Balanced scorecard measuring performance
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Balanced scorecard measuring performance
- 1. 1st May 2013 S t r a t e g i c H o s p i t a l i t y M a n a g e m e n t TH60015E 21094597 To attention of: Terry McCusker
- 2. 1st May 2013 According to Needles et al. (2011) every business primary goal is to increase financial wealth. The easiness of achieving company’s goals can illustrate how well the business is performing. Enterprise’s economical performance is demonstrated by financial indicators related to survival and growth e.g. credit goals, profitability, investments management and performance measurements. The balance sheet is an important document which gives information regarding a company’s ability to pay back its debts when required (liquidity), the amount of past profits preserved in the business used for growth and decrease any borrowed debts or money gained from outside. It provides with information in relation to debt liabilities linked to owner’s equity. If the amount of debt is high it automatically reflects into bigger financial risk (Coltman, 1992) However the balance sheet has its limitations and may require careful considerations to be kept in mind when reading it. For example the asset’s worth is presented in the value of money at the time when the transaction is made and not in their today’s market value. Another value such as ’’goodwill’’ built up through a good reputation is also not indicated on it giving more value to the hotel than the balance sheet shows. In addition to these resources not take into account is the investment in hotel’s employees expressed through recruiting, training etc. This might be due to the fact that it is quite challenging to express human resources with a value but we have to bear in mind they are still part of the enterprise’s assets. The fourth limitation which Coltman (1992) mentions is an estimation or judgment of value to some objects documented on the sheet e.g. depreciation. Therefore comes the question ‘’what is the best formula to calculate depreciation?’’ A single balance sheet represents a snapshot of the financial strength at only one specific point of time. Once this point passes this statement is out of date and any transactions made afterwards have to be reflected in a new document. Income statement also referred as ‘’profit and loss report’’ is another major financial statement used to show the operating result and more specifically the hotel’s revenue
- 3. 1st May 2013 and cost over a period of time e.g. month, quarter etc. It is produced to create answers to the questions how much sales the business had last month comparing it to the month before and the same month a year ago. Furthermore, it provides response to the questions did the sales exceed the expenses, which department performs most efficiently and how profitable is the business overall. As a constrain Fitzroy and Hulbert (2005) explain that the income statement is open to interpretations by hotel operators. Many of them consider it as more important and valuable than the balance sheet. Nevertheless, in order to have complete understanding of hotels operations, managers should have full understanding of both financial statements, as only one of them can not present the whole information needed. Although created as individual documents from one another, one has to bear in mind the close connection between them. (Coltman, 1992) According to Zions Business Resource Centre (2013) financial ratios assess how well the enterprise is performing financially by using its assets and inventories, plus how much profits are generated from them. Additionally, they also highlight the key relationships between elements in financial statements (appendix 3) Liquidity ratios represent the current picture of the business. Current ratios evaluate hotel’s ability to meet short term monetary obligations within payment deadlines in a safe extent. In contrast to this quick ratios assess the financial strength to pay bills if adverse circumstances take place. The liquidity ratios are disbursed out of working capital therefore it is closely dependent of the cash ratios. Needles et al. (2011) give as example Starbucks’s liquidity ratios. During the period 2006-2008 they have remained stable which indicates good cash management strategy. Solvency ratios illustrate the ability to meet long term obligations. Debt to equity ratio reproduces the level of debt in connection to equity and the investment risk involved. Credit officers assume hotels are at larger risk if their debt to equity ratio is high. Working capital is part of cash flow and plays a role in loan agreements (Zions Business Resource Centre 2013). Capital structure looks at the correlation between all the sources of funding and the earning power to cover the debts (Sinha,
- 4. 1st May 2013 2009). Profitability ratios measure the capability to gain reasonable amount of earnings from the factors of production. It helps to determine how efficient the management is using resources to create profit. Оperational ratios – evaluate the return to investment per sterling pound of gross revenue and the relation between sales and total operational costs. Main performance indicators here are the room occupancy level, RevPar and ADR. They are incomplete to some extend if taken into account separately from one another. Activity ratios – reflect on how efficiently the assets are operated within the hotel. Tofeeq, (1997 stated in Khalad and Mazila, 2011) evaluate the ratios as valuable instrument used to bring the attention to any strong and weak areas or potential problems needed to be avoided and reveal solutions for improvement. Even better, ratios can be used for performance comparison against competitors. They are helpful only if calculated accurately enough. According to Zions Business Resource Centre (2013) ratio analysis helps with the decision making process by demonstrating large trends and assessing creditworthiness (Khalad and Mazila, 2011). Even though financial ratios are widely used they have their week sides too. For example they purely present only the past and cannot be used as an indicator for the future. Due to differences in accounting practices and standards their exact global comparability is doubtful. Finally in similarity to the balance sheet Coltman (1992) states that the ratios are based on historical data or in other words present historic cost rather than its present worth. Benchmarking mainly answers the question ‘’who is the best. ‘It can be measured towards both internal between units or external factors e.g. key competitors or industry average. As per Man et al (1998 stated in Wober, 2001) argues that effective benchmarking can only be achieved if comparing alongside partners combined with having the knowledge about ‘’best practice’’, ‘’ goal evaluation’’ as well as ‘’goal setting’’. Another key point contributing to accomplish operational performance is
- 5. 1st May 2013 recognizing company’s competitive strong and weak sides and implements structured practice towards a change. Reports like STAR (Smith Travel Accommodations Report) are essential management tool for competitive measurement allowing for periodical analysis against chosen competitors. This report represents reliable data source used to scale hotel’s total market sales and market share penetration. Coltman (1992) refers to previous and current ratios as comparing ‘’oranges and apples’’ due to the always changing environment in hospitality. The STAR compares ‘’apples with apples’’ as it defines performance over the major common metrics for hotels (e.g. ADR, RevPar, occupancy percentage) in the same local market conditions. (STAR global, 2013) Its usefulness is expressed in ROI analysis. As per Khalad and Mazila (2011) the Balanced scorecard (see appendix 2) is utilized to assess the overall hotel performance by setting standards for each of its 4 perspectives. This framework offers few major advantages to any business. First of all, it put on focus the entire enterprise as one unit by exploiting few basic items required for innovation. Secondly combine together a variety of different initiatives such as quality, customer service and reengineering. Lastly, it creates strategy standards for the lower levels for example managers or employees. The workers can establish particular demands for accomplishment excellent performance. The Balanced scorecard cannot resolve issues it only can assist in achieving the company’s strategy. If the balanced aims are not followed up or no management policies are put into practice the framework is going to fail.
- 6. 1st May 2013 Which method of performance measurement is more efficient - the financial ratios or the balanced scorecard? They both measure the financial performance of an organization in general. The financial ratios evaluate in a short term, based only on financial measurements. The data used in the financial statements as a whole is historical and measures the past. Therefore it is not very appropriate or adequate method for management decision making. In contrast to this the balanced scorecard is more efficient method and could be used to assess potential future performance presents ‘’the whole picture’’ by focusing on both financial and non-financial determinations. Furthermore, it also measure performance against set standards. As a conclusion we can say that the balanced scorecard is more efficient compared to the financial ratios as they are not as comprehensive enough as the scorecard to evaluate the overall organizational performance. However, neither of them can be ignored since they are both important tools. Word count 1456
- 7. 1st May 2013 Appendix 1. Financial and Strategic Objectives
- 8. 1st May 2013 2. Balanced Scorecard Framework 3. Financial Measures Liquidity 1. Current ratio = total current assets/total current liabilities 2. Working capital = total current assets - total current liabilities Solvency 3. Debt/asset ratio = total liabilities/total assets 4. Equity/asset ratio = total equity/total assets 5. Debt/equity ratio = total liabilities/total equity Profitability 6. Rate of return on assets = (net income from operations + interest expense - value of operator and unpaid labor)/average total assets 7. Rate of return on equity = (net income from operations - value of operator and unpaid labor)/average total equity 8. Operating profit margin = (net income from operations + interest expense - value of operator and unpaid labor)/gross revenue
- 9. 1st May 2013 9. Net income Repayment Capacity 10. Term Debt and Capital Lease Coverage Ratio = (net income from operations + total non-organizational income + depreciation expense + interest on term debt and capital leases - total income tax expense-withdrawals) /principal and interest payments on term debt and capital leases 11. Capital replacement and term debt repayment margin = net income from operations + total non-organizational income + depreciation expense - total income tax expense - withdrawals (including total annual payments on personal liabilities) - payment on prior unpaid operating debt - principal payments on current portion of term debt and capital leases Financial Efficiency 12. Asset turnover ratio = gross revenue/average total assets 13. Operating expense ratio = operating expense/gross revenue 14. Depreciation expense ratio = depreciation expense/gross revenue 15. Interest expense ratio = interest expense/gross revenue 16. Net income from operations ratio = net farm income from operations/gross revenue 4. Pyramid of ratios http://www.wiredwessex.co.uk/dyn/essentialbusinessfinance2.pdf
- 10. 1st May 2013 Bibliography: Coltman, M.,(1992) Financial Control for your hotel, New York: Van Nostrand Reinhold. Fitzroy, H. and Hulbert, J. (2005) Strategic Management, Creating Value in Turbulent Times,Berwick upon Tweed: Hermitage Publishing Services. Kaplan, R.S. and D.P. Norton, 1996. The Balanced Scorecard: Translating Strategy into Action. 1st Edn., Boston, Mass: Harvard Business School Press,. Kaplan, R.S. and D.P. Norton, 2000. The Balanced Scorecard: Measures that Drive Performance. 1st Edn., Boston Mass :Harvard Business School Publishing,.. Khalad, M. S. and Mazila, M. Y. (2011) Comparison between Financial Analysis and Balanced Scorecard, American Journal of Economics and Business Administration 3 (4):618-622, Shah Alam: Science Publications. Mann, L., Samson D. and Dow, D. (1998) A field experiment on the effects of benchmarking and goal setting on company sales performance. Journal of Management 24(1), 73-96. Needles, B. E., Power, M., Crosson, S. (2011) Financial and Managerial Accounting, Mason: South Western Cengage Sinha, G. (2009) Financial Statement Analysis, New Delhi: PHI Learning Private Limited. STAR Global (2013) Highlights, The leading Hotel Performance Reports, Competitor and Market Data [online]. Available from: < http://www.strglobal.com/Details/NNA/STAR> [Accessed 22 April 2013]. Tofeeq, G. (1997) Principles of Management, Alexandria: Modern University Office. Wober, K. W. (2001) Benchmarking for Tourism Organizations, An eGuide for Tourism Managers, National Laboratory for Tourism and eCommerce [online]. Available from: < http://fama2.us.es:8080/turismo/turismonet1/BENCHMARKINGFORTOURISM> [Accessed 18 April 2013]. Zions Business Resource Center (2013) How to Analyze Your Business Using Financial Ratios [online]. Available from: <https://www.zionsbank.com/pdfs/biz_resources_book/ratios [Accessed 25 April 2013].