PERFORMANCE which management ensures that resources are

PERFORMANCE EVALUATION

 

Introduction

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Performance
evaluation is a system used by organizations to monitor monitors daily
operations and evaluate whether it is attaining its objectives. In conducting
performance evaluation, managers select and use and use quantitative measures
of capacities, processes and outcomes to develop information about critical
aspects of activities, including their effect on the public. Performance evaluation
is part of performance management system and is aligned with the organization’s
strategy. Performance evaluation is an in-depth system of performance
measurement. Performance evaluation
focuses on an intervention whereas performance measurement focuses on a result.

 

The
Performance Management System (PMS)

 

Performance management system is a structured organization-wide
management tool set to communicate business strategy and measure performance of
an organization. PMS are an integral part of the management control systems. Management
control is a process through which management ensures that resources are
obtained and used effectively and efficiently in accomplishing the
organization’s goals. To be most effective, performance measures should be tied
to the strategic objectives of the organization. The two key principles of
performance measurement include the following;

 

·        
Measurement of performance

·        
Compensation based on measured performance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fig 1.0
Performance Management System

Importance
of performance evaluation to an organization

 

Performance evaluation helps to;

1.     
To communicate the organization’s strategic
direction and strategic priorities.

2.     
To create a shared understanding of the
organization’s goals and objectives.

3.     
To monitor and track the implementation of
strategy.

4.     
To align short-term actions with long-term
strategy.

5.     
To make clear the links between performance of
individuals and sub-units, and sub-units and overall organizational performance.

6.     
To promote integration among various
organizational processes.

7.     
To focus change efforts and facilitate
organizational learning.

 

Characteristics
of an effective performance evaluation system

 

An effective performance evaluation system should
provide timely, accurate feedback on the efficiency and effectiveness of
operations. Organizations rely on an effective performance evaluation tool to
help them manage the performance and well achieve the targets. An effective
performance evaluation system is the one which;

·        
Provides feedback to relevant stakeholders

·        
Includes both short and long term measures

·        
Assigns employees in appropriate jobs &
appropriate performance expectations

·        
Sets attainable performance levels

·        
Both subjective and objective measures are observable

·        
Overall and divisional responsibility and
control is considered

·        
Limit ability to manage or manipulate outcome
measures

Performance evaluation
techniques

 

 

 

 

 

 

 

 

 

a)     
Financial performance measures

 

Financial performance measures are used to monitor
the inflows (revenue) and outflows (costs) and the overall management of money
in the business. These measures focus on information available from the
Statement of profit or loss and Statement of financial position of a business. Financial
measures can be used to record the performance of cost centres, profit centres
and investment centres within a responsibility accounting system but they can
also be used to assess the overall performance of the organisation. For
example, if cost reduction or cost control is identified as a critical success
factor, cost based performance measures might be an appropriate performance
indicator to be used.

Cost based performance measures can be calculated as
a simple cost per unit of output. The organisation will have to determine its
policy for establishing cost per unit for performance measurement purposes. The
chosen method should then be applied consistently.

 

Measuring
profitability

 

The primary objective of a profit seeking company is to maximize profitability. A business needs to make a profit to be able to provide a return to any investors
and to be able to grow the business
by re­investment. Three profitability ratios are often used to monitor the achievement of this objective:

 

·        
Return
on
capital employed
(ROCE) = operating
profit ÷ (non­current liabilities + total equity) %

·        
Return
on
sales (ROS) = operating profit ÷ revenue %

·        
Gross margin = gross profit
÷ revenue %

 

Operating profit is profit before interest
and tax and after non ­production overheads have been charged.

 

Return on capital employed (ROCE)

 

This is a key measure of profitability as an investor will want to know the likely return from any investment made. ROCE is the operating profit as a percentage
of capital employed. It provides
a measure of how much profit is generated
from each $1 of capital employed in the business.

 

Operating profit (profit before interest) is being compared to long term debt (non­current liabilities) plus the equity
invested in the business.

 

Operating profit represents what is available
to pay interest
due to debt and dividends to shareholders so the figures used are comparing like for like.

 

A high ROCE is desirable.  An increase
in ROCE could be achieved by:

 

·        
Increasing profit, e.g. through an increase in sales price or through better
control of costs.

·        
Reducing capital employed, e.g. through the repayment of long term debt.

 

Return on sales (operating margin)

 

This is the operating
profit as a percentage of revenue.
A high return is desirable. It indicates that either sales prices and or volumes are high or that costs are being kept well under control.
ROCE, ROS and the Asset turnover
(see next section) ratios can be used together:

ROCE

=

ROS

×

Asset turnover

Operating profit
———————

 
=

Operating profit
———————

 
×

Revenue
———————

Capital employed

 

Revenue

 

Capital employed

 

 

 

 

 

 

This can be useful
if only partial information is available. For example
if the ROS and Asset turnover ratios are known then the ROCE can be calculated.

 

 

Gross margin

 

The gross margin
focuses on the trading activity of a business as it is the gross profit
(revenue less cost of sales) as a percentage of revenue. A high gross margin is
desirable.  It indicates that either
sales prices and or volumes are high or that production costs are being kept
well under control.

 

Measuring
risk

 

In addition to managing profitability, liquidity and activity
it is also important for a company to manage its risk. How ‘geared’
a business is can be calculated to assess financial risk.
 Gearing indicates
how well a business will be able to meet its long term debts.

 

Capital gearing (leverage)

 

This ratio calculates the relationship between borrowed capital
(debt) and owner’s
capital (equity):

 

Capital gearing = non­current
liabilities (debt) ÷ ordinary shareholders funds (equity)
%

or

 

Capital gearing = non­current
liabilities (debt) ÷ (non­current
liabilities + ordinary shareholders funds (debt
+ equity)) %

 

The level of gearing indicates how much a business relies
on long term debt finance. The higher the percentage the higher
the level of risk as any debt finance
must be paid back through interest and capital
repayments. There is a legal obligation to make these payments.
Repayment of equity finance is through dividends and there is no legal obligation to make these payments to shareholders.

 

There is no ‘correct’
level of gearing
but if debt exceeds equity then gearing is too high.

 

Interest cover
(income gearing)

 

Interest cover = Operating
profit ÷ Finance
cost.

 

This shows how many times the finance cost (interest
payments) could be paid out of the operating profit. The higher
the figure the better.
A decrease in the interest
cover indicates that the company is facing an increased risk of not being able to meet its finance payments as they fall due. This ratio calculates the relationship between borrowed
capital (debt) and owner’s capital (equity):

 

Capital gearing = non­current
liabilities (debt) ÷ ordinary shareholders funds (equity)
%

 

or

 

Capital gearing = non­current
liabilities (debt) ÷ non­current
liabilities + ordinary shareholders funds (debt
+ equity) %

 

 

The level of gearing indicates how much a business relies
on long term debt finance. The higher the percentage the higher
the level of risk as any debt finance
must be paid back through interest and capital
repayments. There is a legal obligation to make these payments.
Repayment of equity finance is through dividends and there is no legal obligation to make these payments to shareholders.

 

There is no ‘correct’
level of gearing
but if debt exceeds equity then gearing is too high.

 

Interest   cover (income   gearing)

 

This shows how many times the finance cost (interest
payments) could be paid out of the operating profit. The higher
the figure the better.
A decrease in the interest
cover indicates that the company is facing an increased risk of not being able to meet its finance payments as they fall due.

 

Interest cover = Operating
profit ÷ Finance
cost.

 

 

b)    
Non-Financial performance measures

 

Although profit cannot be ignored as it is the main objective of commercial organisations, critical success factors (CSFs) and key performance
indicators (KPIs) should not focus on profit alone.
The view is that a range of performance indicators should be used and these should
be a mix of financial
and non­financial
measures. Examples of Non­Financial Performance Indicators (NFPI) include:

 

·        
Measurements of customer
satisfaction e.g. returning customers, reduction
in complaints

·        
Resource
utilisation e.g. are the machines being operated
for all the available hours and producing output as efficiently as possible.

·        
Measurement of quality
e.g. reduction in conformance and non­conformance costs.

 

The Balanced Scorecard (BSC)

 

BSC is an integrated set of performance measures comprising both
current performance indicators and drivers of future performance, and financial
as well as non-financial measures. It is considered a strategic performance
management system that links performance to strategy using a multi-dimensional
set of financial and non-financial performance measures. BSC helps companies
improve corporate governance through the management of business performance and
achievement of strategic goals. The concept of BSC was then extended into a
management tool for describing, communicating and implementing strategy.

 

The four perspectives

 

The framework looks at the strategy
and performance of an organisation from four points of view, known in the model as four perspectives:

 

•           
financial

•           
customer

•           
internal (process) efficiency

•           
learning and growth.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fig 2.0
Balance scorecard approach

 

 

Financial  perspective

 

This focuses on satisfying shareholder value. Appropriate performance measures would include:

•           
return on capital employed

•           
return on shareholders’ funds.

Customer   perspective

 

This is an attempt to measure
the customers view of the organisation by measuring customer
satisfaction. Examples of relevant performance measures would
include:

 

•           
customer satisfaction with timeliness

•           
customer  loyalty.

 

Internal    perspective (process efficiency)

 

This aims to measure the organisation’s output in terms of technical excellence and consumer needs.
Indicators here
would include:

 

•           
unit costs

•           
quality measurement.

Learning and growth
perspective

 

This focuses on the need for continual
improvement of existing products and techniques and developing new ones to meet customers’ changing needs.

 

•           
A measure would include
the percentage of revenue attributable to new products.