Performance Management. Ch. 8 The Strategy Implementa9on Mechanism. Chiara Demar9ni UNIVERSITY OF PAVIA.

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1 UNIVERSITY OF PAVIA! Performance Management Ch. 8 The Strategy Implementa9on Mechanism Chiara Demar9ni Master in Interna+onal Business and Economics!

2 Defini9on Strategy implementa9on encompasses the transla9on of strategic objec9ves into opera9onal objec9ves VALUE SHARING IMPLEMENTATION The strategy implementa9on mechanism entails all the tools for an effec9ve opera9onaliza9on of organisa9onal strategic goals. FORMULATION REWARDING SCHEME PERFORMANCE MEASUREMENT To effec9vely implement strategy, firms have to balance coordina9on and control. EXECUTION 2

3 Strategy implementa9on mechanisms! Budge9ng Non- financial performance measurement systems Budge9ng iden9fies the opera9onal ac9vi9es through which the whole organisa9on can achieve its financial goals Non- financial indicators clarifies which metrics are fundamental for organisa9onal the firm long- term viability Target performance informs the Target selng person responsible for each of the measures what is the desired level for a certain performance. 3

4 Responsibility Centre The organisa9onal structure allowing for the assignment and accountability for opera9onal ac9vi9es, non- financial indicators and targeted performance is the responsibility centre VALUE SHARING IMPLEMENTATION The Responsibility Centre is an organiza9on unit that is headed by a manager who is responsible for its ac9vi9es FORMULATION PERFORMANCE MEASUREMENT REWARDING SCHEME EXECUTION COST REVENUE PROFIT CENTRE CENTRE CENTRE INVESTMENT CENTRE 4

5 Budgetary control Budgetary control involves both planning translated into monetary terms and control: trying to shape the future VALUE SHARING FORMULATION IMPLEMENTATION PERFORMANCE MEASUREMENT Control on agent Budgetary constraints Limit to the devia9ons from planned objec9ves REWARDING SCHEME EXECUTION

6 Budgetary control benefits FORECASTING, i.e. the development of an economic forecast for the next period! AUTHORIZING, i.e. the authorisa9on for the expenditure of money PLANNING, i.e. the quan9fica9on of commands to managers for execu9ng par9cular tasks which they are responsible for MEASURING, i.e. the selng of a standard for controlling the legality of managers ac9ons and the degree of achievement of the set targets MOTIVATING, i.e. the assignment to managers of challenging, but achievable, tasks to be performed VALUE SHARING COMMITMENT, i.e. managers par9cipa9on in budge9ng enhances their willingness IMPLEMENTATION to achieve targets FORMULATION REWARDING SCHEME EXECUTION PERFORMANCE MEASUREMENT DELEGATING COORDINATING, i.e. subordinates par9cipa9on in budge9ng increases the communica9on with superiors, and thus interdepartmental interac9on COMMUNICATING, i.e. budge9ng enhances the informa9on flows, systems and networks that C. Demar9ni bind together Performance the overall Management performance management

7 Budgetary control costs RIGIDITY Reduc9on in COOPERATION SHORT- TERMISM VALUE SHARING FORMULATION IMPLEMENTATION PERFORMANCE MEASUREMENT GAMING REWARDING SCHEME EXECUTION EMPLOYEE DEMOTIVATION

8 Master Budget Master budget is a budget that summarises and integrates all the individual budgets within an organiza9on. OPERATIONAL BUDGET FINANCIAL BUDGET FORMULATION REWARDING SCHEME Sales Budget Produc9on Budget Direct Material Purchases VALUE SHARING Direct Labor Budget IMPLEMENTATION EXECUTION Budget Overhead Budget PERFORMANCE MEASUREMENT Selling and Administra9ve Expenses Budget Cost of Goods Manufactured Budget Schedule of Expected Cash Receipts from Customers Schedule of Expected Cash Payments to Suppliers Cash Budget Budgeted Income Statement Budgeted Balance Sheet 8

9 Master Budget Structure ENDING INVENTORY BUDGET DIRECT MATERIAL BUDGET SALES BUDGET PRODUCTION BUDGET DIRECT LABOUR BUDGET MANUFACTURING OVERHEAD BUDGET SELLING & ADMINISTRATIVE EXPENSE BUDGET COST OF MANUFACTURED GOODS BUDGET CASH BUDGET BUDGETED INCOME STATEMENT BUDGETED BALANCE SHEET 9

10 Sales Budget Total exp sales = 100,000 Jan Dec Year % of annual sales 5% 20% 100% Expected sales in unit 5,000 20, ,000 Expected price Total budgeted revenues 50, ,000 1,000,000 10

11 Produc9on Budget Jan Dec Year Budgeted sales in unit 5, , ,000 + Desired ending inventory 1,000 = 4,000 = 13,000 = Total needs 6,000-24, ,000 - Beginning inventory 500 = 2,000 = 7,800 = Required produc9on 5,500 22, ,200 11

12 Direct Material Budget Jan Dec Year Required produc9on 5,500 * 22,000 * 115,200 * Raw material needed per unit Raw material needed 3, , ,120 + Expected inventory 1,200 = 4,500 = 45,000 = Total needs 4,500-17, ,120 - Beginning inventory 1,100 = 3,400 = 27,800 = Raw material to purchase 4,400 * 14,300 * 86,320 * Cost per unit 0.67 = 0.67 = 0.67 = Total cost for raw material 2,948 9,581 57,

13 Direct Labour Budget Jan Dec Year Required produc9on 5,500 * 22,000 * 115,200 * Direct labour 9me per unit 0.2 = 0.2 = 0.2 = Total hours 1,100 * 4,400 * 23,040 * Direct labour cost/hour Direct labour cost = 25, , ,920 13

14 Manufacturing Overhead Budget Jan Dec Year Required produc9on Overhead manufacturing rate Variable overhead Insurance Amor9za9on Total fixed overhead Total manufascturing overhead - Prepaid property tax - Prepaid insurance - Amor9za9on Cash ourlows for manufacturing overhead 14

15 Cost of Manufactured Goods Budget Jan Dec Year Produc9on cost per unit Direct materials Direct labour Manufacturing overhead Unit product cost Budgeted finished goods inventory: Ending finished goods inventory in units Unit product cost Ending finished goods inventory (in ) Budgeted cost of goods sold Beginning finished goods inventory + Costs of goods manufactured - Ending inventory Budgeted cost of goods C. Demar9ni sold (in ) Performance Management 15!

16 Selling and Administra9ve Budget! Budgeted sales * Variable selling & admin expense/unit = Variable selling & admin expenses + Bad debts + Warehouse rental = Total selling and administra9ve expenses - Bed debt expenses = Cash ourlows from S&A budget Jan Dec Year 16

17 Cash Balance, beginning Add receipts: Cash Budget Collec9ons from customers Total cash available before financing Less disbursements: Direct materials Direct labour Manufacturing overhead Selling and administra9ve expenses Tax remiwance Tax payable Prepaid insurance Prepaid property and business tax Capital asset purchases Dividend payment Total disbursements Excess (deficiency) of cash C. available Demar9ni over Performance disbursements Management Jan Dec Year 17!

18 Cash Budget 18

19 Cash Budget Excess (deficiency) of cash available over disbursements Financing: Borrowing (at the beginning of the month) Repayment (at the end of the month) Interest expense (paid monthly) Total financing Cash balance, ending Jan Dec Year Running total 19

20 Income Statement Jan Dec Year Sales Cost of goods sold Gross Margin Less: Selling & administra9ve expenses Net opera9ng income Less: Interest expense Net income before taxes Income taxes Net Income 20

21 Retained Earnings Statement Jan Dec Year Retained earnings Retained earnings beginning of year Plus: Net Income Sub- total Less: Dividends declared Retained earnings end of year 21

22 Balance Sheet Jan Dec Year Assets Cash Accounts Receivable Financial Statement Inventory: Raw Materials Inventory: Finished goods Prepaid Insurance Prepaid Property and Business Tax Capital assets (net) Total Assets Liabilities & Shareholder's Equity Bank Loan Payable Accounts payable Income taxes payable Shareholders' Equity Capital stock Retained earnings Total Shareholders' equity Total Liabilities & Shareholders' C. Demar9ni Equity Performance Management 22!

23 Balance Sheet 23

24 Non Financial Performance Measures! Non- financial performance indicators play a central role in strategy implementa9on since they reflect the organisa+onal value drivers Budge9ng Non- financial indicators highlight the extent to which strategy and opera9ons are aligned Non- financial performance measurement systems Target selng As managers +me and acen+on is a scarce resource, they will choose to focus their awen9on toward those indicators which are more easily achievable 24

25 Target selng Target selng refers to the legisla9ve ac9vity of sedng performance standards Budge9ng Most of the literature on target selng is related to the budgetary control element Non- financial performance measurement systems Target selng The target selng literature mainly concerns issues psychological in nature, in that managers should feel targets as 9ght but achievable 25

26 Target selng Approaches to target selng Budge9ng Non- financial performance measurement systems Target selng Management should be assigned with Olympian Managers should feel targets, i.e. very difficult targets as +ght but targets that could be achievable achieved by brilliant managers only 26

27 Commitment, target achievability and organiza9onal performance! Budge9ng Non- financial performance measurement systems Target selng 27

28 Regularly discuss and agree ac9on plan. Review stakeholders expecta9ons Clarify and select strategic objec9ves! Design an ac9on plan with a provision of projects TARGET- SETTING WHEEL Map organiza9on al success Budge9ng Set targets Priori9ze objec9ves Non- financial performance measurement systems Target selng Analyse data Collect data Opera9onali ze (few, clear and effec9ve performance measures) 28

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