Financial and Non-Financial Measures in 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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