Performance Measurement and Management for Engineers (eBook)

Michela Arnaboldi, Giovanni Azzone, Marco Giorgino (Autoren)

eBook Download: PDF | EPUB

2014 | 1. Auflage
184 Seiten
Elsevier Science (Verlag)
978-0-12-801920-7 (ISBN)

Infos

Performance Measurement and Management for Engineers introduces key concepts in finance, accounting, and management to project managers who have engineering backgrounds. It focuses these basic concepts on issues of measuring and managing enterprise value. Thus, after defining enterprise value, the book begins by explaining the ways and means of measurement. It then takes up financial measurement, describing and analyzing the typologies of financial indicators while illustrating their advantages and disadvantages. After focusing on measuring enterprise value, the second section takes up managing that value. Like the first, it pursues a double view: using indicators for internal control while employing them to analyze other companies. If engineering project managers possess a source of quantitative and qualitative information about business management, Performance Measurement and Management for Engineers will help them increase their contributions to the business.

• Explains how main performance indicators are related to the value of the company
• Reveals how to assess the financial needs of companies in relation to their financial goals and mechanisms (e.g., equity, debt, and hybrid)
• Describes key information and indicators for assessing the ability of enterprises to create value across time
• Indicates the profitability sources of different business units

Michela Arnaboldi is a member of the core faculty of the School of Management at Politecnico di Milano, where she is Director of the Educational Division of the School of Management. She has served as visiting professor at the Centre for Analysis of Risk and Regulation at the London School of Economics and is a member of the Institute of Public Sector Accounting Research of the University of Edinburgh.

Inhalt

Front Cover 1
Performance Measurement and Management for Engineers 4
Copyright Page 5
Contents 6
Acknowledgments 8
1 Introduction 10
1.1 What is Enterprise Value? 10
1.2 How to Manage Enterprise Value: Enlarging the Performance Measurement Toolkit 13
1.3 Why to Manage Enterprise Value: A Multistakeholder Perspective 14
1.3.1 Enterprise Stakeholders 15
1.3.1.1 Shareholders 15
1.3.1.2 Debtholders 17
1.3.1.3 Other Stakeholders 18
1.3.1.4 Financial Analysts 19
1.3.2 External Accountability 19
1.3.2.1 Disclosure 20
1.3.2.2 Corporate Governance 20
1.3.3 Internal Accountability 21
1.3.3.1 Decision Making and Indicators 22
1.3.3.2 Motivation 24
1.4 Concluding Remarks 27
2 Value-Based Management Indicators 28
2.1 Value-Based Indicators 28
2.1.1 Direct Measurement of Economic Value 28
2.1.1.1 Strategic Perspective 30
2.1.1.2 Financial Analysis 31
2.1.1.2.1 Cost of Capital 32
2.1.1.2.1.1 The Equity Cost of Capital 32
2.1.1.2.1.2 The Firm Cost of Capital 36
2.1.1.2.2 Net Cash Flow Estimation 37
2.1.1.2.3 Terminal Value and Real Options 39
2.1.1.3 Present Value Computation: Enterprise and Equity Value 43
2.1.2 Relative Valuation 43
2.1.2.1 Defining Comparable Companies 44
2.1.2.2 Defining Possible Multiples 44
2.1.2.2.1 Enterprise Value Multiples 45
2.1.2.2.2 Equity Multiples 46
2.1.2.3 From Multiples to Value 46
2.1.2.4 How to Adapt Relative Valuation to Estimate Terminal Value 47
2.1.3 VB Proxies 48
2.1.4 Risk Value Indicators 48
2.1.5 Characteristics of VB Indicators 51
3 Accounting-Based Measures 52
3.1 Traditional Accounting Ratios: ROE and ROI 52
3.1.1 ROI and Its Subcomponents 53
3.1.2 Operating Activity: Further Indicators 54
3.1.3 Characteristics of Ratio Indicators 55
3.2 Residual Income and EVA 56
4 Value Drivers 60
4.1 Nonfinancial Performance Indicators 60
4.1.1 Time Indicators 60
4.1.2 Quality Indicators 62
4.1.3 Productivity Indicators 64
4.1.4 Flexibility Indicators 65
4.1.5 Environmental and Social Responsibility Driver 66
4.2 Nonfinancial Resource State Indicators 70
4.3 Characteristics of Nonfinancial Performance and Resource Indicators 74
4.4 Risk Drivers: Key Risk Indicators 76
4.4.1 Characteristics of KRI Indicators 76
5 Scorecards 78
5.1 Balanced Scorecard 78
5.1.1 Choosing Indicators: Second-Generation BSC 80
5.1.2 Other Types of Scorecards 81
6 Target Setting: Budgeting and Risk Management 84
6.1 Budgeting 84
6.1.1 Defining Targets: Explicit and Implicit Systems 85
6.1.2 Integrating Targets Among Organizational Units 86
6.1.2.1 The Integrated Approach: Master Budget 86
6.1.2.1.1 Sales Budget 87
6.1.2.1.2 Production Budget and Budgeted Inventory Level 87
6.1.2.1.3 Cost of Sales Budget 88
6.1.2.1.4 Period Cost Budget 89
6.1.2.1.5 Capital Budget 90
6.1.2.1.6 Cash Budget 91
6.1.2.1.7 Budgeted Cash Flow Statement 91
6.1.2.1.8 Detailed Cash Budget 93
6.1.2.1.9 Budgeted Financial Statements 93
6.1.2.2 The Adaptive Approach 96
6.2 Enterprise-Wide Risk Management 96
6.2.1 Origin of ERM 97
6.2.2 ERM Framework and Components 98
6.3 Budgeting and ERM: Organizational Configurations 101
7 Long- and Short-Term Decision Making 104
7.1 Investment Appraisal: Long-Term Decisions 104
7.1.1 Net Present Value 105
7.1.2 Profitability Index 105
7.1.3 Internal Rate of Return 106
7.1.3.1 Possible Contrast Between NPV and IRR 106
7.1.4 Discounted Payback Time 108
7.2 Short-Term Decision Making 110
7.2.1 Contribution Margin Analysis 110
7.2.2 CVP and Breakeven Analysis 111
8 Performance Control for Organizational Units 114
8.1 Boundaries and Level of Analysis 114
8.2 Measuring Performances at BU Level 116
8.2.1 Transfer Pricing 116
8.2.1.1 TPS Based on Market 117
8.2.1.2 TPS Based on Cost 118
8.2.1.3 Negotiated TPS 120
8.2.1.4 Models for Choosing the TPS 120
8.2.2 Corporate Cost Allocation 122
8.3 Measuring Performances of Responsibility Centers 123
8.3.1 Preliminary Analysis of Activities: Activity-Based Management 124
8.3.2 Cost Centers 126
8.3.3 Expense Centers 129
8.3.4 Revenue Centers 131
8.4 Measuring Performance Beyond Organizational Boundaries: Supply Chain and Network Accounting 133
8.4.1 Accounting for Network Effects 134
8.4.2 Accounting for the Network as an Entity 135
8.4.2.1 Centrality 136
8.4.2.2 Density 138
8.4.2.3 Multiplexity 138
9 Performance Control for Projects 140
9.1 Earned Value Management 141
9.2 Synthetic Performance Indicators for Project Advancement 144
9.2.1 Relative Performance Indexes 144
9.2.2 Absolute Performance Indexes 144
9.3 Percentage of Completeness and the Calculation of the Earned Value (BCWP) 146
9.4 Estimate at Completion 149
9.5 Completing Cost/Schedule Performance Indexes (TCPI/TSPI) 151
10 Forms and Techniques for Financing 154
10.1 Markets and Financial Needs Coverage 154
10.1.1 How to Measure Financial Needs 155
10.1.2 How to Cover Financial Needs 156
10.2 Forms and Techniques for Short-Term Financing 158
10.2.1 Lines of Credit 158
10.2.2 Commercial Papers 159
10.2.3 Factoring 160
10.3 Forms and Techniques for Long-Term Financing 161
10.3.1 IPOs 161
10.3.2 Bonds 162
10.3.3 Leasing 166
10.3.4 Syndicated Loans 167
Annexure 1: Consolidated Financial Statement 170
A1.1 The Concept of a “Group” 171
A1.2 Theories of Consolidation 172
A1.3 Methods of Consolidation 173
A1.3.1 First Step of Consolidation 173
A1.3.2 Second Step of Consolidation 173
A1.3.3 Third Step of Consolidation 175
A1.3.4 Proportionate Method 175
A1.3.5 Line-by-Line Method (Related to Equity Theory) 177
A1.3.6 Line-by-Line Method (Related to Parent Company Theory) 178
A1.3.7 Equity Method 179
References 180

Textauszug

Chapter 1

Introduction

Large infrastructural projects, technology and product development, manufacturing reconfiguration, and cloud computing conversion are just a few examples of activities that are now carried out in enterprises with increasing frequency. These activities are usually managed by engineers from various disciplines, yet they widely impact overall financial performance, exposure, and company value. In this context, it is mandatory to have managers who are capable of measuring weak signals from operations and projects; understanding their wider financial impact considering internal and external stakeholders; and then knowing, as a consequence, the impact on the enterprise value.

Keywords

present value; decision making; internal accountability; disclosure

Large infrastructural projects, technology and product development, manufacturing reconfiguration, and cloud computing conversion are just a few examples of activities that are now carried out in enterprises with increasing frequency. These activities are usually managed by engineers from various disciplines, yet they widely impact overall financial performance, exposure, and company value. In this context, it is mandatory to have managers who are capable of measuring weak signals from operations and projects; understanding their wider financial impact considering internal and external stakeholders; and then knowing, as a consequence, the impact on the enterprise value.

Enterprise value is the backbone of this book and the focus of this introductory chapter. In the first section, we illustrate what enterprise value is, how to measure it and, finally, how value can be managed in a coordinated but delegated manner.

1.1 What is Enterprise Value?

To address the question “What is enterprise value?” it is first useful to understand what an enterprise is.1 Instead of quoting the formal definition, we can conceptualize companies as input–output systems (Figure 1.1).

Figure 1.1 A company as an input–output system.

Enterprises aim to provide outputs (products and services) to customers and to add value to employed inputs, which include human, financial, and technological resources. To simplify: Enterprises want to maximize their output against their inputs. This simple logical thinking clashes with a fundamental computational problem: There are different types of inputs (people, machines, and patents) and outputs (various products and multiple services), each of them with diverse measurement units; hence, we simply cannot list all of them. To solve this problem and analyze the enterprise capability of creating value, money is used as a reference measurement unit. Inputs and outputs can then be expressed in cash equivalents, measuring inputs in term of the cash outflows needed to get them and outputs in terms of cash inflows deriving from their sale. From an economic point of view, we can further distinguish between:

• Investments (I): Investments refer to cash outflows related to the purchase of assets that a company is going to use for more than 1 year; examples of assets are machinery, patents, equity investments, and land.

• Cash flows (CF): Cash flows refer to cash exchanges related to transactions that have an impact on the short-term operating cycle of the company. Some examples include cash inflows originated by the sales of products or services and cash outflows for personnel wages, material purchases, or rent.

Starting from this assertion, considering a single year, the contribution of company activities to the value of a company can be expressed as net cash flow (NCF) originated for Year 0:

=NCF(0)=CF(0)–I(0)

However, companies are founded and then are supposed to have an infinite lifecycle; hence, to understand the overall value, the time horizon must be lengthened, considering not only the NCF originated at Year 0 but also all the NCFs that the enterprise is going to generate in future years, with an infinite (∞) horizon of time (Figure 1.2).

Figure 1.2 Time horizon for enterprise value and NCF analysis.

The sum of NCFs originated in different years can appear to be the simpler solution to calculate the overall value, yet this solution overlooks a crucial issue. The value of money changes over time. To test this issue yourself, think about this: Would you agree to give a company 10,000€ this year (Y0) in exchange for 10,000€ next year (Y1)? The answer would be no because you could invest your 10,000€ in other risk-free activities—such as government bonds—to obtain a greater amount of money. For example, if the annual interest rate of government bonds (the so-called risk-free rate) is 3%, by investing 10,000€ now (Year 0), you will get back 10,300€ in 1 year. To explain these calculations:

(0)=10,000€[Value atY0]

(1)=10,000€*0.03=10,300€[ValueprojectedatY1withtheannualrisk-freerateof3%]

This future projection of cash flows is generalized with the compounding formula, where rf is the risk-free rate, n is a generic year, and FV stands for future value.

(n)=V(0)×(1+rf)n[compoundingformula]

Going back to our problem of summing NCFs originated in different future years (Figure 1.2), we have the opposite problem: to calculate the present value (PV) of future cash flows. In this case, we use the discounting formula that can be easily obtained by the previous one:

(0)=FV(n)(1+rf)n[discountingformula]

The discounting formula allows us to solve the computational problem of summing expected cash flows over different years. Using the risk-free rate and considering an infinite horizon, the present value of future NCFs can be obtained as follows:

(0)=NCF1(1+rf)1+NCF2(1+rf)2+NCF3(1+rf)3+⋯+NCFN(1+rf)N

(0)=∑t=0+∞NCFt(1+rf)t[presentvalueinrisk-freeconditions]

The calculation of the present value using the risk-free rate does not take into account another element of business activities: Enterprises operate in uncertain conditions; hence, they are not considered by investors as risk-free activities. This uncertainty is compensated by a risk premium for shareholders, who are individuals or entities buying and owning shares of equity2 in a corporation. Considering risk from the shareholders’ perspective, the present value formulation changes by including the risk premium at the denominator in the discounting factor, which is called cost of equity capital (kE). Here, the generic term NCF is substituted by the term free cash flow to equity (FCFE) to clarify that we assume that cash flows pertain to shareholders.3

The value formulated in this perspective is called the equity value (E) and is analytically expressed by

(0)=∑t=0+∞FCFE(t)(1+kE)t[Equitypresentvalue]

Finally, it is important to consider that enterprises are financed not only by equity capital (E) but also by debt capital (D), which may be referred to two main investors: financial institutions and bondholders. In this case, we can still refer to the formulation of equity present value, but another perspective can be adopted wherein the value is calculated with reference to all capital investors (equity and debt). In particular:

• Cash flows at the numerator pertain to both equity and debtholders and are called free cash flow to firm (FCFF).

• The discounting rate is the weighted average cost of capital (WACC), including the required rate of return of shareholder capital (kE) and the average interest rate of debt (kD) after tax (1−t), where t is the tax rate:

(t)=DD+E×kD×(1−t)+ED+E×kE

The formulation using the investors’ perspective is called the enterprise value (EV) and is expressed as follows:

(0)=∑t=0+∞FCFF(t)(1+WACC)t[Enterprisepresentvalue]

1.2 How to Manage Enterprise Value: Enlarging the Performance Measurement Toolkit

Having defined present value as a measure of a company’s objective, the next stage is to understand how to use this metric for performance management. Although present value has the advantage of being synthetic and unique, its operational use is not straightforward, as we cannot measure value in an objective way—we can only estimate it, and any estimation depends on the expectations and information of the single investor looking at the firm. The difficulty in measuring the value of a company is even worse in the present competitive environment for several reasons:

• Increasing pressures for enterprise sustainable corporate behavior: Enterprises are nowadays required to show their capability to pursue not only economic but also environmental and societal sustainable behaviors (often referred to as the triple bottom line). This broadens the factors to be considered as value drivers, although their impact on NCFs is sometimes uncertain. Think, for example, of environmental damages: forecasting their impact on present value is not easy due to the interconnectedness between effects on a company’s reputation, the financial market reaction, and actual damages and costs to be sustained, but each of these can be measured and managed as drivers of V(0).

• Tradeoff between...

Produkt-Details

• Erscheint lt. Verlag: 8.9.2014
• Sprache: englisch
• Themenwelt: Recht / Steuern ► Wirtschaftsrecht
• Themenwelt: Technik ► Elektrotechnik / Energietechnik
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Finanzierung
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Unternehmensführung / Management
• ISBN-10: 0-12-801920-4 / 0128019204
• ISBN-13: 978-0-12-801920-7 / 9780128019207