D4: Performance Measurement and Control | Performance Analysis in Private Sector Organisations (ACCA F5)

D4- Performance Analysis in Private Sector Organisations

Performance Analysis in Private Sector Organisations describes financial performance indicators; describes non-financial performance indicators; analyses past performance; explains the causes and problems created by short-termism and financial manipulation of results; explains the Balanced Scorecard and the Building Block Model and discusses the difficulties of target setting in qualitative areas.

Performance Analysis in Private Sector Organisations

Performance measurement aims to find out how well something or somebody is performing in relation to a plan. Performance measures may either be financial performance indicators (FPIs) or non-financial performance indicators (NFPIs).

a) Describe, calculate and interpret financial performance indicators (FPIs) for profitability, liquidity and risk in both manufacturing and service businesses. Suggest methods to improve these measures.

Financial measures usually relate to “revenues, costs, profits, return on capital, asset values or cash flows” and they are used to “analyse return on capital, profitability, liquidity and financial risk.”

For examples of how to calculate and interpret financial performance indicators, please refer to BPP’s ACCA F5 Performance Management Study Text.

b) Describe, calculate and interpret non-financial performance indicators (NFPIs) and suggest method to improve the performance indicated.

Non-financial measures usually relate to “product or service quality, reliability, speed of performance, risk, flexibility, customer attitudes, innovation, capability and pollution.” These measures are increasing in popularity because they concentrate on several variables, include information on quality, take changes into account and focus on both the short-term and long-term.

For examples of how to calculate and interpret non-financial performance indicators, please refer to BPP’s ACCA F5 Performance Management Study Text.

c) Analyse past performance and suggest ways for improving financial and non-financial performance.

Past financial performance can be analysed using financial ratios:

Liquidity Ratios

Current Ratio

  • Measures firm’s ability to meet its short term obligations
  • Formula: Current Ratio = Currents assets ÷ Current Liabilities

Quick Ratio

  • Measures firm’s liquidity
  • Formula: Quick Ratio = (Cash + Short term investments + receivables) ÷ current liabilities

Inventory Days/ Inventory Turnover Period

  • Indicates the average number of days that inventory is held for
  • Formula: Inventory Days = (Inventory ÷ Cost of Sales) x 365 days

Accounts Receivable Payment Period

  • Measures average time for receivables to be paid
  • Formula: Accounts Receivable Payment Period = (Trade receivables ÷ Credit sales turnover) x 365

Accounts Payable Payment Period

  • Helps assess liquidity
  • Formula: Accounts Payable Payment Period = (Average trade payables ÷ Credit purchases of cost of sales) x 365 days

Profitability Ratios

Net profit margin

  • Indicates profitability of operations
  • Formula: Net profit margin = Net income ÷  Net sales

Gross profit margin

  • Shows profits less overhead costs
  • Formula: Gross profit margin = Gross profit  ÷ Net sales

Return on capital employed

  • Relates profit growth to the funds used to make the profits
  • Formula: Return on capital employed = PBIT ÷ Capital employed

Total asset turnover

  • Measures company’s ability to generate sales given its investment in total assets
  • Formula: Total Asset turnover = Net sales ÷ Average total net sales

Earnings per Share

  • Calculates profit for each share
  • Formula: Earnings ÷ Number of shares

Gearing Ratios

Gearing

  • Measures the financial risk
  • Formula: Gearing = Debt ÷ Debt plus equity
  • Formula: Gearing = Debt ÷ Equity

Past performance can be analysed using non-financial methods such as:

  • Measuring the quality of good and services
  • Monitoring work
  • Measuring customer satisfaction
 Note: Ways for improving financial and non-financial performance should focus on the problems that result in poor performance. 

d) Explain the causes and problems created by short-termism and financial manipulation of results and suggest methods to encourage a long term view.

Short-termism is when there is a “bias towards short-term rather than long-term performance.” Some of the problems with short-termism include:

  • Abandoning future projects to protect short-term cash flow and profits
  • Cutting R&D expenditure
  • Reducing quality control
  • Reducing the level of customer service
  • Cutting training costs

Financial manipulation involves managers manipulating results by changing the timing of purchases, hoarding inventories and advancing or delaying payments and receipts.

Instead of short-termism, a long term view should be encouraged by using the following steps:

  • Setting realistic short term targets
  • Providing sufficient management information
  • Evaluating the performance of managers
  • Linking rewards to share prices
  • Setting  quality based targets

e) Explain and interpret the Balanced Scorecard, and the Building Block Model proposed by Fitzgerald and Moon.

The Balanced Scorecard is a performance management model that was developed by Kaplan and Norton. It looks at the business from four perspectives. Each perspective has a small number of targets which are consistent with other. They are:

  • Customer
  • Internal Business
  • Learning and Growth
  • Financial Perspective

The Building Block Model was developed by Fitzgeral and Moon. It uses building blocks to overcome performance measurement problems in service businesses. They are:

  • Dimensions of performance
  • Standards
  • Rewards

f) Discuss the difficulties of target setting in qualitative areas.

Problems with target setting in qualitative areas include:

  • Selecting a suitable measure of performance
  • Data is not quantifies
  • No system for collecting qualitative data

Resources Used

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