COM 270 Chapter Notes - Chapter 12: Root Mean Square, Accounts Receivable, Current Liability
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•decentralized organizations: ﬁrms that grant substantial decision-making authority to the managers of sub-units
-neither completely centralized or decentralized - it is usually to a matter of a degree!
-advantages of decentralization include:
(i) subunit managers have better information than top managers,
leading to superior decisions
(ii) able to respond quicker to changing circumstances
(iii) increases motivation among managers
(iv) allow managers to identify more strongly with their subunits
(v) provides excellent training for future top-level executives
-disadvantages of decentralization include:
(i) may result in duplication of activities
(ii) lack of goal congruence: managers of subunits pursue
personal goals that are incompatible with the goals of the company
as a whole
-requires managers & subunits to be evaluated, in order to asses areas that need improving/deemed successful/reward/punished/etc.
-responsibility accounting: costs & revenues are traced back only to the organization level where they can be controlled
•responsibility centres (subunits): organizational units responsible for the generation of revenue &/or the incurrence of costs, related to an identiﬁable collected of
related resources & activities
-typically classiﬁed into 3 different types:
(a) cost centres: responsible for controlling costs, but not generating revenue
•managers are responsible for making sure that their services are provided at a responsible cost to the company
•controlled by comparing actual costs with standard/budgeted costs, defect rates, on-time delivery stats, customer satisfaction, etc.
(b) proﬁt centres: responsible for generating revenue, as well as controlling costs
•evaluated according to their proﬁtability
•relative performance evaluation: evaluates each proﬁt centre, relative to the proﬁtability of other, similar proﬁt centres
(c) investment centres: responsible for generating revenue, controlling costs, & investing in assets
•responsible for earning income that is consistent with the amount of assets invested in
•managers play a big role in determining the level of inventory, accounts receivable, investment in equipment, etc.
•return on investment (ROI): the ratio of investment centre income to invested capital "
ROI = Income ÷ Invested capital
-primary tool to evaluate investment centres
-can be broken down further, into proﬁt margin (income:sales) & investment turnover (sales:invested capital) "
ROI = (Income ÷ Sales) ÷ (Sales ÷ Invested capital)
-clearly indicates to managers that there are 2 ways to improve ROI
(iii) improve income earned on each $ of sales
(iv) generate more sales
-net operating proﬁt after tax (NOPAT): measure of investment centre’s income
•must add back income expense & adjust tax expense accordingly
-non-interest-bearing current liabilities (NIBCL): measure of investment centre’s invested capital
•current liabilities that do not require interest payments
•deducted from total assets because they are a “free” source of funds, & thus reduce the cost of the investment in assets
-problems using ROI include:
•typically relies on historical costs, which are affected by depreciation
•as assets become fully depreciated ⇒ investment ↓ ⇒ ROI ↑ ⇒ making comparisons of centres difﬁcult
•may lead managers to delay the purchase of modern equipment required to stay competitive, or to underinvest
•economic value added (EVA): measure performance by adjusting residual income for “accounting distortions” that arise from following GAAP"
EVA = NOPATadjusted - (Cost of capital x Investmentadjusted)
-attempts to avoid the problem of over- or underinvesting
-capitalizes research & development (R&D) as an asset, amortizing their costs over the future periods that will beneﬁt from the R&D
•prevents managers from being tempted to cut back R&D, which increase short-term revenue, but causes harm in the long run
-residual income (RI): net operating proﬁt after taxes of an investment centre, in excess of its required proﬁt "
Residual income = NOPAT - Required proﬁt "
= NOPAT - Cost of capital x Investment "
= NOPAT - Cost of capital x (Total assets - NIBCL)
-required proﬁt: the investment centre’s require rate of return x the level of investment in the centre
-required rate of return: the cost of capital for the investment centre
•balanced scorecard: set of performance measures to evaluate the 4 dimensions of performance, which are predictive of future success
(a) ﬁnancial measures: backward looking measures of proﬁt
(b) customer measures: company’s success in meeting customer’s expectations
(c) internal process measures: company’s success in improving critical business processes
(d) learning & growth measures: company’s success in improving it’s ability to adapt, innovate & grow
-quantitative measures are balanced with qualitative measures
-is a balance of backward-looking & forward-looking measures
-key items for a successful balanced scorecard include:
(i) targets: what managers are expected to achieve for each measure
(ii) initiatives: actions that will be taken in order to achieve the target
(iii) responsibility: a particular employee is given the responsibility & held accountable for the implementation of each initiative
(iv) funding: providing the necessary & appropriate funding for each initiative
(v) top management support: full support & commitment from top management
•strategy map: a diagram of the relationships across the 4 dimensions of a balanced scorecard & the strategic objectives that the company has developed in order to
create shareholder value, & how they will be measured
COM 270 - Chapter 12: Decentralization & Performance Evaluation
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