Performance Measurment Techniques

A Traditional P&L Balance Sheet including:

• Traditional Accounting measures:

  • net income / profit

  • earnings (per share)

• Traditional management approach:

  • improve cost minimization (reduce costs)

  • improve gross margin

• The VBM approach pay atention to the capital that is invested

• Typical KPI´s are:

  • ROIC

  • CFROIC

  • EVA

• What does value orientation mean? How is the creation of value measured?

• Why has value orientation taken on greater significance over the last years?

• What is the correlation between the internationalization of reporting procedures and the Value Based Business Management?

• What components does Value Reporting have?

• What characterizes a value based financial KPI?

• Which requirements should value based KPI’s meet?

• Return KPI's: ROI, ROCE, ROIC, RONA, CFROI, etc.

• Excess profit KPI's: EVA®, Economic Profit, CVA

• Control effect absolute vs. relative KPI's

• What are the typical weak spots?

• Composition of NOPAT and capital invested

• Determination of other financial KPI's

• Transition to other financial KPI's

• What is the connection between EVA® and the stock market value of a

  business? – Calculation of MVA, COV, FGV

• Ignore the cost of the capital invested

• Growth, long-term performance and sustainability were not taken into account

• Can easily be manipulated

Classical KPI´s are:

ROS = Return on sales

EPS = Earnings per share

Mechanism of different types of adjustments:

• Treating expenses as investments

• Treating one-time effects

• Reintegration of liabilities

• Separation between operative und financial results

Choice and amount of adjustments

The most important adjustments in detail: R&D, Goodwill, book profits resulting from

asset disposal etc.

• Orientation on future cash flows is the origin of Shareholder-Value-Thinking

• The shareholder measures the value of a business in looking at his future inflowing earnings.

• Ongoing development of the modern capital market theory

• Disclosure of value gaps through M&A transactions

• Development of a market for corporate control

• Growing significance of institutional and foreign investors

• Conceptual expansion of strategic management

• Asymmetric distribution of information between management and owners (Principal-Agent relationship)

• Shareholder Value approach as basis for strategic incentive schemes (Equity and Equity like)

• Criticism against profit oriented performance indicators

• The causes are interdependent and mutually reinforcing.

• The management is required to close the value gap between market valuation and potential intrinsic value.

1. Total Return Reporting

   • Performance of share pricing, (absolute / compared to indexes), development sample account, dividend development, rating information, Value-at-Risk

2. Value Added Reporting

   • cash flow depiction

   • depiction of a concept for value measurement as well as the underlying value drivers including a target/actual comparison etc.

3. Strategic Advance Reporting

   • Reporting via objective targets and target achievement of the business

   • Depiction of single perspectives of

     the general surroundings as well as their foreseeable developments including chances/risks

   • Mentioning of strategies and actions

     in single sections such as

     Human resources, R&D

• TSR/TRS Total Shareholder Return

• M/B Market to Book

• P/E Price / Earnings (price-earnings ratio)

• NPV Net Present Value

• DCF Discounted Cash Flow

• MVA Market Value Added

• FGV Future Growth Value

• COV Current Operations Value

• Against a direct connection to stock market value

  • Volatility of stock prices

  • No direct measured value for single business units

  • No direct reference to control parameters (value drivers) of the business

  • No definite connection to the results from management decisions

• Against a direct connection to company value determined with the DCF-method

  • Performance measurement based on future results contradicts the imperative of objectivity / freedom from manipulation

• Volatilität der Aktienkurse: Starke Schwankungen können durch Spekulationen oder externe Faktoren verursacht werden, die nicht immer die tatsächliche Unternehmensleistung widerspiegeln.

• Fehlende direkte Messwerte für einzelne Geschäftseinheiten: Der Gesamtwert einer Aktie spiegelt nicht immer den wahren Wert einzelner Unternehmensbereiche wider.

• Kein direkter Bezug zu Steuerungsparametern: Aktienkurse korrelieren oft nicht direkt mit den Schlüsselfaktoren, die das Geschäft tatsächlich antreiben.

• Unsicherer Zusammenhang mit Managemententscheidungen: Aktienkurse reflektieren nicht immer genau die Ergebnisse von Managemententscheidungen.

• Widerspruch zur Objektivität bei DCF-Methode: Die Bewertung basierend auf zukünftigen Ergebnissen kann subjektiv und manipulierbar sein, was die Genauigkeit beeinträchtigt.

• Lack of correlation (synchronization: R2 of a regression analyses) between key performance indicators from annual financial statements and the development of stock prices

• lack of consideration of risks

• No depiction of capital requirements for financing growth

• Neglect of economic effects after observation period

• Orientation towards the past

• Differing determination of financial KPI's due to different options within external accounting

• Lack of consideration of fair value of cash and assets

• Distortion of performance indicators due to age structure of fixed assets

• Distortion of performance indicators due to Leasing and depiction of Goodwill

• No documentation of variations regarding the financial structure

main thesis of value based business approach —> Breaking even is not enough

The quality of a financial KPI can be measured

in how well it meets certain requirements

• incentive compatibility, suggestibility

• objectivity, freedom from manipulation, correct depiction of value creation

• comprehensibility, internal communicability, acceptance,

  external communicability (derivation from external accounting, publicity of the concept)

• efficiency, effort of determination

—> Breaking Even is not enough as a main thesis of VBM

• EVA® - Economic Value Added

• EP - Economic Profit

• CVA - Cash Value Added

• ROI - Return in Investment

• ROS - return on sales

• ROE return on equity

• ROCE - Return on Capital employed

• ROIC - Return in invested capital

• RONA - Return on net assets

• CFROI - Cash flow return on investment

• CFROA - Cash Flow Return on Assets

• RAROC - Risk adjusted Return on Capital

• RORAC - Return on Risk adjusted Capital

1. Cost reductions have a direct effect on margin only, whereas price increases lead to higher sales

2. Working capital optimisation (e.g. via ABS or factoring, optimised inventory management and payment terms) reduces asset intensity at relatively little cost

3. Vertical integration increases asset intensity, which should be offset by incremental margin in value added

1. Outsourcing reduces capital employed but may reduce valueadded and hence margins

2. A vertical break-up leads to a split into two companies with

   almost double combined sales,but which share the same absolute margin. Relative margin goes down, as does asset

   intensity

3. In a horizontal break-up, combined sales remain at the same level. Asset intensity and margin depend on the business of the two split companies

• short term focus

• many KPI´s prio short term instead of long term goals

• lag of intangible assets