Performance Evaluation Using Accounting Information.
What is performance evaluation? o Performance evaluations are formal review processes designed to encourage the informal day-to-day practice of performance management, while providing a framework in support of merit pay adjustments, promotion and employment decisions. Evaluating staff performance and helping employees develop their skills are important duties associated with performance management. Performance management begins with supervisors and employees collaboratively setting goals and standards, clearly communicating performance expectations and evaluating the results during the performance evaluation process. o A performance appraisal is a systematic and periodic process that assesses an individual employee’s job performance and productivity in relation to certain pre-established criteria and organizational objectives. o o Performance evaluation tools are quantitatively and qualitatively based. They utilize a scoring system that assesses numerical data relative to productivity, as well as characteristic data that measures the quality of the employee’s work.
The indicators on performance evaluations include items such as business ethics, innovation, motivation, job knowledge, skills and expertise, communication, teamwork, work quality, professionalism, task management and project completion. Benefits of performance evaluation: • Facilitation of communication: communication in organizations is considered an essential function of worker motivation. It has been proposed that feedback from performance evaluation aid in minimizing employees’ perceptions of uncertainty.
Fundamentally, feedback and management-employee communication can serve as a guide in job performance. • Enhancement of employee focus through promoting trust: behaviors, thoughts, and/or issues may distract employees from their work, and trust issues may be among these distracting factors. Such factors that consume psychological energy can lower job performance and cause workers to lose sight of organizational goals. Properly constructed and utilized performance evaluation has the ability to lower distracting factors and encourage trust within the organization. Goal setting and desired performance reinforcement: organizations find it efficient to match individual worker’s goals and performance with organizational goals. Performance evaluation provides room for discussion in the collaboration of these individual and organizational goals. Collaboration can also be advantageous by resulting in employee acceptance and satisfaction of appraisal results. • Performance improvement: well constructed performance evaluation can be valuable tools for communication with employees as pertaining to how their job performance stands with organizational expectations. At the organizational level, numerous studies have reported positive relationships between human resource management (HRM) practices and performance improvement at both the individual and organizational levels. • Determination of training needs: “Employee training and development are crucial components in helping an organization achieve strategic initiatives”. It has been argued that for performance to truly be effective, post-appraisal opportunities for training and development in problem areas, as determined by the appraisal, must be offered. Performance can especially be instrumental for identifying training needs of new employees.
Finally, performance can help in the establishment and supervision of employees’ career goals. The Role of Accounting Information in Performance evaluation Accounting information consists of all data that a company records from operating activities and reports to the public at the end of a month or quarter. Accounting information is important for investors, analysts and regulators, management, employees, creditor and debtor. This information is also critical for a firm’s management because it provides insight into the company’s financial robustness and profitability in the short and long terms.
Accounting data frequently is used in performance evaluations, because it is seen as an objective method to evaluate performance. While there are many advantages to using accounting information for this purpose, small-business owners should be careful to understand that there are drawbacks as well. Knowing the pros and cons of using accounting metrics can help business owners choose the right data to use for evaluating employee performance. Budget to Actual Many businesses expect employees to achieve budget targets as part of their overall performance.
While the specifics requirements of each employee differ with the position and nature of the company, it is common for employees to be expected to sell a certain number of items, control costs versus a budgeted amount or reduce waste compared with a benchmark. A potential downfall of using budget information for performance evaluation is that employees may be so concerned with making budget targets that they may do so at the cost of other parts of the business. Sales Growth Sales employees and business management frequently are evaluated on the basis of sales growth.
Sales growth usually is calculated as the percentage that sales have increased over the prior year. While this metric is commonly used to gauge performance, it does not come without drawbacks. If the general economy changes from year to year, then sales may naturally be increasing or decreasing. For example, if the economy is in decline, then employees may be modeling the correct behaviors, but sales may still be slow. In contrast, if the economy is growing, employees may be receiving the benefits of increasing sales while developing habits that will keep this sales growth from being sustainable in the future.
Net Profit In many small businesses, net profit is used as a performance benchmark for the company’s manager. Condensing the operations of a business into its simplest form, net profit measures the amount of profit left after deducting expenses. While profit is important to businesses, focus on profit can have adverse effects on the company in the long term. For example, cutting advertising expenses will grow net profit in the short-term, but in the long-term, potential customers may not know about the company’s products. Expense Reduction
For employees in charge of spending, it is common to evaluate performance based upon cost reduction. This can be a useful metric, as each dollar of expense saved translates into a dollar of profit. However, caution must be exercised, because this performance metric does not account for differences in quality. For example, if a purchasing manager is evaluating on reducing the expense of purchased metal for production, he could be rewarded for buying cheaper substandard material. As such, small-business owners should be cautious when using this metric in isolation. Profitability Analysis: Management analyzes profitability by reviewing the statement of profit and loss, also known as statement of income. This statement indicates a company’s revenue and expense items. Profit Margin Profit margin measures a company’s business performance over a quarter or month and equals net income divided by total revenue. Return on Equity o Return on equity provides an assessment of profitability on owners’ capital and equals net income divided by shareholders’ equity. Working Capital Working capital is a gauge of a firm’s cash availability in the next 12 months and equals current assets minus current liabilities
Budgeting o A budget helps a business know where money comes in and where it goes out. With accurate accounting, a business owner can make decisions to cut back in certain budget areas to improve the profit potential of the business. Without accounting data, the company would be forced to guess how much money should be allotted to each department or line item. A budget that is updated quarterly gives a clear picture of where the business stands financially so that smart money management decisions can be made. Investor Relations A public company has a responsibility to report the company’s financial standing to stockholders. The accounting department of the business creates a public report for investors with the intent of disclosing all financial data. Good accounting practices helps investors trust the management team as they know exactly the points of financial strength and weakness of their investment. A company that does not maintain accounting information would be in danger of lawsuits, claims of fraud and lose access to relationships that provide capital necessary to running the business.
Employee Retention Providing employees with accounting information helps them to make responsible decisions regarding their futures. A business that does not disclose or maintain accurate accounting information would gradually lose credibility with its employees. Employees with retirement accounts managed by their employers rely on the financial stability of companies to ensure their employers follow through Planning o Before most businesses even start operations, some level of planning is done to determine the level of success that can be achieved from operations.
Businesses will examine current economic trends like consumer demand, market size, and number of competitors. This analysis helps companies determine which industry best suits their goods and services and then focuses on planning for the necessary plants and equipment needed to create successful business operations. Management Decisions o Once a business starts producing goods and services, executive managers must review each level of the company to ensure that each department is functioning at its peak.
Some departments may need to be overhauled to re-create a competitive environment that produces high-quality goods and services. Additionally, management will use accounting information to decide if their company could improve operations by purchasing a competitor or enter a new market with their existing production facilities. Profitability o The biggest need for accounting information is to determine overall profitability. Sales, costs of manufacturing, inventory, and expenses are all recorded and presented to company management so the company’s profit levels can be determined.
Financial statements like the balance sheet or statement of cash flows may also be prepared so executive management can assess the value of the company and the cash-generating functions of business operations. Investing o Once companies have a solid understanding of their profitability, they begin to make decisions on investing their cash and retained income from business operations. Executive management will decide what amount of cash should be reinvested into the business and what amount should be invested in interest-bearing securities.
Companies will use these securities investments to generate cash outside business operations, giving them higher cash flows. Accountants must track these investments to ensure that the company does not take on too much investment risk. Performance Analysis o After the financial transactions of a company are properly recorded and presented in financial statements, accountants will review the information to determine the strength of business operations. Accountants use financial ratios to break down the financial statements and compare them to the industry or competitors.
This analysis will help management find weak areas in the company and help allow them to find solutions for strengthening these operations. Accounting Performance Measurement Tools Budgets o Budgeting initiatives help department heads discuss steps to limit the decision-making authority of specific personnel. These include employees running inefficient operations or segment chiefs unable to whittle away at runaway budget deficits. Top leadership may not strip ineffective segment leaders of their operating prerogatives, but budgeting certainly limits how much they can spend.
A budget is a list of planned expenses and revenues, a plan that organizations use to spend and save. 2. Pro Forma Statements o Pro forma or projection-based, accounting reports rely on hypothetical data to illustrate how a firm’s operations may fare under specific scenarios. These include “best,” “average” and “worst”– with these concepts indicating the state of the economy or conditions in the company’s competitive landscape, among other factors. For example, worst-case-scenario pro forma statements show whether a business could generate enough revenues to sustain itself if economic conditions deteriorate. . Accounting Reports o Management accountants and corporate leaders use accounting reports to measure operating performance. By doing so, they help prevent the dismal financial situation that arises when a firm consistently posts negative numbers. Department heads rely on accounting statements to determine operating weaknesses and prescribe the right medicine to fix ineffective mechanisms. The most important accounting statements are balance sheets, income statements, cash-flow reports and equity statements. Balance heets are also called statements of financial position or statements of financial condition. 4. Financial Ratios o Corporate executives and business-unit chiefs analyze financial ratios to determine processes to tear up and those to keep or expand. Inefficient processes may drive away profit opportunities and jobs, especially if a company must shed its workforce to maintain solvency. Management accounting metrics include net profit margin and return on equity. ROE equals net profit divided by shareholders’ equity. Net profit margin equals net income divided by total sales. 5. Technological Tools Organizations rely on various tools to tackle the often thorny issues of management accounting, performance monitoring and regulatory compliance. In the modern era, computer systems play a key role in the way firms record and analyze accounting data. Tools used to evaluate management accounting performance include financial analysis software, project management applications and enterprise resource planning programs. Other tools include industrial control software, calendar and scheduling programs, mainframe computers and computer-aided manufacturing applications. 6. Gap Analysis
A gap analysis is a useful method of measuring performance when there are already fixed performance standards. For example, you may have a goal of producing a certain number of units per month. This could be a performance standard. A gap analysis starts with the established performance measure. After looking at the established performance measure, a manager assesses the current performance level. Finally, the manager will calculate the difference between the performance standard and the actual standard. This provides the gap, which is an indication of how close a company has come to its performance standards.
The smaller the gap, the better the company’s performance. An advantage of this performance measure is that it provides an indication of what needs to be overcome in order to achieve the desired level of performance. LIMITATIONS OF ACCOUNTING INFORMATION IN PERFORMANCE EVALUATION (i) Accounting information is in terms of money. Accounting provides information on events and transactions that are of financial nature or can be expressed in terms of monetary unit. It does not give information in quantity or size terms of in qualitative matters like usefulness or efficient.
Non-monetary events or transactions are completely ignored however important these may be. (ii) Accounting information is expressed in monetary terms and it is assumed that a monetary unit is stable overtime. This is not true at all with the result that the impact of price level changes is not taken into consideration. The assets remain undervalued in many cases especially land and building. The direct outcome of this practice is that balance sheet figures of assets are not helpful in measuring the true financial positions of the enterprise. iii) Accountancy is as yet a inexact science and depends sometimes on a number of estimates, personal judgment etc. Estimates are inherently inaccurate and personal judgments introduce bias in the accounting information. It is not possible to predict with any degree of accuracy the actual useful life of an asset which is done for calculating the depreciation charge. The same is true about provision for doubtful debts. (iv) Accounting information cannot be used as only test of managerial performance. The focus of the financial information is on profit or income which is only ne small aspect of the annual story of business. Profits for a period of one year can readily be manipulated by suppressing such costs as advertisements, research and development, depreciation and so on. (v) Accounting information is not neutral or unbiased. Accountants measure income as conventionally defined: revenues less expenses. But accountants consider only selected revenues and expenses. They fail to give recognition to the benefits received by their efforts to clean up the environment, improve community welfare and introduce safety measures for the workers. vi) Accounting like other disciplines has to follow certain principles which in some cases are contradictory. Current assets are valued on the basis of cost or market price whichever is less following the principle of conservatism. Accordingly the current assets may be valued on cost basis in some year and at market price in another year. In this manner, the rule of consistency is openly violated. (VII) The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information.
In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required. (VIII).
Inability to reflect the true value of strategic management: Various factors such as goodwill and natural circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus, leading to their unavoidable exclusion from financial reports. For example companies depend upon their shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have been hired by the company based upon prior performance, their future performances are not reliably measurable as they may continually vary.
In the initial stages, it may be impossible to measure whether the CEO’s presence will deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise. (VIX). Measuring Volatility of external factors: Financial accounting information does not take into consideration volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a volatile and cosmetic impact upon the earnings of the firm.
For example, tariffs on trade, duties and other environmental issues can have significant short-term volatile effects on the organization Conclusively, In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc.
Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required. References: El-Shishimi, H. and Drury C. (2001) : Divisional Performance Measuring in UK companies, paper presented to the annual Congress of the European Accounting Association, Athens Esptein, M and Ray, M. J (1997):Eniromental Management to improve corporate profitability, Journal of cost management , November-December, pp 26-34 Kaplan R. S and Norton D.
P (2001) “ Transforming the balance scorecard from performance measurement to strategic management : part 2’, Accounting Horizons March, pp87 Kaplan, S. E. , and J. T. Mackey. 1992. An Examination of the association between organizational design factors and the use of accounting information for managerial performance evaluation. Journal of Management Accounting Research (4): 116-130. BABCOCK UNIVERSITY, ILISAN, OGUN STATE Performance Evaluation uses accounting information, limitation reconsidered Emerging issues Assignment BY ADEYEMI EBENEZER ADESUJI MATRIC NO NS/4270