CIMA E3 Study Text

CIMA E3 Study Text
Chapter 16
Non-Financial Performance
Indicators
Chapter 16 Non-Financial Performance Indicators
1. Non-financial performance indicators

We all know that money is important and historically financial performance
was considered the only true measure of an organisation. Now, while
financial metrics are obviously important and can offer a great deal of
insight into an entity’s performance they also have limitations:
 They consist of historical data only, which may not be an indicator of

future performance.
 They can be manipulated through careful selection of accounting

policies. e.g. choosing to depreciate assets over a long period to
increase short term profits, or increasing stock levels to carry over
overheads absorbed into stock to the following period.
 They offer short-term feedback only – often one year at a time.
For this reason many firms also employ non-financial performance

indicators (NFPIs), designed to measure progress towards long term
goals.
NFPIs are an important part of the review and control phase of the rational
planning model:
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Some good examples of NFPIs are detailed in the chart below:
Success Factor NFPI
Sales growth
Number of customers
Competitiveness
Market share
Customer satisfaction
Cost per unit
% of capacity used
Productivity Set-up time
Output per hour
Number of defects
Quality Number of accounts lost
Number of on-time deliveries
Customer wait time
Customer satisfaction Number of complaints
Number of repeat orders
Staff turnover
Job satisfaction
Personnel Days absent
Number of new staff qualifications
Training time per employee
New products/services launched
Sales of new products
Innovation
R&D time per new product
Advantages of NFPIs
 Allows all areas of the business to be directly measured –
measuring productivity through average time to product one unit
directly shows the performance of the production division.
 Are easily understood by all personnel. Non-financial managers will

not understand financial ratios but will understand things like
customer satisfaction and staff turnover very easily.
 Gives a good indication of long term performance – excellent

customer satisfaction ratings will likely result in customer retention
and higher profits longer term.
 Cannot be easily manipulated through accounting policies.
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Disadvantages of NFPIs
• NFPIs allow every aspect of the business to be measured, which can
cause information overload and take focus away from the entity’s
core goals. Look at all the measure in our earlier list – it's going to be
hard to perform brilliantly on all measures and managers may
therefore not focus on the right ones.
• Need to ensure that all NFPIs are somehow linked to financial

performance, because the ultimate goal of a business is to make a
profit.
• The large amount of possible NFPIs means businesses can 'over-

evaluate,' spending time and resources on measurements that
provide little value to the decision making process.
2. Balanced Scorecard
In order overcome possible short-termism of financial measures Kaplan and
Norton developed the Balanced Scorecard which outlined four key areas in
which company and divisional performance should be measured to focus
on both the short and long term needs of the organisation.
The key idea is that managers are to be appraised on a variety of

measures which include non-financial measures so that their focus is both
long and short term.
If a manager was just appraised on profits alone then they might lower
spending on annual training so profits are higher. Under the balance
scorecard though they might also be measured on the 'number of training
days' or a similar training measure, and so would need to balance
performance over both the short term (profit) and long term (training days)
measures.
Similarly spending less on R&D could result in higher profits, but under the
balanced scorecard a worse performance on a measure focused on
development expenditure or number of new products released.
The 4 perspectives and suitable performance measures in each are:
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Customer perspective
Focusing on the customer and meeting their needs.
Possible measures:
 Customer satisfaction - provided by a customer satisfaction survey.
 Number of returns.
 Number of customers moving to the competition.
 Call waiting time / service time.
 Delivery time.
 % of deliveries on time.
Internal business perspective

Focusing on the way the business works and operates with a particular focus
on productivity and efficiency.
Measures include:
 Production time per unit.
 Number of defective products.
 Cost per unit.
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 Material wastage rates.
Innovation and learning perspective

Focusing on innovating in product and processes, and developing and
learning for the future. Learning is more than just training, but includes
any kind of organisational improvements made.
Measures include:
 Number of new products developed.
 Sales from new products.
 Development time of new products.
 R & D spending.
 Amount spent per employee on training.
 Number of qualified staff.
 Number of training programmes available.
Financial
Financial performance remains vital to the organisation’s success, as it gives
an indicator of shareholder wealth and ability to survive long term, and
so must also be balanced against the other factors.
Measures include:
 Profits.
 Return on investment.
 Residual income.
 Costs (variance analysis).
 Sales.
Linked to strategy
In each category, the organisation must follow through from the business
strategy, to ensure they are focused on the long term direction of the
business.
Clear objectives should be set under each category according the SMART
criteria (Specific, Measurable, Achievable, Relevant and Timebound),
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measured at the end of the period, and lessons learnt from actual results to
help to improve performance in future periods and keep the organisation on
track to achieve its strategic goals.
Problems with the balanced scorecard

While the balanced scorecard is a good all round measure of performance
linked to strategy, including both financial and non-financial measures,
there are also issues with using it:
• there are a lot of measures to work towards which can make it hard
for managers and staff to know what to focus upon as it is difficult to
achieve targets based on all measures.
• some measures conflict – e.g. better quality also increases costs and
so it's hard to know what balance to achieve.
• significant additional information is required to be produced –

which may be time consuming and costly and require new
information systems.
• It requires a new mindset and culture change may be required to

ensure staff-buy into the new system.
Example – football club

Each real life situation is different and as such requires a different focus for
the balance scorecard. Let's look at a football club's balanced scorecard to
begin with. Notice as you review this that the customer of a football club
wants very different things than a customer of a normal business – league
and cup success is the most important thing to them. Efficiency measures
for the internal perspective also have to be very different.
Financial
• Profit margins.
• Return on investment.
• Costs vs. budgets.
• Revenues.
Customer focus
• Match results and league position.
• Match attendances home and away.
• Results of customer surveys e.g. satisfaction with provision at the

stadium.
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Innovation and learning
• Number of innovations implemented.
• Spending on learning and development.
• Number of new ideas suggested.
• Improvements in key environmental measures such as carbon

emissions.
Internal Business
• Retention of current players.
• Recruitment of new players of proven quality.
• Health and safety incidents.
Example – Oil research and production

Now let's look at the scorecard for an oil research and production company
(one that sells all their oil on the market and does not do any oil refining).
Financial
• Profit margins.
• Return on investment.
• Costs vs. budgets.
Customer focus
• On time delivery of sales made.
Innovation and learning
• Number of innovations implemented.
• Spending on learning and development.
• Number of new ideas suggested.
• R&D spend.
• Improvements in key environmental measures such as carbon

emissions.
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Internal Business
• Efficiency measures (e.g. output per hour).
• Staff idle time.
• Rig downtime.
• Health and safety incidents.
• Pollution/wastage measures.
You'll notice that the financial and innovations areas are reasonably similar,
whereas the customer and internal perspectives quite different. Health and
safety and environmental issues are critical in this industry and as such must
be on the balanced scorecard.
3. Performance Pyramid
Sometimes, a company can get so embroiled in short-term performance that
it loses sight of its primary vision. The performance pyramid, from Lynch
and Cross, provides an alternative approach to a creating a range of
balanced performance measures, all linked to the achievement of the
business vision.
Measures are selected under nine dimensions of performance: quality,

delivery, cycle time, waste, customer, flexibility, productivity, market and
financial.
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The aim is that the objectives lower in the pyramid, if achieved, should
contribute to achieving the objectives in the next level up. So for example
good quality and on-time delivery will ensure customers are satisfied, which
will in turn lead to good market share and financial performance.
You'll notice that the measures on the left of the pyramid are externally
focused measures (e.g. quality, customer and market) while those to the
right are internally focused (e.g. waste, productivity and financial) so
ensuring the pyramid covers both elements.
The model also covers all levels in the organisation, with the lower level
objectives being at departmental level (e.g. quality of production for the
production department), the next level up being at a systems level
(customer targets combing all the elements of production, customer service
and marketing to focus on customer focused systems), and the top points
being at a business level (being competitive and profitable as a whole).
The performance objectives should be driven from the vision of where

the business wants to be in the future, so that if all the objectives are
achieved the company is moving towards its long term vision.
Example
Bob's Lunchbox is an organic sandwich store with the following vision:
Our vision: great tasting sandwiches, produced organically to create a world

of happier, healthier farmers and an end to factory-produced, processed
foods.
Let's see how Bob's Lunchbox achieves this from the bottom of the pyramid
upwards with some examples of their objectives at the first three levels.
Objectives
Level 1: The production team have objectives to increase the number of

sandwiches produced per hour (cycle time), while keeping wasted
ingredients levels to a minimum (wastage). All food must be sourced from
organic farmers (quality) paid at a competitive price. Customer targets
revolve around keeping waiting times down at the times (delivery) and
shops aim to reduce to a minimum the number of sandwiches thrown away
(wastage).
Level 2: The organisation has overall targets for number of sandwiches sold
per person employed (productivity) and cost reduction targets for the cost
per sandwiches produced (productivity) and measures customer satisfaction
with regular surveys (customer/flexibility).
Level 3: Each shop has a return on investment target (financial) and the
organisation as whole has revenue growth targets (financial/market).
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So the question then comes – are Bob's Lunchbox achieving their vision?
Well on the customer satisfaction front, then probably they are as they
measure customer satisfaction, but in terms of supporting farmers then the
targets are not aligned, and they should aim to include targets based around
that in their set of measures too.
4. Benchmarking
Imagine that we all work for company B in the telecommunications industry.
We all work hard and provide a great service, we cannot see how we could
possibly perform any better than we do. Our Company B appears to be
hitting all its targets and has an operating margin of 30%. It's highly
profitable, staff are motivated and happy, and we have a group of satisfied
customers. It seems healthy.
However, that pesky management accountant has done some analysis, and
found that other competitors in our market are achieving a 40% margin with
similar customer and staff satisfaction ratings. We thought we were doing
well, but when we compare ourselves to our competitors we realise that
was not the case. If they are outperforming us we will soon be out of
business, not matter how well we are doing. While this means change for us,
the management accountant is actually doing us all a favour!
We'll now need to set up a team, understand how competitors are achieving
better performance and make a change.
And this is the essence of benchmarking- comparing ourselves with others,

understanding where and how we can improve and then making the relevant
changes.
In the UK, local authorities are all required to report a wide range of
performance data on their performance and the services they provide to
local residents (e.g. waste collection, spending, education). The data is
then collated centrally so it can be compared. Each local authority can
compare their performance against every other one in the UK, allowing each
authority to see where they are doing well and where they can improve.
Careful comparison of the data has helped many authorities to understand
where they need to improve and put relevant changes in place.
What is benchmarking?
Benchmarking is comparing your performance to the best in the company
or industry, with the aim of learning from those best practices to
improve your performance in the future.
Benchmarking can involve different types of performance comparison,

including:
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 External or competitive benchmarking: comparing against other

organisations in the same industry.
 Functional or process benchmarking: comparing a business function

or process (e.g. finance) with similar divisions of other (usually non-
competing) organisations.
 Internal benchmarking: comparing similar divisions within the

organisation itself e.g. two similar retail outlets.
Procedure
The following is an example of a typical benchmarking methodology:
1. Identify areas to be benchmarked – usually areas where

performance needs to be improved.
2. Map current processes and measure current performance levels in

that area.
3. Identify who to benchmark against – organisations, or other parts of

the same company, which are leaders in this area.
4. Agree with the target organisation/department to undertake the

exercise.
5. Surveys and data collection of target organisation’s processes –

includes performance measurement and process mapping
information.
6. Compare performance and identify process differences.
7. Decide on changes needed and implement those changes.
8. Review progress and control.
What are the difficulties when benchmarking?

A key difficulty with benchmarking is how to successfully get relevant
information about competitor performance. Financial performance may be
obtained through company accounts, and the company's product can be
purchased to trial and test, but ultimately a competitor is unlikely to
exchange important information about internal processes and results.
Functional benchmarking can overcome this problem by exchanging
information with non-competing organisations.
In addition, even where information is available, for instance in company

accounts, it can be hard to make meaningful and fair comparisons due to
differences in the businesses or business process, and so data needs to be
very carefully analysed. In our earlier example of UK local authorities, one
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such example is the cost of waste collection. It is more costly per person to
collect waste from a rural authority than a city due to the time and
distances covered. In this case authorities tend to compare themselves
against those in a similar position to get more relevant data – two rural
authorities should have similar waste collection costs for instance.
5. Critical success factors

It is crucial that what the company is being measured on links directly to
the strategy. If a company aims to be the best quality provider in the
market then it's vital it is measuring quality both of itself and its
competitors
One approach to doing this involves the use of critical success factors: the
key areas in which the organisation has to do well if they are to remain
competitive and profitable.
Critical success factors should flow directly from the organisation’s strategy,
so for example an organisation growing through a strategy of buying lots of
other companies will need to excel at effectively merging the joint
operations.
No more than 4-5 critical success factors are usually defined for each
organisation so they are focused on the key points.
Key performance indicators

These are the ways in which the organisation’s performance for the CSF can
be measured. For a company that does a lot of acquisitions as the way to
grow, to measure the CSF of effectively merging the joint operations, you
might establish the following KPIs:
 % of key staff retained
 Cost savings attained through acquired companies
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 Sales/profit growth in joint business
 Employee satisfaction before and after acquisition
 Customer satisfaction before and after acquisition.
Each of these provides vital information that the organisation must collect,
so for example if they are not doing so already they must measure employee
satisfaction, perhaps through conducting employee surveys, both in their
own company and in the companies being acquired.
Or to take another example, a company operating a call centre might have a

business strategy of expanding organically by growing its client base. The
critical success factors for this strategy would be excellence in handling
calls and excellence in acquiring new business. So here, the KPIs might be
something like this:
• Average number of calls handled per operator per day
• Average call-waiting time
• Customer satisfaction with call outcomes
• Client satisfaction with services offered
• New business acquisition.
The building block model

Fitzgerald & Moon suggested a framework for creating performance
measurement systems, based on three "building blocks":
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Dimensions
Dimensions relate to the goals of the organisation. Appropriate measures

must be devised for each dimension. Fitzgerald & Moon suggest six
dimensions, each with its own critical success factor:
• Profit - successful financial performance and growth e.g. return on

investment
• Competitiveness – e.g. percentage market share
• Resource usage - optimised use of resources e.g. production output

per hour, staff utilisation rates
• Quality issues – e.g. minimising defects
• Innovation – e.g. new products developed
• Flexibility - adaptability to change e.g. a hotel being able to reduce

costs during quiet period or percentage of on-time deliveries given
changing circumstances.
Standards
These are the characteristics of the targets set. To be successful,

Fitzgerald & Moon suggest that employees must see them as fair and
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achievable in order to take ownership of them. For example, a salesperson

who was set a 100% increase in sales in order to achieve a bonus is likely to
see that as unfair, unachievable and not be motivated to achieve it. A 5%
increase might be a target she could take greater ownership over at it is
more realistic.
Rewards
To be motivated, employees must see that targets are:
• clear - a 5% increase in sales targets is clear while a general goal to

'improve your attitude and work' is not.
• controllable – a salesperson probably does have control over

achieving higher sales, so will be motivated. If a production manager
was given a 5% sales increase as a target it would be out of their
control and thus not motivating.
6. Drucker's Management By Objectives (MBO)

A common problem with organisations is that the employees do not always
know what is expected of them, many may work to 'set hours' and may just
leave when their hours are up regardless of how much work has been done,
whether or not they have done a good job or focused on the organisation's
goals. A way of combating this is to manage performance by objectives i.e.
your job is complete when your objectives are complete! This way
employees know exactly what is expected of them and have something
tangible to work towards.
If staff objectives are not aligned to the organisation's objectives then

however well targets are set for staff, the organisation will not move in the
right direction. Drucker believed that objectives should be set at the top
of the organisation, related to the organisation's mission, and then
passed down the organisation to business units and on to staff. In this way
when staff achieve their targets, the business units achieve theirs and the
organisation fulfils its mission. This approach is called management by
objectives.
One key aspect of MBO is that staff should be involved in the target setting
process, both for themselves and their division. This helps to obtain buy-
in into the targets while ensuring they are realistic to ensure people are
motivated to achieve them.
Drucker proposed five steps for effective management by objectives (MBO).

The steps in the process are:
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Set organisation objectives – What does your company want to achieve? For
example, to have the best customer service in the industry.
Align employee objectives – What target can we give our employees to

help us achieve this goal of having the best customer service in the industry?
For example, responding to all customer queries within a day.
Monitor performance – We need to have a way of checking that objectives

are being met. For example, a review of customer queries at the end of the
day to ensure that no queries have gone unanswered for longer than a day.
Evaluate performance – Who has been meeting their objectives and who
hasn't? We need a way of quantifying whether the objective had been met
or not and who has/hasn't met them, online project check-lists for every
employee, for example.
Review and feedback – So 10 of our employees have met their objectives

and 10 haven't, we need to give positive feedback to those who have met
them, and suggest to those who didn't ways in which they can improve in
the future. This also applies to review at higher levels too – so that
departments and business unit targets are reviewed and lessons learned.
7. Stretch targets
A stretch target is one that is very difficult, but not impossible to meet. The
idea is that the team or employee is "stretched" in order to achieve the
target.
For example, a production team that makes 200 units a day may be
stretched to achieve 220, by means of incentives such as bonuses.
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In theory this provides motivation. However, stretch targets can have the
opposite effect if they are seen as unachievable, so care must be taken
when setting them. In addition, they may lead to dysfunctional behaviour by
encouraging staff to take risks or cut corners to meet unrealistic targets.
Similarly, if failure to hit stretch targets is punished, rather than rewarding

success, this can have a highly demotivating effect.
Communication is key here: if employees understand the rules of

engagement then some of the drawbacks can be mitigated.
8. Communication and performance management

Management by objectives depends on the communication between a
manager and their staff member as a key part of the process. So what's the
theory of good communication? Let's take a look and relate it to the setting
of objectives.
How to communicate
Identify
Identifying fair targets through:
• Flowing down higher level targets (e.g. for the division) to lower
level staff to ensure they are consistent. e.g. a sales target of £1m
for the division could be split to £200,000 for each of the 5 sales
staff
• Reviewing previous achievements e.g. Carla's a high performing sales

person who sold £300,000 last year, and so her target is set at
£350,000 for the period.
Explain
Tell employees what the target is and how they will be affected by the
performance being measured. For example, is there a bonus for hitting a
target, or will they be disciplined for failure?
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In our example, the sales manager explains each sales person's targets and
the reason for it. She notes that there there will be bonuses for those who
exceed targets and warnings for those who consistently miss them.
Listen
Communication is a two-way process. People should be encouraged to give

feedback about the targets being set. Are they appropriate given the sales
person's experience and goals. If employees have bought into an
appropriate, achievable measure they are more likely to be motivated to
achieve it.
In our sales department, Ali wants a tougher, more challenging target as he

is gunning for promotion and it is agreed to set it at a higher level. Freya,
on the other hand, is having personal difficulties and it is agreed to lower
the targets for the next few months to allow for these.
9. The completion of the Rational Planning Model?

And so we have now completed all the phases of the rational planning
model. That means it's over, right? Wrong! Of course, the constant in
business is change and so we need to be constantly feeding the results of
our review and control back up to the top of the model, so we can make
any necessary adjustments. For example, if your strategy is selling lemons
and the review and control phase tells you that your lemons aren't selling, -
you'll need to change your mission and start the cycle again!
As a final revision tool here are all the stages along with the key elements
involved in each. This brings together everything you have learnt to
summarise the whole approach to creating a rational plan for a business.
© Astranti 2017
© Astranti 2017

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1. Non-financial performance indicators

 They consist of historical data only, which may not be an indicator of

 They can be manipulated through careful selection of accounting

 They offer short-term feedback only – often one year at a time.

For this reason many firms also employ non-financial performance

Some good examples of NFPIs are detailed in the chart below:

Success Factor NFPI

 Are easily understood by all personnel. Non-financial managers will

 Gives a good indication of long term performance – excellent

 Cannot be easily manipulated through accounting policies.

• Need to ensure that all NFPIs are somehow linked to financial

• The large amount of possible NFPIs means businesses can 'over-

The key idea is that managers are to be appraised on a variety of

The 4 perspectives and suitable performance measures in each are:

 Customer satisfaction - provided by a customer satisfaction survey.

 Number of customers moving to the competition.

 Call waiting time / service time.

Internal business perspective

 Production time per unit.

 Number of defective products.

 Cost per unit.

 Material wastage rates.

Innovation and learning perspective

 Number of new products developed.

 Sales from new products.

 Development time of new products.

 Amount spent per employee on training.

 Number of qualified staff.

 Number of training programmes available.

 Costs (variance analysis).

Problems with the balanced scorecard

• significant additional information is required to be produced –

• It requires a new mindset and culture change may be required to

Example – football club

• Costs vs. budgets.

• Match results and league position.

• Match attendances home and away.

• Results of customer surveys e.g. satisfaction with provision at the

Innovation and learning

• Number of innovations implemented.

• Spending on learning and development.

• Number of new ideas suggested.

• Improvements in key environmental measures such as carbon

• Retention of current players.

• Recruitment of new players of proven quality.

• Health and safety incidents.

Example – Oil research and production

• Costs vs. budgets.

• On time delivery of sales made.

Innovation and learning

• Number of innovations implemented.

• Spending on learning and development.

• Number of new ideas suggested.

• Improvements in key environmental measures such as carbon

• Efficiency measures (e.g. output per hour).

• Staff idle time.

• Health and safety incidents.

Measures are selected under nine dimensions of performance: quality,

The performance objectives should be driven from the vision of where

Our vision: great tasting sandwiches, produced organically to create a world

Level 1: The production team have objectives to increase the number of

And this is the essence of benchmarking- comparing ourselves with others,

Benchmarking can involve different types of performance comparison,