financial results in the future (Neely, 2002). The Wharton School is committed to sharing its intellectual capital through the school’s online business journal, Knowledge@Wharton. They are also used to reward employees financially and measure if a company is meeting its goals. For many organizations, performance measures are quantitative. A non financial performance indicator measures the performance of organisations not using money/profit measures and can provide managers with incentives to improve long-term financial performance. Disclaimer 9. In an article on Oct. 16, 2000, in the Financial Times’ Mastering Management series, Wharton accounting professors Christopher Ittner and David Larcker suggest that financial data have limitations as a measure of company performance. More important, stock market and long-term accounting performance are both higher when these measurement gaps are smaller. Financial performance indicators (FPIs) - it is still important to monitor financial performance, e.g. A third of financial services companies, for example, made a major change in their performance measurement system during the past two years and 39% plan a major change within two years. Short- run profitability is only one of the factors contributing to a company’s long-run objectives. Gap analysis requires managers to rank performance measures on at least two dimensions: their importance to strategic objectives and the importance currently placed on them. Fourth on the list of problems with non-financial measures is lack of statistical reliability – whether a measure actually represents what it purports to represent, rather than random “measurement error”. Although non-financial measures are increasingly important in decision-making and performance evaluation, companies should not simply copy measures used by others. non-IFRS financial measures. In particular, the performance measure should support the corporate objectives and the competitive strategies of the organisation.”. Customer's satisfaction scores and input output efficiencies scores. Although there are many advantages to non-financial performance measures, they are not without drawbacks. All materials copyright of the Wharton School of the University of Pennsylvania. What do we mean by non-financial metrics? advantages Non-financial measures offer four clear advantages over measurement systems based on financial data. There are many non-financial performance measures that companies can use to examine how well their business is doing. The second drawback is that, unlike accounting measures, non-financial data are measured in many ways, there is no common denominator. As a result, Xerox shifted to a customer loyalty measure that was found to be a leading indicator of financial performance. Non-financial performance metrics such as customer loyalty, employee engagement, product quality, innovation quotient or market dominance have increasingly been … Often, the financial statements (e.g., balance sheet, income statement, and statement of cash flows) of a company are used to measure the financial performance of … Non-financial metrics are quantitative measures that cannot be expressed in monetary units. For example, interim research results or customer indices may offer an indication of future cash flows that would not be captured otherwise. Content Filtrations 6. In contrast, statistical analyses indicate these dimensions are strongly associated with a company’s market value. By excluding these intangible assets, financially oriented measurement can encourage managers to make poor, even harmful, decisions. Second, critics of traditional measures argue that drivers of success in many industries are “intangible assets” such as intellectual capital and customer loyalty, rather than the “hard assets” allowed on to balance sheets. Below is the text of their article. Following points help in understanding the importance of non-financial measures; 1. Common financial metrics include earnings, profit margin, average order value, and return on assets. Xerox, for example, spent millions of dollars on customer surveys, under the assumption that improvements in satisfaction translated into better financial performance. (Dr. They do not deal with progress relative to customer requirements or competitors, nor other non-financial objectives that may be important in achieving profitability, competitive strength and longer-term strategic goals. Kaplan and Norton consider BSC as ‘ Organisational performance management tool’. The topic of alternative (or non-GAAP) performance measures (APMs) regularly appears in the financial press. First of these is a closer link to long-term organizational strategies. Today there is greater emphasis on non-financial and multi-dimensional performance measures to understand and manage the performance of the organisation to achieve its goals. More importantly, the results also suggest that (1) the process by which nonfinancial measures affect employee job satisfaction is not different from that of financial measures, and (2) the relative importance of nonfinancial measures vis-à-vis financial measures has … To avoid “reinventing the wheel”, an inventory of current measures should be made. A second method is to use standard classifications such as financial, internal business process, customer, learning and growth categories. By informing the lower-level managers about the significance of non-financial measures and goals, and long-run factors as well, top management can duly minimise the tendency to over-emphasise ROI and RI. Also, these techniques are short-term measures and division managers may be tempted, therefore, to derive short-term benefits (through using these measures) at the expense of long-term benefit of the company. The issue at this stage is the extent to which current measures are aligned with the company’s strategies and value drivers. Perhaps the most sophisticated method of determining value drivers is statistical analysis of the leading and lagging indicators of financial performance. For example, revenue that a company earns from selling the product last year. For example, if the customer line wait is too long, then improving employee training or hiring more employees could improve the output (decrease customer line wait). Non-financial performance measures are performance measures that are not communicated in currency-based terms. Others assign arbitrary weightings to the various goals. Non-financial performance indicators (NFPIs) - these measures will reflect the long-term viability and health of the organisation. Really, in essence, two steps here. Most companies track hundreds, if not thousands, of non-financial measures in their day-to-day operations. This article discusses the advantages and disadvantages of non-financial performance measures and offers suggestions for implementation. Non-GAAP financial measures are numerical measures of a company’s historical or future financial performance, financial position, or cash flows that adjust GAAP amounts in some fashion and are intended to supplement the company’s GAAP disclosures. There are common ones, and ones that are industry of business specific. Sign up for the weekly Knowledge@Wharton e-mail newsletter, offering business leaders cutting-edge research and ideas from Wharton faculty and other experts. Here’s the situation: the job of a CFO continues to evolve alongside technology. The input measures are used to improve the output measures. These measures focus on the long-term success and the qualitative aspects of a business. Consider, for example, investments in research and development or customer satisfaction programs. Finally, although financial measures are unlikely to capture fully the many dimensions of organizational performance, implementing an evaluation system with too many measures can lead to “measurement disintegration”. The additional non-financial measures or multiple measures of performance are market share, customers’ complaints, personnel turnover ratios, personnel training and development, product or service quality, delivery reliability, minimisation of wastages and losses etc. Non financial measures are often linked to either the inputs or outputs of an activity or process. We will discuss these measures in this unit. Privacy Policy 8. is a balanced set of measures that organizations use to motivate employees and evaluate performance. Prohibited Content 3. The need for digital transformation in companies is obvious and urgent. Unknown or unverified causal links create two problems when evaluating performance: incorrect measures focus attention on the wrong objectives and improvements cannot be linked to later outcomes. Our survey of 148 US financial services companies — a joint research project sponsored by the Cap Gemini Ernst & Young Center for Business Innovation and the Wharton Research Program on Value Creation in Organizations – found significant “measurement gaps” for many non-financial measures. A greater number of diverse performance measures frequently requires significant investment in information systems to draw information from multiple (and often incompatible) databases. Yet many managers feel traditional financially oriented systems no longer work adequately. Non-financial performance measurement: Non-financial performance measurement is a measure for establishment of non-financial indicators of a business. For example, many executives rate environmental performance and quality as relatively unimportant drivers of long-term financial performance. Since the choice of performance measures has a substantial impact on employees’ careers and pay, controversy is bound to emerge no matter how appropriate the measures. Consider, for example, investments in research and development or customer satisfaction programs. Measurement refers to numerical information that quantifies input, output, and performance dimensions of processes, products, services, and the overall organisation (outcomes). While this seems intuitive, experience indicates that companies do a poor job determining and articulating these drivers. However, executives’ rankings of value drivers may not reflect their true importance. This study examines whether non-financial performance measures (NFPMs) included in CEO bonus contracts (hereafter, bonus contracts) are complementary to the use of equity-based compensation, and whether NFPMs and equity-based compensation jointly explain future firm … Once known, these factors determine which measures contribute to long-term success and so how to translate corporate objectives into measures that guide managers’ actions. Development can consume considerable time and expense, not least of which is selling the system to skeptical employees who have learned to operate under existing rules. Likewise, a specific division may have invested on providing training, education, job enrichment and development, whereas some other division might have totally neglected these activities. First, the firm needs to identify a strategy, and second, they need to design objectives and measures to ultimately achieve that strategy. For example, two divisional managers having equal amounts of investments in their respective divisions, may also have similar ROI and RI. Fryer (and other cooking equipment) reliability. In short BSC is a framework used for evaluating business performance of a company. Content Guidelines 2. using ROCE, EBITDA, EVA. Evaluating performance using multiple measures that can conflict in the short term can also be time-consuming. Lack of causal links is a third issue. The two note that other measures, such as quality, may be better at forecasting, but can be difficult to implement. New research from Wharton’s Santiago Gallino and Robert Rooderkerk of Erasmus University offers companies practical advice on how to develop new products that are ready to compete in an omnichannel world. Financial measures are incomplete and metrics are rarely providing much of valuable information about performance like non-financial data (Kotane and Kuzmina-Merlino, 2011; Merril et … A nonfinancial performance measure expresses performance in a measure other than money. We investigate the relationship between internal performance evaluation and the ability of external market participants to assess the effectiveness of management’s quality strategy for a sample of 156 Australian manufacturing firms that link executive compensation to non-financial performance measures (NFPM). However, like all subjective assessments, these methods can lead to considerable error. performance measures are measures such as firm profit and earnings per share; non-financial performance measures are measures such as market share, efficiency, and leadership. One major car manufacturer, for example, structures executive bonuses so: 40% based on warranty repairs per 100 vehicles sold; 20% on customer satisfaction surveys; 20% on market share; and 20% on accounting performance (pre-tax earnings). First of these is a closer link to long-term organizational strategies. Under U.S. accounting rules, research and development expenditures and marketing costs must be charged for in the period they are incurred, so reducing profits. Answer: The balanced scorecard A balanced set of financial and nonfinancial measures used by organizations to motivate employees and evaluate performance. Difference between financial performance measurement and non-financial performance measurement: This is understandable given the varied uses for, and opinions on, such measures. Report a Violation, Service Performance and Measurement: Improvement and Procedure, Financial Measures for Evaluating Division’s Performance, Return on Investment (ROI): Advantages and Disadvantages. For example, shortly after becoming the first US company to win Japan’s prestigious Deming Prize for quality improvement, Florida Power and Light found that employees believed the company’s quality improvement process placed too much emphasis on reporting, presenting and discussing a myriad of quality indicators. However, this does not surely mean that their performances are also equal. Financial evaluation systems generally focus on annual or short-term performance … Such measures are often used to evaluate the time, quality or quantity of a business activity. In addition, companies should remember that performance measurement choice is a dynamic process – measures may be appropriate today, but the system needs to be continually reassessed as strategies and competitive environments evolve. Regardless of any innovation in automation and artificial intelligence, there are critical financial performance measures that will remain of constant concern for financial operations, such as … The following inputs/outputs could be identified for providing customer service: The customer service outputs of the counter service activity include the following: 2. One method for assessing this alignment is “gap analysis”. They felt this deprived them of time that could be better spent serving customers. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. But many businesses, especially those burdened by legacy systems, still struggle to transform their operations to cater to the increasingly empowered digital customer. The non-IFRS financial measures that we report should only be considered in addition to, and not as substitutes for, or superior to, our –IFRS financial measures. This is not easy. Non-financial measures have found increasing acceptance in the business world--however, their application in the health care industry remains limited. Consider, for example, investments in research and development or customer satisfaction programs. Choosing performance measures is a challenge. Third, non-financial measures can be better indicators of future financial performance. Percent order accuracy in serving the customer, 3. Specifically, non-financial performance measures flow from the firm's strategy. For example, 72% of companies said customer-related performance was an extremely important driver of long-term success, against 31% who chose short-term financial performance. Managers tend to use one of three methods to identify value drivers, the most common being intuition. The lack of an explicit casual model of the relations between measures also contributes to difficulties in evaluating their relative importance. Once measures have been documented, their value for performance measurement can be assessed. Similar disparities exist for non-financial measures related to employee performance, operational results, quality, alliances, supplier relations, innovation, community and the environment. Before publishing your articles on this site, please read the following pages: 1. The indicators should be based on the company’s strategy and include key measures of manufacturing, marketing and R and D systems. Although it is difficult to quantify intangible assets in financial terms, non-financial data can provide indirect, quantitative indicators of a firm’s intangible assets. Image Guidelines 5. A brief list of non-financial measures of performance is given in Exhibit 11.8. Many companies adopt non-financial measures without articulating the relations between the measures or verifying that they have a bearing on accounting and stock price performance. Inadequacies in financial performance measures have led to innovations ranging from non-financial indicators of “intangible assets” and “intellectual capital” to “balanced scorecards” of integrated financial and non-financial measures. However, the quality of short-term financial measurement is considerably better than measurement of customer satisfaction. Performance measurement has evolved from purely financial performance measures such as profit, cash flow or the return on capital employed (ROCE). http://media.blubrry.com/kw/p/d1c25a6gwz7q5e.cloudfront.net/audio/Article279.mp3, Why India’s V-Shaped Economic Recovery Falls Short, The Omnichannel Dilemma: How Retailers Can Get It Right, How Companies Can Leverage Technology to Deliver Hyper-Personalized Services. Some of the inputs that impact the customer service outputs include the following: 4. Performance measurement systems play a key role in developing strategy, evaluating the achievement of organizational objectives and compensating managers. Many companies have failed to benefit from non-financial performance measures through being reluctant to take this step. Noise refers to changes in the performance measure that are beyond the control of the manager or organization, ranging from changes in the economy to luck (good or bad). Plagiarism Prevention 4. For example, one division might have provided excellent customer service and thereby has created customer goodwill and reputation for the company. Johnson and Kaplan have emphasised the importance of non-financial measures and comment in the following manner: “More important than attempting to measure monthly or quarterly profits is measuring and reporting a variety of non-financial indicators. These measures generally exhibit poor statistical reliability, reducing their ability to discriminate superior performance or predict future financial results. The company responded by eliminating most quality reviews, reducing the number of indicators tracked and minimizing reports and meetings. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. Many companies attempt to overcome this by rating each performance measure in terms of its strategic importance (from, say, not important to extremely important) and then evaluating overall performance based on a weighted average of the measures. Colin Drury also advises considering other measures of performance in the following words: “ROI and Residual income can not stand alone as a measure of divisional performance. Third, non-financial measures can be better indicators of future financial performance. For example, a company emphasising quality could measure internal failure indicators – scrap, network, part-per- million defect rates, unscheduled machine down-time and external failure indicators – customer complaints, warranty expenses and service calls. The purpose of this article is to understand the influence of non-financial measures (efficiency, productivity, and quality) on the financial performance of for-profit system hospitals. A nonfinancial performance measure expresses performance in a measure other than money. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. In response, companies are implementing new performance measurement systems. Bureaucracies can cause the measurement process to degenerate into mechanistic exercises that add little to reaching strategic goals. Also, financial and non-financial goals and targets are often included as a part of a divisional manager’s plan and responsibility. Because many non-financial measures are less susceptible to external noise than accounting measures, their use may improve managers’ performance by providing more precise evaluation of their actions. Non-financial measures offer four clear advantages over measurement systems based on financial data. There are whole host of examples of non-financial performance measures, a few are product quality rating. But successful research improves future profits if it can be brought to market. By the time companies overhaul their[…]. Financial performance measures are outlined in the financial statements of companies. It is rightly claimed that any financial measures like ROI and RI have drawbacks while evaluating divisional performance, since it is virtually impossible to capture in one financial measure all the variables that measure the success of a division. Non financial measures of performance In recent years we have seen major changes in the business world, including deregulation, the growing expectations of shareholders (the business owners) and the impact of new technology. This occurs when an overabundance of measures dilutes the effect of the measurement process. Non-financial performance measures can provide deep insights into inner workings of your business and serve as leading indicators of future financial performance. 1. The other division might have done very poorly in the area of customer service. Finally, the choice of measures should be based on providing information about managerial actions and the level of “noise” in the measures. Without knowing the size and timing of associations among measures, companies find it difficult to make decisions or measure success based on them. Get Knowledge@Wharton delivered to your inbox every week. ROI and RI both are recognised as important measures for evaluating the performance of a divi­sion. Divisional performance measurement should also measure those other factors that are critical to the success of the organisation. A recent survey of U.S. financial services companies found most were not satisfied with their measurement systems. Balanced Scorecard (BSC) Approach As it is mostly known, the BSC strikes the balance between the financial and non financial measures of performance. A process is a sequence of activities for performing a task. Third, non-financial measures can be better indicators of future financial performance. The choice of measures must be linked to factors such as corporate strategy, value drivers, organizational objectives and the competitive environment. The output measures tell management how the activity is performing, such as keeping the line wait to a minimum. Moreover, these categories do little to help determine weightings for each dimension. The starting point is understanding a company’s value drivers, the factors that create stakeholder value. Non-financial data can provide the missing link between these beneficial activities and financial results by providing forward-looking information on accounting or stock performance. These measures support the financial measures or KPI (key performance indicators). Unfortunately, relatively few companies develop such causal business models when selecting their performance measures. Later analysis found no such association. Performance measures are typically used by organizations to implement and drive strategic objectives. Time and cost has been a problem for some companies. Research has identified five primary limitations. A fast-food restaurant can develop a set of linked nonfinancial performance measures across inputs and outputs. We look at how recent regulator focus on the clarity of explanations of APMs fits into the recurring debate. Our non-IFRS financial measures may not connectioncorrespond to non-IFRS financial measures that other companies report. Obviously, difference in the different divisions on account of non-performance of these and similar activities will not enter into ROI and RI calculated for different divisions. However, as we stated, it is important to have a range of performance measures considering non-financial as well as financial matters. The income statement, balance sheet and cash flow statements can be used in a variety of ways through horizontal, vertical and ratio analysis to determine the best ways for companies to … For example, new product development or expanding organizational capabilities may be important strategic goals, but may hinder short-term accounting performance. Many non-financial data such as satisfaction measures are based on surveys with few respondents and few questions. To illustrate, the counter service activity of a fast-food restaurant such as McDonald is used. Measures such as customer satisfaction, market share, category ownership, and new product adoption rate fall into the non-financial metrics. The non-financial measures are vital to the success of a division and also to the overall success of a firm. For example, airlines use on-time performance, percent of bags lost, and number of customer complaints as nonfinancial performance measures. Most financial measures are lagging indicators, which means they reflect what has already happened. Performance can be expressed in non-financial and financial terms. However, these and other financial measures are not considered fully adequate to evaluate the performance of a responsibility centre. Hence, it has been argued that additional non-financial measures should be used to evaluate a division’s performance besides using ROI and RI techniques. One bank that adopted a performance evaluation system using multiple accounting and non-financial measures saw the time required for area directors to evaluate branch managers increase from less than one day per quarter to six days. They believed there was too much emphasis on financial measures such as earnings and accounting returns and little emphasis on drivers of value such as customer and employee satisfaction, innovation and quality. TOS 7. Consequently, the use of strategic performance measurement systems (SPMSs), namely the Balanced Scorecard (BSC), is proposed to communicate non-financial measures to investors and stakeholders. This also lowers the risk imposed on managers when determining pay. Finally, after measures are chosen, they must become an integral part of reporting and performance evaluation if they are to affect employee behavior and organizational performance. Rather than attempting to extract such informa­tion from a system designed primarily to satisfy external reporting and auditing requirements, we should design systems consistent with the technology of the organisation, its product strategy and its organisation structure.”. Return on investment and residual income are short-run concepts that deal only with the past year, whereas managerial performance measures should focus on future results that can be expected because of present actions. 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