Chapter 22: Strategic Cost Management BALANCE SCORECARD
Four Major Management Function
• Strategic Management – involves the development of a sustainable competitive position in
which the firm’s competitive advantage provides continued success.
• Planning & Decision making – involves budgeting & profit planning, cash flow management &
other decision related to firm’s operation
• Control – involves two function a) Operation control & b) Management control
Preparation of Financial Statements – involves compliance by management with reporting
requirements (i.e SEC, BIR, BSP,etc.)
Strategic Competitive Analysis
• Cost leadership – firm succeeds by producing products or services at lowest cost in the industry.
• Differentiation- firm succeeds by developing & maintaining a unique value for the product, as
perceived by customer
• Focus – firm succeeds by targeting its attention to specific segment of a market (i.e. by type of
customers, segment of the product line or geographical area).
The Balance Scorecard
- It consists of integrated system of performance measures that are derived from and support the
company’s strategy.
- To emphasize the importance of using strategic information, both financial and non-financial
accounting reports of firm’s performance are often based on critical success factors in difference
dimension.
- An effective management requires a balanced prospective on performance measurement which is
called “Balance scorecard”.
It integrates the performance measure in four key areas:
>> Financial perspective >> Internal Business processes
>> Customer satisfaction >> Innovation & learning
Four perspectives of Balance Scorecard
• Financial Perspective - Measures of profitability and market value among others, as indicators
of how well the firm satisfies its owners and shareholders.
• Customer Satisfaction - Measures of quality service and low cost, among others, as indicators of
how well the firm satisfies its customer.
• Internal Business Processes - Measures the efficiency & effectiveness with which the firm
produces the product or services
• Innovation and Learning - Measures of the firm’s ability to develop and utilize human resources
to meet the strategic goal now and into the future.
Illustrative Balance Scorecard
The Balance Scorecard for XYZ for 2018
Evaluating the Success of a Strategy
• We analyze changes in operating income into components that can be identified with growth,
differentiation & cost leadership.
• Subdividing the changes in operating income to evaluate the success of company strategy is
similar to variance analysis.
• However, focus here is on comparing actual operating performance over (2) different periods &
explicitly linking it to its strategic choices.
The following analytical relationship may be used:
GROWTH COMPONENT (QTY)
Revenue effect of growth component formula Cost effect of growth component formula
(Actual units of output sold this year - (Actual units of input used that would
Actual units of output sold last year) x have been used to produce this year’s
output price last year = Favorable output assuming the same input-
(unfavorable) output relationship that existed last
year - Actual units of input to produce
last year) x input price last year =
Favorable (unfavorable)
PRICE RECOVERY COMPONENT
Revenue effect of price recovery component Cost effect of price-recovery component formula:
(Output price this year – output price (Input price this year - input price last
last year) × actual output sold this year) × actual units of inputs used
year = Favorable (unfavorable) that would have been used to
produce this year’s output assuming
the same input-output relationship
that existed last year = Favorable
(unfavorable)
PRODUCTIVITY COMPONENT
Actual units of input used to produce this
year’s output - Actual
inputs that would have been used to
produce this year’s output assuming the
same input-output relation that existed last
year) x input price last year = Favorable
(unfavorable)
Internal Business Process Performance
- Most Performance measure are self-explanatory
- Three are NOT that is: delivery cycle time, throughput time & manufacturing cycle efficiency (MCE)
Delivery Cycle Time
➢ The amount of time from order receipt to delivery of completed order.
➢ This is a key concern to customer as they prefer it to be as short as possible.
➢ Cutting this can be a key competitive advantage.
➢ Many companies include this in performance measure on their balance score card
Throughput (Manufacturing cycle) Time
➢ The amount of time required to turn raw material into finished goods.
➢ This is made up of process time(amt of time worked to do the product), inspection time (time
spent in ensure product is not defective), move time (need time to move material or moving
partially compete product from station to station & queue time (amount of time a product
spend waiting). Only process time adds value to the product, while inspection, move time &
queue time are non-add value.
Manufacturing Cycle Efficiency (MCE)
➢ By improving the process non add value activities (inspection, move & queue time throughput
time was reduced by many companies to only a fraction of previous levels.
➢ Throughput time can be put into better perspective by computing the MCE as follows:
MCE rate = value added time/Throughput time
➢ If MCE is < than 1, the non-added value time is present in the process.
Illustrative Prob 2
Illustrative Prob 2 sol
Chapter 23: Financial & Non-financial Performance measure
Performance evaluation
• It is the process by which managers at all levels, gain information about the performance of task
within the firm & assess such performance against pre-established criteria as set out in budget,
plans and goals, with the following goal:
1. Motivate the manager to provide a high level of effort.
2. Guide them to make decision that are congruent with the goal of top management
3. Provide a basis for determining fair compensation for the managers
Steps in measuring performance
1. Choosing among performance measures
➢ Return on investment (ROI)
➢ Residual income (RI)
➢ Economic value added (EVA)
➢ Return on sales (ROS)
2. Choosing time horizon of the performance means:
➢ One year VS Multi year
➢ Short run VS Long run
3. Choosing alternative definition
➢ Total asset available
➢ Total asset employed (minus idle asset & purchased for future use
➢ Total assets employed minus current liabilities
➢ Shareholder’s equity
4. Choosing measurement alternatives for performance measure
➢ Current cost VS Historical cost
➢ Gross value VS Book value/carrying amt
5. Choosing target levels of performance
➢ Selection of benchmark or target (i.e ROI for division)
➢ Asset valuation (historical vs current
➢ Continuous improvement target
6. Choosing the timing feedback
➢ Criticality of information to organization success
➢ Level of management receiving feedback
➢ Company’s IT sophistication
➢ Lower-level managers responsible for day-to-day operation
*Timely reporting of actual results & identification of deviation causes could signal corrective action.
Return of Investment (ROI)
Advantages:
➢ It is easily understood and has gain wide usage
➢ It is comparable to interest rates of returns of alternative investment.
Limitations:
➢ Emphasizes short-run performance rather than long run profitability.
➢ It results to dis-incentive for high ROI units to invest in projects with ROI greater than the
minimum rate of return but less than unit’s current ROI.
Formula:
ROI
ROI X
ROI Operating Margin x Asset Turnover (Return on Sales)
Return on Sales (ROS)
➢ It is a ratio used to evaluate a company's operational efficiency.
➢ It is calculated by dividing operating profit by net sales.
ROS
➢ It is only useful when comparing companies in the same line of business and of roughly the same
size.
Residual Income (RI)
It is the net operating income that an investment center is able to earn above some minimum return on
operating assets.
Advantages:
➢ A unit pursues investment opportunity as long as the return from the investment exceeds the
minimum rate set by the firm.
➢ The firm can adjust the required rate of return for differences in risk & type of assets
➢ It is possible to calculate a different investment change for different type of assets.
Limitations:
➢ Since it’s not a %, it suffers same problem of profit centers in that, it is not useful for composing
units of significantly different sizes
➢ It is not intuitive as ROI.
➢ It may be difficult to obtain a minimum rate of return
Formula:
Operating Income xxx
Less: Min required
return -xxx*
Residual Income xxx
*Capital x Rd (%)
Economic Value Added (EVA)
➢ It is a business units income after taxes after deducting the cost of capital.
➢ The concept is the same as Residual Income, but EVA uses the firm’s cost of capital (WACC)
instead of minimum rate of return.
➢ The cost of capital is obtained by weighted Average cost of firms two source of fund:
borrowing and selling stock.
WACC is computed as follows:
WACC = (Weightage of Equity x Cost of Equity) + [(Weightage of Debt x Cost of Debt ) x (1–Tax
Rate)]
100% = 50/50, 40/60
EVA formula:
After tax income xxx
Less: Cost of Capital
(Capital x WACC) -xxx
Economic Value Added (EVA) xxx
WACC = (Weightage of Equity x Cost of Equity) +[(Weightage of Debt x Cost of Debt ) x (1–Tax
Rate)]
= (50% x 14% ) + (50% x [10%-(1-40%)]}
= 7% +3%
= 10%
Illustration:
R0I= 630k/3,000k 1,800K/10,000K
21% 18%
ROS 630K/9,000k 1,800K/20,000k
7% 9%
NI 630K 1,800K -RD (3000K x 16% ), ( 10,000k x 16% )
480k 1,600k
RI 150k k 200,000 K
Assumption Ratio, D-40%, 9% , S-60%, 10%
WACC = 60% X 10%)+ 40% X 9% x (1-40%)
=6%+ 2.16
= 9.16%
NI-T (630k x 1-40%) , (1800K X 1-40%) 37,k 1,080k
-3,000K X 9.16% 10,000k x 9.16% 274.8k 916k
EVA 103.2k 164k
ROI (S)= 94.7k/800k = 94.7k/370
=11.84% =25.59%
RI (P)
OI 91,700 91,700
Less: Rd
760K x10% 76,000 (350K x 10%) 35,000
RI 15,700 56,700
WACC = (40% x 15% ) +(60% x 10% x (1-40%)
=6% + 3.6%
= 9.6%
EVA RI
NI after tax 45,000 (75kx60%) 75,000
Less: Cost of cap
(530K x 9.6%) 50,880 (530K x 12% 63,600
EVA -5,880 RI 11,400
Performance measurement in MNC
▪ Company set up - Division VS Corporation
▪ Other environment variable
➢ Economic variable (includes currency restriction, taxes, transfer, prices, capital
market and inflation)
➢ Legal & Political (includes quality, efficiency, & effectiveness of legal structure,
defense policy, foreign policy, degree of gov’t control & level of political unrest
➢ Education (could refer to literary rate, sophistication of accounting
system, degree of technical training & mgmt dev’t program
➢ Sociological & cultural (MN firm treatment by host country manifested in cultural
& social diversity, social attitude toward mat’l gain & cultural attitude
towards authority & persons in subordinate position & work ethics
Manager Performance VS Performance of unit
▪ Different firm Level: Top management, Middle level & Operating level
▪ Manager assigned to a poor performing unit
➢ Favorable outcome takes years, thus it may be mistake to conclude from poor
performance.
▪ Division performance may be adversely affect by economic conditions and other constraints
beyond manager’s control
In evaluating performance, the following need to be looked into:
➢ Manager’s environment (manager’s action outcome vs effort & decision making skills.
Consider uncontrollable factors (i.e machine breakdown Lack of control means there is
some degree of uncertainty)
➢ Include only factors that the manager controls.
➢ Due to uncertainty & lack of observability, efforts made by manager
were overlooked by top management. A risk averse manager is
improperly biased to avoid decisions with uncertain outcom
Intensity of incentive: Financial & non-financial
▪ Incentive is tied up with compensation to encourage manager’s
goal be congruent with the firm’s interest.
▪ Managers are evaluated based on the change they can effect, even
if not completely controllable.
▪ The more company has sensitive performance measure available
to them, they more they rely in incentive compensation for managers.
▪ Salary increases and promotion to higher ranks depend on some measure of performance but
incentive are less direct.
Chapter 24: Managing Productivity & Marketing Effectiveness
Managing Productivity
- Sustaining profitability & maintaining/improving market share requires effective marketing activities.
- Having ability to produce more with less resources are the story behind progress & success.
- Productivity has become the wealth not only of the company, but of the country.
- Benefits of higher productivity to business are; a) competitive advantage b) higher than average
returns c) attainment of long term success.
Measuring Productivity
• Total Productivity - is the measure that include all the inputs used in the production. Below is
the summary of productivity measure:
• Partial productivity - relates to one or part of the input factors to the output. Basic formula is as
follows:
Measuring Productivity (By Part)
- A measure of productivity can either be operational or financial productivity measure:
Illustration 1
Illustration 2 cont…
➢ We can note the following on this illustration:
Operating income has increase only to 17% [(2200-1880) ÷ 1880], even though sales has
increase favorably by 20% (1600 ÷ 8000) or [(4,800-4000) ÷4000)] even with the fixed cost
remains at P600K.
➢ The variable cost has increased by 32% [(1600+400) -(1200+320) ÷ 1,520]
➢ Number of factors should have contributed to the increase in direct materials & direct labor
costs as well as increase in the # of units manufactured & sold. Further there are changes in
proportion of the inputs used in production, & unit cost of resources (mat’l & labor).
➢ The company should identify factors that caused the change in order for it to implement some
cost saving measures to increase operating income, thus it need to know changes in production
of individual production resource. Partial productivity measure provides such.
By-Part Financial Productivity Analysis
Material Labor
➢ 2019 Productivity 0.0067 unit/Peso spent ➢ 2019 Productivity 0.025 unit/labor hr
vs vs
➢ 2020 Productivity 0.0060 unit/ Peso spent ➢ 2020 Productivity 0.024 unit/ labor hr
This financial productivity indicates the The direct labor partial financial productivity
number of units of output for every peso is 0.025 in 2019 and it reduced to 0.0024, a
spent. In 2019 direct material financial 4% decrease [(0.025-0.024) ÷ 0.025]. This
productiveness is 0.0067 while in 2020 its contradicts the direct labor partial operation
only 0.0060. This indicates decrease in productivity reported earlier at 20%
productivity in 2020 by 10% [(0.0067- improvement.
0.0060) ÷ 0.0067]
Illustration 2 cont…
Figure 24.2 provides by-Part Operation & financial productivity analysis of Press Tool:
By-Part Operation Productivity Analysis
Material Labor
➢ 2019 Productivity 0.16 unit/lb of mat’l ➢ 2019 Productivity 1 unit/labor hr
vs vs
➢ 2020 Productivity 0.15 unit/lb of mat’l ➢ 2020 Productivity 1.20 unit/ labor hr
For 2020, productivity per pound of material For 2020 productivity per hr the company
is lower by .01 unit/lb, a decrease of 6.25% have produced 1.20 unit/hr as against 1
(.01÷.16). In 2020, the company required unit/hr in 2019. With total hours available of
only 32,000 lbs of mat’l (4,800 ÷ 0.15), which 8,000 the company manage to produce
should only been 30,000 lbs (4,800/.16), an 9,600 unit as compare with 8,000 units only
increase 2,000 lbs which is unfavorable. in 2019.
By-Part Productivity measure
Advantage
1. Allows analysis on a particular production input.
2. Easy to interpret by all and easy to assess productivity performance.
3. The standard for performance is often short-term for operational control, i.e. productivity ratios
of prior batches of goods & productivity trends within the year can therefore be tracked.
Limitation
1. Being particular in its analysis, it ignores any effect that changes in other manufacturing factors
have on productivity.
2. It ignores any effect that changes in other production factors have on productivity.
3. It ignores the effect that changes in the firm’s operating characteristics have on productivity of
the input.
4. An improved partial productivity does not imply that the firm or division operates efficiently
Measuring Productivity cont…
Total productivity shows the relationship between output & the total cost of all resources. It is a
financial measure & can either be number of units or sale value of output obtained., thus formula is as
follows:
Total Productivity measure
Advantage
1. Total Productivity measure the combined productivity of all ope- rating factors. It decreases
the possibility of manipulating factors to improve productivity measure of other manufacturing
factors.
Limitation
1. Total productivity is a financial measure & executive at the operational level may have difficulty
linking productivity measures to their day-to-day operation.
2. The basis for assessing changes in productivity could vary over time, that year, yearly measures
use different years as the base.
3. It can ignore the effects of changes in demand for the product, changes in selling prices of the
goods and services & special purchasing & selling arrangements on productivity.
Managing Marketing effectiveness
- No entity can gain success without effective marketing activities that will enable to accomplish the
following: a) Earned projected operating income b) Attained desired & budgeted mkt price c) adapt to
mkt change.
- Factors that affect marketing effectiveness include selling price, sales quantity, product mix, market
size & market share. Variances in any of these factor affects company’s operating results & these can
prevent entity in achieving its short-term performance objectives & strategic goals.
Summary of Variances (Sales)
- This is the difference bet actual peso receive/unit VS budgeted sales/unit per master budget. It
measures the impact of deviation of actual selling price from budgeted selling price on CM & income.
- This is the difference bet actual units sold VS budgeted unit. It measures the effect on CM &
operating income when quantity sold for one or more products differs from quantity per master
budget.
Summary of sales variances
- This is the difference between the actual VS budgeted sales mix, the actual total unit sold and the
budgeted CM/unit of product. It measures the effect on CM & Operating income due to deviation of
actual sales mix from budgeted mix.
-This measures the effect on CM & operating income due to deviation of the actual total sales units from
budgeted total units.
Illustration 2 Prob
Illus 2 Solution_Total Variance computation
Illus 2 Solution_ Variance breakdown
(630k+2,620k=3,250k)
Sales Price Variance
(a-
Flavor Actual CM Budget CM b=c Actual Var (c x d)
-
Vanilla 5.50 7 1.50 180,000 -270,000
-
Chocolate 8.50 9 0.50 270,000 -135,000
Strawbery 12.50 11 1.50 330,000 ……..495,000
Mango 18.00 15 3.00 180,000 ……..540,000
Total 630,000
Sales Volume Variance
Actual Budget CM
C ( a-
Flavor (a) (b) b ) (d) Var (c x d)
Vanilla 180,000 250,000 -70,000 7 - 490,000
Chocolate 270,000 300,000 -30,000 9 - 270,000
Strawbery 330,000 200,000 …130,000 11 …1,430,000
Mango 180,000 50,000 …130,000 15 ….1,950,000
Total 960,000 800,000 2,620,000
Illus 2 Solution_ Sales Mix
Illus 2 Solution_ Sales volume variance breakdown
(1,140k+1,480k=2,620k)
Sales Mix variance
Sales Qty variance
Summary of Variances (Market effectiveness)
- This measures the effect of changes in the total market size on the firm’s CM and Operating income. As
the size of the total market for the firm’s product changes, the total sales of the firm are likely to change
with it.
-This variance compares the firm’s actual market share to its budgeted market share & measures the
effect of change in the firm’s market share on its total CM and operating income.
Illustration 3
Illustration 3 sol
unfavorable
