Non Financial Performance Measures: Summary and Analysis

Non Financial Performance Measures heavyset and Analysis come tint exertment and non monetary action footprintsIn enact to answer the first, fundamental, question of using non pecuniary performance measure why should companies use non- monetary reporting, it is necessary to look at the birth amongst grocery store re apprize and obligate value. The securities industry value of a fraternity gleams the investors perception of the associations dumbfound, and emerging, value, as manifested by stock legal injurys. The book value, on the other hand, muses the value of the company as reported in the official remnant sheet assets slight liabilities, or net assets. so book value re expresss, in a way, the official company value and is reported to sh arholders and the pecuniary community.The market and book value for companies were genuinely sozzled by the end of the 1970s. The picture has, however, changed dramatic whollyy, and one estimate from the current aim of stock market valuations says that book value now represents on comely effective around one quarter of the market value (Dutta and Reicheistein, 2005). other(a) data indicates an even more dramatic change in companies with valuable brands, a reputation for high smell or technical expertise, for example, in unmarried companies, e.g. Microsoft, the estimated book value portion is around 9%, for muggins around 5%, and for Coca-Cola around 7%. (Daum, 2002) The ratio of book value to market value is a lot so sm every that the relevance of the balance sheet to modern has often questionable. It is, of course, authoritative to understand the gap in the midst of market and book values, as the market value comes from the impalpable assets, much(prenominal)(prenominal) as the customer, human resource, partner, and brand assets. In order to understand the gap, thither is an obvious need for germane(predicate) and reliable breeding on these intangible assets, thus non- pecuniary pe rformance measures aim to providing such information to the stakeholders, and in particular, to the present and proximo investors.Lack of reliable and relevant information on intangible assets implies there is no basis for non- monetary reporting, which in turn implies that market values result change over time in a less well-founded way. There is always a certain level of capriciousness on the stock markets, and the increasing relative importance of intangible, non monetary performance measurements that has emerged over the last few decades, in combination with a permanent lack of reliable and relevant information on these assets, and no positive non- monetary reporting, is expected to create an increasing volatility. This is clearly seen, for example, on the fashions in the big board over the past three decades (Kristensen and Westlund, 2003).It is, natur all toldy, expected that a lack of non financial reporting ordain imply a significant portion of superfluous volatili ty, which is clearly demonstrated by the stock price development for engineering science stocks (Kristensen and Westlund, 2003). For example, the IT bubble to a significant extent was built up by a lack of proper information and analysis of intangible assets in these companies, due to a lack of non financial performance measurement and thus an overvaluing of intangible technology assets, such as AOLs telecommunications distri exclusivelyion ne iirks at the time of the AOL-Time Warner merger (The Economist, 2002). It is clear that this demonstrates a malfunctioning of the capital markets, make significant negative consequences by destroying values in the bunco term, as well as long term.As such, the main purpose of non financial performance measurement is to provide the market investors and analysts with information to control the present and expected future value of a company. Ultimately, the cover of verifying the market value at a certain time ordain wherefore be more fact based, thus reducing the unnecessary price volatility. In order to accurately achieve this, the tonality predictors of a companys future financial performance revenue, profits and market sh ar, be crucial. Most recent seek identifies these predictors as being primarily intangibles, non financial assets, thus explaining why market value today is basically immovable by intangible assets. (Kristensen and Westlund, 2003) In particular, indicators related to the customer asset the sizing and fiber of the customer base, the human capital, the brand assets, the value of corporate citizenship, and the crockeds point of intersection quality and expertise, entrust dominate. If such an indicator is a reasonably lasting, tall(prenominal) and sustainable predictor of future financial performance, it should be called a appraise Driver (Kristensen and Westlund, 2003). Non-financial reporting aims at disclosing information on value drivers, which essential be operationalised and tran sparent and, ideally, verifiable consort to freshly accounting standards in order to become true non financial performance measures. innate quality management (TQM) practices have been implemented by firms followinged in enhancing their natural selection prospects by including quality and continuous improvement in their strategic priorities. As such, they often have to be measured using both financial and non financial measures, as the expertise and cultural aspects of the TQM attend are often uncontrollable to measure by purely quantitative, financial means. One of the secern measures of the success of TQM is the balanced scorecard (BSC) approach, which appraises both the four key dimensions of firm performance customers, financial, learning and growth, and withal the internal business processes. The main prefer of this is that TQM does not consider employee rapture in its search for continuous improvement, but the BSC does consider employee satisfaction. (Hoque, 2003) Th erefore, by adopting a BSC a firm that has adopted TQM will overcome this oversight which will in turn increase employee satisfaction and subsequently firm performance. Indeed, in the modern business context, employee satisfaction is key to firm performance, and so the BSC is an important non financial performance measure.TQMs stark pursuit of quality demands that firms identify all non-value adding waste in the manufacturing process and implement procedures to eliminate, or at least reduce, such activities. This implies better toil planning to limit over- outturn and excessive inventory and improved product and comprise design to eliminate wasteful movement and handling. (Smith, 1997) Substandard items moldiness be eliminated and a changed attitude reinforced which is customer- revolve arounded and adopts the next person on the production line is my customer approach (Hoque, 2003). The cost of quality is a voltagely important component of management accounting systems which may facilitate the executing of total quality management, despite being difficult to measure in absolute financial terms. The be of prevention, appraisal and adversity are all aspects of the cost of quality, and it is often necessary to use non financial performance measures to assess these.Prevention costs include the costs of plant, product and process planning, halt maintenance, training and the implementation of statistical process control systems, and appraisal costs include the costs of inspection and testing of both incoming and surpass materials, and the cost of maintaining and administering appraisal systems and equipment, both of which can be measure financially However, whilst ruin costs include, at the internal level, the financial costs of scrap, re spring, design and safety stocks necessary to provide a buffer against such failure at the external level they include losses associated with customers, goodwill and reputation, all of which require non financial perform ance measurements. Analysis of the costs of external failure is increasingly enough the focus of attention in this area, reflecting the current trend towards increasing customer orientation of management accounting. (Smith, 1997) Quality considerations also run for beyond those focused on the difficult cost of quality question, and non financial reporting is useful in providing measures of other aspects of quality, such as the quality of purchased components, equipment failure and maintenance efforts.As a result, it is necessary for TQM practitioners to consider the relationship between the types of targets or benchmarks used in the two main separate performance improvement strategies continuous improvement and radical change. (Johnston et al, 2001) hypothesised that the process of target setting and the punish structures adopted would be different between the two strategies, proposing that organisations involved in continuous improvement of a process will base their performanc e targets on past performance and internal benchmarking, arrived at through consultation and with a mixture of financial and non-financial measurements of targets. However, for processes involving radical change, targets will be based on external benchmarks imposed by elderberry bush management, with purely financial targets, and financial rewards for their achievement. However, research showed that financial measurement and reward strategies predominated in both improvement strategies, thus implying that the potential benefits of adopting process changes are being constrained by only considering the financial side.However, whilst academic research and other research activities among accounting organisations on intangible assets has so furtheraway mainly focused on creating awareness of the significant importance of intangibles on future financial performance, to a lesser extent, research has dealt with the serious information deficiencies related to intangible assets (Hothorn et al, 2005). In particular, the research focus seems to have been on studying the dramatic shift in production functions and asset subject of the economy, rather than the underlying problems associated with measuring intangible assets, especially in cases such as Enron, where derivatives were grossly overvalued (Wilson et al, 2003). This research involves a multitude of research activities, including the macroeconomic theory of growth, as well as empirical studies on individual companies.The growing importance of intangible assets has already been demonstrated, and one rationale merchantman this development is the fact that the annual United States investments in intangible assets are of nigh the same magnitude as investments in physical assets approximately $1.2 trillion (Lev, 2001). These activities have clearly led to a rather oecumenical acceptance that traditional, financial, accounting-based, information systems fail to provide investors and policy makers with insights on t he clashing on the economy from intangibles. This is of increasing importance, given that the volatility of stock prices is becoming abnormally high, and this raises many serious consequences, including systematic inefficiency in managerial decisions.The recommendations so far from researchers seem to be voluntary disclosure of information on intangibles, and indeed, some companies now report externally on various aspects of intangible assets, but this happens in a very non-standardised way and seems to be of special value for investors decisions. Consultants, in particular linked to the accounting industry, are by trial and error analysing causes and consequences of investments in intangible assets, but this research provides only marginal guidelines in identifying exceed practice for non financial reporting (Kristensen and Westlund, 2003) Different suggestions have been presented by researchers to identify the new research agenda to understand better and manage intangible asse ts, with Lev (2001), for example, suggesting a focus on research related to organizational structures. The obviously incorrect validation of intangible assets in the cases of Enron and WorldCom (The Economist, 2002), shows that another focus of research must be to identify best practice methodological analysis to measure intangible assets, and to measure the main intangible value drivers for future financial performance.Indeed, the sustainability of non financial reporting is completely dependent on how it will be accepted by the stakeholders of the business community investors, analysts, customers, boards, management, employees, the accounting profession, etc This, in turn, completely depends on the ability and willingness by the accountants to provide a musket ball verification of the process to generate information, as well as on the information itself. Finally, this in turn depends on the quality of the information Companies must start by first identifying their true value dri vers both financial and non-financial within the context of their business model, and by ensuring they have be the just metrics as well as the measurement methodologies and systems to capture the ripe information for internal management (PriceWaterhouseCoopers, 2001).Recognising that the treatment of non financial performance is a key current issue in accountancy, accounting associations have already identified a phone function of criteria and principles to secure and describe the quality of non-financial information. This process, however, appears far from being finalised, and in particular lacks a focus on the statistical characteristics of the information, and there is also a need for further operationalisation and transparency of the quality principles (Lev, 2001) As a general principle, any verification process should verify that non-financial reporting includes the right choice of information, has the necessary degree of relevance, and that the information provided has a reasonable level of reliability. If these three requirements are not sufficiently action there is unlikely to be a sustainable future for non financial performance measurement, in TQM or any other business aspect. make headway to this, information that does not say anything or very little somewhat future financial performance should not be included in non-financial reporting. All the included information must manifest the so called economic value Drivers (Kristensen and Westlund, 2003) and such value drivers should be either leavely linked to future financial data, or they could be indirectly linked, through a direct value driver. Thus, relevance should be defined by the existence of confirm links to future financial numbers however this raises a number of pertinent questions to be answered by the accounting profession. Mainly, they would need to decide which financial criteria should primarily be considered to secure relevance and which future time detail is of interest to inv estors. For the moment, it is probably worthwhile to have a very capacious scope here, as this would mean that any financial information of interest could be used and, in addition, the future time period is defined in a very generic way. Of course, it is much more difficult to verify links to financial numbers if the lead time is substantial, and so care should be taken that the data will have a recognised financial impact within a reasonably short period of time.Indeed, whatever financial criterion and time period is chosen, it is crucial to be able to verify a strong enough and stable likely future financial impact from the non financial data. In order to better, and more accountably, measure this, such impacts should be statistically significant according to a standard statistical measurement, written into the accounting standards. However, the question that stiff is still whether impacts should also exceed a certain financial level, as well as a statistical level, in order to stipulate as a significant non financial value driver. In this context, it is also difficult to decide whether these qualifying criteria should also involve the extent to which a value driver will explain any likely magnetic variation in the future financial criterion. There are many potential principles to be found in information theory and statistics that might be used here, such as direct explanatory power (Kristensen and Westlund, 2003), but unfortunately the requirement levels necessary to use these principles are not very easy to determine, and could be open to abuse.In summary, in almost all modern industries, the book value of a company does not reflect the actual market value of the company, due to the increasing importance of branding, technology, noesis and reputation. Whilst the market and book values were still very close at the end of the 1970s, since then the picture has changed dramatically, with estimates stating that book value now represents just one quarter of the market value. As a result, it is reasonable to shut that the measurement of intangible, non financial factors is now roughly three times as important to investors as the measurement of financially measured, tangible assets.As the market value comes from intangible assets, like the customer, human resource, partner and brand assets, in order to understand the gap there is an obvious need for relevant and reliable information on these intangible assets, which is best provided by non financial performance measures. In the context of TQM, a large portion of the process improvements seen due to TQM initiatives will not have a definite financial effect rather they will improve a products attractiveness to customers, or improve the efficiency of a firms processes. As a result, their primary impact will be difficult to measure by financial measures, and so non financial performance measures will be most relevant.From this, it follows that the accountancy profession needs a new reporti ng system and also need to define a best practice of measurement for these non financial performance measures, in order to reflect the true value of initiatives such as TQM. This system has a number of requirements, including causality, standardisation, relevance or link to financial results and reliability. The prevailing opinion appears to be that it is time that new reporting systems are introduced and implemented, as the discrepancy between the importance of intangibles and the ability to account for these types of assets constitutes a growing challenge for companies, investors and for caller in general. The relevant people, including academics, managers, accountants, practitioners and auditors, should thus come together and formulate a new charter for future reporting of non financial performance measures.ReferencesDaum, J. H. (2002) intangible asset Assets or the Art to Create protect Wiley.Dutta, S. and Reicheistein, S. (2005) Stock Price, Earnings, and Book Value in Manag erial Performance Measures. Accounting Review Vol. 80, thing 4, p. 1069.Hoque, Z. (2003) Total Quality Management and the Balanced Scorecard Approach A circumstantial Analysis of their Potential Relationships and Directions for Research. Critical Perspectives on Accounting Vol. 14, go away 5, p. 553.Hothorn, T. Leisch, F. Zeileis, A. and Hornik, K. (2005) The traffic pattern and Analysis of Benchmark Experiments. Journal of Computational Graphical Statistics Vol. 14, Issue 3, p. 675.Johnston, R. Fitzgerald, L. Markou, E. and Brignall, S. (2001) prey setting for evolutionary and revolutionary process change. 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