In this post we’re going to look at a question which at first glance may seem perfectly straightforward: how do you know whether an organisation is doing well or not?
How do you measure success or failure? Would you look at sales? Or is profit better? Or do you need to look at a relative measure like return on capital employed? What if your business doesn’t make any profit – what then?
The technical term for this area of management accounting is Performance Management and it is a far more complex field than many organisations appreciate. Looking at a good performance management system should be like looking through a kaleidoscope – you don’t see a single thing in your vision to focus on such as ‘profit’ or ‘share price’ or ‘market share’ but a whole array of different targets which collectively represent the overall picture. We’re going to take a brief look at two of the management tools available for trying to achieve this kaleidoscopic effect.
The three e’s of “value for money” (VFM)
Public sector – or not-for-profit organisations – often use this framework to avoid tunnel-visioning on single aspects of performance. If you think about universities, for example, they would look at their performance from three intertwined perspectives:
Effectiveness: How do you know whether a university is ‘effective’? Surely by looking at degree results, employment statistics upon graduation, the number of students going into post-graduate research, feedback from student alumni on their experiences and so on. But a university may be top of all these lists and still not be offering VFM because this success has to be done within budget.
Economy: Maybe the university achieves top results but is paying tutor salaries of £500k per year to achieve them or perhaps student feedback is amazing but this is because the university provides luxury accommodation and facilities. A university which is ‘effective’ but is bankrupting itself in this way is offering poor value for money and is not sustainable as an enterprise.
Efficiency: What if those great degree results are because highly paid tutors are teaching classes of three students and they only teach one class a week. If that is the case then there is no efficient use being made of the resources available and value for money is not being provided.
Ultimate performance is obtained only in the area where all three of these intersect and all areas are being achieved simultaneously and equally.
Profit-making organisations in the private sector often use this framework to achievethe same effect. All profit-making businesses need to focus on the following:
Financial perspective: Set targets for sales growth, profit margins, costs, cashflow and liquidity in order to maintain financial stability and deliver investors with required returns. But there is a danger that this could be achieved by cutting costs and increasing selling prices. If financial targets are the dominant focus of the organisation it may lead to the customers’ perspective being jeopardised if prices are increased to generate greater returns.
Customers’ perspective: Therefore, the financial perspective needs to be balanced by targets which drive performance in ways which matter to the customer – delivery times, complaints resolution, answering queries within a certain amount of time and quality. Conversely, if the organisation achieves its customer targets then happy customers will buy more goods and hence the pursuit of financial goals is simultaneously assisted.
Internal perspective: Equally the internal perspective should not be ignored. Targets should be set for staff retention and morale, after all happy staff give better service to customers and keep recruitment costs low so two other perspectives are addressed simultaneously – wastage reduction helps financial perspective and quicker production times better for the customer perspective.
Innovation and learning perspective: This helps the organisation focus on the longer term profitability of the business by using targets such as number of days spent on staff training, research and development, new ideas generated, all of which boost morale (internal perspective), create new products for market (financial perspective) and give customers more choice (customer perspective).
Both models encourage a multi-dimensional view of performance in which a range of different and interlinked aspects of performance are embedded. Each of them co-exist, simultaneously and equally, like the images in a kaleidoscope and the pursuit of one goal cannot be to the detriment of any other. The ultimate aim is to help organisations build sustainable businesses with happier stakeholders.
Andy Booth is a trainer for AAT Mastercourses on Financial Performance, Management Reporting, and Budgeting topics.