Financial and Nonfinancial Performance Measures

Learning Objective 1 Select financial and nonfinancial performance measures to use in a balanced scorecard

As you have learned, many organizations record financial and nonfinancial performance measures for their subunits on a balanced scorecard. The scorecards of different organizations emphasize different measures, but the measures are always derived from a company’s strategy. Consider the case of Hospitality Inns, a chain of hotels. Hospitality Inns’ strategy is to provide excellent customer service and to charge a higher room rate than its competitors. Hospitality Inns uses the following measures in its balanced scorecard:

  1. FINANCIAL PERSPECTIVE—the firm’s stock price, net income, return on sales, return on investment, and residual income
  2. CUSTOMER PERSPECTIVE—market share in different geographic locations, customer satisfaction, brand image, and average number of repeat visits
  3. INTERNAL-BUSINESS-PROCESS PERSPECTIVE—customer-service time for making reservations, check-in, and restaurant services; cleanliness of the hotels and rooms; time taken to clean rooms; room-service and restaurant quality; reductions in waste output and energy and water consumption; number of new services, such as wireless Internet, provided to customers; and the time taken to plan and build new hotels
  4. LEARNING-AND-GROWTH PERSPECTIVE—the education, skills, and satisfaction levels of the firm’s employees; employee turnover and hours of employee training; and the company’s achievement of ISO 14001:2015 certification for environmental management

As in all balanced scorecard implementations, the goal is to make improvements in the learning-and-growth perspective that will lead to enhancements in the internal-business-process perspective that, in turn, will result in gains in the customer and financial perspectives. Hospitality Inns also uses balanced scorecard measures to evaluate and reward the performance of its managers.

Some performance measures, such as the time it takes to plan and build new hotels, have a long time horizon. Other measures, such as check-in time or quality of room service, have a short time horizon. In this chapter, we focus on organization subunits’ most widely used performance measures that cover an intermediate to long time horizon. These are internal financial measures based on accounting numbers routinely reported by organizations. In later sections, we describe why companies use both financial and nonfinancial measures to evaluate performance.

Designing accounting-based performance measures requires several steps:

  1. Step 1: CHOOSE PERFORMANCE MEASURES THAT ALIGN WITH THE FIRM’S FINANCIAL GOALS. For example, is operating income, net income, return on assets, or revenue the best measure of a subunit’s financial performance?
  2. Step 2: CHOOSE THE DETAILS OF EACH PERFORMANCE MEASURE IN STEP 1. Once a firm has chosen a specific performance measure, it must make a variety of decisions about the precise way in which various components of the measure are to be calculated. For example, if the chosen performance measure is return on assets, should it be calculated for 1 year or for a multiyear period? Should assets be defined as total assets or net assets (total assets minus total liabilities)? Should assets be measured at historical cost or current cost?
  3. Step 3: CHOOSE A TARGET LEVEL OF PERFORMANCE AND FEEDBACK MECHANISM FOR EACH PERFORMANCE MEASURE IN STEP 1. For example, should all subunits have identical targets, such as the same required rate of return on assets? Should performance reports be sent to top managers daily, weekly, or monthly?

The decisions made in these steps don’t have to be sequential. The issues considered in each step are interdependent, and top managers will often iterate through these steps several times before deciding on one or more accounting-based performance measures. At each step, the answers to the questions raised depend on top management’s beliefs about how well each measure fulfills the criteria of promoting goal congruence, motivating management effort, evaluating subunit performance, and preserving subunit autonomy (see Chapter 23).