Open Tuition Revision Notes P5

8/4/2019 Open Tuition Revision Notes P5

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PERFORMANCE MEASUREMENT (1)

FINANCIAL PERFORMANCE:

GROWTH: Revenue / Prots / EBITDA / Market Share

PROFITABILITY: Absolute prot / ROCE / Prot margin

GEARING: Gearing ratio

LIQUIDITY: Current ratio / Net cash ow

SHAREHOLDERS: EPS / Share price / PE ratio

Always comment on any signicant changes (e.g. new issue o shares) and likely reasons/eects(e.g. new investment - thereore possibly more prot in the uture)

PAPER P5 JUNE 2011 REVISION


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FITZGERALD AND MOONS BUILDING BLOCKS

Look at perormance under six headings:

* FINANCIAL

* QUALITY

* FLEXIBILITY

* EFFICIENCY (resource utilisation)

* INNOVATION

* COMPETITIVENESS



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KAPLAN & NORTONS BALANCED SCORECARD

The Four Perspectives

The Balanced Scorecard groups perormance measures into our general perspectives:

Financial perspective;Customer perspective;Internal process perspective;Innovation and Learning perspective.

According to each perspective o the Balanced Scorecard, a number o key perormance indicators can be usedsuch as:

Financial

Cash owReturn on InvestmentReturn on capital employedReturn on equity

Customer

Delivery Perormance to Customer - by DateDelivery Perormance to Customer - by QualityCustomer satisaction rateCustomer retention rate

Internal Business Processes

Number o ActivitiesAccident Ratios

Equipment Eectiveness

Innovation and Learning

New innovationsTraining per employeeInternal Promotions %Employee Turnover

Under each perspective we should have a Goal; a Measure; and a Statistic

E.g. under the Financial Perspective, a Goal may be survival; a relevant Measure or this Goal may be net cash ow;and the Statistic would be an actual gure or the net cash ow.



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DIVISIONAL PERFORMANCE MEASUREMENT

Type o responsibility centre:

Cost centre:

Manager has authority or decisions over costs (but not revenue)

Revenue centre:

Manager has authority or decisions over revenue (but not costs)

Proft centre:

Manager has authority or decisions over costs and revenues (but not capital investment decisions)

Investment centre:

Manager has authority or decisions over costs, revenues, and new capital investment.

Controllable actors:

The manager should only be assessed over those items over which he has control.

For example, i a manager is given authority to make decisions over everything except salary increases which aredictated by central management, then it would be unair to include salaries in his perormance measurement.

I (or example) it is a prot centre, then or the purposes o measuring his perormance the prot o the divisionshould be calculated ignoring salaries.



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RETURN ON INVESTMENT V RESIDUAL INCOME

Division X o Y plc is currently reporting prots o $125,000 p.a. on capital employed o $800,000A new project is being considered which will cost $100,000 and is expected to generate profts o $15,000 p.a.

(a) Calculate the Return on Investment or Division X, with and without acceptance o the new project.

(b) Calculate the Residual Income o Division X, with and without the new project. Y plc calculatesResidual Income using a notional interest rate o 14%.



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ECONOMIC VALUE ADDED

Z plc AccountsIncome Statement

$

Operating prot 7,000

Interest (1,000)6,000

Tax at 30% (1,800)

Prot ater tax $4,200

Balance Sheet

$

Net assets $30,000

Share Capital ($1 shares) 5,000

Reserves 15,000

20,000

Non current liabilities

10% Bank loan 10,000

$30,000

The market value o the shares is $5 per share.

The cost o equity nance is 18%

Calculate the Economic Value Added (EVA)



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UNCERTAINTY

Sales per week

Sales (units) Probability

10 0.3

20 0.5

30 0.2

Selling price: $20 p.u.Cost: $10 p.u.Any unsold units must be sold as scrap or $1 p.u.Units must be purchased each week beore demand is known.

(a) Expected Values

(b) Maximax

(c) Maximin

(d) Minimax Regret



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LEARNING CURVES

As cumulative output doubles, the cumulative average time (labour cost) per unit alls to a xed percentage o theprevious average time (labour cost)

Example 1

First batch takes 100 hours to produce. There is a 75% learning eect.

How long will it take to produce another 7 batches.

Example 2

First batch takes 60 hours to produce. There is an 80% learning eect.

How long will it take to produce the 50th batch?

Learning curve ormula: y = axb

y = average time per batcha = time or initial batchx = number o batchesb = learning actor

b =log r

log 2



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TRANSFER PRICING

OBJECTIVES:

* Goal congruence

* Perormance appraisal

* Divisional autonomy

OVERALL:

* Must maximise group prot

PRACTICAL:

* T.P. oten xed by Head Ofce

* Problem - loss o autonomy

- possibility o dysunctional decisions

APPROACH:

Allow individual managers to negotiate the transer price

Selling division:Minimum T.P. = Marginal cost + opportunity cost

Receiving division:

Maximum T.P. is lower o(a) external purchase price (on intermediate market)

and(b) net marginal revenue (selling price less costs o receiving division)



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TRANSFER PRICING

[S = selling division; R= receiving division]

S R

(1) Variable production cost 15 8

Final selling price $30

(2) As (1), but intermediate market exists.

S can sell intermediate market at $18; R can buy on intermediate market at $20

(a) S has unlimited production capacity and there is limited demand on the intermediatemarket

(b) S has limited production capacity and there is unlimited demand on the intermediatemarket

(3) S has restricted capacity to make A and B

R wants product A.

A B

Ss Variable production cost per unit 80 120

Ss Intermediate market price per unit 100 150



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PRODUCT LIFE CYCLE

There are our main stages in a products lie cycle:

Introduction; Growth; Maturity; and, Decline

Understanding the product lie-cycle encourages a more long-term view o the likely returns rom a product andthe amount worth investing in a new product.

In addition, understanding as to which phase the product is in will help determine the appropriate pricing strategyat each stage.


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SIX SIGMA

Six Sigma was originally developed as a set o practices designed to improve business processes and eliminatedeects.In Six Sigma, a deect is dened as anything that could lead to customer dissatisaction.

Six Sigma asserts that

* Continuous eorts to achieve stable and predictable process results (i.e. reduce process variation) are o vitalimportance to business success.

* Manuacturing and business processes have characteristics that can be measured, analyzed, improved andcontrolled.

* Achieving sustained quality improvement requires commitment rom the entire organization, particularlyrom top-level management.

Features that set Six Sigma apart rom previous quality improvement initiatives include

* A clear ocus on achieving measurable and quantiable nancial returns rom any Six Sigma project.

* An increased emphasis on strong and passionate management leadership and support.

* A special inrastructure o Champions, Master Black Belts, Black Belts etc. to lead and implement the SixSigma approach.

* A clear commitment to making decisions on the basis o veriable data, rather than assumptions andguesswork.

A key methodology o Six Sigma is DMAIC.

The basic methodology consists o the ollowing fve steps:

* Dene process improvement goals that are consistent with customer demands and the enterprise strategy.

* Measure key aspects o the current process and collect relevant data.

* Analyze the data to veriy cause-and-eect relationships. Determine what the relationships are, and attemptto ensure that all actors have been considered.

* Improve or optimize the process based upon data analysis using techniques like Design o Experiments.

* Control to ensure that any deviations rom target are corrected beore they result in deects. Set up pilot runsto establish process capability, move on to production, set up control mechanisms and continuously monitorthe process.


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DEDICATED CELLS

A cell is a team o people working together instead o individuals working alone on a task.

The potential benefts include:

* members o the team eel more responsible or the teams perormance as team spirit increases

* knowledge is shared within the team and as a result the knowledge o each member improves

* members o the team support each other

* individual members have more scope or specialization on areas dealt with by the team


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CHARACTERISTICS OF SERVICE VERSUS MANUFACTURING BUSINESSES

It is harder to measure the quality o a business than the quality o a service because o the ollowing dierencesbetween the two:

INTANGIBILITY

A service cannot be taken home with you as a product can

SIMULTANEITY

A service is used at the same time as it is perormed

HETEROGENUITY

Many services are non-standard (each one is dierent) whereas many products are all o identical products

PERISHABILITY

A service is immediately used-up - it cannot be stored like a product


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VALUE ANALYSIS

Value analysis attempts to nd the least-cost method o making a product or providing a service that achieves thedesired outcome.

Instead o just trying to cut costs everywhere, value analysis analyses costs between those that are value-added (i.e.add value to the product/service rom the perspective o the customer and aect the customers buying decision)and those that are non-value-added (i.e. do not add value to the product/service in the eyes o the customer).

Wherever possible, non-value-added activities should be eliminated.

Non-value-added activities could include such things as repairing aulty work and keeping unnecessary levels ostock.


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BUDGETING

Purpose:

Planning; Control; Coordination; Motivation(targets/perormance measurement)

Incremental budgeting

Base on last years actual results. Adjust or ination / volume changes

Zero based budgeting

For each cost: Identiy alternatives available / cost them out / choose the best

Activity based budgeting

Same idea as zero-based, but tie in with company strategy. Identiy critical success actors and apply zero-based approach to whole activity

Beyond Budgeting (article)


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STRATEGIC MANAGEMENT ACCOUNTING

* Traditional management accounting is looking backwards was perormance better or worse than budget?etc..

* Strategic management accounting is trying to look orward and plan how to improve in the uture

* Advantages o strategic planning:

provides long-term plans claries objectives identies risks orces management to think and make decisions ensures consistency o long-term/medium-term/short-term plans

* Tools:

SWOT analysis Boston Matrix/ Ansos product-market matrix / Porters ve orces model (see article)

* Freewheeling opportunism no long-term plans decide on opportunities as they arise

* Need to identiy and ocus on critical success actors

* Enterprise Resource Planning System (sotware) integrates all management inormation and makes it all

easily/immediately accessible to users


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PROBLEMS WITH BUDGETS

One o the main purposes o a budget it to motivate managers they will be rewarded i they do better thanbudget.

However there can be problems, including:

1 Managers are tempted to over-budget (budget padding) and budget gures that are easy or themto beat.

2 The budget rapidly becomes unrealistic and risks losing the motivational aspect unless it iscontinually updated/revised.

3 It is impossible to predict the economic climate when preparing the budget, and upturns in theeconomy make it easier or the manager to beat budget, without actions on their part. (and similarlythe reverse eect or downturns in the economy.

4 In the same way as item (3), changes in the market and the competition will eect whether themanager does better or worse than budget.

5 It is impossible or the original budget to take account o new opportunities that might arise duringthe period. There is a danger that managers will not be prepared to consider new opportunitiesbecause they are not in the budget (additional expenses involved might result in them overspendingas against budget.

6 I managers are rewarded simply or achieving budget, then there is no incentive or them to do

better still. This is more o a problem with the design o the reward scheme than the budget itsel,but consideration does need to be given to relating the level o the reward to the extent to whichthe manager does better than budget.

The budget needs to be continually revised to take into account changing circumstances i it is to continuallystretch the managers and encourage them to perorm better.Alternatively/additionally attempts should be made to compare managers perormance with that o othermanagers with similar responsibilities in the company (or in other companies) rather than against a budget that islikely to be unrealistic because o the types o problems listed.


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REWARD SCHEMES

Employees are commonly rewarded based on their perormance against pre-established measures.

Potential benets o perormance related pay include:

1 The employee will be more motivated to improve his/her perormance.

2 The measures used inorm the employee what actions the company considers to be important.

3 A well-designed scheme can help keep good employees rom looking to leave the company.

However, when a reward scheme is being designed it is necessary to be aware o problems that can arise, includingthe ollowing:

1 Employees will ocus all their eorts on whatever perormance measures are being applied to them.They will pay less attention to other areas not covered by their reward scheme, even though theymay be important to the company.

It is necessary to identiy the key actors that are necessary or the success o the company, and havea range o measures that cover these key actors.

2 It is natural or employees to ocus on how well they will be measured in the short-term rather thanthe long-term eect o their actions.

The perormance measures should include measures that will be good or the company in thelonger term e.g. include non-nancial measures such as quality.

Thought should be given to making the reward itsel encourage long-term thinking e.g. rewardemployees in the orm o shares in the company that must be held or a minimum period beorethey can sell them.

3 Many goals o the company depend on the actions o a group o employees working together ratherthan those o an individual employee.

Thought needs to be given to making part o the reward (bonus) or each employee based onperormance measure applied to the group, in addition to perormance measures applied to theindividual.


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Present Value Table

Present value of 1 i.e. (1 + r)n

Where r = discount rate

n = number of periods until payment

Discount rate (r)

Periods

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1

2 0980 0961 0943 0925 0907 0890 0873 0857 0842 0826 2

3 0971 0942 0915 0889 0864 0840 0816 0794 0772 0751 3

4 0961 0924 0888 0855 0823 0792 0763 0735 0708 0683 4

5 0951 0906 0863 0822 0784 0747 0713 0681 0650 0621 5

6 0942 0888 0837 0790 0746 0705 0666 0630 0596 0564 6

7 0933 0871 0813 0760 0711 0665 0623 0583 0547 0513 78 0923 0853 0789 0731 0677 0627 0582 0540 0502 0467 8

9 0941 0837 0766 0703 0645 0592 0544 0500 0460 0424 9

10 0905 0820 0744 0676 0614 0558 0508 0463 0422 0386 10

11 0896 0804 0722 0650 0585 0527 0475 0429 0388 0305 11

12 0887 0788 0701 0625 0557 0497 0444 0397 0356 0319 12

13 0879 0773 0681 0601 0530 0469 0415 0368 0326 0290 13

14 0870 0758 0661 0577 0505 0442 0388 0340 0299 0263 14

15 0861 0743 0642 0555 0481 0417 0362 0315 0275 0239 15

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1

2 0812 0797 0783 0769 0756 0743 0731 0718 0706 0694 2

3 0731 0712 0693 0675 0658 0641 0624 0609 0593 0579 3

4 0659 0636 0613 0592 0572 0552 0534 0516 0499 0482 4

5 0593 0567 0543 0519 0497 0476 0456 0437 0419 0402 5

6 0535 0507 0480 0456 0432 0410 0390 0370 0352 0335 6

7 0482 0452 0425 0400 0376 0354 0333 0314 0296 0279 7

8 0434 0404 0376 0351 0327 0305 0285 0266 0249 0233 8

9 0391 0361 0333 0308 0284 0263 0243 0225 0209 0194 910 0352 0322 0295 0270 0247 0227 0208 0191 0176 0162 10

11 0317 0287 0261 0237 0215 0195 0178 0162 0148 0135 11

12 0286 0257 0231 0208 0187 0168 0152 0137 0124 0112 12

13 0258 0229 0204 0182 0163 0145 0130 0116 0104 0093 13

14 0232 0205 0181 0160 0141 0125 0111 0099 0088 0078 14

15 0209 0183 0160 0140 0123 0108 0095 0084 0074 0065 15


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Annuity Table

Present value of an annuity of 1 i.e.

Where r = discount rate

n = number of periods

Discount rate (r)

Periods

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1

2 1970 1942 1913 1886 1859 1833 1808 1783 1759 1736 2

3 2941 2884 2829 2775 2723 2673 2624 2577 2531 2487 3

4 3902 3808 3717 3630 3546 3465 3387 3312 3240 3170 4

5 4853 4713 4580 4452 4329 4212 4100 3993 3890 3791 5

6 5795 5601 5417 5242 5076 4917 4767 4623 4486 4355 6

7 6728 6472 6230 6002 5786 5582 5389 5206 5033 4868 7

8 7652 7325 7020 6733 6463 6210 5971 5747 5535 5335 8

9 8566 8162 7786 7435 7108 6802 6515 6247 5995 5759 9

10 9471 8983 8530 8111 7722 7360 7024 6710 6418 6145 10

11 1037 9787 9253 8760 8306 7887 7499 7139 6805 6495 11

12 1126 1058 9954 9385 8863 8384 7943 7536 7161 6814 12

13 1213 1135 1063 9986 9394 8853 8358 7904 7487 7103 13

14 1300 1211 1130 1056 9899 9295 8745 8244 7786 7367 14

15 1387 1285 1194 1112 1038 9712 9108 8559 8061 7606 15

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1

2 1713 1690 1668 1647 1626 1605 1585 1566 1547 1528 2

3 2444 2402 2361 2322 2283 2246 2210 2174 2140 2106 3

4 3102 3037 2974 2914 2855 2798 2743 2690 2639 2589 4

5 3696 3605 3517 3433 3352 3274 3199 3127 3058 2991 5

6 4231 4111 3998 3889 3784 3685 3589 3498 3410 3326 6

7 4712 4564 4423 4288 4160 4039 3922 3812 3706 3605 7

8 5146 4968 4799 4639 4487 4344 4207 4078 3954 3837 89 5537 5328 5132 4946 4772 4607 4451 4303 4163 4031 9

10 5889 5650 5426 5216 5019 4833 4659 4494 4339 4192 10

11 6207 5938 5687 5453 5234 5029 4836 4656 4486 4327 11

12 6492 6194 5918 5660 5421 5197 4988 4793 4611 4439 12

13 6750 6424 6122 5842 5583 5342 5118 4910 4715 4533 13

14 6982 6628 6302 6002 5724 5468 5229 5008 4802 4611 14

15 7191 6811 6462 6142 5847 5575 5324 5092 4876 4675 15

1 (1 + r)nr


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Paper P5 - 'Best' numbers questions

4

5

6

13

22

30

31

32

34

35

3637

38

39

40

41

42

44

45

46

47

49

51

52

57

58

59

60

62

63


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Paper P5 - 'Best' written questions

1

10

11

12

17

21

25

29

32

50

53

65

68

Documents

Open Tuition Revision Notes P5