ACCA p5 EW 2011

Chapter 1: Strategic management accounting 1 Chapter 2: Strategic planning techniques 31 Chapter 4: Changes in business structure and management accounting 77 Chapter 5: External factors

ACCA

Advanced Performance Management

Paper P5

Advanced performance

management

Publishing

Welcome to Emile Woolf‘s study text for

Paper P5 Advanced Performance Management which

Third edition published by

Chapter 1: Strategic management accounting 1

Chapter 2: Strategic planning techniques 31

Chapter 4: Changes in business structure and management accounting 77

Chapter 5: External factors on organisational performance 95

Chapter 6: Performance measurement systems and design 119

Chapter 7: Strategic performance measurement 227

Chapter 8: Decentralisation and divisional performance 247

Chapter 10: Japanese business practices and management accounting techniques 295

Chapter 12: Performance measurement and strategic HRM issues 331

Chapter 13: Strategic models and performance measurement 375

Chapter 14: Alternative views of performance measurement 387

Chapter 15: Current developments and emerging issues in performance

management 375 Appendix 1: Revision: ABC and other accounting methods 387

Appendix 2: Accounting for decision-making 411

Appendix 3: Decision-making with risk and uncertainty 431

Appendix 4: Budgeting and quantitative techniques in budgeting 447

Appendix 5: Discounted Cash Flow (DCF) and long-term decisions 473 Appendix 6: Pricing and life cycle issues 495

MAIN CAPABILITIES

On successful completion of this paper, candidates should be able to:

A Use strategic planning and control models to plan and monitor organisational performance

B Assess and identify relevant macroeconomic, fiscal and market factors and key external influences on organisational performance

C Identify and evaluate the design features of effective performance management information and monitoring systems

D Apply appropriate strategic performance measurement techniques in

evaluating and improving organisational performance

E Advise clients and senior management on strategic business performance evaluation and on recognising vulnerability to corporate failure

F Identify and assess the impact of current developments in management accounting and performance management on measuring, evaluating and

improving organisational performance

Rationale

The Advanced Performance Management syllabus further develops key aspects

introduced in Paper F5, Performance Management, at the skills level and draws on

aspects of the material covered from a more strategic and operational planning

perspective in Paper P3, Business Analysis

The syllabus introduces candidates to the strategic role of management accounting

as a discipline for planning and controlling performance so that strategic objectives

can be set, monitored and controlled It also covers the impact of external factors on strategic management issues, such as macroeconomic, fiscal, market and environmental impacts on performance From appreciating the strategic context of performance management and the impact of wider factors, the syllabus examines, at

an operational level, the issues relating to performance measurement systems and their design

The syllabus then moves from performance management systems and their design

to the scope and application of high-level performance measurement techniques in a variety of contexts, including not-for-profit organisations and multinational businesses Having covered the strategic aspects of performance management and operational systems for the measurement and control of performance in a variety of contexts, candidates are then expected to synthesise this knowledge in the role of an advisor to senior management or independent clients on how to assess and control the performance of an entity, including the recognition of whether a business is facing difficulties or possibly failure

Finally, the syllabus deals with current developments in performance management and with emerging issues as they might affect or influence the management of performance within organisations

A Strategic planning and control

1 Introduction to strategic management accounting

2 Performance management and control of the organisation

3 Changes in business structure and management accounting

4 Effect of Information Technology (IT) on strategic management accounting

5 Other environmental and ethical issues

B External influences on organisational Performance

1 Changing business environment

2 Impact of external factors on strategy and performance

C Performance measurement systems and design

1 Performance management information systems

2 Sources of management information

3 Recording and processing methods

3 Divisional performance and transfer pricing issues

4 Strategic performance measures in not-for-profit organisations

5 Non- financial performance indictors

6 The role of quality in management information and performance measurement systems

7 Performance measurement and strategic human resource management issues

8 Performance measurement and the reward systems

9 Other behavioural aspects of performance measurement

E Performance evaluation and corporate failure

1 Alternative views of performance measurement and management

2 Strategic performance issues in complex business structures

3 Predicting and preventing corporate failure

F Current developments and emerging issues performance

management

1 Current developments in management accounting techniques

2 Current issues and trends in performance management

Approach to examining the syllabus

Paper P5 builds on paper F5, Performance Management, and candidates are expected

to have a thorough understanding of the paper F5 syllabus In addition, candidates will also be required to apply the principles and techniques covered in paper F2, Management Accounting

Paper P5 has a link with Paper P3, Business Analysis, in the areas of strategic

planning and control and performance measurement

Study Guide

This study guide provides more detailed guidance on the syllabus You should use this as the basis of your studies

A STRATEGIC PLANNING AND CONTROL

1 Introduction to strategic management accounting

a) Explain the role of strategic performance management in strategic planning and control

b) Discuss the role of corporate planning in clarifying corporate objectives, making strategic decisions and checking progress towards the objectives

c) Compare planning and control between the strategic and operational levels within a business entity

d) Assess the use of strategic management accounting in the context of multinational companies

e) Discuss the scope for potential conflict between strategic business plans and short-term localised decisions

f) Evaluate how SWOT analysis may assist in the performance management process

g) Evaluate the methods of benchmarking performance

2 Performance management and control of the organisation

a) Evaluate the strengths and weaknesses of alternative budgeting models and compare such techniques as fixed and flexible, rolling, activity based, zero based and incremental

b) Assess how budgeting may differ in not-for-profit organisations from profit-seeking organisations

c) Evaluate the impact to an organisation of a move beyond budgeting

3 Changes in business structure and management accounting

a) Identify and discuss the particular information needs of organisations adopting a functional, divisional or network form and the implications for performance management

b) Assess the influence of Business Process Re-engineering on systems development and improvements in organisational performance

c) Discuss the concept of business integration and the linkage between people, operations, strategy and technology

d) Identify and discuss the required changes in management accounting systems as a consequence of empowering staff to manage sectors of a business

4 Effect of Information Technology (IT) on strategic management accounting

a) Assess the changing accounting needs of modern service orientated businesses compared with the needs of traditional manufacturing industry

b) Discuss how IT systems provide the opportunity for instant access to management accounting data throughout the organisation and their potential impact on business performance

c) Discuss how IT systems facilitate the remote input of management accounting data in an acceptable format by non-finance specialists

d) Explain how information systems provide instant access to previously unavailable data that can be used for benchmarking and control purposes and help improve business performance

e) Assess the need for businesses to continually refine and develop their management accounting and information systems if they are to maintain

or improve their performance in an increasingly competitive and global market

5 Other environmental and ethical issues

a) Discuss the ways in which stakeholder groups operate and how they effect an organisation and its strategy formulation and implementation

b) Discuss the ethical issues that may impact on strategy formulation and business performance

c) Discuss the ways in which stakeholder groups may influence business performance

B EXTERNAL INFLUENCES ON ORGANISATIONAL PERFORMANCE

1 Changing business environment

a) Assess the continuing effectiveness of traditional management accounting techniques within a rapidly changing business environment

b) Evaluate how risk and uncertainty play an important role in long term strategic planning and decision-making that relies upon forecasts of exogenous variables

2 Impact of external factors on strategy and performance

a) Discuss the need to consider the environment in which an organisation

is operating when assessing its performance, including:

i) Political climate ii) Market conditions iii) Funding

b) Assess the impact of governmental regulations and policies on performance measurement techniques used and the performance levels

achieved (for example, in the case of utility services and former state monopolies)

C PERFORMANCE MEASUREMENT SYSTEMS AND DESIGN

1 Performance management information systems

a) Identify the accounting information requirements and describe the different types of information systems used for strategic planning, management control and operational control and decision-making

b) Discuss, with reference to performance management, ways in which the information requirements of a management structure are affected by the features of the structure

c) Evaluate the compatibility of the objectives of management accounting and management accounting information

d) Discuss the integration of management accounting information within

an overall information system, for example the use of enterprise resource planning systems

e) Evaluate whether the management information systems are lean and value of the information that they provide

f) Define and discuss the merits of, and potential problems with, open and closed systems with regard to the needs of performance management

g) Highlight the ways in which contingent (internal and external) factors influence management accounting and its design and use

h) Advise how anticipated human behaviour will influence the design of a management accounting system

i) Discuss the impact of responsibility accounting on information requirements

2 Sources of management information

a) Identify and discuss the principal internal and external sources of management accounting information

b) Demonstrate how these principal sources of management information might be used for control purposes

c) Identify and discuss the direct data capture and process costs of management accounting information

d) Identify and discuss the indirect costs of producing information

e) Discuss the limitations of using externally generated information

f) Demonstrate how the information might be used in planning and controlling activities e.g benchmarking against similar activities

g) Discuss those factors that need to be considered when determining the capacity and development potential of a system

3 Recording and processing methods

a) Demonstrate how the type of business entity will influence the recording and processing methods

b) Discuss how IT developments e.g unified corporate databases and network technology may influence management accounting systems

c) Discuss the difficulties associated with recording and processing data of

h) Identify and discuss the characteristics of operational performance

i) Discuss the relative significance of planning as against controlling activities at different levels in the performance hierarchy

2 Strategic performance measures in private sector

a) Demonstrate why the primary objective of financial performance should

be primarily concerned with the benefits to shareholders

b) Justify the crucial objectives of survival and business growth

c) Discuss the appropriateness of, and apply different measures of performance, including:

i) Return on Capital Employed (ROCE) ii) Return on Investment (ROI)

iii) Earnings Per Share (EPS) iv) Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA)

v) Residual Income (RI) vi) Net Present value (NPV) vii) Internal rate of return and modified internal Rate of Return (IRR, MIRR)

d) Discuss why indicators of liquidity and gearing need to considered in conjunction with profitability

e) Compare and contrast short and long run financial performance and the resulting management issues

f) Explore the traditional relationship between profits and share value with the long-term profit expectations of the stock market and recent financial performance of new technology companies

g) Assess the relative financial performance of the organisation compared

to appropriate benchmarks

h) Discuss and apply Six Sigma measures of performance

3 Divisional performance and transfer pricing issues

a) Describe, compute and evaluate performance measures relevant in a divisionalised organisation structure including ROI, RI and Economic value added (EVA)

b) Discuss the need for separate measures in respect of managerial and divisional performance

c) Discuss the circumstances in which a transfer pricing policy may be needed and discuss the necessary criteria for its design

d) Demonstrate and evaluate the use of alternative bases for transfer pricing

e) Explain and demonstrate issues that require consideration when setting transfer prices in multinational companies

4 Strategic performance measures in not-for-profit organisations

a) Highlight and discuss the potential for diversity in objectives depending

f) Assess ‘value for money’ service provision as a measure of performance

in not-for-profit organisations and the public sector

5 Non-financial performance indicators

a) Discuss the interaction of non-financial performance indicators with financial performance indicators

b) Discuss the implications of the growing emphasis on non-financial performance indicators

c) Discuss the significance of non-financial performance indicators in relation to employees

d) Identify and discuss the significance of non-financial performance indicators in relation to product/service quality e.g customer satisfaction reports, repeat business ratings, customer loyalty, access and availability

e) Discuss the difficulties in interpreting data on qualitative issues

f) Discuss the significance of brand awareness and company profile and their potential impact on business performance

6 The role of quality in management information and performance measurement systems

a) Discuss and evaluate the application of Japanese business practices and management accounting techniques, including:

i) Kaizen costing, ii) Target costing, iii) Just-in-time, and iv) Total Quality Management

b) Discriminate between quality, quality assurance, quality control and quality management.

c) Assess the relationship of quality management to the performance management strategy of an organisation

d) Advise on the structure and benefits of quality management systems and quality certification

e) Justify the need and assess the characteristics of quality in management information systems

7 Performance measurement and strategic Human Resource Management issues

a) Explain how the effective recruitment, management and motivation of people is necessary for enabling strategic and operational success

b) Discuss the judgemental and developmental roles of assessment and appraisal and their role in improving business performance

c) Advise on the relationship of performance management to performance measurement (performance rating) and determine the implications of performance measurement to quality initiatives and process redesign

8 Performance measurement and the reward systems

a) Explore the meaning and scope of reward systems

b) Discuss and evaluate different methods of reward practices

c) Explore the principles and difficulty of aligning reward practices with strategy

d) Advise on the relationship of reward management to quality initiatives, process re-design and harnessing of e-business opportunities

e) Assess the potential beneficial and adverse consequences of linking reward schemes to performance measurement, for example, how it can affect the risk appetite of employees

9 Other behaviour aspects of performance measurement

a) Discuss the accountability issues that might arise from performance measurement systems

b) Evaluate the ways in which performance measurements systems may send the wrong signals and result in undesirable business consequences

c) Demonstrate how management style needs to be considered when designing an effective performance measurement system

E PERFORMANCE EVALUATION AND CORPORATE FAILURE

1 Alternative views of performance measurement and management

a) Evaluate the ‘balanced scorecard’ approach as a way in which to improve the range and linkage between performance measures

b) Evaluate the ‘performance pyramid’ as a way in which to link strategy, operations and performance

c) Evaluate the work of Fitzgerald and Moon that considers performance measurement in business services using building blocks for dimensions, standards and rewards

d) Discuss and apply the Performance Prism

e) Discuss and evaluate the application of activity-based management

f) Evaluate and apply the value-based management approaches to performance management

2 Strategic performance issues in complex business structures

a) Evaluate the use and the application of strategic models in assessing the business performance of an entity, such as Ansoff, Boston Consulting Group and Porter

b) Discuss the problems encountered in planning, controlling and measuring performance levels, e.g productivity, profitability, quality and service levels, in complex business structures

c) Discuss the impact on performance management of the use of business models involving strategic alliances, joint ventures and complex supply chain structures

3 Predicting and preventing corporate failure

a) Assess the potential likelihood of corporate failure, utilising quantitative and qualitative performance measures

b) Assess and critique quantitative and qualitative corporate failure prediction models

c) Identify and discuss performance improvement strategies that may be adopted in order to prevent corporate failure

d) Discuss how long-term survival necessitates consideration of life-cycle issues

e) dentify and discuss operational changes to performance management systems required to implement the performance improvement strategies

F CURRENT DEVELOPMENTS AND EMERGING ISSUES IN

PERFORMANCE MANAGEMENT

1 Current developments in management accounting techniques

a) Discuss the ways through which management accounting practitioners are made aware of new techniques and how they evaluate them

b) Discuss, evaluate and apply environmental management accounting

c) Discuss the use of benchmarking in public sector performance (league tables) and its effects on operational and strategic management and client behaviour

d) Discuss the issues surrounding the use of targets in public sector organisations

2 Current issues and trends in performance management

a) Assess the changing role of the management accountant in today’s business environment as outlined by Burns and Scapens

b) Discuss contemporary issues in performance management

c) Discuss how changing organisation’s structure, culture and strategy will influence the adoption of new performance measurement methods and techniques

Paper P5

Advanced performance management

t

DCF tables Present value table

Present value of 1 i.e ( 1 + r )−nwhere r = discount rate, n = number of periods until payment

0.980 0.961 0.942 0.924 0.906

0.971 0.943 0.915 0.888 0.863

0.962 0.925 0.889 0.855 0.822

0.952 0.907 0.864 0.823 0.784

0.943 0.890 0.840 0.792 0.747

0.935 0.873 0.816 0.763 0.713

0.926 0.857 0.794 0.735 0.681

0.917 0.842 0.772 0.708 0.650

0.909 0.826 0.751 0.683 0.621

0.888 0.871 0.853 0.837 0.820

0.837 0.813 0.789 0.766 0.744

0.790 0.760 0.731 0.703 0.676

0.746 0.711 0.677 0.645 0.614

0.705 0.665 0.627 0.592 0.558

0.666 0.623 0.582 0.544 0.508

0.630 0.583 0.540 0.500 0.463

0.596 0.547 0.502 0.460 0.422

0.564 0.513 0.467 0.424 0.386

0.804 0.788 0.773 0.758 0.743

0.722 0.701 0.681 0.661 0.642

0.650 0.625 0.601 0.577 0.555

0.585 0.557 0.530 0.505 0.481

0.527 0.497 0.469 0.442 0.417

0.475 0.444 0.415 0.388 0.362

0.429 0.397 0.368 0.340 0.315

0.388 0.356 0.326 0.299 0.275

0.350 0.319 0.290 0.263 0.239

0.893 0.797 0.712 0.636 0.567

0.885 0.783 0.693 0.613 0.543

0.877 0.769 0.675 0.592 0.519

0.870 0.756 0.658 0.572 0.497

0.862 0.743 0.641 0.552 0.476

0.855 0.731 0.624 0.534 0.456

0.847 0.718 0.609 0.516 0.437

0.840 0.706 0.593 0.499 0.419

0.833 0.694 0.579 0.482 0.402

0.507 0.452 0.404 0.361 0.322

0.480 0.425 0.376 0.333 0.295

0.456 0.400 0.351 0.308 0.270

0.432 0.376 0.327 0.284 0.247

0.410 0.354 0.305 0.263 0.227

0.390 0.333 0.285 0.243 0.208

0.370 0.314 0.266 0.225 0.191

0.352 0.296 0.249 0.209 0.176

0.335 0.279 0.233 0.194 0.162

0.287 0.257 0.229 0.205 0.183

0.261 0.231 0.204 0.181 0.160

0.237 0.208 0.182 0.160 0.140

0.215 0.187 0.163 0.141 0.123

0.195 0.168 0.145 0.125 0.108

0.178 0.152 0.130 0.111 0.095

0.162 0.137 0.116 0.099 0.084

0.148 0.124 0.104 0.088 0.074

0.135 0.112 0.093 0.078 0.065

Annuity table

Present value of an annuity of 1 i.e

( )

r r 1

0.980 1.942 2.884 3.808 4.713

0.971 1.913

20829 3.717 4.580

0.962 1.886 2.775 3.630 4.452

0.952 1.859 2.723 3.546 4.329

0.943 1.833 2.673 3.465 4.212

0.935 1.808 2.624 3.387 4.100

0.926 1.783 2.577 3.312 3.993

0.917 1.759 2.531 3.240 3.890

0.909 1.736 2.487 3.170 3.791

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

9.787 10.58 11.35 12.11 12.85

9.253 9.954 10.63 11.30 11.94

8.760 9.385 9.986 10.56 11.12

8.306 8.863 9.394 9.899 10.38

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

0.893 1.690 2.402 3.037 3.605

0.885 1.668 2.361 2.974 3.517

0.877 1.647 2.322 2.914 3.433

0.870 1.626 2.283 2.855 3.352

0.862 1.605 2.246 2.798 3.274

0.855 1.585 2.210 2.743 3.199

0.847 1.566 2.174 2.690 3.127

0.840 1.547 2.140 2.639 3.058

0.833 1.528 2.106 2.589 2.991

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 4.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

1 Strategic management accounting

2 Introduction to strategic planning and control

multi-6 The effect of IT on management accounting

7 Stakeholders and ethical considerations

Strategic management accounting

„ Introduction

„ The nature of strategic management accounting

1.1 Introduction

The purpose of management accounting is to provide relevant and reliable information so that managers can make well-informed decisions The value of management accounting depends on the quality of the information provided, and whether it helps managers to make better decisions

Management accounting is often associated with long-established methods of costing and financial reporting, such as absorption costing, standard costing, variance analysis and budgetary control reports

These traditional methods might be adequate for operational decisions but do not provide useful information for the formulation of strategy particularly if the business environment that is continually changing

The differences between planning at strategic and operational levels is summarised

in the following table:

Strategic management Operational management

Mainly a longer-term focus Short-term focus: day-to-day

operational issues

Feedback may be occasional Regular feedback about performance Broad ‘higher level’ issues, such as

acquisitions and disposals, as well as

the development of internal resources

Approach to measuring performance:

Where are we?

Where do we want to be?

How do we get there?

What are the risks?

Control actions based on routine information and concerned with the current use of resources and improving the efficiency and effectiveness of resources, and with cost control

Largely external in focus Mainly internal focus

Forward looking Backward looking

Non-routine issues Concerned with detailed plans and

controls The criticisms of traditional management accounting methods will be considered in more detail in a later chapter

4.2 The nature of strategic management accounting

Strategic management accounting provides managers with information that is relevant to making and monitoring strategic decisions It provides information:

„ about longer-term strategic issues, as well as the shorter term

„ of a non-financial nature as well as financial information

„ obtained from external as well as internal sources

„ about the business environment as well as internal operations

„ that recognises the significance of change and the need to anticipate major changes in the business environment

„ where the focus is on being competitive and succeeding in a competitive market environment

„ about strategic objectives

„ customer satisfaction and adding value

„ product life cycle

„ internal and external analysis: SWOT analysis

„ benchmarking

„ risk and uncertainty

Strategic management accounting techniques

Advanced cost accounting:

„ JIT based systems

„ activity based management and activity based costing;

„ backflush accounting;

„ throughput accounting;

Strategic management accounting:

„ life cycle costing;

Introduction to strategic planning and control

„ Levels of strategic planning

„ Definition of strategic planning and control

„ Advantages of formal strategic planning

„ Strategic planning process

„ Performance management systems

„ Linking performance measurement to strategy

This paper is about performance management and not just about performance measurement Measurement is a component of management In this paper you are required to do more than simply apply measures In addition you might be required

to review measures in place and suggest alternatives when weaknesses are identified This review would be in the context of the strategy of the organisation and how the performance management system was working to help achieve the corporate objectives

2.1 Levels of strategic planning

Planning is a hierarchical activity, linking strategic planning at the top with detailed operational planning at the bottom Strategic plans set a framework and guidelines within which more detailed plans, and shorter-term planning decisions, can be made

R N Anthony identified three levels of planning: within an organisation:

„ Strategic planning This involves identifying the objectives of the entity, and

plans for achieving those objectives, mostly over the longer term Strategic plans include corporate strategy plans, business strategy plans and functional strategy plans

„ Tactical planning These are shorter-term plans for achieving medium-term

objectives An example of tactical planning is the annual budget Budgets and other tactical plans can be seen as steps towards the achievement of longer-term strategic objectives

„ Operational planning This is detailed planning of activities, often at a

supervisor level or junior management level, for the achievement of short-term goals and targets For example, a supervisor might divide the workload between several employees in order to complete all the work before the end of the day

2.2 Definition of strategic planning and control

‘Strategic planning and control’ within an entity is the continuous process of:

„ identifying the goals and objectives of the entity

„ planning strategies that will enable these goals and objectives to be achieved

„ setting targets for each strategic objective (performance targets)

„ converting strategies into shorter-term operational plans

„ implementing the strategy

„ monitoring actual performance (performance measurement and review)

„ taking control measures where appropriate when actual performance is below the target

Other aspects of strategic planning and control are:

„ re-assessing plans and strategies when circumstances in the business environment change

„ where necessary, changing strategies and plans

2.3 Advantages of formal strategic planning

Companies often have a formal strategic planning process, because a formal system

of planning:

„ clarifies objectives

„ helps management to make strategic decisions Strategic planning forces managers to think about the future: companies are unlikely to survive unless they plan ahead

„ establishes targets for achievement

„ co-ordinates objectives and targets throughout the organisation, from the mission statement and strategic objectives at the top of a hierarchy of objectives, down to operational targets

„ provides a system for checking progress towards the objectives

However, planning must also be flexible Plans and targets might need to change in response to changes in the business environment, for example, a new initiative by a rival company

Changes in strategic plans

Strategic plans often cover a period of several years, typically five years or longer They are prepared on the basis of the best information available at the time, using assumptions about the nature of the business environment – competitive conditions, market conditions, available technology, the economic, social and political climate, and so on

However, the business environment can change very quickly, in unexpected ways Changes can create new threats to a company, or they can create new business opportunities Whenever changes occur, a company should be able to respond – taking measures to deal with new threats, or to exploit new opportunities

The response of a company to changes in its environment could mean having to develop new strategies and abandon old ones When changes are made, the original strategic plan will no longer be entirely valid, although large parts of it might be unaffected

Strategic planning in practice is therefore often a mixture of:

„ formal planning, and

„ developing new strategies and making new plans whenever significant changes occur in its business environment

Responding to unexpected changes by doing something that is not in the formal plan is sometimes called ‘freewheeling opportunism’ It means making unplanned decisions, to take advantages of opportunities as they arise, or to deal with unexpected threats

2.4 Strategic planning process

Different methods and approaches may be used to develop strategic plans

A basic approach to strategic planning is shown in the following diagram

Mission and objectives

Position audit Corporate appraisal Environmental analysis

Strategic direction STRATEGIC CHOICE

Evaluation of strategic

options

Review and control implementation Strategic

Mission and objectives

The entity exists for a purpose, which may be expressed formally in a mission statement

The entity must develop clear objectives, such as the maximisation of shareholder wealth These objectives should be consistent with the mission statement Targets can be established for the achievement of objectives within the planning period

Objectives should take into account the interest and power of stakeholders Stakeholder mapping is a useful tool in this regard

Strategic analysis

Environmental analysis

Environmental analysis involves an analysis of developments outside the organisation that are already affecting the organisation or could affect the organisation in the future These are external factors that might affect the achievement of objectives and strategy selection

An external analysis might consider:

„ the political situation in each country where it has operating subsidiaries

„ changes in the law, and how these affect the organisation

„ changes in economic conditions

„ social factors and cultural factors, such as an increasing average age in the population

„ technology changes: the development of the internet and e-commerce, for example, have had enormous consequences for business within the past few years

„ the competitive environment, such as the entry of a new competitor into the market, or the ‘globalisation’ of the market

An external analysis should identify opportunities and threats that face the organisation Strategies might be developed to exploit opportunities or take counter-measures to deal with threats

Models that might be used include:

of its suppliers, its liquidity and cash flows, and so on

Strategies should seek to make full use of any strengths within the entity and to reduce or remove significant weaknesses

Models that might be used include:

„ Ms (Men, Management, Money, Make-up, Machinery, Methods, Markets, Materials, Management information)

„ Financial analysis

„ Benchmarking

„ Product life cycle

„ Boston consulting grid

„ Value chain analysis

of strategy and what the entity might be capable of achieving

SWOT analysis is the analysis of the strengths and weaknesses of an organisation, and the opportunities and threats in its environment This method of strategic analysis is often used by organisations as a starting point for strategic planning Strategic management accounting can assist with SWOT analysis by trying to put costs or benefits to particular strengths, weaknesses, opportunities and threats, so that strategic managers are able to assess their importance

SWOT analysis is explained in more detail later

Gap analysis

A strategic plan should set out the ways in which an organisation intends to achieve its objectives One way of doing this is to prepare a forecast of what is likely to happen if the company carries on with its current plans and policies, and does not take any new strategic initiatives

Gap analysis involves:

„ identifying the corporate objectives for the organisation, and what strategic management wants the organisation to achieve each year over the planning period

„ comparing these strategic targets with the expected actual results, if there are no changes in strategy and no new planning initiatives

The gap is the difference between these two and is known as is a planning gap

(Gap analysis is sometimes described as an analysis of the difference between

‘Where we are’ and ‘Where we want to be’.)

Planning horizon

Position if no action is taken

Strategies should be developed to close the gap, so that expected performance is in line with the strategic aims and objectives

Cost leadership means becoming the lowest-cost producer in the market A

company that can make products or provide services at a lower cost than competitors will succeed, by selling at lower prices and winning the biggest share of the market

Differentiation means making products or services that are considered by

customers to be different from those of competitors, and because they are different they are better A company that is not the least-cost producer can therefore succeed

by offering product or service that customers will pay a higher price (than the cost producer’s price) to obtain

least-Either of these strategies might be pursued with a broad focus or in a niche market

Strategic direction

This concerns which products should be sold to which markets A useful model here is Ansoff’s Grid which is covered in more detail later It identifies four possible alternatives:

„ Sell existing products in existing markets – Market penetration strategy

„ Sell existing products in new markets – Market development strategy

„ Sell new products in existing markets – Product development strategy

Sell new products in new markets – Diversification strategy

Strategic method

This concerns the question of how to grow? Growth can be achieved through:

„ Internal growth (also called organic growth)

„ Acquisitions and mergers

„ Joint ventures or strategic alliances

Evaluation of strategic options

Strategies should be evaluated to decide whether they might be appropriate Johnson and Scholes have suggested that strategies should be assessed for:

„ suitability;

Suitability relates to the strategic logic and strategic fit of the strategy

The strategy must fit the company's operational circumstances and strategic position

Key questions include does the strategy:

„ Exploit company strengths and distinctive competences?

„ Rectify company weaknesses?

„ Neutralise or deflect environmental threats?

„ Help the firm to seize opportunities?

„ Satisfy the goals of the organisation?

„ Fill the gap identified by gap analysis?

„ Generate/maintain competitive advantage?

Feasibility

Questions that might be asked to assess feasibility are:

„ Can we afford it?

„ Will we have the labour skills needed?

„ Can we achieve the necessary product quality?

„ Can we produce at the cost that will be necessary?

„ Do we have the marketing skills needed?

„ Can we obtain the raw materials needed?

Acceptability

A strategy must be acceptable to the key stakeholders affected by it A strategy is inappropriate if it is unacceptable to any key stakeholders

Strategic implementation

The selected strategies should then be implemented

The implementation of strategies should be monitored Changes and adjustments should be made where these become necessary

Areas of importance here are change management and project management These are covered in more detail later

Review and control

This is a key area An entity will have management information systems in place to monitor the progress of the business These are particularly important to the introduction of a new strategy where timing and achievement of progress points might be vital to its success This covered in more detail later

2.5 Performance management systems

Performance management systems have a key role to play in many aspects pf strategic planning and are concerned with:

A system of performance management is concerned with the following:

„ setting targets for the achievement of the entity’s main strategic objective

„ setting targets for each strategy that is implemented for achieving the main strategic objective

„ setting targets at all levels of management within the entity: all planning targets (at all levels within the entity) should be consistent with the strategic targets and objectives

„ measuring actual performance

„ comparing actual performance with the targets

„ where appropriate, taking control measures

„ where appropriate, changing the targets

In many organisations, performance measurement systems are also used in a system

of incentives and rewards, and managers are given a reward (often a cash bonus) for achieving or exceeding one or more agreed performance targets

Performance management is therefore concerned with planning and controlling, at all levels within an organisation

2.6 Linking performance measurement to strategy

The measures of performance used throughout an organisation should be linked to the corporate strategy of the organisation, and should be consistent with corporate strategy This means that there has to be consistency between performance measures at all levels in the organisation, from operating levels up

The performance measures that are used should focus on targets where success is a critical factor

The performance measures that are chosen should do the following:

„ Measure effectiveness – the effectiveness of processes, and the effectiveness of products and services in meeting customer needs

„ Measure efficiency – the use of resources within the organisation

„ Include ‘external’ measures from outside the organisation as well as internal measures

„ Be a mixture of financial and non-financial measurement, and qualitative and quantitative measurements

„ Focus on the long-term as well as the short-term

„ Be flexible so that the measures used are continually changed in response to a changing business environment

„ Recognise the trade-off between different measures of performance: for example,

it is often necessary to make compromises to reach a suitable balance between short-term and long-term targets

„ Recognise the motivational effect that performance measurements can have on employee and management behaviour

Strategic objectives

„ Performance measurement system?

„ Planning and corporate objectives

„ Management accounting and performance measurement

The purpose of strategic planning and control is to help an entity to achieve its strategic objectives It is normally assumed that the objective of a company is to provide a high return to its owners, the shareholders, consistent with the level of risk in the business

Not-for-profit entities also have strategic objectives, which relate to the purpose for which they exist These objectives are non-financial in nature

3.1 Planning and corporate objectives

Performance measurement is an integral part of a system of planning and control

„ Planning targets clarify the objectives of the organisation Corporate objectives

are converted into planning targets Similarly, the objectives of strategic plans are converted into planning targets A target should be a clear statement of what

an entity wants to achieve within a specified period of time Planning targets are usually quantified, but may be expressed in qualitative terms

„ Measurements of performance (target and actual) help to improve management’s understanding of processes and systems

„ Planning targets are set at strategic, tactical and operational management levels Using quantitative measures of performance makes it easier to set targets for managers and the organisation as a whole

„ In a well-designed performance management system, all planning targets are consistent with each other, at the strategic, tactical and operational levels

„ When the business environment is changing, a performance measurement system should provide for the continual re-assessment of planning targets, so that targets can be altered as necessary to meet the changing circumstances

„ Actual performance, at the strategic, tactical and operational levels should be measured and monitored Comparing actual performance with targets provides useful control information Differences between actual performance and targets can be analysed, to establish the causes Where appropriate, action can be taken

to improve performance by dealing with the causes of the poor performance

„ Performance measures also make it possible to compare the performance of different organisations or different divisions within the same organisation

„ Performance measurement systems promote accountability of the organisation

to its stakeholders

„ A performance management system may be linked to a system of rewarding individuals for the successful achievement of planning targets

3.2 The need for performance measurement

Every managed organisation needs a system of performance measurement

„ Managers need to understand what they should be trying to achieve A sense of purpose and direction is provided by plans (strategies, budgets, operational plans and so on), and for each plan there should be objectives and targets Setting targets for achievement (performance targets) is an essential part of planning

„ Managers also need to know whether they are successful The information they need is provided by comparing:

- their actual results or performance with the performance target, and

- the performance target with the current forecast of what performance will be Targets, forecasts and actual performance should be measured, in order to compare them Ideally measures of performance should be quantified values (financial or non-financial measures), because numerical measures of performance are easier to compare than non-quantified (‘qualitative’) measures

The benefits of performance measurement systems

The advantages of having a formal system of performance measurement can be summarised as follows:

„ A well-structured system of performance measurement clarifies the objectives of the organisation, and shows how departments, work groups and individuals within the organisation contribute to the achievement of those objectives

„ It establishes agreed measures of activity, based on key success factors

„ It helps to provide a better understanding of the processes within the organisation, and what each should be trying to achieve

„ It provides a system for comparing the performance of different organisations or departments

„ The system establishes performance targets for the organisation’s managers, over a suitable time period for achievement

3.3 Management accounting and performance measurement

Management accounting is an important element in performance measurement systems Many performance targets are financial in nature, such as achieving targets for return on capital, profits and sales revenue and targets for keeping expenditure under control

However, a performance measurement system uses a wide range of targets at the strategic, tactical and operational level Many of these are non-financial targets, and not all targets are quantifiable

Clearly, a comprehensive management accounting system should therefore provide information for setting targets and measuring actual performance at all levels It should also provide non-financial information as well as financial information

If a management accounting system cannot provide all this information to management, managers will have to rely on other information systems in addition

to the management accounting system An entity might then have several different information systems, which is probably inefficient and less effective than a fully co-ordinated management information system

Levels of management and management information

„ Levels of management

„ Potential conflict between strategic plans and short-term decisions

In ‘traditionally-structured’ large organisations, there is a hierarchy of managers, from senior management down to junior managers and supervisors The responsibilities of managers vary according to their position in the management hierarchy

Even in small organisations, the nature of management activities can be analysed into different levels

Strategic management is concerned with:

„ deciding on the objectives and strategies for the organisation

„ making or approving long-term plans for the achievement of strategic targets

„ monitoring actual results, to check whether these are in line with strategic targets

„ where appropriate, taking control action to bring actual performance back into line with strategic targets

„ reviewing and amending strategies

A strategy is a plan for the achievement of a long-term objective The main objective

of a profit-making entity may be to maximise the wealth of its owners Several strategies are selected for the achievement of this main objective, and each individual strategy might have its own specific objective

Strategic planning is often concerned with developing products and markets and for long-term investment For example, a company seeking to increase its profits by 10% a year for the next five years might select the following strategies:

„ Marketing strategy: to expand into markets in other countries (with specific countries selected as planning targets for each year of the plan)

„ Innovation strategy: to invest in research and development (with a target to launch, say, two new products on the market each year for the next five years)

„ Investment strategy: to invest in new technology (with a target, say, of replacing all existing equipment with new technology within the next five years)

Tactical management

Tactical management is associated with the efficient and effective use of an organisation’s resources, and the control over expenditure In a large organisation, tactical managers are the ‘middle managers’

Tactical management is concerned with implementation and control of term plans, within the guidelines of the organisation’s strategic plans For example, budgeting and budgetary control are largely tactical management responsibilities

There isn’t a clear dividing line between tactical management and operational management, but essentially the differences are a matter of detail Tactical management may be concerned with the performance of an entire department during a one-week period, whereas operational management may be concerned with the activities of individuals or small work groups on a daily basis

4.3 Potential conflict between strategic plans and short-term decisions

Problems may occur in any organisation, but especially large organisations with a large number of managers, when ‘local’ operational managers take decisions that are inconsistent with long-term strategic objectives

There a several reasons why this might happen

„ ‘Local’ managers might be rewarded for achieving short-term planning targets, such as keeping actual expenditure within the budget limit However, although there is a short-term benefit, there might be longer-term damage For example, a local manager might decide to cut the training budget for his staff in order to reduce costs, but in the long-term the future success of the company might depend on having well-trained and skilled employees

„ ‘Local’ managers might fail to buy into the plan because they believe it to be unfair

„ ‘Local’ managers might be unaware of the strategic plans and objectives, due to poor communication within the entity

In any system of performance management, especially in systems where managers are rewarded for achieving planning targets, it is important to make sure that the short-term planning targets are consistent with longer-term strategic objectives

Strategic management accounting and multi-nationals

„ Global competition

„ Multinational organisations and global organisations

„ Strategic management accounting issues

multi-nationals

5.1 Global competition

Many business entities have expanded beyond their national markets and operate in foreign markets The reasons for this are many and varied but include:

„ Cost reduction opportunities due to economies of scale

„ Few growth opportunities in domestic markets

„ Extension of product life by selling into new markets

„ Convergence of markets so that a standard product can be sold in many

countries

„ Emergence of new markets

„ Avoidance of currency risk by setting up operations in other countries to supply those countries

5.2 Corporate strategies for international business

Large companies have developed strategies for growing their business operations internationally

When an entity starts to sell its products in foreign markets for the first time, it will probably think of the foreign market as an extension of its domestic market It will not change its product design for the foreign markets, and will sell an identical product in all the countries where it operates The product will be manufactured in the entity’s domestic country, and exported to the foreign markets

However, as an entity becomes more committed to its foreign markets, and as foreign sales increase, the situation changes The entity will start to recognise differences between the different foreign markets Customers in each different market will have slightly different needs and preferences The entity might therefore alter its products to suit the needs of each local market As a result, total sales will increase However, profits will fall This is because the cost of adapting products to local market needs is high

5.3 Multinational organisations and global organisations

Companies that operate in different countries and many different national markets are called either multinational companies (MNCs) or global companies Often, the two terms are used with the same meaning

However, a difference can be identified between MNCs and global companies according to their differences in corporate strategy

„ An international company is a company with all or most of its production

operations in a single country Most of its senior managers are nationals of the country The company sells its products in different companies, through local sales agents or local sales offices in each country, or using international sales representatives

„ A global company is a company with operations in a large number of different

countries, making a similar range of products or providing a similar range of services Its senior managers are nationals of a variety of different countries

When companies expand their business outside their ‘home country’, they will usually begin as an international company, but may eventually develop into a global company

Management make strategic decisions for each

foreign market individually

Management develop worldwide strategies for all their markets

Products are adapted and designed to the

requirements of the local market

The company produces core products These are standardised for all markets, with only minimal design changes for individual national markets Marketing (for example, advertising) is adapted

in each country to suit the local culture

There is a uniform approach to marketing in all countries, with only small variations

Countries are selected as a target for

production and sales entirely on the basis of

their potential for profitability

Countries are selected for their ability to contribute to the integrated global strategy

The aim is to optimise the value chain in each

country of operation

The value chain is broken up, and different parts

of the value chain are in different countries The aim is to optimise the value chain globally

A multinational company often has the culture

of the country where its head office is based

(for example, the US)

A global company develops a global culture Its senior managers are likely to come from different countries

As international competition becomes more intense, and as IT systems and communication systems develop, companies are continually looking for new strategies and new forms of organisation structure to support those strategies

„ Production systems, marketing systems and other operations have been made more flexible

„ Lean manufacturing systems have been developed with the aim of improving quality and reducing costs Lean manufacturing systems, and the search for economies of scale, are benefits that can be obtained from a global organisation

of business operations

„ However to deal with uncertainty and volatility in local markets, corporations need to change their organisation structures from vertical bureaucracies to decentralised organisations with team-based management, and greater