DIVISIONAL PERFORMANCE measure and control divisional

performance.
MEASUREMENT
wHY DIVISIONS ARE CREATED?
Large companies produce and
● Growing size of the
sell a wide variety of products
throughout the world. Because of organization
the complexity of their operations, it ● Diversification of products
is difficult for top management to ● Geographical expansion
directly control operations. It may ● Better control and fixation of
therefore be appropriate to divide a responsibility
company into a separate self deal of
independence. A divisional manager
has responsibility for both the
production and marketing activities
of the division. The danger in
creating autonomous divisions is that
divisional managers might not pursue
goals that are in the best interest of
the company as a whole. Consider
financial performance measures that
will motivate managers to pursue
those goals that will best benefit
the company as a whole. In other
words, the objective is to develop
the performance measures that will (a) Centralized organization is an
achieve goal congruence. organization in which top
Financial measures cannot management makes most
adequately measure all those decisions and controls most
factors that are critical to the success activities from the central
of a division. Emphasis should also be headquarters.
given to reporting key non-financial (b) Decentralization is defined as
measures relating to such areas as delegating authority to make
competitiveness, product leadership, decisions.
quality, delivery performance, In general, a divisional structure will
innovation and flexibility to respond lead to decentralization of the
to changes in demand. Performance decision making process and
measures should be developed that divisional managers may have the
support the objectives and freedom to set selling prices, choose
competitive strategies of the suppliers, make product mix and
organization. Divisional financial output decisions and so on.
performance measures should
therefore be seen as one of a range
of measures that should be used to
ORGANIZATIONAL SEGMENTATION BY This could be a useful way to break
RESPONSIBILITY the connection between divisional
performance appraisal and published
A responsibility center is an profits.
organizational unit headed by an Published profits may be affected by
executive responsible for all its accounting adjustments, most of
activities– who is required from time which the divisional manager has no
to time to make decisions regarding control over.
quantity and quality of tasks, and (However, it is worth noting that
the amount of resources to be many analysts now use EBITDA, i.e.
consumed in performing the task. earnings before interest, tax
depreciation and amortization to
MEASURES OF PERFORMANCE monitor companies' performance.
● FINANCIAL MEASURES OF EBITDA is a reasonably close
PERFORMANCE approximation to cash flow.)
- Amount of expenses incurred
- Revenue earned If a division's asset base is valued at
- Profit its replacement cost this will take
- ROI inflation into account and should also
- expresses divisional encourage divisional managers to
profit as a percentage of replace obsolete assets with more
the assets employed in productive modern assets.
the division
- Assets employed can be A major disadvantage of ROI is that
defined as total managers may be motivated to
divisional assets, assets make decisions that make the
controllable by the company worse off.
divisional manager or
net assets
- Investment Turnover x ADVANTAGES DISADVANTAGES
Profitability
As relative Disincentive to
measures, it invest
enables
comparisons to
be made with
divisions or
RETURN ON CAPITAL companies of
EMPLOYED different size.
If depreciation is ignored divisional
It is used Subject to
profits will differ from published
externally and is manipulation
profits.
well understood
by users of ADVANTAGES DISADVANTAGES
accounts.
Achieve Goal Absolute measures
ROI forces Lack of goal COngruence
managers to congruence There is greater it means that it is
make good use probability that difficult to compare
of existing managers will the performance of
capital resources be encouraged a division with
and focuses when acting in that of other
attention on their own best divisions or
them, interest of the companies of a
particularly company. different size.
when funds for
further To overcome this
investment are deficiency,
limited. targeted or
budgeted levels of
Not suitable for RI should be set for
investment each division that
decisions are consistent with
asset size and the
market conditions
- Residual Income of the divisions
- measure is an attempt
to overcome some of the More Flexible
drawbacks of ROI RI can apply a
- RI is calculated by different cost of
charging an investment capital to
center with the cost of investment with
the capital it employs different risk
i.e. notional or imputed characterstics.
interest charge is made.
- The division’s - Economic Value Added
performance can then be ● NON-FINANCIAL MEASURES OF
measured by comparing PERFORMANCE
the profit it achieves, - Employee Productivity
after the interest - Employee Morale and
charge, with pre-set Attitude
target - Qualitative Aspects of
Performance
- Marketing Effectiveness
- Social Responsibility
BENEFITS OF PERFORMANCE
MEASURES
● Develops agreed measures of
activity.
● Clarifies the objectives of the
organization.
● Greater understanding of the
process.
● Helps facilitate comparison
between divisions. Promotes
accountability to stakeholders.
● Helps in setting targets for
managers.
● Helps facilitate comparison
between different
organizations