Paper 2 - Performance Management 

AIM

To develop a good understanding of knowledge required and techniques available to enable managers to measure and manage business performance within their organisation. Both financial and non-financial measures of performance are included in this paper.

On completion of this paper candidates should be able to:

• understand how performance measures should be linked to overall organisation strategy
• prepare budgets and use them to control and evaluate organisational performance
• identify and apply techniques that aid making decisions that will maximise financial performance
• identify and implement appropriate costing systems and business control systems
• identify and apply techniques to evaluate decisions in relation to: costing, pricing, product range, marketing strategy, purchasing and production strategies
• identify and apply non-financial performance measures, and understand the inter-relationships between different performance measures
• understand the behavioural and organisational consequences of using performance measurement and performance management techniques
• identify and apply techniques for evaluating the performance of divisions
• identify and understand issues that may cause performance not to meet expectations, such as: actions of competitors, labour disputes, supply problems, foreign exchange movements and late payment
• demonstrate the skills expected in the Diploma in Financial Management.

Candidates are expected to have a good knowledge of basic accounting principles from subject area 1. Knowledge from subject areas 3 and 4 will be helpful but not essential.

The syllabus considers Performance Management from three broad and overlapping perspectives, namely: planning and decision making, measuring performance, and managing performance.

There are also some general issues.

1. Mission statements, objectives and targets
2. Responsibility centres
3. Information systems and costing systems to provide appropriate information
4. Overall organisation strategy and how performance measurement and management should enable strategy to be realised.

a. Preparing budgets, fixed and flexible budgets, cash budgets

b. Budgets in different contexts, including: manufacturing, sales, service industries

c. Alternative approaches to budgeting, for example, zero-based budgeting and activity-based budgeting

d. Decision making techniques required to determine plans that will maximise financial performance for products, customers etc, including:

1. Cost-Volume-Profit analysis, including break-even and margin- of-safety

2. relevant costs and opportunity costs

3. limiting factors and scarce resources

4. decision making under uncertainty, particularly expected values

e. Pricing policies (for example: penetration, skimming) and techniques for setting prices (for example: cost- plus, variable cost-plus, marginal cost, target cost and pricing)

f. Strategic planning and operational planning

g. The future of budgets and alternatives to budgeting

h. Costing data for decision making, and use of activity-based costing data

i. Transfer pricing policies and practices.

3. Performance Measurement

a. Financial measures of performance, including:

1. actual v budget and variances, for costs, profit and cash

2. standard cost variances, operating statements and appraisal of performance

3. measures of shareholder value

b. Critical success factors and key performance indicators

c. Non-financial performance measures

d. Balanced scorecard

e. Benchmarking against world's best practice

f. Divisional performance measures, including:

1. Return on Investment

2. Residual Income and EVAŽ

3. Accounting profit and controllable profit

4. Cash flows.

a. Purchasing and production management, including:

1. supply chain management

2. e-procurement

3. just-in-time production and purchasing

4. target costing and kaizen costing

5. out-sourcing, joint-ventures and partnerships

b. Activity-based management and business process re-engineering

c. Techniques for ensuring value-for money, particularly re not-for-profit organisations

d. Techniques to ensure continuous improvement

e. Use of performance measurement techniques to manage performance

f. Management of divisional performance, including transfer pricing issues

g. Behavioural and organisational consequences of performance measures, particularly budgeting and other accounting system data

h. Understanding of practical issues that may affect an organisation's ability to manage performance effectively, including: actions of competitors, price movements, foreign exchange movements, labour disputes, supply problems, etc

i. Incentive schemes linked to performance measures.

No issues relating to performance management are specifically excluded.

The key topics include:

• Decision making techniques to enable managers to maximise financial performance
• Budgeting and standard costing techniques that assess financial performance

a. Preparing budgets, fixed and flexible budgets, cash budgets

b. Budgets in different contexts, including: manufacturing, sales, service industries

c. Alternative approaches to budgeting, for example, zero-based budgeting and activity-based budgeting

d. Decision making techniques required to determine plans that will maximise financial performance for products, customers etc, including:

1. Cost-Volume-Profit analysis, including break-even and margin-of-safety

2. relevant costs and opportunity costs

3. limiting factors and scarce resources

4. decision making under uncertainty, particularly expected values

e. Pricing policies (for example: penetration, skimming) and techniques for setting prices (for example: cost-plus, variable cost-plus, marginal cost, target cost and pricing)

f. Strategic planning and operational planning

g. The future of budgets and alternatives to budgeting

h. Costing data for decision making, and use of activity-based costing data

i. Transfer pricing policies and practices.

a. Financial measures of performance, including:

1. actual v budget and variances, for costs, profit and cash

2. standard cost variances, operating statements and appraisal of performance

3. measures of shareholder value

b. Critical success factors and key performance indicators

c. Non-financial performance measures

d. Balanced scorecard

e. Benchmarking against world's best practice

f. Divisional performance measures, including:

1. Return on Investment

2. Residual Income and EVAŽ

3. Accounting profit and controllable profit

4. Cash flows.

a. Purchasing and production management, including:

1. supply chain management

2. e-procurement

3. just-in-time production and purchasing

4. target costing and kaizen costing

5. out-sourcing, joint-ventures and partnerships

b. Activity-based management and business process re-engineering

c. Techniques for ensuring value-for- money, particularly re not-for-profit organisations

d. Techniques to ensure continuous improvement

e. Use of performance measurement techniques to manage performance

f. management of divisional performance, including transfer pricing issues

g. Behavioural and organisational consequences of performance measures, particularly budgeting and other accounting system data

h. Understanding of practical issues that may affect an organisation's ability to manage performance effectively, including: actions of competitors, price movements, foreign exchange movements, labour disputes, supply problems, etc

i. Incentive schemes linked to performance measures.

No issues relating to performance management are specifically excluded.

The key topics include:

• Decision making techniques to enable managers to maximise financial performance
• Budgeting and standard costing techniques that assess financial performance
• Costing systems and the use data produced, including activity-based costing
• Techniques to aid performance evaluation of divisions
• Techniques to manage the performance of purchasing, production and sales functions
• Understanding of behavioural and organisational consequences of performance measurement
• Practical issues that affect a firms ability to manage performance effectively
• Non-financial performance indicators and balanced scorecard.

The Study Guide takes the syllabus content and expands it into study sessions of similar length.

These sessions indicate what the examiner expects of candidates for each part of the syllabus, and therefore gives you guidance in the skills you are expected to demonstrate in the examinations.

The time to complete each session will vary according to your individual capabilities and the time you have available to study. However, repeated coverage of the material is vital to ensure your understanding and recall of the subject. Be sure to practice questions from your textbook or past examination papers to consolidate your knowledge.

• Explain the purposes of and inter- relationships between mission statements, strategy, corporate objectives and targets
• Discuss the importance of relating performance measurement and performance management to the overall mission, strategy and objectives of the organisation
• Describe the nature of responsibility centres, such as investment centres, profit centres, cost centres etc.
• Identify and discuss recent changes that have taken place within many organisation structures, such as flatter structures, and greater decentralisation.

• Describe and evaluate different types of information systems that provide the information required for performance management
• Explain the features of enterprise-wide resource planning systems and other company-wide management information systems (MIS)
• Describe the role of costing systems, and evaluate their strengths and weaknesses
• Describe the links between overall corporate strategy and performance management within an organisation.

• Prepare basic budgets for sales, production and purchases etc.
• Demonstrate differences between fixed and flexible budgets
• Prepare a cash budget
• Prepare basic budgets for different types of organisations, such as manufacturing, service companies, not-for-profit organisations.

• Explain and distinguish between strategic planning and operational planning
• Explain and evaluate the appropriateness of different budgeting approaches, such as zero-based budgets and activity-based budgets
• Explain and evaluate the recent critique of budgeting, 'beyond budgeting'
• Explain and evaluate alternatives to budgeting.

• Distinguish fixed and variable costs, and combinations of these two costs
• Explain the assumption of linearity and the limitations of this assumption
• Demonstrate understanding of the Cost-Volume-Profit (CVP) model
• Prepare breakeven charts, profit-volume charts and margin-of-safety calculations, and interpret the information prepared
• Comment on the limitations of CVP analysis and other factors that may need to be considered with CVP information.

• Define and distinguish between relevant costs, sunk costs and opportunity costs.
• Explain the concept and use of incremental costs
• Use an incremental cost approach to decision making, particularly for make-buy decisions and additional/ special orders
• Explain and illustrate the impact of limiting factors/scarce resources in decision making
• Prepare simple calculations to determine the optimal mix of 2 products where there are limiting factors (simplex calculations will not be required).

• Demonstrate simple techniques for decision making under uncertainty, such as conservatism, sensitivity analysis, 'maximin-minimax'
• Demonstrate the use of probability estimates and expected values in decision making under uncertainty
• Comment on the strengths and weaknesses of the techniques mentioned above.

• Identify and discuss market conditions that will affect the choice of pricing policies, including price elasticity
• Discuss different pricing policies and strategies with which they would be appropriate, for example: skimming and penetration policies
• Calculate prices using various techniques, such as: full cost-plus, variable cost -plus, variable cost, marginal cost, and explain where different techniques might be appropriate
• Explain the operation of target costing
• Discuss the implications of different pricing techniques, for example marginal cost for certain short-run pricing decisions
• Evaluate the implications of activity-based costs for pricing

• Identify the circumstances where transfer pricing will be required, and the issues that will arise, particularly in relation to the nature of divisionalisation in different companies
• Explain the 'general rule' for transfer pricing and discuss its application
• Discuss the different techniques for setting transfer prices and evaluate their applicability in different situations and divisionalised structures, including: market-based prices, marginal cost transfers, cost-plus prices and negotiated prices
• Discuss the impact of transfer prices on divisional performance assessment.

• Discuss the ways in which costing data is used in decision making
• Explain the concept of 'different costs for different purposes' and discuss the issues that arise from this
• Outline the background to the development of activity-based costing, using the 'relevance lost' approach
• Calculate simple activity-based costs and compare with traditional volume-based costing methods.

• Explain the different uses to which activity-based cost data can be applied
• Demonstrate the use of activity-based cost data for making make/buy and outsourcing decisions
• Demonstrate the use of activity-based cost data for product continuance decisions
• Demonstrate the use of activity-based cost data for customer profitability analysis and decisions
• Discuss other relevant factors that need to be considered in conjunction with cost data
• Discuss the problems of implementing and using activity-based techniques, and discuss how these problems might be minimised.

• Demonstrate the use of budgets to measure performance
• Evaluate actual results compared to budget and calculate budget variances
• Explain process of setting standard costs, and use of standard costs to set targets
• Calculate standard cost variances and prepare operating statements
• Evaluate performance using standard cost variances
• Recommend action using standard cost variance analysis
• Discuss the relevance of the original budget, and its assumptions, when interpreting standard cost variances.

• Explain the importance of the shareholder value concept, and discuss its limitations, for example in comparison with stakeholder approaches
• Explain the common methods for measuring shareholder value, such as: profit, return on assets, return on sales, Economic Value Added (EVAŽ)
• Discuss problems of implementing shareholder value measures and approaches to minimise these problems.

• Discuss the implications of the growing emphasis on NFPIs, and the benefits their use might bring to an organisation
• Discuss the interaction of NFPIs and financial measures of performance
• Identify and comment on NFPIs in relation to: employee performance, quality, customers, supply chain etc.
• Explain the concept of critical success factors
• Discuss the relation between critical success factors and strategic targets
• Discuss the problems that may arise in implementing and using NFPIs and CSFs for measuring performance.

• Explain the development of the balanced scorecard as proposed by Kaplan and Norton
• Explain the main features of the balanced scorecard and the interaction within the different perspectives
• Discuss the implementation of a balanced scorecard, the selection of measures to be used, and who should own the implementation process
• Evaluate the benefits that might arise from using a balanced scorecard
• Explain the concept and potential benefits of benchmarking performance
• Measures against worldwide best practice
• Discuss the problems of implementing and using benchmarking techniques
• Discuss the relationship between balanced scorecard and benchmarking.

• Discuss the general issues in relation to assessing the performance of divisions,
• especially the importance of the nature of divisions in a particular organisation
• Calculate the basic divisional performance measures: accounting profit, return on investment, residual income, controllable profit, and cash flows
• Discuss the strengths and weaknesses of the above measures and the conditions where each measure would be appropriate.

• Explain the development of economic value added (EVAŽ)
• Discuss the strengths and weaknesses of EVAŽ
• Discuss the problems of implementing EVAŽ
• Discuss the relationship between financial measures of divisional performance and non-financial measures
• Discuss the issues that arise when divisions are assessed, including problems that arise from using a range of different performance measures (note the link with balanced scorecard)
• Comment on the issues that arise in relation to assessing divisional performance and the performance of the divisional management
• Discuss the inter-relationship between divisional performance measures and transfer pricing
• Discuss the action needed by management to ensure divisions operate effectively in line with the whole organisation's objectives.

• Outline the key elements of operations management, including: procurement, logistics, production management, and quality management
• Distinguish between functional operational structures, matrix structures and process-based structures
• Discuss production issues, such as: 'lean manufacturing' , 'focus factories', 'flow-line production', 'cell production', and discuss the implications for performance management
• Explain the problems that may arise in the transition between different production systems
• Explain the basic features of MRP and MRP II systems
• Explain the basic features of optimised production technology (OPT) and theory of constraints, and contrast with MRP systems
• Discuss the information that is available from production planning systems and its use in managing performance.

• Explain the basic features of the supply chain; including: environmental factors, technology, suppliers, production (of goods or services), customers, and logistics
• Discuss strategies and measures that have been used to improve performance in the supply chain, such as, a reduction in the number of suppliers
• Discuss measures that can be used to control and improve supply chain performance, and comment on issues that can arise, including, the problems of framing contracts, ensuring quality, and obtaining continuous improvement
• Explain the changes in procurement procedures that have taken place using electronic data transfer and the internet
• Discuss measures that can be used to control and improve e-procurement performance.

• Discuss the changes in the nature of the supplier relationship in recent years
• Explain the benefits and weaknesses of out-sourcing
• Discuss measures that can be used to determine whether out-sourcing would improve performance and measures that could be used to control this process once implemented
• Discuss the benefits and weaknesses of joint-ventures and partnerships between supplier and customer
• Discuss measures that can be used to determine whether a joint-venture or partnership would improve performance and measures that could be used to ensure continued improvement through such relationships.

• Explain the just-in-time production and just-in-time purchasing philosophy, including the kanban system
• Discuss operational issues that arise as a result of implementing just-in-time
• Discuss financial consequences, in the short-term and medium-term, that follow implementing just-in-time procedures
• Discuss measures that can be used to control and improve production and procurement performance if just-in time procedures are implemented.

• Explain the basic features of target costing and contrast these with traditional cost-plus costing procedures
• Discuss the cost reduction objectives of target costing
• Explain the basic elements of the 'kaizen' approach
• Explain techniques that can be used to ensure continuous improvement in performance
• Discuss the basic features of kaizen costing and how these may help to manage performance.

• Explain the main features of activity-based management (ABM)
• Contrast ABC with ABM
• Discuss the benefits that may arise from using ABM and the problems that may be encountered in its use
• Explain the concept of value-added (VA) and non value-added (NVA) activities
• Discuss the problems that may arise with the implementation of the VA-NVA distinction.

• Explain the main features of business process re-engineering (BPR)
• Discuss whether and how BPR could improve performance
• Discuss Hammer's contention that BPR will only realise its full potential if carried out for the whole organisation; discuss the problems that might arise in ; adopting this approach and possible; approaches to minimise the problems
• Discuss the evidence that BPR has only been successful in a minority of implementations
• Contrast BPR with ABM.

• Explain how performance measures interact with performance management, particularly the issue of ' what you measure is what you get'
• Explain how performance measures and targets can be used to motivate individuals and discuss the problems that may arise
• Discuss whether and how participation in the target-setting process may improve performance
• Discuss the role of organisational culture and the style of management in managing performance.

• Explain the concept of value-for-money
• Distinguish not-for-profit organisations from commercial organisations, in particular in relation to their mission and objectives
• Explain techniques for ensuring value-for-money that may be particularly appropriate for not-for-profit organisations, such as: effectiveness audits, VFM audits, programme budgeting techniques
• Discuss the role of motivation and rewards in not-for profit organisations.

Explain the practical difficulties that may affect an organisation's ability to manage performance effectively, including:

• actions of competitors, including new entrants
• price movements
• foreign exchange movements
• labour disputes
• supply problems
• rapid technological change.

• Explain the role of incentive schemes in encouraging high levels of performance from staff
• Outline different forms of incentive scheme, such as: individual, unit and company-wide, and different elements within a scheme, such as: cash bonuses, shares and options
• Discuss the strengths and weaknesses of different incentive schemes
• Discuss problems that may occur with incentive schemes that are not carefully constructed and implemented.

When studying for this paper, it will be necessary to discuss examples from a wide variety of organisations, in particular: manufacturing companies, service companies, multinational companies, financial services companies, and not-for-profit organisations.