MCS designers apparently disagree whether single measure to evaluate the profit performance and capital investment performance is preferable or SEPARATE measures for each are preferable – COMMENT
There should be different measures used for evaluating profit performance and capital investment performance as needed.The goal of performance measurement systems is to implement strategy. In setting up such systems, senior management selects measures that best represent the company's strategy. These measures can be seen as current and future critical success factors; if they are improved, the company has implemented its strategy. The strategy's success depends on its soundness. A performance measurement system is simply a mechanism that improves the likelihood the organisation will implement its strategy successfully.
Measuring Profitability
There are two types of profitability measurements used in evaluating a profit center, just as there are in evaluating an organization as a whole. First, there is a measure of management performance, which focuses on how well the manager is doing. This measure is used for planning, coordinating, and controlling the profit center's day-to-day activities and as a device for providing the proper motivation for its manager. Second, there is the measure of economic performance, which focuses on how well the profit center is doing as an economic entity. The messages conveyed by these two measures may be quite different from each other. For example, the management performance report for a branch store may show that the store's manager is doing an excellent job under the circumstances, while the economic performance report may indicate that because of economic and competitive conditions in its area the store is a losing proposition and should be closed.The necessary information for both purposes usually cannot be obtained from a single set of data. Because the management report is used frequently, while the economic report is prepared only on those occasions when economic decisions must be made, considerations relating to management performance measurement have first priority in systems design-that is, the system should be designed to measure management performance routinely,with economic information being derived from these performance reports as well as from other sources.
Capital Investment Measurement
Most proposals require significant new capital. Techniques for analyzing capital investment proposals attempt tofind either
(a) The net present value of the project, that is, the excess of the present value of the estimated cash inflows over the amount of investment required, or
(b) The internal rate of return implicit in the relationship between inflows and outflows. An important point is that these techniques are used in only about half the situations in which, conceptually, they are applicable.
There are at least four reasons for not using present value techniques in analyzing all proposals.
1.The proposal may be so obviously attractive that a calculation of its net present value is unnecessary. A newly developed machine that reduces costs so substantially that it will pay for itself in a year is an example.
2.The estimates involved in the proposal are so uncertain that making present value calculations is believed to be not worth the effort-one can't draw a reliable conclusion from unreliable data. This situation is common when the results are heavily dependent on estimates of sales volume of new products for which no good market data exist. In these situations, the "payback period" criterion is used frequently.
3.The rationale for the proposal is something other than increased profitability. The present value approach assumes that the "objective function" is to increase profits, but many proposed investments win approval on the grounds that they improve employee morale, the company's image, or safety.
4.There is no feasible alternative to adoption. Environmental laws may require investment in a new program,as an example.
The management control system should provide an orderly way of deciding on proposals that cannot be analyzed by quantitative techniques. Systems that attempt to rank non-quantifiable projects in order of profitability won't work. Many projects do not fit into a mechanical ranking scheme.