Financial and Non-Financial Measures in Performance Management

This essay discusses the importance of determining both financial and non-financial performance of a business organization. It covers various financial measures such as profitability statement, balance sheet, and ratio analysis, along with their limitations. It also discusses non-financial measures such as the Balanced Scorecard, Performance Pyramid, and Building Block Model. The essay concludes that both financial and non-financial measures are necessary for effective performance management.

FINANCIAL AND NON-FINANCIAL
MEASURES

ESSAY
Every business organization needs to determine their financial as well as non-
financial performance. Financial accounting aims at measuring the performance of business
in terms of finance management; hence, it is a part of performance management. Determining
company’s profitability and financial position are the most important financial measurement.
Along with this, organizations also need to measure their non-financial performance to
achieve their set business targets and objectives. In the present essay, it will be discuss that
how firms make use of both the traditional financial measure and non-financial measure in
the performance management.
According to White, Sondhi and Fried (2003), financial performance of the business
can be measured in monetary terms. Every business organization aims at maximizing their
profitability, long term survival and business growth. Enterprises make use of invested funds
to earn great amount of profits. Thus, all the operating activities have been done so as to get
good profitability. However, ability of the organization to run business for a long term period
is known as business survivals and measure the success of company. Furthermore, manager
aims at running a successful business in order to make organizational growth. However, Chee
and et.al. (2006), said that non-financial measure includes internal operating measure as well
as employee and customer-oriented measures. Production volume, productivity, defects,
waste management, introducing new product, cycle time, operating efficiency and inventory
levels are internal measures. However, employee satisfaction, staff turnover, workers
training, skills, absence rate and safety measurement are the employee oriented measures
whilst market share, customer acquisition, retention, delivery performance, waiting time and
customer complaints are customer-oriented measures.
As per the view point of Minnis and Sutherland (2015), profitability statement helps
to determine the results of operating business functions. The author said that this statement
combines incurred business expenditures and revenues for a fixed period of time. The surplus
of incomes over the expenses will indicate profits for the enterprise and shows better
performance while excessive business payments contribute to loss and indicate poor
performance. Thus, it became clear that high profitability indicates better operational results
while decreasing profitability is a sign of worst performance. Moreover, it helps managers to
determine the operating efficiency of business. However, according to Titman, Martin and
Keown (2015), it has been critically evaluated that the statement does not provide
information about the real business profits. The reason behind this is that statement records
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transactions on accrual concept; hence, it represents artificial profits. Under the accrual basis,
transactions are recorded at the time of occurrence whether it has been received in cash or
not. Therefore, it is not a better measurement of company's operational performance.
According to Fraser and Ormiston (2015), balance sheet is a tool to measure financial
performance of the company. It is a summarized statement of all the assets such as fixed as
well as current assets and all the liabilities in terms of both the long term and short term.
Assets are the sources that will be used to generate profits whilst liabilities are the outside
financial sources such as creditor’s bank loan, overdraft and accounts payable. Moreover, the
statement helps to determine the proportion of owner's share on the business assets that is
called equity. Thus, it helps to represent the financial position of business. On contrary, as per
the view point of Bédard and Courteau (2015), balance sheet is not a good performance
measurement as it is a time consuming process and determines financial status at a specified
date only. The author said that initially, business needs to prepare journal, ledger, trial
balance, trading as well as profit and loss account for preparing balance sheet; thus, it takes
very much time. Further, in case of any mistakes in transaction recording process, balance
sheet does not indicate correct financial status. Thus, lack of data reliability may also lead to
take harmful managerial decision. This in turn, it will lead to take poor managerial decisions
and influence business operations in an adverse manner.
Another, according to Hu and et.al. (2012), ratio analysis is the best tool to measure
the financial performance of companies. It indicates the relationship between various
components of the financial position. Numerous ratios can be determined to analyse
company's performance such as profitability, liquidity, gearing, efficiency and investors ratio.
Profitability ratios such as gross margin and net margin identify the business profit on total
sales. Another, current and quick ratio measure company’s ability to discharge their short
term obligations; hence, good liquidity indicates better financial performance and vice versa.
However, solvency ratios such as debt-equity ratio and time to interest ratio measure
company's ability to pay off its long term liabilities. In addition to it, investors ratios such as
price to earnings ratio, growth ratio, enterprise value to revenue and EBIT measure the
possibility of future business growth whilst return on assets and equity are the measurement
of manager's efficiency and effectiveness. Thus, the ratio analysis greatly helps to analyse,
evaluate and interpret the overall financial performance and aids managers to take qualified
managerial decisions. On contrary to it, Kumbirai and Webb (2013), argued that although
ratio analysis examines the financial performance but it cannot be identified as a better
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performance measurement tool due to its various limitations. According to the Kumbirai and
Webb, (2013), one of the important drawbacks of this technique is that it measures the
historical business performance that does not provide assistance to forecast the financial
performance in the future context. Furthermore, different organizations follow distinct
accounting principles; hence, comparison may not provide any meaningful result. In the
present dynamic environment, market changes impact the organization operations in a great
manner while ratio analysis does not consider it such as inflation. Different organizations
follow distinct accounting standards thus, it does not help in making comparative analysis.
Further, it does not provide assistance to the managers for taking strategic long term business
decisions. However, organizational success greatly depends upon the effectiveness of long
term managerial decisions. In addition to it, setting an ideal ratio for all types of industries is
not possible thus, target ratio cannot be determined. Therefore, it can be concluded that ratio
analysis cannot be considered as the best performance measurement tool due to existed
limitations.
As per the view point of Ormiston and Fraser (2013), cash flow statement is a
measurement of liquidity position. It identifies the cash inflow and outflow from various
operating, investing and financing activities. Operating activities refer to daily routine
functions such as trading activities while investing activities measure cash sources, its
applications from acquisition and sale of company's assets. Another, financing activities refer
to the collection and payment of financial sources such as debt and equity. Thus, the
statement helps to determine the cash changes between two different accounting periods in
order to determine liquidity. However, according to Healy and Palepu (2012), the statement
cannot be considered as a better tool of liquidity measurement. The reason behind that is cash
is not the only component that affects the company's liquidity position. Thus, the statement
does not consider the other components such as debtors, accounts receivable, bank and
inventory. Moreover, Robu and Toma (2015), claimed that the statement eliminates non-cash
business expenses; hence, it does not measure the real financial performance. Furthermore,
such statement represents only the historical cash changes and does not provide assistance to
forecast the future cash flows. In addition, the statement does not identify the net business
earnings. Along with this, inter-industry comparison cannot be done by using this statement.
Thus, it can be said that cash flow statement is not a good financial measurement tool as it
does not help managers to take effective cash management decisions.
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Therefore, it is clear that along with the evaluation of financial performance,
companies also need to determine their non-financial performance. The reason behind such
requirement is that financial performance does not help managers to take effective long term
decisions. Furthermore, financial performance only focuses on internal business control and
eliminates external business environment. Thus, objectives of organizational success and
growth prospectus cannot be achieved in a great manner. According to Boscia and McAfee
(2014), in the present dynamic and complex environment, strategic capabilities gain a
significant importance to improve company’s performance and get competitive advantageous.
NFPI includes management of human resources, quality of offered products and services,
brand awareness, company profile etc. Workers play an important role in the organization
success as they provide services to the customers and drive larger the sales and profits.
Skilled, efficient, qualified and experienced employees greatly contribute to improve business
performance as they serve large number of customers in an appropriate manner and result in
enlarging the customer loyalty to a great extent. Another, Chee and et.al. (2006), said that
success of many industries depends upon the organization strategic capabilities such as
human resources, intellectual business capital and customer loyalty. Therefore, new product
development, high level of customer satisfaction, employee satisfaction and qualitative
products provide assistance to the managers in achieving business targets in a great manner.
NFPI plays a crucial role as it determines the market performance. All the organization
operate in business external environment hence, it is very important to analyse the external
performance.
According to Boscia and McAfee (2014), Balance Scorecard (BSC) System highly
encourages to take efficient strategic decisions through focusing at achieving short term and
long term business objectives. In the context to financial measurement, it determines the
profitability while in context to market performance, it considers customers, employees,
innovations, product quality and opportunity of new product development to accomplish the
vision of company. The strategy map of BSC consists of four perspectives that are financial,
customer, internal process as well as learning and growth. The top priority of BSC system is
larger the business sales, reduce cost and increase profits that come under the financial
perspective, while increasing customer satisfaction, maintaining service quality, attracting
new customer, retaining existing customers and ensuring customer loyalty are the customer
perspective objectives. However, learning and growth perspective focuses on improving
employee skills, ensuring team building, satisfying employees, increasing staff turnover and
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lowering the absence rate. On contrary, internal process consists of improving product and
service quality, operating successfully through handling operational difficulties and
improving manager’s efficiency. As per the view point of Humphreys, Gary and Trotman
(2015), BSC system is greatly helpful in the management of hospitality industry. The
approach helps industry to measure relationship between all the perspectives. For instance,
high employee turnover will help to improve product quality that will result in high consumer
satisfaction and attract new customers. This in turn will also result in improving customer
loyalty and building brand image. Thus, financial objectives of high sales, low cost and better
profitability can be achieved in a great manner.
Moreover, according to Perkins, Grey and Remmers, (2014), BSC works as an alarm
or warning indicator which shows negative business consequences earlier as well as helps to
identify the possibility of future operational difficulties. Furthermore, BSC will be considered
as an appropriate performance measurement tool for SMEs in the UK. It assists managers in
budgetary control, maintaining good relationship with the customers and taking strategic
decisions. Thus, BSC implementation greatly satisfies the need of SMEs rather than large
business organizations. On contrary, Nørreklit and Mitchell (2014), argued that customer
perspective gains top preference in BSC approach rather than finance perspective. Further, all
the BSC prospectus are correlated with each other and ultimately impacts the financial
performance. Thus, it can be said that it is more helpful in analysing the financial business
performance. They argued that BSC is a very difficult approach as it takes very much time
and resources to implement. It essentially needs for making strategy, establishing the
relationship between all the perspectives, regular reporting and dealing with the people;
hence, it brings implementing difficulties to the organization. Furthermore, practically
workers do not understand the strategy clearly; hence, it is a great disadvantage of BSC
system.
According to Istrate, Macovei and Bucur (2015), performance pyramid is the other
NFPI which incorporates both the financial and NFP as well. The pyramid consists of four
levels that are explained hereunder:
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(Source: Non-financial performance indicators, n.d.)
As per the diagram, corporate vision is the top priority for all the corporations;
therefore, all the business functioning go towards achieving these targets. The vision
describes the ways of bringing long term success through building a strong competitive
position. Second level of pyramid measures the financial and marketing success of company
while third level describes the strategic objectives. Maximizing the customer satisfaction,
flexibility and productivity contribute to accomplish the organizational targets in a great
manner. The lowest level indicates the department performance in terms of quality, delivery,
cycle time and waste. Timely delivery, better quality, reducing the cycle time and waste will
indicate good department performance and vice versa. Thus, the pyramid is a NFPI that
analyses both the internal and external effectiveness. However, Watts and McNair-Connolly,
(2012), claimed that pyramid has certain drawbacks; hence, it is not a powerful performance
management tool. It majorly concentrates on the shareholders as well as customers and does
not consider the other stakeholders. Further, it does not make proper analyse of firm’s
performance; therefore, it cannot be used for the management purpose.
According to Mitchell, Holland and Forrest, (2014), building block model is the NFPI
that has three components such as Dimension, Standards and Rewards.
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(Source: Non-financial performance indicators, n.d.)
On the basis of above graph, it can be said that dimension measures the company's
financial as well as non-financial performance that helps to predict future growth. For
instance, high productivity, innovations, flexibility, service quality, competitive strength and
turnover indicate that there is a great possibility of making business growth in upcoming
period. Further, setting standards and reward system such as incentives, appraisal and
promotion work as a motivator because employees try to meet the standards and perform
better. Thus, it helps to motivate staff and makes able to the business in order to enjoy long
term success. Moreover, according to Chen and et.al., (2015), the model provides huge
assistance to managers to improve their employee turnover, worker’s empowerment,
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customer satisfaction, improve product quality and increase market share in order to compete
effectively. It helps to enhance overall business performance through eliminating operating
hazards and ensuring long term future sustainability.
On the basis of above analysis, it can be reported that both the FPI and NFPI are
important to take effective and strategic decisions. FPI indicates the business profits and
financial status after a specified period. However, the main limitation of it is that it does not
take into consideration the market changes. Further, in the present competitive environment,
organization also needs to compete effectively at the market place. Another drawback of
financial measurement is that it determines the historical performance; hence, it is not helpful
in predicting future success. Therefore, NFPI plays a vital role in the business. It measures
the strategic capabilities that majorly contributes to enhance the competitive business position
and gets benefited of it. Moreover, it measures the financial health in terms of market share
and determines the external business environment. Along with this, it determines the
satisfaction level of customers and employees to derive future business growth and success.
Customers can be satisfied through providing products and services at affordable prices along
with reducing waiting time and mitigating their complaints. By doing that, business will be
able to get high customer satisfaction and attract new customer also. Furthermore, training
and other benefits in terms of monetary and non-monetary lead to minimize employee
turnover in a great manner. Thus, both the FPI and NFPI are equally important for every
organization.
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