Advanced Financial Techniques - EVA Performance Management
We have worked with some of the most advanced organizations in terms of Performance Management. Many Australian and Asian organizations have adopted techniques not yet well understood by organizations that are just starting on the Journey of Performance Management. This White Paper discusses some of the more advanced techniques, how organisations use them and typical outcomes.
Scorecard Performance Management vs. 360 Degree vs. Appraisal
As with any new or improved system, there is debate about the correct instrument to use, where to use it and what the expected outcomes will be.
On balance, our experience is that:
The Scorecard approach is the most effective instrument to drive organizational performance providing that you have high quality objectives set for every employee.
360 Degree is best used to assess skills (competency) gaps and use this for refining for personal development.
An appraisal system without clear objectives is marginally beneficial but can also turn management against any people process as they perceive the process takes up too much time with little or no organisational improvement.
This experience is consistent with research conducted by a number of academics, in particular Associate Professor Alan Nankervis of Curtain University (now with RMIT).
Advanced Financial Objectives –EVA
Given that more organisations are now selecting the right instruments for the job, we are also seeing a trend towards increasingly sophisticated financial objectives. In advanced organisations, managers and executives are now using more advanced Financial Metrics when setting objectives. There is a distinct movement to financial metrics that eliminate the ability for management to manipulate the outcome.
This trend is a consequence of a number of factors including:
Shareholder associations becoming increasingly concerned about executives being paid bonuses on financial metrics that can be manipulated by management. For examples, if an executive is paid a bonus on Earnings Per Share, the simplest way to increase Earnings Per Share is to announce a share buy back program. As the number of shares in circulation declines, earnings per share increases and the executive by default gets paid a bonus even though the underlying financial performance may not be improved.
Measures such as EBIT (Earnings
Before Interest and Tax) do not take into account capital usage. The
organization may be very ineffective in its capital management and the return
it is deriving from the use of this capital and yet executives still get paid
bonuses on the basis that EBIT is increased.
To address the weaknesses as outlined above, organisations are starting to use EVA as a measure of true economic performance.
EVA is defined as:
NET OPERATING PROFIT AFTER TAX - (Cost of Capital % x Total Capital)
EVA considers not only Operating Profit but the use of capital to generate the profit outcome. If EVA is negative, then the organization is effectively destroying shareholder wealth.