-financial information is often not in numerical 

terms, but qualitative, or soft, rather than quantitative. Qualitative information often represents 

opinions of individuals and user groups. However there are issues related to its use.

- Decisions often appear to have been made on the basis of quantitative information; however 

qualitative considerations often influence the final choice, even if this is not explicit. 

- Conventional information systems are usually designed to carry quantitative information and 

are sometimes less able to convey qualitative issues. However the impact of a decreased 

output requirement on staff morale is something that may be critical but it is not something 

that an information system would automatically report. 

- In both decision making and control, managers should be aware that an information system 

may provide a limited or distorted picture of what is actually happening. In many situations, 

sensitivity has to be used in interpreting the output of an information system. 

- Information in the form of opinions is difficult to measure and interpret. It also requires more 

analysis. 

- Qualitative information may be incomplete. 

- Qualitative aspects are often interdependent and it can be difficult to separate the impact of 

different factors. 

- Evaluating qualitative information is subjective, as it is not in terms of numbers - there are no 

objective formulae as there are with financial measures. 

- The cost of collecting and improving qualitative information may be very high. 

- Difficulties in measurement and interpretation mean that qualitative factors are often ignored. 

Models for evaluating financial and non-financial performance 

As discussed, it is important that a business appraises both financial and non-financial performance. 

There are four key tools available:

- balanced scorecard 

- The performance pyramid 

- Fitzgerald and Moon's building block model 

- The performance prism

The benefits of these models are as follows:

- financial and non-financial performance measures are included 

- they are linked in to corporate strategy 

- include external as well as internal measures 

- include all important factors regardless of how easy they are to measure

- show clearly the tradeoffs between different dimensions of performance 

- show how measures will motivate managers and employees. 

BALANCED SCORECARD

A balance Scorecard is an integrated set of performance measures derived from the company’s 

strategies that gives the top management a fast but comprehensive view of the organizational unit. 

(i.e. a division or a strategic business unit (S.B.U) 

The balanced scorecard philosophy assumes that an organizations vision and strategy is best 

achieved when the organization is viewed from the following four perspectives. 

1) Customer perspectives (How customers do see us?)

This gives rise to targets that matter to customer’s perspectives. 

2) Internal business process (What must we excel in?)

This aims to improve internal processes and decision making quality control.

3) Learning and growth perspective (Can we continue to improve and create value?

This considers an organization’s capacity to maintain its competitive position through 

acquisition of new skills. 

4) Financial perspective (How do we look to shareholders?)

This covers traditional measures such as profitability, R. O. I etc. 

By implementing the balanced scorecard, the major objectives for each of the four perspectives 

should be articulated. 

These objectives should be translated into specific performance measures and targets for 

achievements. 

This method integrates traditional financial measures with operations, customer and staff issues vital 

in long run competitiveness. 

Illustration

ABC Ltd has in the past produced just one fairly successful product. Recently, however, a new 

version of this product has been launched .Development work continues to add a related product to 

the product list. Given below are some details of the activities during the months of November 2009

Balanced Scorecard as a Strategic Management System 

1) Clarifying and translating vision and strategy into specific strategic objectives and identifying 

the critical drives of the strategic objectives.

2) Communicating & linking strategic objectives &measures. 

Once employees understand the high level objectives and measures, they should establish local 

objectives that support the business unit’s global strategy. 

3) Plan, set targets & align strategic initiatives. Such targets should be over a 3 – 5 year period 

broken down on a yearly basis so that progression targets can be set for assessing the progress 

being made towards achieving the long term targets. 

4) Enhancing strategic feedback and learning so that managers can monitor and adjust the 

implementation of their strategy and if necessary make fundamental changes to the strategy 

itself. 

Benefits of Balanced Scorecard 

1) It brings together in a single report four different perspectives on a company’s performance that 

relate to many of the dispersed elements of the company’s competitive agenda such as becoming 

customer oriented, shortening response time, improving quality, emphasizing team work, 

reducing new product launch times and managing for the long term. 

2) It provides a comprehensive framework for translating a company’s strategic goals into a 

coherent set of performance measures by developing the major goals for the four perspectives 

and translating these goals into specific performance measures. 

3) It helps managers to consider all the important operational measures together i.e. to enables 

mangers see whether improvements in one area may have been at the expense of another. 

4) It improves communication within the organization and promotes the active formulation and 

implementation of organizational strategy by making it highly visible through the linkage 

performance measures to business unit strategy. 

Limitations of Balanced Scorecard 

1) The assumption of the course and effect is too ambitious and lack a theoretical underpinning r 

empirical support. 

The empirical studies undertaken have failed to provide evidence on the underlying linkages 

between non-financial data and future financial performance. 

2) There is an omission of important perspective most notable being the environmental impact on 

society perspective and an employee perspective. There is nothing to prevent companies adding 

additional perspectives to meet their own requirements but they must avoid the temptation of 

creating too many perspectives and performance measures as a major benefit of performance 

measure is the consciousness and clarity of presentation.