Balance Scorecard

Managing Finance (MNGFIN)

Week 5: Strategic management accounting

The nature and role of strategic management accounting Textbook reading (Atrill & McLaney: Ch. 9)

Last week’s objectives helped you develop an understanding of the role of budgets

in the strategic planning process. Budgets are useful tools for setting financial

standards of performance and act as motivators for effective management. However,

budget preparation, management, monitoring, and analysis represent only a small

portion of the role that management accounting can take within the strategic

planning process. Of course, strategic planning requires an organisation to fully

examine and analyse itself both internally and externally.

Management accounting is a unique field that is excellently positioned to assist with

both the internal evaluation as well as external analysis that organisations must

conduct to remain competitive. It may seem that management accounting is strongly

focused on the measuring of internal performance of the organisation. This was the

common belief for many years; however, in the contemporary business landscape,

companies are finding that they can also practice such analysis on their competitors

as well as their customers. Consequently, this forces them to be more outward

looking, to develop competitive strategies, and to monitor these strategies using the

appropriate range of performance measurements. The role of management

accounting is expanding from supportive to participative as new methods are being

used to help meet corporate strategic objectives.

Competitor and customer profitability analysis Textbook reading (Atrill & McLaney: Ch. 9) To better understand the expanding strategic role that management accounting is

acquiring within the organisation, it is important to examine two key areas from this

field: competitor analysis and customer profitability analysis. The methods and

techniques that you have examined and explored to this point have all been focused

on measuring and analysing the performance of the organisation itself. This

information is of great importance, as it provides detail with regards to profitability,

sustainability, etc. However, if the concentration remains solely on the individual

organisation, true analysis has fallen short, as companies do not operate in vacuums.

Managers must do their best to understand the competitive stance of other

organisations with regards to costs, strategies, resources, capabilities, and

objectives. In other words, an organisation must do its best to understand what its

competition might do if it were to reduce prices, launch a new product, or attempt to

enter a new market. While obtaining such precious information proves to be difficult

at times, there are numerous sources that can be utilised, such as public financial

reports, industry reports, government statistics, and simple observations of

behaviours and actions. As the reading mentions, one of the most sought-after areas

is the cost structure of competitors. Such details can uncover valuable insight into a

competitor’s ability to match price reductions and to weather changes in sales

volume.

The importance of understanding possible movements or reactions of competitors

cannot be denied, yet it is equally important to properly analyse the customers that a

business currently has or wishes to attract. Just as the internal focus of management

accounting can be used to analyse the profitability of separate business units or

divisions within an organisation, a strategic focus can be taken with regards to the

profitability of a particular customer, or categories of customers.

Consider an appliance manufacturer that produces and sells three separate

products: refrigerators, ovens, and dishwashers. While it may be beneficial to

understand the profitability of each product line, this company may wish to compare

the profitability of its household versus commercial customers or families versus

single customers. Doing so may help to reveal information or trends that could

improve competitiveness, force pricing changes, or launch new product strategies.

The examples provided in the reading (Example 9.1 and Figure 9.2) help to illustrate

how a simple customer profitability analysis can be conducted and how it can reveal

vital information on a particular customer. The trend analysis in Figure 9.2 shows

how costs have been rising in certain areas, and this analysis assisted the

organisation in taking action to correct it.

Competitive advantage through cost leadership Textbook reading (Atrill & McLaney: Ch. 9) You are probably familiar with the popular strategies that many businesses employ

to help solicit customers. Retailers are notorious for conducting ‘sales’, ‘reductions’,

or ‘clearance events’ that are aimed at attracting new customers and retaining

existing ones. The intent in gaining the competitive advantage is to make up for

lower profit margins with a higher sales volume. While temporary price reductions

may help to boost sales and steal volume away from the competition, such strategies

are often limited in their duration, as many organisations cannot sustain their

operations over the long term with profit margins that are minimal or nonexistent.

Remaining competitive on a low-price strategy requires that the company work to

maintain low costs, as this will provide the organisation with a wider margin of safety

and the ability to be profitable while charging a lower price than the competition.

One of the greatest examples of this strategy has been Wal-Mart. The organisation

focuses on low-pricing strategy for its customers and has been able to do so through

effective cost management throughout its value chain. By analysing the entire

sequence through which products flow from beginning to end and eliminating

activities that are wasteful and add unnecessary (or redundant) costs, Wal-Mart has

been able to keep costs down at each step of the chain, making it a cost leader in

the retail industry.

Such value-chain analysis is an example of incorporating the total life-cycle of a

product as part of the cost management process. Your reading examines this and

two other costing approaches, target costing and kaizen costing, which were covered

during the discussion of pricing and costing in a competitive environment (Week 3).

As you will see, these costing methods are not intended for independent use; rather,

they should be used to complement and support the other methods as a part of the

total life-cycle costing approach. By effectively managing costs, rather than simply

trying to reduce them, organisations better position themselves to remain competitive

over the long term. Cost leadership is not so much a collection of techniques, but

rather a philosophy that an organisation should strive to follow. The organisation can

help make cost management an integral part of what the company is—rather than

just what it does—by making individuals at all levels responsible for costs,

encouraging and promoting ideas, and utilising benchmarks to encourage and

measure performance.

Using the Balanced Scorecard Textbook reading (Atrill & McLaney: Ch. 9) Scorecards are great models for measuring performance. They are used frequently

in various contests as a method for judging the performance against a set of

specified criteria. Robert Kaplan and David Norton developed the Balanced

Scorecard for organisations as a model for measuring and evaluating performance

against certain standards. It is important to note that the Balanced Scorecard is not a

‘ready-to-use’ tool, already set with criteria. Rather, it is a framework that forces the

organisation to look at four separate functional key areas: financial, customer,

internal business processes, and learning and growth. It is up to the individual

company to develop its own standards and measures based on its unique situation.

The primary purpose of the Balanced Scorecard is to force the organisation to

critically look at all areas within the company, rather than simply focusing on only a

few. While financial performance is important, it could come at the expense of long-

term success; thus, it is important to also consider the customer as well as learning

and growth issues. Customer satisfaction is vital; however, an organisation must also

achieve certain financial results to remain competitive.

The Balanced Scorecard forces the organisation to consider the effects of each area

on the other. Long-term financial success requires investment in human resources,

attention to improving internal business processes, and a focus on increasing

customer satisfaction. The relationship between these areas must be strong, as they

are highly dependent on each other and must be addressed together to enhance the

likelihood of organisational success. The example provided in the reading, (Un)Real

World 9.10, helps to demonstrate why organisations must address a wide range of

activities concurrently and shows the resulting complexity that these organisations

are faced with. The (Un)Real World example depicts a situation that does not

address the complexity of the operations as an integral set of activities. In this

scenario, the use of the Balanced Scorecard would enhance operational

performance, improve customer satisfaction (safety in this case), and ensure that the

rest of the financial and non-financial issues would all be addressed simultaneously.

Shareholder value analysis in strategic decision making Textbook reading (Atrill & McLaney: Ch. 9)

The ultimate goal of managers within an organisation is to increase the wealth of its

shareholders. These are the individuals who own the organisation and have given

the responsibility to managers for securing an adequate return on their investment.

As you can imagine, this places pressure on managers to perform and achieve

financial viability within a reasonable amount of time. Failure to do so may very well

result in a release from one’s duties! However, this goal must also be balanced with

the long-term sustainability and competitiveness of the organisation.

Traditional methods for measuring shareholder wealth have centred on the

standardised financial reporting methods, such as profits. The use of such traditional

evaluation standards has long been under fire due to the inability to incorporate risk,

variations of accounting methods, and the short time period in which profit is

measured. As a result, new approaches have surfaced to better measure and

analyse the returns to shareholders over time. The reading for this topic introduces

you to two concepts believed to better track such returns: shareholder value analysis

(SVA) and economic value added (EVA ® ).

Based on the concept of net present value analysis, SVA looks at the free cash flows

that an organisation generates through key variables such as sales revenue,

operating profit margin, tax rate, additional investment in working capital, and

additional investment in non-current assets. By working through the examples

provided in the reading, you will see that organisations can increase the wealth of

investors by focusing on increasing or decreasing these key variables. These value

drivers become important considerations with regards to strategic decisions, such as

acquisitions, new product development, or restructuring.

EVA ® is based on economic profits and helps to evaluate whether returns will

exceed the required returns of investors over the long term. The formula for EVA ® is

provided in your reading (p. 371) and illustrates that the key variables of

concentration are net operating profit after tax, shareholder required rates of return,

and amount of capital invested. By completing such analysis, the organisation is able

to determine whether or not the business is increasing the wealth of the investor or

has long-term growth potential. This allows the organisation to choose strategies that

will increase EVA ® to its fullest extent. As you read through this section, you will find

that both SVA and EVA ® have their respective benefits and drawbacks. The

examples provided help to illustrate and reinforce the usefulness of each approach.