Qn:

Please read the e-textbook on Balanced Scorecard (BSC) and Corporate Social Performance (pp.908 - 910, indicated as page 404 - 406 in VitalSource) and answer the following question. There is a growing emphasis for inclusion of nonfinancial social performance criteria in the design of executive compensation and reward process. For instance, executive compensation can be linked to company performance compared to financial and nonfinancial objectives. These objectives are to achieve targeted earnings and uphold the corporate social values including customer satisfaction, ethical business conduct, and respect for the environment, corporate governance system in the Company etc. Discuss the potential advantages and pitfalls of relying on corporate social performance as part of executive compensation design.BALANCED SCORECARD AND TRANSFER PRICING 43 Analyze investment centers using the balanced scorecard. Evaluating performance solely on financial measures has limitations such as: (1) some managers might forgo profitable projects to keep their return on investment high, (2) residual income is less useful when comparing investment centers of different size, and (3) both return on investment and residual income can encourage managers to focus too heavily on short-term financial goals. In response to such limitations, companies also use nonfinancial measures. FedEx tracks the percentage of on-time deliveries. Penn judges production managers on the percent of defective tennis balls manufactured. Walmart 's credit card screens often ask customers at checkout whether the cashier was friendly or the store was clean. Coca-Cola measures its water usage to enhance sustainability. This kind of information helps division managers run operations and helps top management evaluate division managers. Balanced Scorecard The balanced scorecard is a system of performance measures, including nonfinancial measures, used to assess company and division manager performance. The balanced scorecard requires managers to think of their company from four perspectives. 1. Customer: What do customers think of us? 2. Internal Processes: Which operations are crucial to customers? 3. Innovation/Learning: How can we improve? 4. Financial: What do our owners think of us? The balanced scorecard collects information on key performance indicators (KPIs) on each of the four perspectives. KPIs vary across companies. Exhibit 24.17 lists common KPIs on the balanced scorecard Point: A survey found that nearly 60% of global companies use some form of balanced scorecard. EXHIBIT 24.17 Balanced Scorecard Performance Indicators Employee Training ROL Customer Internal Processes Innovation/Learning Financial . Customer satisfaction rating . Defect rates . Employee satisfaction . Net income # of new customers Cycle time Employee turnover . RO % of on-time deliveries . Product costs . $ spent on training Sales growth % of sales from new products . Labor hours per order # of new products . Profit margin . Time to fill orders . Accident-free days . # of patents . Residual income % of sales returned . Warranty claims . $ spent on research . Investment turnoverAfter selecting KPIs, companies collect data on each indicator and compare actual amounts to target (goal) amounts. For example, a company might have a goal of filling 98%% of page 908 customer orders within two hours. Results on this KPI help division managers in improving order fulfillment. Exhibit 24.18 is an example of balanced scorecard reporting on the customer perspective for a retailer. This scorecard reports that 1.2% of all orders are returned. The color of the circles in the Signal column reveals whether the company is beating its goal (green), meeting its goal (gray), or not meeting its goal (red). The retailer is meeting or exceeding its goals on orders returned and customer satisfaction. However, the company received more customer complaints than was hoped for. A manager would combine this information with information from other performance indicators to improve customer service. EXHIBIT 24.18 Balanced Scorecard Reporting: Retailer KPI: Customer Perspective Actual Goal Signal Orders returned 1.2% 29% Customer satisfaction rating 9.5 of 10.0 9.5 Number of customer complaints 142 100Decision Maker CFO As CFO, your best division, based on ROI, reports a large decrease in employee satisfaction. Should you investigate reasons for employee dissatisfaction or ignore it because financial performance is superb? Answer: You should investigate. Lower employee satisfaction can lead to higher employee turnover and lower customer satisfaction, both of which can increase financial costs. NEED-TO-KNOW 24-4 Balanced Scorecard A3 Classify each of the performance measures below into the best balanced scorecard perspective to which it relates: customer (C ), internal processes (P ), innovation and learning (I ), or financial ( F ). 1. On-time delivery rate 2. Accident-free days 3. Sustainability training workshops 4. Defective products made 5. Residual income 6. Patents applied for 7. Sales returns 8. Customer complaints Solution 1. C 2. P 3. 14. P 5. F 6. 17. CS. C Do More: QS 24-16, QS 24-17, E 24-17, E 24-18Transfer Pricing C1 Explain transfer pricing and methods to set transfer prices. Divisions within a company sometimes do business with one another. For example, a separate division of Harley-Davidson manufactures the plastic and fiberglass parts used in its motorcycles. Anheuser-Busch InBev 's metal container division makes cans used in its brewing operations and also sells cans to soft-drink companies. A division of Prince produces strings used in tennis rackets made by Prince and other manufacturers. The price used to record transfers of goods across divisions of the same company is called the transfer price. Transfer prices can be used in cost, profit, and investment centers. page 909 Because these transfers are not with customers outside the company, the transfer price has no direct impact on company income . However, transfer prices can impact division income and, if set incorrectly, lead to bad decisions. To illustrate the impact of alternative transfer prices on division income, consider a company who's LCD division makes touch-screens that are used in its Phone division or sold to outside customers. LCD's variable manufacturing cost is $30 per screen, and the market price is $80 per screen. There are two extremes for the transfer price. . Low Transfer Price The Phone division manager wants to pay a low transfer price. The transfer price cannot be less than the $30 variable cost per screen, as any lower price would cause the LCD manager to lose money on each screen. . High Transfer Price The LCD division manager wants to receive a high transfer price. The transfer price cannot be more than $80 per screen, as the Phone division manager will not pay more than the market price. The transfer price must be between $30 and $80 per screen, and a negotiated price somewhere between these two extremes is reasonable-see the graphic below. I won't pay more than the $80 market price to buy this from LCD. My department loses money Phone Manager If the transfer price Is less than $30 per screen. LCD Manager $80 Market Price per Unit $30 Variable $0 Cost per Unit Negotiation Range How do we determine the transfer price? The answer depends in part on whether the LCD division has excess capacity.How do we detennine the transfer price? The answer depends in part on whether the LCD division has excess capacity. X0 Excess Capacity Ifthe LCD division can sell every screen it produces at a market price of$30 per screen= the LCD manager would not accept any transfer price less than 580. This is a market based transfer price ne based on the market price of the good or service being transferred. Any transfer price less than 880 would cause the LCD manager to incur an unnecessary armaments]: cost that would lower the divisions income and hurt its managers performance evaluation. Excess Capacity With excess capacity, LCD should accept any transfer price of $30 per unit or greater: and the Phone division would purchase screens from the LCD division. This would allow the LCD division to cover variable costs and some (or all) ofits fixed costs and to increase company income. For example= ifa transfer price of $50 per screen is used= the Phone manager will buy from LCD division because that price is below the $30 market price. For each screen transferred from LCD to Phone at SiU. the LCD division receives a confribufion margin of $20 (computed as 850 transfer price less 830 variable cost) to contribute toward recovering its fixed costs. This is called costrbnsed transfer pricing. Under this approach. the transfer price might be based on variable costs. total costs: or variable costs plus a markup. Tramfe r Pric ill 3 Used by Companies With excess capacity. division managers often negotiate a transfer price between variable cost per unit and market price per unit. The negotiated transfer price and resulting page 910 departmental performance reports reect. in part. the negotiating skills of the respective division managers. This might not be best for overall company performance. Determining the transfer price under excess capacity is complex and is covered in advanced courses. CORPORATE SOCIAL RESPONSIBILITY This chapter focused on performance measurement and reporting. Companies report on their sustainability performance in a variety of ways. One approach integrates sustainability metrics in the four balanced scorecard perspectives (customer, internal process, innovation and learning, and financial). Many key performance indicators address the internal process and innovation and learning perspectives. For example, General Mills reports on its environmental targets and progress in its annual corporate sustainability report. Exhibit 24.19 captures how this information might appear as part of a balanced scorecard report. Some companies report the direct effects on income from a focus on sustainability. For example, Target recently started a Made to Matter department. To be sold in this department, brands must focus on consumer wellness and be committed to social responsibility. Target's Made to Matter department reported sales of over $1 billion in a recent year. Teysha , this chapter's feature company, uses a labor-intensive production process. This provides jobs for local Latin Americans. "Every artisan we work with receives fair trade wages and consistent work, "explains Sofia Luz Eckrich, owner. While focused on the "people" aspect of the triple bottom line, Teysha fills a niche by bringing unique products to market. Alyssa Greenberg EXHIBIT 24.19 Balanced Scorecard-Sustainability KPI: Internal Process Perspective Actual Reduction Goal Reduction Signal Emissions 23% 20% Energy usage 10% 20% Solid waste 38% 50% Fuel 25% 35%Decision Analysis OOO Cash Conversion Cycle A4 Compute the number of days in the cash conversion cycle. Effectively managing working capital is important for businesses to survive and profit. For example, lean manufacturers try to reduce the time from paying for raw materials (cash outflow) to collecting on credit sales from customers (cash inflow). Measures based on accounts receivable, accounts payable, and inventory are used to evaluate performance on each of these separate dimensions. These measures can be combined to show how a company manages its working capital. The cash conversion cycle, or cash-to-cash cycle, measures the average time it takes to convert cash outflows into cash inflows. It is defined in Exhibit 24.20. EXHIBIT 24.20 Cash Conversion Cycle Cash conversion cycle = Days' sales in Days' sales in Days' payable + accounts receivable inventory outstanding Formulas for Components of Cash Conversion Cycle page 911 Accounts receivable, net Days' sales in accounts receivable Net sales x 365 Inventory Days' sales in inventory Cost of goods sold * 365 Accounts payable Days' payable outstanding (Days' sales in accounts payable) Cost of goods sold * 365 Exhibit 24.21 shows these calculations for General Mills , a food processor.Exhibit 24.21 shows these calculations for General Mills , a food processor. EXHIBIT 24.21 Cash Conversion Cycle Applied $ millions Current year Prior year Accounts receivable, net. . . . $ 1,430 $ 1,361 Net sales. . $15,620 $16,563 Days' sales in accounts receivable 33 days 30 days Inventory . .. $ 1,484 $ 1,414 Cost of goods sold. $10,056 $10,734 2 Days' sales In inventory . 54 days 48 days Accounts payable. $ 2,120 $ 2,047 Cost of goods sold. $10,056 $10,734 3 Days' payable outstanding. . 77 days 70 days Cash conversion cycle (1) + (2) - (3) . .. ... .... 10 days 8 days Point: Calculations rounded to the nearest day. General Mills's cash conversion cycle is 10 days in the current year and 8 days in the prior year. This is a short period and indicates the company efficiently manages its cash. For comparison, the American Productivity and Quality Center (APQC) reports an average cash conversion cycle of 45 days. The most efficient companies report cash conversion cycles of 30 days or less, while the least efficient take over 80 days to convert cash outflows to cash inflows. If the cash conversion cycle is too long, companies do not have use of that money and risk missing investment opportunities. To speed up the cash conversion cycle companies can: . Offer customers fewer days to pay. Offer customers discounts for prompt payment. Adopt lean principles to reduce inventory. Negotiate longer times to pay suppliers