ACCA P5 Advance Performance Management
Divisional Performance Measures and Performance Appraisal:
The need for divisional performance measure has grown with increasing practice
of intrapreneurship (managers’ controlled semi-autonomous unit e.g. divisions, subsidiaries,
strategic business units) within organisation. This has added strategic roles, responsibilities
and authorities to managers (an example of job enrichment). Associated to these
managers face challenges to coordinate, tackle conflicts and enhance
performance of own division with respect to other division or the organisation
as a whole. Substantial amount of managers’ incentive is linked to performance
of his/her division. So, here we go through some of divisional performance
measures.
Return on Investment (ROI): ROI is replacement for ROCE at
divisional level. It calculates relative percentage return, rather than an
absolute return - i.e. a profit or loss. ROI facilitates comparison of
different divisions or companies.
Mathematically, ROI = PBIT/Investment*100
Any investment that generates return above cost of capital
is acceptable.
However, ROI can motivate managers to make dysfunctional decision
which may not adhere to corporate benefit.
An example: Company A has linked substantial amount of
managerial bonus to divisional ROI. Company’s cost of capital is 8%, so any
project earning higher than 8% are acceptable to company. X is one of the divisions
of Company A. Its historical ROI has never dropped from 20% and manager will
quite sure to maintain the level under present condition. Meantime, X division
manager is presented with a project that has return of 15%. In such case,
however it seems beneficial project from company’s view, company x manager will
reject the project because ROI of division will fall to lower value and
managers bonus will also decrease.
Residual Income (RI): RI was developed to tackle the
dysfunctional behaviour that can result from using ROI. Under RI a notional interest charge is levied on
divisions to charge them for use of fixed and/or working capital. It should be noted that there are many
different methods of levying this charge. The method used will depend largely
on the level of control that divisions have over fixed assets and working
capital. The interest charge is deducted from operating profit to calculate
the profit or loss being made by the divisions – ie. an absolute return.
Mathematically, RI = PBIT – imputed interest (capital
employed * cost of capital)
Decision rule: accept the project if the RI is positive.
CIMA Article: Here’s mud in RIs
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