Performance measurement for adding value
Throughout the course of business activity an entrepreneur will constantly strive to add value into the business. Considering that only firms with historical performance and growth can be measured directly and with full confidence the owner of the business needs to be able to measure value adding progress on an on-going manner.
Businesses of all sizes and in all industries are subject to macro-economic conditions prevailing within the market they operate, and in some cases this market conditions can be of global outreach. The idea of a global village is already upon us. For a profit-seeking firm this means that they cannot avoid global trends even in those cases when they only operate locally. This is a very broad description of circumstances, since there are always exceptions to the rule. As was the case with previous articles, subject of this work is for-profit small and medium size firms (SME).
The idea of measuring performance is about understanding how well the firm is doing, or going back at the start of the business life the owner needs to be able to measure the value being added to business. In most of the cases owner, investors, board of directors in larger firms, are happy when share price, profit, and earnings per share go up. Unfortunately, when situations like this happen to coincide with favourable macro-economic conditions this feeling can be turned into complacency. In the same way declining share price may not result from a bad asset management, always considering that the firm will be subject to macro-economic conditions and global trends. Examples on both sides of the spectrum are countless. Some of them were so extreme that they have become legendary and now serve as classic textbook examples.
Information technology is continuing to revolutionise business processes and models in most of the industries and as result of new technology new ones are being created. Complacency of comfortable end results is more common with severe consequences for the firms in question. From the viewpoint of managing business it has made it more difficult since it is causing more volatility in the market and in the business life cycle, making necessary that firms stay updated with market news and trends. For performance measurement this means that it has shifted its attention and form period reporting into actionable inputs for decision making.
This shift of performance measurement from reporting into monitoring and recommendation means that new set of metrics have to be developed serving the need for long-term health of the firm in line with expected macro-economic conditions and market trends. For example, even in cases that certain product has above average returns in the past if macro-economic conditions and global trends tell of declining market demand there is no point in continuing developing that product. In fact, one form of adding value is through divesting.
In broad terms, idea generated from the owner or senior management, performance measurement could be organised around two questions;
1. What is firm’s position alongside market conditions and future trends in creating value, and what risks could prevent this value creation?
2. Is the firm’s current value in line with its historical performance (in case where such records exist), or, what is potential economic value creation for the firm as a whole or specific product line?
The first question looks at the firm’s health by examining key drivers of its financial performance. Specifically, how did the firm achieve its most recent result, and did the firm sacrifice future performance to achieve these results. For example, does the firm has the right product, people and processes to continue to create value considering forthcoming macro-economic conditions and market trend? Another approach would be to assess potential risks and the procedures that firm has in place to prevent and manage those risks.
The second question would be to measure performance by looking at financial results or share price when possible. However, examining financial statement results without considering context may very easily lead to mistaken conclusions. When evaluating profit figures measurement must also take into consideration factors outside management control.
In any case management’s ability to measure performance in a holistic way is superior to the questions raised. This sort of methodology will help managers to prioritise tasks and switch between short and long term goals on a case by case basis. This seems perfect approach for smaller firms where decision lies with a single person. With larger firms with several layers of management this sounds unworkable.
An important element of adding value process is measurement of organisational health. It assesses potential of the firm by looking into people, skill and culture to maintain and improve performance. In practice this would differ depending on the industry, although in every case the firm’s management should be aware of its culture which will push forward its workforce towards adding value. Well educated and well trained workforce is key to meeting market challenges in a modern rapidly changing environment. However, for example, training should be organised alongside future needs of the individual on expected assumption of new responsibilities. Therefore, training would be assessed on employee’s ability on taking new task after completed training and quality of the task completed.
Some of the measurements are very common and been around for so long that it is very easy to be applied in a new environment and for decision making. Typically, financial statement ratios can be easily translated into target setting measures which will then be continuously monitored. As mentioned, an advantage of smaller firms lays on that that decision making is more concentrated enabling them to react quickly to changing market conditions.