ACCA Applied Knowledge · Management Accounting

Performance measurement - application: formula sheet

Full chapter guide

Key formulas

Gross profit margin: Gross profit ÷ Revenue × 100; Measures profit after direct costs of sales only.
Operating profit margin: Operating profit ÷ Revenue × 100; Operating profit is profit before interest and tax. It is after all operating expenses.
Return on capital employed (ROCE): Operating profit (PBIT) ÷ Capital employed × 100; Capital employed = total assets less current liabilities, or equity plus non-current liabilities.
Asset turnover: Revenue ÷ Capital employed (times); Shows the revenue generated per $1 of capital employed. Use the same capital employed as in ROCE.
ROCE link: ROCE = Operating profit margin × Asset turnover; Use it to explain why ROCE changed.
Current ratio: Current assets ÷ Current liabilities; Shows short-term solvency.
Quick (acid test) ratio: (Current assets − Inventory) ÷ Current liabilities; Excludes inventory because it is the least liquid current asset.
Inventory days: Inventory ÷ Cost of sales × 365; Average days inventory is held before sale.
Receivables days: Trade receivables ÷ Credit revenue × 365; Average time customers take to pay.
Payables days: Trade payables ÷ Credit purchases × 365; Use cost of sales if purchases are not given.
Gearing: Debt ÷ Equity × 100, or Debt ÷ (Debt + Equity) × 100; Two versions exist. Use the one the question states, or state which you use.
Interest cover: Operating profit ÷ Finance costs (times); Shows how easily profit covers interest.
Defect rate: Defect rate = Defective units ÷ Total units produced × 100%; A quality measure. Lower is better. Use the same base (produced or inspected) when comparing periods.
Customer complaints rate: Complaints rate = Number of complaints ÷ Number of orders (or customers) × 100%; A customer measure. Choose a base that matches the question.
Labour turnover rate: Labour turnover = Number of leavers ÷ Average number of employees × 100%; An employee measure. High turnover can mean low morale and extra recruitment and training cost.
On-time delivery rate: On-time rate = Deliveries on time ÷ Total deliveries × 100%; A delivery measure. Higher is better.
Capacity or machine utilisation: Utilisation = Actual hours used ÷ Available hours × 100%; An operations measure. Very high use can leave no slack for maintenance.
Economy: Economy = actual cost of inputs compared with budgeted or benchmark cost of the same quality of inputs; Spending less is only economical if quality is held constant. Example measure: cost per hour of agency nurse.
Efficiency: Efficiency = outputs ÷ inputs (or inputs ÷ outputs); Example: patients treated per doctor, or cost per patient treated. State clearly which way round you use.
Effectiveness: Effectiveness = actual outcome or output achieved compared with the objective or target; Example: percentage of students passing, or waiting time target met.
Link between the 3 Es: Inputs → (economy) → process → (efficiency) → outputs → (effectiveness) → outcomes; Use this chain to decide which E a measure tests.
Return on investment: ROI = divisional profit ÷ capital employed × 100%; Use the profit measure and capital figure the question states, usually profit before interest and tax, and capital employed at the start or year end as instructed.
Residual income: RI = divisional profit − (capital employed × required rate of return); The deduction is called the imputed interest charge. The answer is in money, not a percentage.
Decision rule for ROI: Accept if project ROI > target ROI (company view); manager accepts if new ROI > current divisional ROI; The two rules can conflict. That conflict is a common exam point.
Decision rule for RI: Accept if project RI > 0, that is, project return > required return; Compare the project profit with the capital charge on the project.
Minimum transfer price: Minimum = marginal cost + opportunity cost per unit to the selling division; With spare capacity, opportunity cost is zero, so minimum = marginal cost. At full capacity, opportunity cost is the contribution lost on external sales.
Maximum transfer price: Maximum = lower of external market price for the buyer and net marginal revenue to the buyer; The buyer should not pay more than it could buy for elsewhere.
Characteristics of good indicators (SMART): Specific, Measurable, Achievable, Relevant, Time-bound; Also add controllable, understandable and timely. Use whichever list fits the question wording.
Lagging vs leading indicator: Lagging = reports past outcomes; Leading = predicts future outcomes; Profit, revenue and market share are lagging. Customer satisfaction and employee training are usually leading.
Main behavioural problems: Short-termism (also called myopia), manipulation, tunnel vision, risk aversion, sub-optimisation; Always link each problem to what the measure rewards. Myopia is another name for short-termism, not a separate problem.
Controllability principle: Judge managers only on items they can influence; Uncontrollable items distort fairness and reduce motivation.

Quick revision

Return on capital employed = profit before interest and tax ÷ capital employed.
ROI = divisional profit ÷ divisional capital employed, usually shown as a percentage.
Residual income = divisional profit − (capital employed × required rate of return).
ROI can lead managers to reject projects that earn above the company's cost of capital but below the division's current ROI.
RI favours accepting any project that earns more than the required return.
Balanced scorecard perspectives: financial, customer, internal business process, and learning and growth.
Value for money covers economy (cost of inputs), efficiency (output per input) and effectiveness (meeting objectives).
Non-financial indicators often give earlier warning than financial results.
A transfer price must leave the selling division willing to sell and the buying division willing to buy.
Targets can cause short-term thinking, manipulation of figures and conflict between divisions.
Always read whether a ratio needs year-end or average figures before calculating.
Compare a ratio with a benchmark, such as prior year or a competitor, before commenting.

Common mistakes

Using net profit or profit before tax in ROCE. Fix: Use operating profit (profit before interest and tax) unless the question gives a different definition.
Confusing gross profit margin with operating profit margin. Fix: Gross margin uses gross profit, which deducts only cost of sales. Operating margin uses profit after all operating expenses.
Classifying a money-based quality figure, such as cost of rework, as non-financial. Fix: Look at the unit. If the answer is in dollars, it is financial, whatever area it covers.
Dividing labour turnover by opening or closing staff instead of the average. Fix: Use the average number of employees unless the question gives a different base.
Treating economy as meaning cheapest at any quality. Fix: Define economy as the lowest cost for the required quality. Poor-quality cheap inputs are not economical.
Mixing up efficiency and effectiveness. Fix: Efficiency is doing things right (output per input). Effectiveness is doing the right things (achieving objectives).
Using ROI as the company's decision rule for projects. Fix: For the company, compare project return with the required return. Mention the ROI conflict only as a behavioural issue.
Writing residual income as a percentage. Fix: RI is an amount of money. Always include the currency, such as $ in ACCA questions.
Treating short-termism and manipulation as the same thing. Fix: Short-termism trades future value for current results with real actions. Manipulation changes timing or reported figures to look better.
Calling profit a leading indicator because it matters most. Fix: Profit is lagging because it reports what has already happened. Leading indicators predict, such as customer satisfaction or orders on hand.

Exam tips

Write the formula first. Method marks and clear thinking follow, and you avoid choosing the wrong profit figure.
In number entry questions, check the unit and decimal places asked for before you type.
For interpretation, give a direction, a cause and a consequence, in that order.
Check ROCE against margin × asset turnover. It catches many mistakes in seconds.
Read whether gearing uses debt ÷ equity or debt ÷ (debt + equity). The two give different answers.
Always check the unit. Money means financial, anything else means non-financial.
Learn two or three measures for each area: quality, customer, employees, delivery. Multiple response questions often ask you to pick them.
Write the direction of improvement next to each measure in your notes, so you can judge results quickly.