Table of Contents

Introduction

Performance evaluation is a very important aspect of human resource management because it gives a company the opportunity to measure people’s behavior and how efficient they are.

This report is aimed at giving an overview of divisional performance measurement for divisional managers and what criteria are used to evaluate the performances. The report will be giving tools such as return on investment, residual income and profit margin, in carrying out this evaluation.

Finally, limitations to using these tools for evaluation will be given.

Divisional Performance Measurement

Performance measurement is used by many organisations to determine how people in the organisation behave by evaluating their performances and giving feedback (Mullins, 2002).

A division is a subset or segment within an organisation with a divisional chief who is responsible for most business activities and profitability of that segment (Drury and EL-Shishini, 2005). Divisional chiefs can also be accountable for investment activities. According to Merchant (1998), because manager’s performance are measured by factors that are controlled by managers, the performance of divisional should only include those factors that are controllable by the divisional managers. Divisional managerial performance does not involve costs that can not be controlled or influenced by the divisional manager (Drury and EL-Shishini, 2005). Uncontrollable factors include;

Uncontrollable changes in the environment (competition, economic, political and legal factors)
Group general costs
Uncontrollable cost of common resources like; training, personnel, group planning, internal auditing, legal services

There are three types of performance evaluation in a division. They include; Economic (Activity) Evaluation, Operations evaluation and Managerial evaluation. Operations evaluation is concerned with measuring performance on a day to day basis in relationship with competitors and plans made by the division and company. Management accounting is a very important tool used to evaluate divisional performance. There should be a clear distinction between economic and divisional managerial performance in order to better understand how performance for divisional managers can be evaluated.

Tools used to measure performance

A divisional controllable profit is one way to measure performance for divisional managers. Divisional controllable profits are used to measure divisional managerial performance because they involves only those factors (revenues and expenses), that can be controlled or influenced by divisional managers (Drury and EL-Shishini, 2005). Divisional contribution to corporate sustaining costs (cost incurred as a result of the division operating as a separate entity) and profits and divisional net income are used to evaluate economic performance because they are uncontrollable costs and need to be avoided by the division.

Return on investment (ROI) is tool that is used by most companies to compare their financial performance and percentage return on investment in different sizes of businesses or divisions with a group (Drury and EL-Shishini, 2005). It is important for a company because it provides useful information for flexible measures of return on capital invested and managerial performance (Johnson and Kaplan, 1987). ROI is mostly used to evaluate economic performance of a division to ensure consistency with figures from financial reports (Drury and EL-Shishini, 2005). On the other hand, ROI could be a major weakness when used to measure divisional managerial performance; rather, residual income could be more useful to measure divisional managerial performance. According to Drury and EL-Shishini (2005)

“Controllable residual income involves deducting from controllable profit a cost of capital charge on the investment controllable by the divisional manager”

This is used because a positive net present value (NPV) might increase the possibility for divisional manager to invest in a project (Drury and EL-Shishini, 2005). This is a more flexible because different cost of capital can be related or incorporated with different investments with different risks (Drury and EL-Shishini, 2005). Residual income are not widely used by companies; most companies use ROI (Skinner, 1990). This because ROI is a ratio and can be used to compare different divisions within a company and is also used by most outsiders to measure the performance of a company – therefore corporate managers ask divisional managers to use ROI as a form of measurement to match that of outsiders (Drury and EL-Shishini, 2005).

Managerial performance can also be measured using what is know by cost centre as described as a means of maximising output given a total cost, but also minimising cost of given output and average cost. This means divisional managers are under constrain to maximise output by making maximum use of resources and using same cost budget.

Profit margins are also used to measure divisional managerial performance. This is the percentage of profits made over a unit of sales in the company (Drury and EL-Shishini, 2005). The performance of the manager of a division can be evaluated by looking at if the division is making a profit or a loss.

Asset turnover is also used to measure performance of divisional managers. This is how much in sales is generated from £1 of assets invested in the company (Drury and EL-Shishini, 2005). This shows how well managers are making use of the assets in their division by optimising their use (Drury and EL-Shishini, 2005). Asset turnover and profit margin can reflect on ROI, in that any changes in them will bring about a change in ROI.

Limitations

Using financial performance measurement to measure the performance will only focus on short term managerial performance evaluation rather than long term evaluation (Drury and EL-Shishini, 2005). This encourage managers to be more short term oriented than looking into the long term and what they can achieve during this period. Short term measurement does not encourage managers to accept positive NPV investment that have a long term payoff (Drury and EL-Shishini, 2005). This financial performance measure also deals with present reports, making it more short term than long term.

References

Merchant, K A, (1998) Modern Management Control Systems: Text and Cases, Prentice Hall, Upper Saddle River, New Jersey

Johnson, T and Kaplan, R S, (1987) Relevance Lost: the Rise and Fall of Management Accounting, Harvard Business School Press, Boston.

Skinner, R C, (1990) ‘The Role of Profitability in Divisional Decision Making and Performance Evaluation,’ Accounting and Business Research, vol. 20, no. 78, 135-141.

C Drury and H EL-Shishini (2005) Divisional Performance Measurement: An Examination of the Potential Explanatory Factors. CIMA

Mullins, Laurie (2002). Management and organisational Behaviour. 6^th Edition. Harlow, Prentice hall