MODERN MEASURES OF FINANCIAL/PERFORMANCE EVALUATION

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MODERN MEASURES

•                            Economic Value Added

•                            Residual Income

•                            Six Sigma

•                            Bench Marking

•                            Performance Prism

•                            Balanced Score Card

◦     ECONOMIC VALUE ADDED

◦       Stern Stewart &Co Gave A Modified Concept Of Economic Income In The Name Of Economic Value Added

◦       Measures The Economic Profit Rather Accounting Profit

◦       Economic Profit=net Operating Profit After Taxes-cost Of Capital

◦       If Eva Is Positive Then The Organization Is Creating Wealth And If It Is Negative Then It Is Destroying The Wealth

◦       Accountant Does Not Take Into Account The Cost Of Equity Capital But Economist Charges All Resources In His Computation Of Profit Including An Opportunity Cost For The Equity Invested In His Business.

◦     ECONOMIC VALUE ADDED

◦  EBIT

◦  LESS INTEREST

◦  NET INCOME

◦  LESS COST OF EQUITY CAPITAL

◦  ECONOMIC VALUE ADDED

◦       IT IS THE RETURN A FIRM EARNS IN EXCESS OF THE MINIMUM REQUIRED RATE OF RETURN BY THE INVESTORS.

◦       EVA=NETOPERATING PROFIT AFTER TAX(NOPAT)-(WEIGHTED AVERAGE COST OF CAPITALXCAPITAL EMPLOYED)

◦       EVA=NOPAT-(WACXCE)

◦     CALCULATION OF CAPITAL EMPLOYED

◦    BOOK VALUE OF COMMON EQUITY

◦    +PREFERENCE CAPITAL

◦    +MINORITY INTEREST

◦    +DEFERRED INCOME TAX RESERVE

◦    +LIFO RESERVE

◦    +ACCUMULATED GOODWILL AMORTIZATION

◦    +INTEREST BEARING SHORT TERM DEBT

◦    +LONG TERM DEBT

◦    +PRESENT VALUE OF NON CAPITALIZED LEASES

◦    +CAPITALIZED LEASE OBLIGATION

◦     IMPORTANCE

◦   BETTER FINANCIAL MGMT

◦   Helps In Capital Budgeting Decisions

◦   Measuring Performance And Mgmt Compensation

◦   Limitation:-

◦   Ignores Inflation

◦   Biased

◦     Residual Income(RI)

◦     Developed By The General Concept Of Us

◦     Used As Part Of Divisional Performance Mgmt

◦     Defined As Income Remaining Out Of Profit Before Taxes After Making Provisions For The Expected Return On Investment.

◦     The Expected Return As Capital( Imputed Interest Charge)

◦     Logic Is The Division Bears A Charge For The Assets Provided By The Organization To The Division For Use

◦     Ri=Profit-Capital Charge

◦     =Profit-(Required Rate Of Return x investment)

◦     The Objective Of The Firm Should Be To Maximize The Residual Income.

◦     Performance Of The Division

◦     Evaluation

◦     Merits

◦     Maximises The Overall Value Of The Growth Of The Firm

◦     Knowledge Of The Opportunity Cost Of Capital

◦     Goal Congruence

◦     Limitation

◦     Not Satisfactory Definition

◦     Difficult To Get Rate Of Imputed Charges

◦     Absolute Measure Of Performance

◦     Six Sigma

◦   Set Of Techniques And Tools For Process Improvement.

◦   Introduced By Engineer Bill Smith While Working At Motorola.

◦   Jack Welch Made It Central To His Business Strategy At General Electric In 1995

◦   Process Is One In Which 99.99966% Of All Opportunities To Produce Some Features Of Part Are Statistically Expected To Be Free Of Defects.

◦     Six Sigma

◦     Primarily A Mgmt Philosophy That Aims To Improve Upon Customer Satisfaction To Near Perfection

◦     Smarter Way To Manage A Business Or A Department By Managing With Facts, Figures And Data

◦     The Objective Of Six Sigma Is To Drive Process Improvement By Focusing On Defect Elimination Rather Creating And Improving Products/Services That Results In A Very Small Number Of Defects.

◦     As Per Pande And Ecke Six Sigma Efforts Target The Main Areas Of Improvement

•                 Improves Customer Satisfaction

•                 Reducing Cycle Time

•                 Reducing Defects

Three Critical Success Factors-Strategic Component, Tactical Components, Cultural Components

◦     Five Strategies Of Six Sigma

•                      D-Define:-Goals Of The Improvement Activity

•                      M-Measure-The Existing System

•                      A-Analyze The System To Identify The Ways To Eliminate The Gap Between The Current Performance/Or Process

•                      I-Improve The System

•                      C-Control

◦    Three More Parameters:-Recognizing, Standardize And Integration

◦    Two Methodologies:

◦    DMAIC For Existing Process And DMADAV For Creating New Processes

◦     Benchmarking

◦     Which Will Help A Company To Achieve This Comparative Cost Efficiency

qMay Be Defined As A Continuous Information Sharing Process, Adopted By An Organization Internally And Externally To Identify Its Strong Or Weak Points Against The Toughest Competitors, To Improve The Activities Carried Out And Services Provided By It.

qDavid T,Kearns,”Bench Marking As The Continuous Process Of Measuring Products, Services And Business Practices Through The Comparison With The Strongest Competitors Or With Companies That Are Recognized As Industry Leaders. It Is Continuous Search For Superior Competitive Performance.

◦     Bench MARKING

◦     STEPS:-

•                  Identifying Key Variables For Bench Marking

•                 Selecting Comparative Companies

•                 Gathering Required Data

•                 Increased Budget For Data Generation

•                 Evaluating And Interpreting The Performance Gap

•                 Improving The Performance

Comparison In These Areas:-

•                 Cost Of Product/Service

•                 Productivity

•                 Standard Of Performance

◦     Benefits

◦     Continuous Search For Better Ways

◦     Reduction Of Cost

◦     Higher Customer Satisfaction

◦     Balance Score Card

◦     Developed By Dr. Robert Kaplan And David Norton

◦     It Is A Mgmt. System Enable Organization To Clarify Their Vision And Strategy And Translate Them Into Action.

◦     Balanced Scorecard Is A Set Of Financial And Non Financial Measures Relating To Company’s Critical Success Factors. It Is A Tool Of Mgmt. Which Helps Companies To Assess Overall Performance, Improve Operational Performance, Enable Mgmt. To Introduce And Implement Better Plans For Improvement.

◦     Component Of Balance Score Card

◦     A Well Designed Balance Scorecard Is a Combination of Financial Measures of Past Performance Along With Firm’s Measures of Future Performance. The Objectives and Measures of an Organization Balance Score Card Are Derived from Firm’s Vision and Strategy. The Main Purpose  Is To Provide A Framework For Translation Of Firm’s Strategic Objectives Into A Set Of Performance Measures,

◦     Components Of Balance Score Card Are :

•                       The Learning And Growth Perspective

•                       The Business Process Perspective

•                       The Customer Perspective

•                       The Financial Perspective

◦     The Performance Prism

◦     Second Generation Performance Measurement

◦     Mgmt Framework That Is Innovative In Its Approach And Addresses An Organization’s Stakeholders-Principally Investors,Customers ,Intermediaries,Employees,Suppliers Etc

◦     Reciprocal Relation Is Examined: Expectation Of The Stakeholders And Organizations’ Expectation From Stakeholders

◦     Focuses On Strategies, Processes,And Capabilities To Satisfy Two Critical Sets Of Wants And Needs.