Performance Management Information Systems

Performance Management Information Systems

1. Introduction to planning, control and decision – making

Strategic planning is the process of deciding on objectives for the organisation, changes in these objectives, the resource to attain these objectives, and the policies that are to govern the acquisition, use and disposition of these resources.

Management control is the process by which managers assure that resources are obtained and used effectively and efficiently in the accomplishment of the organisation’s objectives. It is sometimes called tactics or tactical planning.

Operational control (or operational planning) is the process of assuring that specific tasks are carried out effectively and efficiently.

Within and at all levels of the organisation, information is continually flowing back and forth, being used by people to formulate plans and take decisions, and to draw attention to the need for control action, when the plans and decisions don’t work as intended.

Key terms: Planning means formulating ways of proceeding. Decision – making means choosing between various alternatives. These two terms are virtually inseparable: you decide to plan in the first place and the plan you make is a collection of decisions.

Strategic decisions are long – terms decisions and are characterised by their wide scope, wide impact, relative uncertainty and complexity.

Control is used in the sense of monitoring something so as to keep it on course, like the ‘controls’ of a car, not (or not merely) in the sense of imposing restraints to exercising tyrannical power over something. We have more to say about control later in this Study Text.

1.1 Information for planning, control and decision - making

Robert Anthony, a leading writer on organisational control, suggested what has become a widely used hierarchy, classifying the information used at different management levels, for planning, control and decision – making into three tiers: strategic planning, management control and operational control.

We consider each tier in turn in Section 2 – 4.

Key terms: Strategic planning. The process of deciding on objectives of the organisation, changes in these objectives, the resources used to attain these objectives, and the policies that are to govern the acquisition, use and disposition of these resources.

Management (or tactical) control. The process by which managers assure that resources are obtained and used effectively and efficiently in the accomplishment of the organisation’s objectives. It is sometimes called tactics or tactical planning.

Operational control (or operational planning). The process of assuring that specific tasks are carried out effectively and efficiently.

2. Management accounting information for strategic planning, control and decision – making

Management accounting information can be used to support strategic planning, control and decision – making. Strategic management accounting differs from traditional management accounting because it has an external orientation and a future orientation.

This section identifies the accounting information requirements for strategic planning, control and decision – making.

2.1 Future uncertainty: Much strategic planning is uncertain.

(a) Strategic plans may cover a long period into the future, perhaps five to ten years ahead or even longer.

(b) Many strategic plans involve big changes and new ventures, such as capacity expansion decisions, decisions to develop into new product areas and new markets, and so on.

Inevitably, management accounting information for strategic planning will be based on incomplete data and will use forecasts and estimates.

(a) It follows that management accounting information is unlikely to give clear guidelines for management decisions and should incorporate some risk and uncertainty analysis (e.g. sensitivity analysis).

(b) For longer – term plans, discounted cash flow techniques ought to be used in financial evaluation.

(c) The management accountant will be involved in the following.

        I.            Project evaluation

      II.            Managing cash and operational matters

    III.            Reviewing the outcome of the project (post implementation review)

2.2 External and competitor orientation: Much management accounting information has been devised for internal consumption. However, it is important to balance this with a consideration of external factors.

(a) Strategic planning and control decisions involve environmental considerations.

(b) A strategy is pursued in relation to competitors.

2.3 The challenge for management accountants

Traditional accounting systems have had a number of perceived failings.

(a) Direction towards financial reporting. It is necessary to report historical costs to shareholders, but the classifications of transactions for reporting purposes are not necessarily relevant to decision making.

(b) Misleading information. This is particularly with regard to overhead absorption.

(c) Neatness rather than usefulness. Importance is placed on financial reporting templates, rather than providing solutions for management accountants.

(d) Internal focus. Management accounting information has been too inward looking (for example, focusing on achieving internal performance targets, like budgets). However, organisations also need to focus on customers and competition.

(e) Inflexibility. Traditional accounting systems have displayed an inability to cope with change, and the modern business environment.

The challenge lies in providing more relevant information for strategic planning, control and decision – making. Traditional management accounting systems may not always provide this.

(a) Historical costs are not necessarily the best guide to decision-making. One of the criticisms of management accounting outlined by Kaplan, Bromwich and Bhimani is that management accounting information is biased towards the past rather than the future.

(b) Strategic issues are not easily detected by management accounting systems.

(c) Financial models of some sophistication are needed to enable management accountants to provide useful information.

2.4 What is strategic management accounting?

The aim of strategic management accounting is to provide information that is relevant to the process of strategic planning and control.

Key Term: Strategic management accounting is a form of management accounting in which emphasis is placed on information about factors which are external to the organisation, as well as non-financial and internally generated information.

2.4.1 External orientation: The important fact which distinguishes strategic management accounting from other management accounting activities is its external orientation, towards customers and competitors, suppliers and perhaps other stakeholders. For example, while a traditional management accountant would report on an organisation's own revenues, the strategic management would report on market share or trends in market size and growth.

(a) Competitive advantage is relative. Understanding competitors is therefore of prime importance. For example, knowledge of competitors' costs, as well as a firm's own costs, could help inform strategic choices: a firm would be unwise to pursue a cost leadership strategy without first analysing its costs in relation to the cost structures of other firms in the industry.

(b) Customers determine if a firm has competitive advantage.

2.4.2 Future orientation: A criticism of traditional management accounts is that they are backward looking.

(a) Decision-making is a forward- and outward-looking process.

(b) Accounts are based on costs, whereas decision-making is concerned with values.

Strategic management accountants will use relevant costs (i.e. incremental costs and opportunity costs) for decision-making.

2.4.3 Goal congruence: Business strategy involves the activities of many different functions, including marketing, production and human resource management. The strategic management accounting system will require inputs from many areas of the business.

(a) Strategic management accounting translates the consequences of different strategies into a common accounting language for comparison.

(b) It relates business operations to financial performance, and therefore helps ensure that business activities are focused on shareholders' needs for profit. In not for profit organisations this will not apply, as they do not focus on shareholder profitability. (We look at not for profit organisations in more detail later in this Study Text.)

It helps to ensure goal congruence, again by translating business activities into the common language of finance. Goal congruence is achieved when individuals or groups in an organisation take actions which are in their self-interest and also in the best interest of the organisation as a whole.

2.5 What information could strategic management accounting provide?

Bearing in mind the need for goal congruence, external orientation and future orientation, some examples of strategic management accounting are provided below.

Item	Comment
Competitors' costs	What are they? How do they compare with ours? Can we beat them? Are competitors vulnerable because of their cost structure?
Financial effect of competitor response	How might competitors respond to our strategy? How could their responses affect our sales or margins?
Product profitability	A firm should want to know not just the profits or losses that are being made by each of its products but also why one product should be making good profits whereas another equally good product might be making a loss.
Customer profitability	Some customers or groups of customers are worth more than others.
Pricing decisions	Accounting information can help to analyse how profits and cash flows will vary according to price and prospective demand.
The value of market share	A firm ought to be aware of what it is worth to increase the market share of one of its products.
Capacity  expansion	Should the firm expand its capacity and, if so, by how much? Should the firm diversify into a new area of operations, or a new market?
Brand values	How much is it worth investing in a brand which customers will choose over competitors' brands?
Shareholder wealth	Future profitability determines the value of a business.
Cash flow	A loss-making company can survive if it has adequate cash resources, but a profitable company cannot survive unless it has sufficient liquidity.
Effect of acquisitions and mergers	How will the merger affect levels of competition in the industry?
Decisions to enter or leave a business area	What are the barriers to entry or exit? How much investment is required to enter the market?

3. Management accounting information for management control

Management control is at the level below strategic planning in Anthony's decision-making hierarchy and is concerned with decisions about the efficient and effective use of resources to achieve objectives.

Management control, which we briefly touched on in Section 1, is at the level below strategic planning in Anthony's decision-making hierarchy. While strategic planning is concerned with setting objectives and strategic targets, management control is concerned with decisions about the efficient and effective use of an organisation's resources to achieve these objectives or targets.

(a) Resources (which can be categorised as a series of 'M's): money, manpower, machinery, methods, markets, management, and management information.

(b) Efficiency in the use of resources means that optimum output is achieved from the input resources used. It relates to the combinations of men, land and capital (e.g. how much production work should be automated) and to the productivity of labour, or material usage.

(c) Effectiveness in the use of resources means that the outputs obtained are in line with the intended objectives or targets.

The time horizon involved in management control will be shorter than at the strategic decisions level, there will be much greater precision and the focus of information will be narrower.

Management control activities are short-term non-strategic activities.

3.1 Examples of management control (or tactical) planning activities

(a) Preparing budgets for the next year for sales, production, inventory levels, and so on

(b) Establishing measures of performance by which profit centres can be gauged

(c) Developing a product for launching in the market

(d) Planning advertising and marketing campaigns

(e) Establishing a line of authority structure for the organisation

3.2 Examples of management control activities

(a) Ensuring that budget targets are reached, or improved on

(b) Ensuring that other measures of performance are satisfactory, or even better than planned

(c) Where appropriate, changing the budget because circumstances have altered

Management control is an essentially routine affair in that it tends to be carried out in a series of regular planning and comparison procedures; that is, annually, monthly or weekly, so that all aspects of an organisation's activity are systematically reviewed. For example, a budget is usually prepared annually, and control reports issued every month or four weeks. Strategic planning, in contrast, might be irregular and occur when opportunities arise or are identified.

3.3 Information requirements

Features of management control information

(a) Primarily generated internally (but may have a limited external component)

(b) Embraces the entire organisation

(c) Summarised at a relatively low level

(d) Routinely collected and disseminated

(e) Relevant to the short and medium terms

(f) Often quantitative (labour hours, volumes of sales and production)

(g) Collected in a standard manner

(h) Commonly expressed in money terms

Types of information

(a) Productivity measurements

(b) Budgetary control or variance analysis reports

(c) Cash flow forecasts

(d) Manning levels

(e) Profit results within a particular department of the organisation

(f) Labour revenue statistics within a department

(g) Short-term purchasing requirements

3.4 Source of information: A large proportion of this information will be generated from within the organisation (it has an endogenous source) and it will often have an accounting emphasis. Tactical information is usually prepared regularly; perhaps weekly or monthly.

3.5 Management control and strategic planning compared: The dividing line between strategic planning and management control is not a clear one. Many decisions include issues ranging from strategic to tactical. Nevertheless, there is a basic distinction between the two levels of decision.

(a) The decision to launch a new brand of calorie-controlled frozen foods is a strategic plan (business strategy), but the choice of ingredients for the frozen meals involves a management control decision.

(b) A decision that the market share for a product should be 25% is a strategic plan (competitive strategy), but the selection of a sales price of $2 per unit, supported by other marketing decisions about sales promotion and direct sales effort to achieve the required market share, would be a series of management control decisions.

Management control tends to be carried out in a series of regular planning and comparison procedures (annually, monthly, weekly). For example, a budget is usually prepared annually and control reports issued every month or four weeks. Strategic planning, in contrast, might be irregular and occur when opportunities arise or are identified.

4. Management accounting information for operational control

Operational control, the lowest tier in Anthony's hierarchy, is concerned with assuring that specific tasks are carried out effectively and efficiently.

The third and lowest tier in Anthony's hierarchy of decision-making consists of operational control decisions. Just as 'management control' plans are set within the guidelines of strategic plans, so too are 'operational control' plans set within the guidelines of both strategic planning and management control.

4.1   Example: Link between strategic plans and operational/management control decisions

(a) Senior management may decide that the company should increase sales by 5% per annum for at least five years – a strategic plan.

(b) The sales director and senior sales managers will make plans to increase sales by 5% in the next year, with some provisional planning for future years. This involves planning direct sales resources, advertising, sales promotion, and so on. Sales quotas are assigned to each sales territory – a tactical management control decision.

(c) The manager of a sales territory specifies the weekly sales targets for each sales representative. This is an operational control decision: individuals are given tasks which they are expected to achieve.

Operational control decisions are therefore much more narrowly focused and have a shorter time frame than tactical or strategic decisions.

4.2 Operational control activities: Although we have used an example of selling tasks to describe operational control, it is important to remember that this level of decision-making occurs in all aspects of an organisation's activities, even when the activities cannot be scheduled nor properly estimated because they are non-standard activities (such as repair work and answering customer complaints).

The scheduling of unexpected or 'ad hoc' work must be done at short notice, which is a feature of much operational decision-making. In the repairs department, for example, routine preventive maintenance can be scheduled, but breakdowns occur unexpectedly and repair work must be scheduled and controlled 'on the spot' by a repairs department supervisor.

Operational control activities can also be described as short-term non-strategic activities.

4.2   Information requirements

(a) Operational information is information which is needed for the conduct of day-to-day implementation of plans.

(b) It will include much 'transaction data', such as data about customer orders, purchase orders, cash receipts and payments and is likely to have an endogenous source.

(c) Operating information must usually be consolidated into totals in management reports before it can be used to prepare management control information.

(d) The amount of detail provided in information is likely to vary with the purpose for which it is needed, and operational information is likely to go into much more detail than tactical information, which in turn will be more detailed than strategic information.

Whereas tactical information for management control is often expressed in money terms, operational information, although quantitative, is more often expressed in terms of units, hours, quantities of material, and so on.

5. Types of information systems: You should be aware of the main characteristics of transaction processing systems, management information systems, executive information systems and enterprise resource planning systems.

5.1 Transaction processing systems: Transaction processing systems (TPS) collect, store, modify and retrieve the transactions of an organisation.

A transaction is an event that generates or modifies data which is eventually stored on an information system.

Transaction processing systems (TPS) collect, store, modify and retrieve the transactions of an organisation. The four important characteristics of a TPS are as follows.

(a) Controlled processing: The processing must support an organisation's operations.

(b) Inflexibility: A TPS wants every transaction to be processed in the same way regardless of user or time. If it were flexible there would be too many opportunities for non-standard operations.

(c) Rapid response: Fast performance is critical. Input must become output in seconds so customers don't wait.

(d) Reliability: Organisations rely heavily on transaction processing systems, with failure potentially stopping business. Back-up and recovery procedures must be quick and accurate.

5.1.1 Properties of a TPS: The components of a TPS include hardware, software and people. People in a TPS can be divided into three categories – users, participants and people from the environment.

The users are employees of the company who own the TPS. The users will not alter data themselves, but will use the TPS to provide inputs for other information systems such as inventory control.

Participants are direct users of the system. They are the people who enter the data. Participants include data entry operators, customer service staff and people working at checkouts.

People from the environment are people who sometimes require the services of a TPS as they enter transactions and validate data, such as customers withdrawing money from an ATM.

5.1.2 Types of TPS: Batch transaction processing (BTP) collects transaction data as a group and processes it later, after a time delay, as batches of identical data.

An example of BTP is cheque clearance. A cheque is a written order asking the bank to pay an amount of money to the payee. The payee cannot withdraw the money until the cheque is cleared. This involves checking that the payer has enough money in their account to cover the cheque. It usually takes three working days – cheques are cleared in a group during a quiet period of the day.

Real time transaction processing (RTTP) is the immediate processing of data. It involves using a terminal or workstation to enter data and display results and provides instant confirmation. A large number of users can perform transactions simultaneously but access to a central online database is required.

An example of an RTTP system is a reservation system involved in setting aside a service or product for the customer to use at a future time. Such systems are commonly used for flight or train bookings and hotel reservations and require an acceptable response time, as transactions are made in the presence of customers.

5.2 Management information systems: Management information systems (MIS) convert data from mainly internal sources into information (e.g. summary reports, exception reports). This information enables managers to make timely and effective decisions for planning, directing and controlling the activities for which they are responsible.

Management information systems (MIS) generate information for monitoring performance (eg productivity information) and maintaining co-ordination (e.g. between purchasing and accounts payable).

MIS extract, process and summarise data from the TPS and provide periodic (weekly, monthly, quarterly) reports to managers.

Today MIS are becoming more flexible by providing access to information whenever needed, rather than pre-specified reports on a periodic basis. Users can often generate more customised reports by selecting subsets of data (such as listing the products with a 2% increase in sales over the past month), using different sorting options (by sales region, salesperson, highest volume of sales) and different display choices (graphical, tabular). MIS have the following characteristics.

• Support structured decisions at operational and management control levels

• Designed to report on existing operations

• Little analytical capability

• Relatively inflexible

• An internal focus

5.3 Executive information systems: Executive information systems (EIS) draw data from the MIS and allow communication with external sources of information.

Executive information systems (EIS) provide a generalised computing and communication environment for senior managers to support strategic decisions.

Executive information systems draw data from the MIS and allow communication with external sources of information. EIS are designed to facilitate senior managers' access to information quickly and effectively. They have:

• Menu-driven user friendly interfaces

• Interactive graphics to help visualisation of the situation

• Communication capabilities linking the executive to external databases

An EIS summarises and tracks strategically critical information from the MIS and includes data from external sources, eg competitors, legislation and databases such as Reuters.

A good way to think about an EIS is to imagine the senior management team in an aircraft cockpit, with the instrument panel showing them the status of all the key business activities. EIS typically involve lots of data analysis and modelling tools, such as what-if analysis to help strategic decision-making.

A model of a typical EIS is shown below.

5.4 Enterprise resource planning systems: Executive resource planning systems (ERP systems) are modular software packages designed to integrate the key processes in an organisation so that a single system can serve the information needs of all functional areas.

Most organisations around the world have realised that, in a rapidly changing environment, it is impossible to create and maintain a custom-designed software package that will cater to all their requirements and also be completely up to date. Realising the requirement of user organisations, some of the leading software companies have designed enterprise resource planning software which will offer an integrated software solution to all the functions of an organisation.

ERP systems are large-scale information systems that impact an organisation's accounting information systems. These systems permeate all aspects of the organisation. A key element necessary for the ERP to provide business analysis is the data warehouse. This is a database designed for quick search, retrieval, query, and so on.

Executive resource planning systems (ERP systems) are modular software packages designed to integrate the key processes in an organisation so that a single system can serve the information needs of all functional areas.

ERP systems primarily support business operations – those activities in an organisation that support the selling process, including order processing, manufacturing, distribution, planning, customer service, human resources, finance and purchasing. ERP systems are function-rich, and typically cover all these activities – the principal benefit being that the same data can easily be shared between different departments.

This integration is accomplished through a database shared by all the application programs. For example, when a customer service representative takes a sales order, it is entered in the common database and it automatically updates the manufacturing backlog, the price, the credit system and the shipping schedule.

ERP systems work in real time, meaning that the exact status of everything is always available. Further, many of these systems are global. Since they can be deployed at sites around the world, they can work in multiple languages and currencies. When they are, you can immediately see, for example, exactly how much of a particular part is on hand at the warehouse in Japan and what its value is in yen or dollars.

5.4.1 Example: ERP: Say you are running a bicycle shop. Once you make a sale, you enter the order on the ERP system. The system then updates the inventory of bicycles in the shop, incorporates the sale into the financial ledgers, prints out an invoice, and can prompt you to purchase more bikes to replace the ones that you have sold. The ERP system can also handle repair orders and manage the spare parts inventory. It can also provide automated tools to help you forecast future sales and to plan activities over the next few weeks. There may also be data query tools present to enable sophisticated management reports and graphs to be generated. In addition, the system may handle the return of defective items from unhappy customers, the sending out of regular account statements to customers and the management of payments to suppliers.

ERP systems can assist with the scheduling and deployment of all sorts of resources, physical, monetary and human. A water company might use their ERP system to schedule a customer repair job, deploy staff to the job, verify that it got done, and subsequently bill the customer. An oil company might use it to ensure that their tankers are loaded, that a shipping itinerary is prepared and completed on schedule, and that all the equipment and people required for loading and unloading the cargo in each port are present at the right times. A bus company might use its system to manage customer bookings, record receipts and plan preventive maintenance activities for their fleet.

5.4.2 Benefits of ERP: The benefits that may be realised from a successfully implemented ERP project include:

(a) Allowing access to the system to any individual with a terminal linked to the system's central server

(b) Decision support features, to assist management with decision-making

(c) In many cases, extranet links to the major suppliers and customers, with electronic data interchange facilities for the automated transmission of documentation, such as purchase orders and invoices

(d) A lot of inefficiencies in the way things are done can be removed; the company can adopt so-called 'best practices' – a cookbook of how similar activities are performed in world-class companies

(e) A company can restructure its processes, so that different functions (such as accounting, shipping and manufacturing) work more closely together to get products produced

(f) An organisation can align itself to a single plan, so that all activities, all around the world, are smoothly co-ordinated

(g) Standardising Information and work practices so that the terminology used is similar, no matter where you work in the company

(h) A company could do a lot more work for a lot more customers without needing to employ so many people

6. Open and closed systems: Systems can be open or closed. The word system is impossible to define satisfactorily (the tax 'system', the respiratory 'system', the class 'system'). Basically it means something that connects things up.

6.1 Closed systems: A closed system is isolated and shut off from the environment. Information is not received from or provided to the environment.

Closed systems are seldom, if ever, found in naturally occurring situations. A typical example of a closed system would be a chemical reaction that takes place under controlled conditions in a laboratory. Closed systems can be created to eliminate external factors and then used to investigate the relationship between known variables in an experiment.

All social systems have some interaction with the environment and so cannot be closed systems. A commercial organisation, for example, could not operate as a closed system, as it would be unable to react to the external environment and so would not be commercially or economically viable.

6.2 Open systems: An open system is connected to and interacts with the environment and is influenced by it.

An open system accepts inputs from its surroundings, processes the inputs in some manner and then produces an output. The input parameters can be foreseen or unpredictable. Similarly, outputs can either be predicted or unforeseen. For example, consider a metal smelting works. Predictable inputs would include items like the raw materials and coal while the predictable outputs would be ash, smoke and the smelted metal. If the raw material to be smelted became contaminated in some way, it is likely that an undesirable product would be produced. These are examples of unforeseen inputs and outputs.

All social systems, including business organisations, are open systems. For example, a business is a system where management decisions are influenced by or have an influence on suppliers, customers, competitors, the Government and society as a whole. Employees are obviously influenced by what they do in their job, but as members of society at large they are also part of the external environment, just as their views and opinions expressed within the business are often a reflection of their opinions as members of society at large.

6.3 Open and closed systems and performance management: Systems are rarely either open or closed, but open to some influences and closed to others. Organisations must carefully choose the form of management accounting system based on the respective scenario.

The chemical laboratory could use a closed system. Here, performance is largely influenced by an internally created environment and external factors would not affect the output or result of the activity.

However, if an organisation's performance is influenced by environmental factors, it should operate an open system that accepts input from the external factors and examines their impact on performance output.

The advantages of an open system are:

(a) It encourages strong communication, which helps an organisation to operate efficiently and become effective.

(b) It adapts to the changing environment and there is scope for absorbing new pieces of information into the system.

(c) It highlights the interdependencies of different operations and processes within a business and the environment in which it operates.

(d) It helps business leaders and managers to focus on the external factors that shape behaviour and patterns within the organisation.

Management should consider the potential limitations of open systems.

(a) Non-linear relationships could exist among variables. A small change in one variable could cause a large change in another and affect the business result in a positive or negative way.

(b) It could prove difficult to measure the success of the system, specifically metrics relating to input, processing and output as well as the interrelationship among them.