Strategic Performance Measurement
Performance
Strategic Performance Measurement
Syllabus tag: KASNEB CPA | Advanced Level | CA34S3 Advanced Management Accounting | Topic 7 Strategic Performance Measurement
Lesson objectives
By the end of this topic, you will be able to:
- Explain the limitations of purely financial measures
- Apply the balanced scorecard and its four perspectives
- Compute economic value added and the adjustments it requires
- Compare EVA with residual income and ROI
- Explain the building block model and benchmarking
Why this matters
CA25 measured divisions by ROI and residual income and showed how ROI can cause a manager to reject a good project. This topic addresses the wider problem: financial measures report what has already happened, and by the time they do, the decisions that caused them cannot be changed.
Why financial measures alone fail
- Backward-looking. They report the past, not the capacity to perform
- Short-termist. Cutting training, maintenance or research improves this year and damages the next
- Ignore the drivers. Customer satisfaction, quality and staff capability determine future profit and appear nowhere
- Manipulable. Timing and estimates move reported profit without changing the business
- Silent on intangibles, which are often the main source of value
The balanced scorecard
Four perspectives, each with a question:
| Perspective | The question |
|---|---|
| Financial | How do we appear to shareholders? |
| Customer | How do customers see us? |
| Internal business process | What must we excel at? |
| Learning and growth | Can we continue to improve and create value? |
The perspectives form a causal chain running upward: better trained staff improve processes, better processes satisfy customers, satisfied customers produce financial results. Learning and growth is the foundation and financial performance the outcome.
That direction is the point. A company cutting training to improve this year's financial measure is damaging the base of the chain to flatter its top.
Measures must be few. A scorecard with sixty measures has no focus and becomes a reporting exercise. Each should link to a strategic objective and have a target and an owner.
The main difficulties are choosing measures that genuinely drive the outcomes, conflicts between perspectives, the cost of collecting non-financial data, and managers who continue to be paid on the financial measure alone — which quietly restores the original problem.
Economic value added
EVA = Adjusted NOPAT − (Adjusted capital × WACC)
It is residual income with accounting adjustments intended to bring the figures closer to economic reality.
Worked example. NOPAT KES 42,000,000, capital employed KES 210,000,000, WACC 13.5%:
Capital charge = 210,000,000 × 13.5% = 28,350,000 EVA = 42,000,000 − 28,350,000 = KES 13,650,000
With adjustments. Research spending of 8,000,000 was expensed; EVA capitalises it as an investment and amortises 2,000,000:
| KES | |
|---|---|
| NOPAT | 42,000,000 |
| Add back R&D expensed | 8,000,000 |
| Less amortisation | (2,000,000) |
| Adjusted NOPAT | 48,000,000 |
| Capital employed | 210,000,000 |
| Add capitalised R&D | 6,000,000 |
| Adjusted capital | 216,000,000 |
| Capital charge at 13.5% | (29,160,000) |
| EVA | 18,840,000 |
Why the adjustments matter. Under the unadjusted figure a manager improves performance by cutting research. Capitalising it removes that incentive entirely — the spending becomes an asset earning a return rather than an expense reducing profit. Other common adjustments treat operating leases, provisions and goodwill similarly.
| ROI | Residual income | EVA | |
|---|---|---|---|
| Expressed as | Percentage | Shillings | Shillings |
| Charges for capital | No | Yes | Yes |
| Accounting adjustments | No | No | Yes |
| Encourages rejecting good projects | Yes | No | No |
| Comparable across sizes | Yes | No | No |
EVA's weaknesses are the number of adjustments required, which makes it costly and subjective, and that it remains an annual measure and so still short-term relative to a strategy.
:::checkpoint A divisional manager is judged on EVA and proposes cancelling a research programme to improve it. Explain why the EVA adjustments should prevent this from working, and what would happen under residual income instead. :::
The building block model
Designed for service businesses, where output is intangible and simultaneous with delivery.
Dimensions — what is measured: competitiveness, financial performance, quality, flexibility, resource utilisation, innovation. The first two are results; the other four are determinants of those results.
Standards must be owned by those judged on them, achievable rather than demoralising, and fair across different units.
Rewards must be clear, controllable by the person rewarded, and motivating.
The clearest failure this model diagnoses: a target that is imposed rather than owned, or that depends on things the manager cannot influence, will be gamed rather than met.
Benchmarking
- Internal — against another unit of the same group
- Competitive — against a direct rival
- Functional — against a different industry doing the same activity well
- Strategic — against high performers generally
Functional benchmarking often produces the largest gains, because a company comparing its warehousing with a specialist logistics business learns more than comparing with a competitor that has the same bad habits it does.
:::checkpoint A hospital is designing a performance system. Suggest one measure for each of the four balanced scorecard perspectives, and explain why the financial perspective alone would be an inadequate measure of a hospital. :::