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.
