Measures such as customer satisfaction, market share, category ownership, and new product adoption rate fall into the non-financial metrics. 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. is a balanced set of measures that organizations use to motivate employees and evaluate performance. Non-financial measures include any quantitative measure of either an individual’s or an entity’s performance that is not expressed in monetary units. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. Xerox, for example, spent millions of dollars on customer surveys, under the assumption that improvements in satisfaction translated into better financial performance. Performance measures might be simple (derived from one measurement) or composite. 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”. Most financial measures are lagging indicators, which means they reflect what has already happened. 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. The resulting “causal business model” can help determine which measures predict future financial performance and can assist in assigning weightings to measures based on the strength of the statistical relation. Plagiarism Prevention 4. Managers tend to use one of three methods to identify value drivers, the most common being intuition. The indicators should be based on the company’s strategy and include key measures of manufacturing, marketing and R and D systems. Research has identified five primary limitations. Such measures are often used to evaluate the time, quality or quantity of a business activity. Difference between financial performance measurement and non-financial performance measurement: This article discusses the advantages and disadvantages of non-financial performance measures and offers suggestions for implementation. The lack of an explicit casual model of the relations between measures also contributes to difficulties in evaluating their relative importance. All materials copyright of the Wharton School of the University of Pennsylvania. Report a Violation, Service Performance and Measurement: Improvement and Procedure, Financial Measures for Evaluating Division’s Performance, Return on Investment (ROI): Advantages and Disadvantages. Some of the inputs that impact the customer service outputs include the following: 4. First of these is a closer link to long-term organizational strategies. Many non-financial data such as satisfaction measures are based on surveys with few respondents and few questions. Fryer (and other cooking equipment) reliability. By excluding these intangible assets, financially oriented measurement can encourage managers to make poor, even harmful, decisions. 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. 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 … 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. Time and cost has been a problem for some companies. Non-financial performance measures can provide deep insights into inner workings of your business and serve as leading indicators of future financial performance. 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. Divisional performance measurement should also measure those other factors that are critical to the success of the organisation. However, as we stated, it is important to have a range of performance measures considering non-financial as well as financial matters. Bureaucracies can cause the measurement process to degenerate into mechanistic exercises that add little to reaching strategic goals. Performance measurement systems play a key role in developing strategy, evaluating the achievement of organizational objectives and compensating managers. Having a complete understanding of these factors can add another layer to financial metrics and help frame financial results. Prohibited Content 3. 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. 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. Friendly service experience for the customer. Non-financial performance indicators (NFPIs) - these measures will reflect the long-term viability and health of the organisation. Managers must be aware of how much success is due to their actions or they will not have the signals they need to maximize their effect on performance. Introduction. 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. Performance can be expressed in non-financial and financial terms. Later analysis found no such association. As a result, Xerox shifted to a customer loyalty measure that was found to be a leading indicator of financial performance. The second drawback is that, unlike accounting measures, non-financial data are measured in many ways, there is no common denominator. For example, revenue that a company earns from selling the product last year. They have found the costs of a system that tracks a large number of financial and non-financial measures can be greater than its benefits. Let’s look at something called the “balanced scorecard.” The Wharton School is committed to sharing its intellectual capital through the school’s online business journal, Knowledge@Wharton. In contrast, statistical analyses indicate these dimensions are strongly associated with a company’s market value. Managers chase a variety of measures simultaneously, while achieving little gain in the main drivers of success. The input measures are used to improve the output measures. There are whole host of examples of non-financial performance measures, a few are product quality rating. Similarly, investments in customer satisfaction can improve subsequent economic performance by increasing revenues and loyalty of existing customers, attracting new customers and reducing transaction costs. Percent order accuracy in serving the customer, 3. Content Guidelines 2. Financial performance indicators (FPIs) - it is still important to monitor financial performance, e.g. Consider, for example, investments in research and development or customer satisfaction programs. Financial evaluation systems generally focus on annual or short-term performance against accounting yardsticks. Without knowing the size and timing of associations among measures, companies find it difficult to make decisions or measure success based on them. Non-financial metrics are quantitative measures that cannot be expressed in monetary units. 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. Once measures have been documented, their value for performance measurement can be assessed. But successful research improves future profits if it can be brought to market. Morissette (1996) provides a widely accepted definition of non-financial performance indicators. 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. For example, new product development or expanding organizational capabilities may be important strategic goals, but may hinder short-term accounting performance. Short- run profitability is only one of the factors contributing to a company’s long-run objectives. 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. 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. 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. While these may be appropriate, other non-financial dimensions may be more important, depending on the organization’s strategy, competitive environment and objectives. ROI and RI both are recognised as important measures for evaluating the performance of a divi­sion. However, the quality of short-term financial measurement is considerably better than measurement of customer satisfaction. These measures are typically separated into four perspectives outlined in the following. Although non-financial measures are increasingly important in decision-making and performance evaluation, companies should not simply copy measures used by others. Consider, for example, investments in research and development or customer satisfaction programs. 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. This is understandable given the varied uses for, and opinions on, such measures. 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. Before publishing your articles on this site, please read the following pages: 1. Performance measurement has evolved from purely financial performance measures such as profit, cash flow or the return on capital employed (ROCE). For example, two divisional managers having equal amounts of investments in their respective divisions, may also have similar ROI and RI. 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 … Evaluating performance using multiple measures that can conflict in the short term can also be time-consuming. TOS 7. Although there are many advantages to non-financial performance measures, they are not without drawbacks. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. Disclaimer 9. In particular, the performance measure should support the corporate objectives and the competitive strategies of the organisation.”. In short BSC is a framework used for evaluating business performance of a company. The issue at this stage is the extent to which current measures are aligned with the company’s strategies and value drivers. However, these and other financial measures are not considered fully adequate to evaluate the performance of a responsibility centre. 1. For example, interim research results or customer indices may offer an indication of future cash flows that would not be captured otherwise. The following inputs/outputs could be identified for providing customer service: The customer service outputs of the counter service activity include the following: 2. While this seems intuitive, experience indicates that companies do a poor job determining and articulating these drivers. The easiest way to define non-financial performance measures is to Here’s the situation: the job of a CFO continues to evolve alongside technology. 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). 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 performance measures are performance measures that are not communicated in currency-based terms. Such measures are often used to evaluate the time, quality or quantity of a business activity. 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). 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. The starting point is understanding a company’s value drivers, the factors that create stakeholder value. 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. It found that measures related to innovation, management capability, employee relations, quality and brand value explained a significant proportion of a company’s value, even allowing for accounting assets and liabilities. 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. Many companies have failed to benefit from non-financial performance measures through being reluctant to take this step. 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. Moreover, these categories do little to help determine weightings for each dimension. 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. financial results in the future (Neely, 2002). 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 … For many organizations, performance measures are quantitative. Thus, management uses non-financial measures to get an idea of future finan… 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. Answer: The balanced scorecard A balanced set of financial and nonfinancial measures used by organizations to motivate employees and evaluate performance. The choice of measures must be linked to factors such as corporate strategy, value drivers, organizational objectives and the competitive environment. There are a number of problems associated with the exclusive use of financial performance indicatorsto monitor performance: 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. 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”. There are common ones, and ones that are industry of business specific. This 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. Headlines about India’s encouraging economic indicators mask the ground realities, according to new research co-authored by Wharton’s Heather Schofield. 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. 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. One method for assessing this alignment is “gap analysis”. For example, many executives rate environmental performance and quality as relatively unimportant drivers of long-term financial performance. 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 … First, the firm needs to identify a strategy, and second, they need to design objectives and measures to ultimately achieve that strategy. However, like all subjective assessments, these methods can lead to considerable error. This also lowers the risk imposed on managers when determining pay. Balanced Scorecard (BSC) Approach As it is mostly known, the BSC strikes the balance between the financial and non financial measures of 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.”. Performance measures are typically used by organizations to implement and drive strategic objectives. 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). Following points help in understanding the importance of non-financial measures; 1. There are many non-financial performance measures that companies can use to examine how well their business is doing. 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. Choosing performance measures is a challenge. Finally, the choice of measures should be based on providing information about managerial actions and the level of “noise” in the measures. A nonfinancial performance measure expresses performance in a measure other than money. Really, in essence, two steps here. The two note that other measures, such as quality, may be better at forecasting, but can be difficult to implement. Similar disparities exist for non-financial measures related to employee performance, operational results, quality, alliances, supplier relations, innovation, community and the environment. 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. A second method is to use standard classifications such as financial, internal business process, customer, learning and growth categories. In response, companies are implementing new performance measurement systems. What do we mean by non-financial metrics? The non-financial measures are vital to the success of a division and also to the overall success of a firm. To illustrate, the counter service activity of a fast-food restaurant such as McDonald is used. For example, airlines use on-time performance, percent of bags lost, and number of customer complaints as nonfinancial performance measures. Copyright 10. For example, one division might have provided excellent customer service and thereby has created customer goodwill and reputation for the company. 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. The output measures tell management how the activity is performing, such as keeping the line wait to a minimum. advantages Non-financial measures offer four clear advantages over measurement systems based on financial data. non-IFRS financial measures. Measurement refers to numerical information that quantifies input, output, and performance dimensions of processes, products, services, and the overall organisation (outcomes). 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. Others assign arbitrary weightings to the various goals. Consider, for example, investments in research and development or customer satisfaction programs. A brief list of non-financial measures of performance is given in Exhibit 11.8. Non financial measures are often linked to either the inputs or outputs of an activity or process. In general, financial performance is easy to measure (earning per share, profit, dividends, EVA etc) but these measurements do not tell managers why financial performance has improved. Third, non-financial measures can be better indicators of future financial performance. 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. These measures support the financial measures or KPI (key performance indicators). By supplementing accounting measures with non-financial data about strategic performance and implementation of strategic plans, companies can communicate objectives and provide incentives for managers to address long-term strategy. The need for digital transformation in companies is obvious and urgent. More important, stock market and long-term accounting performance are both higher when these measurement gaps are smaller. Financial evaluation systems generally focus on annual or short-term performance … First of these is a closer link to long-term organizational strategies. The other division might have done very poorly in the area of customer service. For example, airlines use on-time performance, percent of bags lost, and number of customer complaints as nonfinancial performance measures. Privacy Policy 8. 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). By the time companies overhaul their[…]. Yet many managers feel traditional financially oriented systems no longer work adequately. However, this does not surely mean that their performances are also equal. 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. This occurs when an overabundance of measures dilutes the effect of the measurement process. Our non-IFRS financial measures may not connectioncorrespond to non-IFRS financial measures that other companies report. Once managers have determined that the expected benefits from non-financial data outweigh the costs, three steps can be used to select and implement appropriate measures. These measures focus on the long-term success and the qualitative aspects of a business. Get Knowledge@Wharton delivered to your inbox every week. 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. A recent survey of U.S. financial services companies found most were not satisfied with their measurement systems. A process is a sequence of activities for performing a task. One study examined the ability of non-financial indicators of “intangible assets” to explain differences in US companies’ stock market values. But many businesses, especially those burdened by legacy systems, still struggle to transform their operations to cater to the increasingly empowered digital customer. However, executives’ rankings of value drivers may not reflect their true importance. Non-financial performance measurement: Non-financial performance measurement is a measure for establishment of non-financial indicators of a business. They felt this deprived them of time that could be better spent serving customers. Unfortunately, relatively few companies develop such causal business models when selecting their performance measures. Also, financial and non-financial goals and targets are often included as a part of a divisional manager’s plan and responsibility. They are also used to reward employees financially and measure if a company is meeting its goals.