Performance Measurement and Control
Financial and non-financial measures
Know ROI (divisional profit / capital employed) and residual income (profit − imputed interest on capital). ROI can discourage managers from accepting projects below current ROI even when they earn more than the cost of capital; RI avoids this. Traps: forgetting that RI is an absolute measure and cannot compare divisions of different size, and mixing profit before/after interest.
The balanced scorecard and performance hierarchy
Memorise the four perspectives: financial, customer, internal business process, learning and growth. Link measures to strategy and to the performance hierarchy (mission, goals, critical success factors, KPIs). Traps: placing a measure in the wrong perspective (e.g. staff training is learning and growth, not internal process).
Divisional structures and transfer pricing
Distinguish cost, profit, investment and revenue centres. Transfer prices affect divisional profit and behaviour. Minimum transfer price for the selling division = variable cost + lost contribution (opportunity cost). Traps: using full cost without opportunity cost, and ignoring that group profit is unaffected by internal transfers.
The building block model
Fitzgerald and Moon's building block model uses dimensions (financial and non-financial, determinants and results) and standards (ownership, achievability, equity). Use it to critique a performance measurement system.
Worked example
Division profit $200,000, capital employed $1,000,000, cost of capital 12%. ROI = 20%. RI = 200,000 − (12% × 1,000,000) = $80,000. A project earning 15% raises RI but lowers ROI, illustrating the behavioural difference.