Performance measurement - overview: formula sheet

Key formulas

Performance measurement chain

Mission → Objectives → Strategy → CSFs → KPIs → Targets

Each level should support the one before. KPIs are only useful if they track a CSF.

Control loop

Set targets → Measure actual → Compare → Take action

Comparison without action is wasted effort.

Goal congruence

Goal congruence = individual or divisional goals aligned with organisational goals

Lack of it leads to dysfunctional behaviour.

Good KPI features

Linked to a CSF, measurable, clearly defined, controllable by the manager

Use as a checklist when judging a measure.

Gross profit margin

Gross profit ÷ Revenue × 100%

Shows the margin after direct costs of sales.

Operating (net) profit margin

Profit before interest and tax ÷ Revenue × 100%

Shows control of overheads as well as direct costs.

Return on capital employed (ROCE)

Profit before interest and tax ÷ Capital employed × 100%

Capital employed = total assets less current liabilities, or equity plus long-term debt.

Asset turnover

Revenue ÷ Capital employed (times)

ROCE = operating profit margin × asset turnover.

Current ratio

Current assets ÷ Current liabilities

Shown as a ratio, such as 1.5 : 1.

Quick (acid test) ratio

(Current assets − Inventory) ÷ Current liabilities

Removes inventory as it is the least liquid current asset.

Inventory days

Inventory ÷ Cost of sales × 365

Use cost of sales, not revenue.

Receivables days

Trade receivables ÷ Credit revenue × 365

Use credit sales if given; otherwise revenue.

Payables days

Trade payables ÷ Credit purchases × 365

If purchases are not given, cost of sales is often used.

Working capital cycle

Inventory days + Receivables days − Payables days

Shorter usually means less cash tied up.

Gearing (debt ÷ equity)

Long-term debt ÷ Equity × 100%

An alternative is debt ÷ (debt + equity). Use the definition in the question.

Interest cover

Profit before interest and tax ÷ Interest

A low figure means profit gives little protection for interest payments.

Defect rate

Defect rate = Defective units ÷ Total units produced × 100%

Use the same base (units produced or units inspected) when comparing periods.

Labour turnover rate

Labour turnover = Number of leavers (usually replaced) ÷ Average number of employees × 100%

High turnover raises recruitment and training cost and lowers efficiency.

Capacity utilisation

Capacity utilisation = Actual output ÷ Maximum possible output × 100%

Both figures must be in the same units and period.

On-time delivery rate

On-time delivery = Deliveries on time ÷ Total deliveries × 100%

A common customer-service measure.

Absenteeism rate

Absenteeism = Days (or hours) lost through absence ÷ Total days (or hours) scheduled × 100%

Keep days with days and hours with hours.

Economy

Economy = spending the least on inputs, for the quality required

Measure with cost per unit of input, e.g. cost per hour of agency staff, or actual input cost compared with budget.

Efficiency

Efficiency = outputs ÷ inputs (or inputs ÷ outputs)

Examples: patients treated per nurse hour, cost per patient treated. Say which direction you use.

Effectiveness

Effectiveness = actual outcome or output achieved compared with the objective

Examples: percentage of pupils reaching a target grade, percentage of target beneficiaries reached.

Value for money

VFM = economy + efficiency + effectiveness (the 3Es)

Some texts add equity (fairness) as a fourth E. Use it only if the question does.

Return on investment (ROI)

ROI = Divisional profit ÷ Capital employed × 100%

Capital employed is usually total assets less current liabilities. Use the profit and capital figures the question tells you to use. Often it is operating profit before interest and tax.

Residual income (RI)

RI = Divisional profit − (Capital employed × Required rate of return)

The deduction is called the imputed interest or capital charge. The answer is a money amount and can be negative.

Decision rule for ROI

Accept a project if its ROI is above the target ROI; managers often compare it with the division's current ROI

Comparing with the current divisional ROI is where goal congruence problems arise.

Decision rule for RI

Accept a project if it increases RI, that is, if its return exceeds the required rate

This is more likely to match the interests of the whole group.

Responsibility centre controls

Cost centre: costs. Revenue centre: revenue. Profit centre: costs and revenue. Investment centre: costs, revenue and investment

Match the centre to what the manager controls.

Balanced scorecard perspectives

Financial + Customer + Internal business process + Innovation and learning

Learn the four names and the question each one asks. Kaplan and Norton's original wording.

Building block model: three parts

Dimensions + Standards + Rewards

Six dimensions: competitiveness, financial performance, quality, flexibility, resource utilisation, innovation. Standards should be ownership, achievability and equity (fairness).

Types of benchmarking

Internal, competitor, functional (generic), strategic

Match the type to who you compare with.

Quick revision

• A performance measure must link to an organisational objective.
• Return on capital employed = profit before interest and tax ÷ capital employed.
• Gross profit margin = gross profit ÷ revenue; operating margin = operating profit ÷ revenue.
• Asset turnover = revenue ÷ capital employed.
• Non-financial indicators cover areas such as quality, customer satisfaction, delivery and staff.
• Value for money has three parts: economy, efficiency and effectiveness.
• Economy is about low input cost, efficiency is about output per input, effectiveness is about achieving objectives.
• Cost centres are judged on costs, profit centres on profit, and investment centres on profit relative to investment.
• Return on investment = divisional profit ÷ divisional capital employed.
• Residual income = divisional profit − (capital employed × required rate of return).
• The balanced scorecard has four perspectives: financial, customer, internal business process, and innovation and learning.
• Check units and rounding in number entry questions before you submit.

Common mistakes

• Treating a CSF and a KPI as the same thing Fix: A CSF is an area of success, such as customer satisfaction. A KPI is the number that measures it, such as the percentage of customers rating service as good.
• Choosing a KPI that is easy to measure but unrelated to the CSF Fix: Always start from the CSF in the question and choose the measure that directly tracks it.
• Using revenue instead of cost of sales for inventory days. Fix: Inventory is held at cost, so use cost of sales. Receivables use revenue; payables use purchases or cost of sales.
• Deducting interest before calculating ROCE. Fix: ROCE uses profit before interest and tax, because capital employed includes debt that earns the interest.
• Classing a money measure as non-financial because it relates to quality or staff, such as cost of rework. Fix: Ask: is it measured in money? If yes, it is financial. Defect rate is non-financial; cost of defects is financial.
• Dividing by the wrong base, such as defects over good units instead of total units. Fix: Read what the rate is 'of' and use that total as the denominator.
• Treating efficiency and effectiveness as the same thing. Fix: Efficiency is doing things right (output per input). Effectiveness is doing the right things (meeting objectives).
• Calling a lower cost per patient 'economy'. Fix: Cost per patient links cost to output, so it is efficiency. Economy is only the cost of inputs, such as the price paid for drugs.
• Calling a unit a profit centre because it makes a profit figure. Fix: Ask what the manager can control. If they cannot influence revenue or cannot set prices, it is not a profit centre.
• Treating RI as a percentage. Fix: RI is a money amount. ROI is a percentage. Check the unit in the answer options.

Exam tips

• Learn the chain mission, objective, strategy, CSF, KPI so you can place any term in the scenario quickly.
• In KPI questions, anchor on the CSF named in the scenario and reject measures that track something else.
• When a scenario describes odd manager behaviour, think goal congruence and the effect of the measure on behaviour.
• Read multiple response questions carefully and select exactly the number requested.
• Remember that measures should be controllable by the person being judged, as examiners often test this.
• Write the formula first on your scratch pad. Examiners set wrong answers that come from common formula errors, such as using revenue for inventory days.
• Read the definition given in the question. If the exam states how to compute gearing or capital employed, follow it exactly.
• In multiple response questions, calculate each ratio you need before judging the statements. Do not guess from the trend alone.