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PERFORMANCE MEASUREMENT

Performance measurement
Section – A
a. Liquidity position of Sparkles
The one major thing around which the concept of a modern day organization or company
revolves is money. A liquidity ratio helps to analyse how soon and how quickly a company can
pay off its debts as and when they become liquid (Vaitilingam, 2014). There are various types of
liquidity ratios which help in understanding the different types and degrees of liquidity of a
company. In the context of Sparkes Limited, let us compute and analyse these ratios.
(i) The quick ratio is also known as the acid test ratio- the formula for the quick rate is
the sum of cash, cash equivalents, short term investments and current receivables,
divided by the short term liabilities. This helps in analysing what portion of debt can
be recovered in near absolute future, and only those sources of income are taken into
consideration which can realise cash within a very short span, where a ratio of more
than one is favourable, in our case, in 2017, it was desirable.
2018 2017
Quick
Ratio =
Trade and other receivables +Cash and
short term deposits
Trade and other receivables +Cash and
short term deposits
Current Liabilities Current Liabilities
= 13330+200 11300+1450
16720 9800
= 13530 12750
16720 9800
= 0.81 1.3
Please note that all the figures are in 000’pounds
(i) Current ratio also known as the working capital ratio- current ratio is the ratio of a
company’s current assets to its current liabilities (Needles & Powers, 2013). This
ratio enables to understand what portion of current debts can be paid off by current
assets. A ratio of 1 or more is feasible, in our case, in both the years, it was favorable.
(ii)
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Performance measurement
2018 2017
Current Ratio = Current Assets Current Assets
Current
Liabilities Current Liabilities
= 18030 16050
16720 9800
= 1.08 1.64
Please note that all the figures are in 000’pounds
(iii) Cash Ratio- is the ratio of the company’s cash and cash equivalents to its current
liabilities. This ratio helps in understanding what portion of the current debt can be
paid off by cash in hand and bank and any other cash equivalents.
2018 2017
Cash Ratio = Cash and Cash equivalents Cash and Cash equivalents
Current Liabilities Current Liabilities
= 200 1450
16720 9800
= 0.01 0.15
Please note that all the figures are in 000’pounds
(iv) Working capital- Current Assets- current liabilities computes the working capital of a
company. A positive working capital ensures that there is cash and asset, enough to
pay off the current debts of the company and that it does not need to resort to external
sources of income for the same (Porter & Norton, 2014).
2018 2017
Working capital = Current Assets- Current Liabilities Current Assets- Current Liabilities
= 18030-16720 16050-9800
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Performance measurement
= 1310 6250
Please note that all the figures are in 000’pounds
b. Bankruptcy for Sparkles
Altman Z score is a method of analyzing the risk of failure of an organization by using
probability tools. This score establishes the portability of failure of the organization by
analytically analyzing two years scores. A high score implies lesser chances of failure and a
lower score highlights danger. A score of 2.9 is favorable. The score of 2.6 is favorable for non-
manufacturing company.
Z score= 1.2A+1.4B+3.3C+0.6D+1.0E
Where,
A= Ratio between working capital and total assets
B= Ratio between retained earnings and total assets
C= Ratio between earnings before interest and tax and total assets
D= Ratio between market value of equity and total liabilities
E= Ratio between sales and total assets
Let us analyze the risk of bankruptcy for Sparkes.
A= Ratio between working capital and total assets
2018 2017
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Performance measurement
Working
Capital = Current assets- Current Liabilities = Current assets- Current Liabilities
=18030-16720 =16050-9800
1310 6250
Total assets 102880 104900
Ratio A =1310/102880 =6250/104900
0.013 0.060
B= Ratio between retained earnings and total assets
2018 2017
Total assets 102880 104900
Retained Earnings 11960 20100
Ratio B =11960/102880 =20100/104900
0.116 0.192
C= Ratio between earnings before interest and tax and total assets
2018 2017
Total assets 102880 104900
Earnings before interest and
tax 18080 21630
Ratio C =18080/102880 =21630/104900
0.176 0.206
D= Ratio between market value of equity and total liabilities
2018 2017
Market Value of equity 142000 148000
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Performance measurement
Total liabilities 29720 23600
Ratio D =142000/29720 =148000/23600
4.778 6.271
E= Ratio between sales and total assets
2018 2017
0.176 0.206
Total assets 102880 104900
Sales 93000 108000
Ratio E =93000/102880 =108000/104900
0.904 1.030
Z score= 1.2A+1.4B+3.3C+0.6D+1.0E
2018 2017
Z
scor
e = 1.2A+1.4B+3.3C+0.6D+1.0E = 1.2A+1.4B+3.3C+0.6D+1.0E
=(1.2*0.013)+(1.4*0.116)+(3.3*0.176)+(0.
6*4.778)+(1.0*0.904)
=(1.2*0.060)+(1.4*0.192)+(3.3*0.206)+(0.
6*6.271)+(1.0*1.030)
=0.016+0.162+0.581+2.867+.0.904 =0.072+0.269+0.680+3.763+1.030
3.7164 5.814
All the figures are 000's pounds
For both the years Sparkes has a Z score of 3 and above and hence they are not likely to go for
bankruptcy. Sparkes limited is not likely to go bankrupt.
c. Argenti’s A score model
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Performance measurement
Argenti’s A scoring model is a more subjective model. This model derives the risk of failure and
bankruptcy of an organisation on personal scoring grounds (Deegan, 2011).
The management is given scores based on three broad categories and many subcategories. These
scores are then totalled to find a failure threshold score. A score of 25 or less shows a higher
chance of failure and bankruptcy, and a score of 60 and beyond shows a certain case of success.
Anything within the remaining grey area, needs to be further watched for performance. The three
broad categories are:
1. Defects
2. Mistakes
3. Symptoms of failure
Let us discuss in detail about these concepts
1. 1. Defects- A total of 45 marks is allocated to this category. Anything in the range of 10
is considered inferior. There can be two types of mistakes- management weakness and
accounting deficiencies. Each defect is enumerated and scored, and then a total is arrived
to find the final score in this category. Management weakness can be any fault in the
management- their approach, the bureaucracy, the positioning and placement, roles and
responsibility, the fraudulent intentions of all or few, a laid back board of directors, etc.
Accounting deficiency is mostly marked by poor accounting and financial planning,
defective books of accounts, poor budgetary planning and budgeting controls, inadequate
or ineffective budget and lack of sound costing systems and bad and weak cost control
(Petty et al., 2012).
2. 2. Mistakes- any mistake, be it. Its impact on the fundamental of the company
determines whether it impacts the going concern concept or not. In short, the bankruptcy
of the company shall depend on many factors including mistakes made. There can be a
mistake in the scale of operations. Any project or undertaking went wrong can lead to
complete failure of the company. Often managements fail to determine the correct pace
of growth of the company (Parrino, Kidwell & Bates, 2012). They grow at speed higher
than what the financial fundamentals of the company can absorb. This leads to a
significant impact on the structure of the company and leads to failure. Also, a position
where a company sits in respect to its counterpart companies should be monitored. It
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Performance measurement
cannot lie so high that one small hit to it can lead to a complete breakdown. So these are
the common mistakes that can break a company. A maximum of 15 marks can be treated
as safe. Anything higher is impactful and hard to accept.
3. Symptoms of failure- signs or indication start being given by the financial health of the
company. The management which identifies these and acts immediately upon them only
thrives. This is the final stage and it is close enough to failure (Vaitilingam, 2014).
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Performance measurement
SECTION B
(i) Before considering the proposal:
Investments on net asset
(Currently) 20,000,000
Cost of capital 10%
Thus, cost of capital 20000000*0.1
2,000,000
Return on Investment
(Gain from Investment- Cost of investment)/ Cost of
investment
(4,400,000- 2,000,000)/20,000,000
12%
Residual income 4,400,000-2,000,000
2,400,000
After considering the proposal 1:
Further investment in assets 2,000,000
Annual profit from 300,000
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Performance measurement
investment
Now total capital 20,000,000+2,000,000
= 22,000,000
cost of capital 22,000,000*.1
=2,200,000
Total income 4,400,000+300,000
= 4,700,000
Return on Investment (Gain from Investment- Cost of investment)/ Cost of investment
(4,700,000-2,200,000)/22,000,000
= 11.36
Residual income 4,700,000-2,200,000
=2,500,000
(ii) After considering proposal 2:
Disposal worth 4,600,000
New Asset worth = 20,000,000-4,600,000
= 15,400,000
Cost of capital =15,400,000*0.1
=1,540,000
New profit = 4,400,000-600,000
= 3,800,000
Return on Investment (Gain from Investment- Cost of investment)/ Cost of investment
=(3,800,000-1,540,000)/15,400,000
=14.68%
Residual income =3,800,000-1,540,000
=2,260,000
Since proceeds from the disposal to be credited to head office, the value has not been included in
computing the gains for the same.
All the values are in Pounds.
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Performance measurement
(iii) Often instead of just looking at the percentages in terms of returns, one should also
look at the effective numbers of profit. For existing scenario, the rate of return is high,
as per the given capital and income mix. The ROI is 12%, whereas the RI- residual
income is 2.4million. In the first proposal, the ROI stoops down to 11.36%, but
residual income increases to 2.5 million. In proposal 2, the ROI increases to 14.68%,
but the Residual income decreases to 2.26 million. As per given scenario, Division X
can accept the proposal 1 since it looks beneficial. Proposal 2 is also not feasible
because the sale proceeds of the asset will not be used by the division but will be
credited to the head office.
(iv) An organization is said to be working centralized if all the operations are carried out,
controlled and managed from the same business location. It also refers to holding of
power by the management instead of delegation of power (Davies & Crawford,
2012). However, in Welsh Limited’s case, the former meaning holds good. The
company has two divisions- X and Y. Decentralization has its own pros and cons. The
comparison between the two are as follows:
(a) Control- the control over operations is stronger when there is a centralisation. With
decentralised operations, the power also gets distributed, and there is more liberty
regarding control and management. A centralised system can exercise more stringent and
effective control (Carmichael & Graham, 2012). Where on the one hand a more
centralised control is lost, with decentralisation, for a smaller team, there are supervisors,
so on one side the management controls weaken, but the individual controls strengthens.
So there is a dual aspect to it.
(b) Cost- a decentralized organization invites higher cost for everything. Manpower, labor,
infrastructure, infrastructure maintenance, management, validations, checks, and the list
keeps going. Thus, a decentralized environment of work attracts higher costs. These cost
factors can be offset if the effectiveness of work offsets the costs by generating higher
revenues (Carmichael & Graham, 2012).
(c) Lesser pressure on top management- With their work distributed to a different section of
supervisors, the work burden in terms of supervision is shifted and they can concentrate
on other more important areas of work and can venture out into newer arenas. Thus it is
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Performance measurement
an advantage to the top management as they get more brain space and more liberty to
explore.
(d) Development by promoting team culture- with decentralization, the organization is
divided into smaller teams and groups. This gives a closer view of work, he supervisors
give more importance to the individuals and a cohesive atmosphere is developed
(Vaitilingam, 2014).
(e) Effectiveness- Smaller groups are easier to manage and redress and this increases the
efficiency of the group as a whole. Decisions are made quickly, and there is involvement
of everyone running the show. There is more closeness and sense of belonging.
(f) No unanimousity- since the control is scattered, there is lack of uniformity.
(g) Lack of coordination- there is lack of coordination when there are so many locations,
so many teams to manage. Selection of the right people for running the show is not an easy
task too (Davies & Crawford, 2012).
(h) Statutory compliances- With decentralisation comes a lot of regulatory compliances.
Licenses, connections, and many such arrangements have to be done. Legal agreements are
also to be adhered to run multiple centres effectively.
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Performance measurement
References
Carmichael, D.R. and Graham, L. (2012) Accountants Handbook. Financial Accounting and
General Topics, John Wiley & Sons.
Davies, T. and Crawford, I. (2012) Financial accounting. Harlow, England: Pearson.
Deegan, C. M. (2011) In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill
Needles, B.E. and Powers, M. (2013) Principles of Financial Accounting. Financial Accounting
Series: Cengage Learning.
Parrino, R, Kidwell, D. & Bates, T. (2012) Fundamentals of corporate finance. Hoboken,
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012)
Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education
Australia.
Porter, G. and Norton, C. (2014) Financial Accounting: The Impact on Decision Maker. Texas:
Cengage Learning
Ross, S., Christensen, M., Drew, M., Bianchi, R., Westerfield, R. And Jordan, B.(2014)
Fundamentals of Corporate Finance, 7th ed. North Ryde: McGraw-Hill Australia Pty Ltd.
Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT
Prentice Hall.
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