ABC, the Balanced Scorecard and EVA-Distinguishing the Means from the End

CoolAvenues Newswire | January 16,2014 11:49 am IST

ABC, the Balanced Scorecard and EVA are modern tools for performance measurement and management that are being used by many companies across the World.


Are ABC, the Balanced Scorecard and EVA frameworks mutually exclusive or can they be used together in the same organisation?
 

ABC and the Balanced Scorecard provide managers with the information needed to make "value creating" decisions.

EVA provides a decision framework, performance measures and incentives to motivate management to create value.
 

In business, a manager must manage many inputs, and both ABC and the Balanced Scorecard help managers to make decisions.
But EVA is needed to determine whether we win or we lose.
 

By using EVA for decisions, performance measures and rewards, managers are motivated to use the information at hand to act as owners and create value.
 

Activity Based Costing:
 

Traditional cost accounting sends the wrong signals to managers
Activity-based costing addresses the drawback in the traditional cost accounting systems. These traditional systems are based on a few cost drivers, usually direct labour or direct machine hours, and do not accommodate the recent changes in business environment.
 

As an organisation's product and customer mix becomes more diverse, the assignment of overhead expenses becomes grossly misleading, distorting the costs of individual products/services. As a result, many manufacturing organisations have cost systems, which can support financial reporting, but provide distorted information about the individual products. This sends the wrong signal to decision makers.
 

ABC improves the quality of product and customer costing and helps identify areas for improvement
ABC is a cost measurement system that provides a cost for each product, service or customer by analysing each activity needed to produce a product or service a customer. The difference from traditional methods is illustrated in Exhibit 1. For example, a product that has a short processing cycle may use a disproportionate amount of inventory space or time on the receiving dock. When indirect costs are allocated to products based on the wrong cost driver products will appear less or more expensive than they actually are. ABC is used to identify all activities, direct and indirect, and allocate the costs associated with these activities more precisely.
 

 

ABC can be used in any type of organisation. It is most useful though, when an organisation has complex transfer pricing issues, high indirect costs and shared processing stations. ABC provides useful insights, but information without action does not add value. The results should be used to generate improvement. Procter & Gamble makes use of ABC technologies to identify per case cost of inefficient industry practices, and the amounts that can be saved by improving those practices. Process reengineering programs often follow an ABC analysis, with streamlined processes, reduced cost and higher quality pursued.


Many ABC systems are designed to capture costs that appear on the P&L statement only. We would argue that this approach is flawed because it provides incomplete information. One must also capture the cost of capital employed to produce a certain product or serve a certain customer. For example, if a customer insists on extended terms of payment, the additional carrying cost of Accounts Receivable associated with this customer must be captured in the ABC system. Managers must focus on cost and capital.
 

Cost information alone does not provide a complete picture
But even when a typical ABC system is upgraded to include the cost of capital, it still provides an incomplete picture. While the cost aspect is vital, managers need to understand the impact on revenues, volumes, customer satisfaction, market position, employee morale and many other factors. Therefore, cost information alone, regardless of how accurate it is, is insufficient to maximise value. Managers need to understand how costs interact with other performance indicators before they can improve the performance of their business. This ties into the Balanced Scorecard.
 

The Balanced Scorecard:
 

Balance Scorecard provides a broader view of the business and helps translate the business strategy into objectives
The Balanced Scorecard recognises the need to identify and track a number of financial and non-financial measures to provide a broader view of the business. For this purpose, an organisation is not limited to accounting data. A company may select indicators of process efficiency, safety, customer satisfaction or employee morale. This can capture information about current performance and emphasize leading indicators of future success. The objective is to produce a set of measures matched to the business so that performance can be monitored and valuated.
 

The Balanced Scorecard was created by Robert Kaplan and David Norton to translate vision and strategy into objectives. The balanced scorecard is meant to help managers keep their finger on the pulse of the business. Each organisation will emphasize different measures depending on their strategy. Management is, in effect, translating their strategy into objectives that can be measured (see Exhibit 2).
 

 

Choose variables that can predict the future or explain the past
The scorecard is a collection of data that helps a manager understand performance. The measures help managers balance their focus between current and future performance. Leading variables are future performance indicators, and lagging variables are historic results. Financial measurements are typically lagging variables, telling managers how well they have done. On the other hand, an example of a leading indicator is training costs, which influences customer satisfaction and repeat business. Some variables exhibit both lagging and leading characteristics, such as n-time deliveries (a lagging measure of operational performance and a leading indicator of customer satisfaction).

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