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12.6: Summary and Key Terms

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  • Section Summaries

    12.1 Explain the Importance of Performance Measurement

    • Well-designed performance measurement systems help businesses achieve goal congruence between the company and the employees.
    • Managers should be evaluated only on factors over which they have control.
    • Performance measures can be based on financial measures and/or nonfinancial measures.
    • Performance measurement systems should help the company meet its strategic goals while helping the employee meet his or her professional goals.

    12.2 Identify the Characteristics of an Effective Performance Measure

    • A good performance measurement system uses measures over which a manager has control, provides timely and consistent feedback, compares the measures to standards of some form, has both short- and long-term measures, and puts the goals of the business and the individual on an equal level.

    12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added

    • Three common performance measures based on financial numbers are return on investment, residual income, and economic value added.
    • Return on investment measures how effectively a company generates income using its assets.
    • ROI can be broken into two separate measures: sales margin and asset turnover.
    • Residual income measures whether or not a project or a division is exceeding a minimum return that has been determined by management.
    • Economic value added is used to measure how well a project or division is contributing to shareholder wealth.
    • A big challenge with ROI, RI, and EVA is determining which value of income and assets to use in calculating these measures.

    12.4 Describe the Balanced Scorecard and Explain How It Is Used

    • Balanced scorecards use both financial and nonfinancial measures to evaluate employees.
    • The four categories of a balanced scorecard are financial perspective, internal business perspective, customer perspective, and learning and growth perspective.
    • Financial perspective measures are usually traditional measures, based on financial statement information such as EPS or ROI.
    • Internal business perspective measures are those that evaluate management’s operational goals, such as quality control or on-time production.
    • Customer perspective measures are those that evaluate how the customer perceives the business and how the business interacts with customers.
    • Learning and growth perspective measures are those that evaluate how effectively the company is growing by innovating and creating value. This is often done through employee training.
    • Well-designed balanced scorecards can be very effective at goal congruence through the utilization of both financial and nonfinancial measures.

    Key Terms

    after-tax income
    income reduced by tax expenses
    asset turnover
    measure of how efficiently a company is using its capital assets to generate revenues
    balanced scorecard
    tool used to evaluate performance using qualitative and nonqualitative measures
    capital asset
    tangible or intangible asset that has a life longer than one year
    controllable factor
    component of the organization for which the manager is responsible and that the manager can control
    cost center
    part of an organization in which management is evaluated based on the ability to contain costs; the manager primarily has control only over costs
    economic value added (EVA)
    measure of shareholder wealth that is being created by a project, segment, or division
    fixed asset
    tangible long-term asset
    goal congruence
    integration of multiple goals, either within an organization or across multiple components or entities; congruence is achieved by aligning goals to achieve an anticipated mission
    invested capital
    fixed assets, productive assets, or operating assets
    investment center
    organizational segment in which a manager is accountable for profits (revenues minus expenses) and the invested capital used by the segment
    means to measure something such as a goal or target
    minimum required rate of return
    minimum return, usually in a percentage form, that a project or investment must produce in order for the company to be willing to undertake it
    operating asset
    product asset plus intangible asset and current asset
    operating income
    income before considering interest and taxes
    performance measure
    metric used to evaluate a specific attribute of a manager’s role
    performance measurement system
    evaluates management in a way that will link the goals of the corporation with those of the manager
    productive asset
    fixed asset plus inventory
    profit center
    organizational segment in which a manager is responsible for and evaluted on both revenues and costs
    qualitative factor
    component of a decision-making process that cannot be measured numerically
    quantitative factor
    component of a decision-making process that can be measured numerically
    residual income (RI)
    amount of income a given division (or project) is expected to earn in excess of a firm’s minimum return goal
    responsibility accounting
    method of encouraging goal congruence by setting and communicating the financial performance measures by which managers will be evaluated
    return on investment (ROI)
    measure of the percentage of income generated by profits that were invested in capital assets
    revenue center
    part of an organization in which management is evaluated based on the ability to generate revenues; the manager's primary control is only revenues
    sales margin
    measure of how much profit is generated by each sales dollar
    someone affected by decisions made by a company; may include an investor, creditor, employee, manager, regulator, customer, supplier, and layperson
    owner of stock, or shares, in a business
    strategic plan
    broad vision of how a company will be in the future
    uncontrollable factor
    decision or outcome over which a manager does not have control
    weighted average cost of capital
    cost that the company expects to pay on average to finance assets and growth using either debt or equity