Financial Performance Measurement
The motive of every business is to realize the bottom line of maximum financial benefits. In order to comply with the same, companies have come up with financial performance measurement techniques. The very idea is to ensure that no matter what the resources do and the way they function, they would have to show profits in the profit and loss statements. It is carried out generally in three different steps. They have been mentioned as follows:
Firstly, it encompasses selecting the goals of the organization.
Secondly, and also as the most important part, it is to consolidate the measurement of information with respect to the performance.
Finally, the required changes made by the managers so as to serve as a remedy over the weak links in the financial charts of the company. So, one can say that the financial aspects of performance measurement is basically sales driven. There are certain milestones that companies set for employees. A deficiency in being able to fulfill even a certain process can be harmful for the position. So, this method of performance measurement is also known to show certain insecure for the employees. Here, it might not give the most authenticated results. Business Performance Management is by and large measured by the financial aspects of performance measurement. The specific techniques for the same have been mentioned as follows:
Approaches to Financial Performance Measurement
Economic Values Added
This method deals directly with the economic profit of the organization that goes directly into the balance sheets. This method in other words can be used to measure the Net Operating Profit after Taxes. There are also certain adjustments that are made in the calculation of Economic value added so that the companies can make it more synchronized with the profit entry in the profit and loss statements. This method is generally used by lower stature companies these days. The reason for the same is that at the moment, the companies can afford to look at the business functioning only from the financial perspective. There is much more to achieve.
The fundamental law of economics says that management would have to make the most of the least resources that are available to them. In regard to keeping with the statement, the companies generally identify the processes that are in the system and then classify them as separate activities. Followed by this, the companies assign separate costs to each of the activities. This can be done in the form of direct and indirect costs.
Reason for shift from Financial to Non-Financial aspect
In other words, we can say that this is also a form of performance measurement on the basis of finance aspects. One can assign costs to each of the activities, but then there are always, restrictions on the use of the activities that are highly expensive. Once, again, this method would not be applicable in the long-run. The reason for the same is that this method forms a hindrance to the long-term investments. One must understand that an investment for a particular activity can lead to improvements of certain others in the long run. This can be with respect to work force as well as the equipment that is required to perform the activities. So, as a remedy, one has to switch to better methods that are of non-financial significance. (Activity Based Costing (ABC, 2010)
Non-Financial Performance Measurement
These are among the most widely applicable performance measurement techniques in the current scenario of the corporate world. We have seen the shortcomings of the financial aspects. The following methods tend to improve them for the betterment of the organizations:
Approaches to Non-Financial performance measurement
The best approach for performance measurement is the six sigma approach. In this method, the companies try to identify the shortcomings in each of the processes that are a part of the functioning of the organization. These are then corrected by certain quality analysis tools. The companies also have special people who are only responsible for the same. As the name suggests, this approach makes the companies 99.99966% error free. As it has its long term accounting as well, it can be used over the financial performance measurement techniques.
Theory of Constraints
This theory deals with continuously helping the organizations in achieving their goals. The concept is more applicable these days because it identifies the constraints that lie in the path of the business. It is transported in a five-step process. This has been mentioned as follows:
* Firstly, identification of the constraints is done.
* Then, the companies decide the ways of constraint exploitation.
* It makes the entire system aligned as per as the decision taken.
* Then, a negative strategy is used to increase the capacity of the organizations to handle more constraints.
* Then, the companies' see whether the constraints have been removed as a result of this. If it has not then they go back at identification part. (Constraint Management, 2010)
Advantages of Non-financial aspects and Disadvantages of Financial aspects
The biggest disadvantage of the financial aspect is that it does not consider the broad view of the business. The companies have to give maximum regard to the available monetary benefits. If this is not reached, the management would not recommend for a certain activity to take place as a part of its functioning. There have been many companies in the past which have lost to great extents because of such a disastrous situation. One can take IBM for example. The company could not sustain the fact that it was not making immediate profits. As a result, they sold their laptop manufacturing and saw the other company making huge benefits.
An advantage of the non-financial aspect is that it it allows the time for training. We all know that training is one of those areas which consume a lot of money in the beginning. The immediate profits associated with the same might not be as much as compared to the amount of money put into doing it. But, the non-financial aspect gives respect to the long-term advantages associated with the training. This is generally not given any attention from the financial point of view which considers only the short run.
The non-financial aspects build a reputation for a company. It helps a company take up strategies like cost-differentiation. These strategies are extremely helpful in making a company the cost leader in the market. The financial perspective may never give any room for the same. Under the dynamic environment of today, it became a must for companies to look for strategies like this.
As most of the companies of today have further strengthened and even widened their visions, simply looking for the monetary profits as a part of the performance measurement criterion is not worth mush scope. As for example, technology has been advancing at a tremendous pace these days. This is because; organizations are putting in a huge amount of money in Research and development. If the companies follow the economic value added approach or the activity-based costing approach, they would not have the heart to invest to such large extents. In the short-term, they can have a good flow of cash with them, but as we have seen companies like Procter & Gamble advance to such great extents, success at the international level can only come through investment in technology.
So, the method of financial performance measurement is not viable in the current era. It is certainly better to use the non-financial aspects of performance measurement as we have seen. The reason for the same is that they aim for the development of the total quality of the products. In this era of completion where the product life cycles are dependent on the efficiency of the companies to be able to maintain their products in the market, companies need to focus more on customer satisfaction than anything else. This is possible to a larger extent in non-financial performance measurement.