Critically Discuss: Financial and Non-Financial Measures in Management

This essay critically discusses the necessity of utilizing both traditional financial measures and non-financial measures for effective management. It delves into the significance of financial performance indicators like profitability statements, balance sheets, ratio analysis, and cash flow statements, while also evaluating non-financial performance measurement tools such as the balanced scorecard. The essay draws on various authors' viewpoints to analyze the strengths and weaknesses of both financial and non-financial performance indicators in managing firm performance, emphasizing the importance of a combined approach for long-term business success. The discussion also references specific articles to provide a comprehensive understanding of the topic.

FINANCIAL AND NON-FINANCIAL
MEASURES

TABLE OF CONTENTS
ESSAY.......................................................................................................................................3
INTRODUCTION......................................................................................................................3
Financial and Non-financial Measures.......................................................................................3
CONCLUSION........................................................................................................................10
REFERENCES.........................................................................................................................11
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ESSAY
INTRODUCTION
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 discussed that how firms make use of both the traditional financial measure and non-
financial measure in the performance management. The present essay will carry out the
critical discussion of traditional financial measures such as profitability statement, balance
sheet, ratio analysis and cash flow statement. Moreover, NFPI tools such as balance
scorecard, performance pyramid and building block model will be critically evaluated. The
critical discussion will be done as per the view points of different authors that help to
evaluate the significance and drawbacks of FPI and NFPI in managing firm's performance.
Financial performance measurement tools revolves around analysing organization's
spendings, revenues, profitability, liquidity, solvency, cash flow capacity and others. In other
words, it is a quantitative measurement. Thus, it does not reflect total manager's contribution
to the firms. NFPI will be greatly helpful in analysing overall managerial contribution. It will
assist users to determine long term business performance. Present essay will taken into
consideration that how financial tools provide assistance to measure organization
performance. Moreover, it describe the consequences of this analysis as per literature review.
However, it will discuss the importance and drawbacks of NFPI such as BS, performance
pyramid and building block model. The critical discussion of the FPI and NFPI will guide us
to managing business performance.
FINANCIAL AND NON-FINANCIAL MEASURES
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 measures the success of company. Furthermore, manager
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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. On contrary, according to Bharadwaj (2015), 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. According to Barnett, Michael and Robert (2012), 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 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 the contrary,
Bédard and Courteau (2015), critically evaluated that balance sheet is not a good performance
measurement as it is a time consuming process and determines financial status at a specified
date only. Likewise, Ongore and Kusa, (2013), 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
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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 and efficiency as well as
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 performance measurement tool due to its various limitations. 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. Similarly,
Ic and et.al., (2015), mentioned that 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.
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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, as per Healy and Palepu (2012), it has been critically
evaluated that the statement cannot be considered as a better tool of liquidity measurement.
The reason behind that is that cash is not the only component that affects the company's
liquidity position. Thus, the statement does not consider 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. Moreover, Ameer and Othman, (2012),
said that 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.
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. As per the view point of Fu and Zeng (2015), 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.
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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 operates 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 taking 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. According to Epstein and et.al., (2015), 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. As per the view points of Vorhies, Orr and
Bush (2015), learning and growth perspective focuses on improving employee skills,
ensuring team building, satisfying employees, increasing staff turnover and 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
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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 the contrary, Nørreklit and Mitchell, (2014), critically argued that
customer’s perspective gains top preference in BSC approach rather than finance perspective.
Further, all the BSC prospectus is 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. Richard, Kirby and Chadwick (2013), 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:
(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,
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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), critically said 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. As per Wang and Choi (2013), 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. Likewise, according to Chen and et.al., (2015), the model
provides huge assistance to managers to improve their employee turnover, worker’s
empowerment, 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.
CONCLUSION
On the basis of present essay, it can be concluded that all the organizations need to
incorporate both FPI and NFPI. It has been inferred from the analysis that FPI will be greatly
used in businesses for assessing historical quantitative performance and will make evaluation
of it for decision making process. Thus, it will be helpful in short term business decisions so
that it will be considered to be least vulnerable. On the other hand, our findings about NFPI
presented that it is a more superior tool than traditional financial performance measures. It
can be concluded from the present essay that NFPI measures business performance on the
basis of different quantitative as well as qualitative aspect. It also analyzes the factors which
cannot be controlled by companies. Henceforth, managers can assess the impact of market
risk and take decisions for risk management. At last, essay concludes that NFPI are more
helpful in assessing strategic capabilities and contribute to take effective long term decisions.
This in turn ensures the business growth and long term survival.
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REFERENCES
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