The Performance of FC Division Operating In Malaysia - Case Study Example

MANAGEMENT REPORT By INTRODUCTION This report intends to evaluate the performance of FC division operating in Malaysia using varied performance evaluation methods, give recommendations on improvements where applicable and discuss the suitability of various performance evaluation methods .Analysis on various divisional managers remuneration methods is also included. RETURN ON INVESTMENT OF ABC plc (FC division) Year 2013 Costs Incurred Sales Returns Production cost 275000 internal sales 400000 Administration cost 110000 External sales 100000 Selling and distribution overhead 28000 Total cost 413000 Total sales 500000 Total returns87000 RIO for 2013 87000 x100=21.07% 413000 2014 Costs Incurred Sales Returns Production cost 442750 internal sales 725000 Administration cost 177100 External sales 80000 Selling and distribution overhead 22400 Total cost 642250 Total sales 805000 Total returns 162750 RIO for 2014 162750 x100=25.34% 642250 RESIDUAL INCOME of ABC plc (FC division) For 2013 Division’s net operating income 38000 Average operating asset of the division 1232000 (112%x1100000) Percentage cost of capital 8% RI for 2013 38000 – (8% x1232000) = – 98560 For 2014 Division’s net operating income 61180 Average operating asset of the division 1355200(1232000x110%) Percentage cost of capital 8% RI for 2014 61180 ­ – (8%x1355200) = –47236 Comments on its Performance Despite the low returns on investments in the previous two financial years, there is evidence that the company is slowly but surely picking up. The lower performance of the branch in 2013 can be blamed on instability in the company soon after it was formed. The company had to adjust to situations on the ground previously not anticipated in the planning stage. These may have included poor market response as a result of inadequate marketing. Exposure to new and unique government regulations also affecting the company negatively. Owing to the fact that skilled labor could not be immediately sorted out for locally on the inception of the branch. There was need to commence operations with skilled imported staff. Unfortunately most of these foreign managers had zero experience in Malaysia’s unique market.This also significantly retarded the branch’s ability to realize better earnings. The high inception cost of commencement of the branch which was inclusive of the cost of acquiring licenses, office spaces and construction of industrial site ate into the branches potential profits (Aswathappa, 2005, p.23). The decline on the external sales noted on the year 2014 has been neutralized by the overwhelming surge in internal sales; this has not only improved on the company’s profitability but also ensured it remains viable. The management was however keen to take note of some of these significant drawbacks.And put in adequate and relevant measures had to be put in order to ensure the branch started realizing positive returns and thus e continued profitability ,sustainability and growth. It is as are result of these measures that a positive change has been witnessed in 2014.Despite the improvement in financial year 2014 there is still need for more improvements as mentioned bellow. The management should see to it that increment on the profit margin is prioritized as this is the core aim of the organization .The need for the division as previously seen necessary by the head brunch must therefore be confirmed. Suggestions on Performance Improvement The management has come up with a number of steps the branch should take and changes that should be adopted. All these are aimed at improving on the branches operation and adding onto its profits both in the long term and short term periods. They include: The need for the branch to conduct researches unique to the Malaysian market in a bid to optimally capitalize on it. This should be conducted on a continuous basis and would give the company insight on what is needed in the market. Deficiencies in the market can be effectively noted and be exploited effectively. This can give the company an advantage over it counterparts especially when done in a timely manner. Being new to the Malaysian market will also make it very necessary that the company takes a keen note of the undertakings off other companies within Malaysia that have specialized in offering similar products and services. The operations of the best or better performing companies should be noted .The differences which make those companies better off should then be determined and studied. If relevantly necessary and achievable, emulation of these practices which would in the long run improve on performance should be effected. The branch’s management team should be careful never to focus too much on one market at the expense of another. The external market for instance should never be given too much attention as this would lead to sacrificing of another potential market (external market).Both markets are significant in maximization of sales and therefore relative balancing should be exercised to reduce dependence on one particular market. Too much dependence on a particular market may be counterproductive. In instances where the market too much depended on becomes unstable, the organization may be grossly affected. Lastly, it is advisable that the branch seeks for cheaper sources of both skilled and unskilled labor locally instead of outsourcing. This would help in cutting down on the company’s cost and give authority to managers who are more familiar with the Malaysian market. The company should therefore abandon the normal trend adopted my many international companies of employing foreign managers in company branches. Employment of local managers avoids potential resistance that would arise from locals not being ready to identify by organizations controlled by foreign managers Suitability of ROI and RI Big organizations are in most cases compelled to carry out their activities in different locations. Each individual company division in its isolated location has to be headed by a branch manager who takes the role of controlling and running the division. The division grants managers some sense of responsibility and motivation as they are vested with the task of steering the success of the division (freedom). The employees of such a branch also develop a sense of autonomy and individuality that would stimulate hard work. It is, however, important to note that geographical division of an organization may give a manager a false sense of autonomy that would negatively affect the organization. This falsified sense of autonomy results in managers having divergent targets and goals. Such managers carry out activities that are not in the interest of the overall organization leading to reduction of earnings. This makes it necessary that performance of branches and divisional managers in general be continuously evaluated. Calculation of the Return on Investment (ROI) and the Residual Income (RI) are common method used to evaluate performance of divisions of companies by basis of physical location or use. Return on investment is a method commonly used (Phillips, 2014, p.38). The technique requires that apportioned costs be noted in regards to performance of divisions economically Return on investments requires that assets be traced to specific divisions. Apportioned costs should be noted when focusing on performance of branches of organizations using return on investment method. The method has a number of advantages and disadvantages as below-: Advantages 1. The method relates aspects which are note similar in character .Variant company divisions with variant sizes and investments are related. 2. It is a consistent measure as it uses percentages which are essentially used by companies indetermination of cost of capital 3. The methods come in handy for individuals not within the company as unlike residual income; it can be easily calculated by individuals who lack exceptional financial analysis skills. Performance of branches can therefore be easily be determined by investors Disadvantages 1. Decisions responsible for increment in return on investment may also be responsible for decrease in its wealth economically. A division whose current return on earnings is 35%can have its overall return on investment increasing by disinvestments in an asset whose ROI is 30%.This ids despite the cost of invested funds being less than 30%. 2. In an investment venture whose return on investment is above the cost of capital but less than a division’s current rate of return, the investment would lower the division’s rate of return below the current level. Residual Income This is another method of determining divisional performance. It takes the view that assets are financed and owned by the parent company resources .Were the division autonomous, it would borrow funds to acquire the assets.It is therefore acceptable that the division is charged with an amount equivalent to the borrowed funds. This method also has a number of merits and demerits. Merits 1. Managers using residual income are more readily encouraged to carry out actions bearing in mind the best interests of the organization. This is because it will match their own best interest as far as performance measurement is concerned. 2. Variance in interest charges in relation to risk of individual investment projects is possible. Demerits The method provides an absolute measure instead of a relative measure. Large division’s exhibit larger productions total residual incomes than smaller divisions. Both methods have been criticized of can be criticized of focusing too much on the short term. They also give much emphasis to profits when in the real sense other qualitative factors may be of more significance. They are also challenged by the task of pointing out assets used and controlled by the divisions. As a consequence of the above mentioned problems, both methods may lead to incorrect comparisons across divisions. It has however been suggested that residual income is more appropriate where the division manager has considerable freedom to decide the investment in assets (Das & Pramanik, 2009, p.54). The return on investment on the other hand is regarded to be more appropriate in instances where the division, manager has minimal or no control over the level of investment in a division. Remuneration Methods (i). A fixed basic salary with no performance related bonus This type of remuneration would encourage uniformity and standardization of the organizations expenses on labor. It would also eliminate possible risks of increase in salaries and wages paid by the organization. This type of remuneration would however encourages laxity among managers in the organization. They will not have the motivation to strive in realization of better performances as this wouldn’t affect their reward as far as remuneration is concerned. It would also encourage rigidity in remuneration which may not be effective. This is because the uniqueness of the various divisions in particular locations might not respond the rigidities. Other companies in a particular region might pay its managers more than expected. Divisional managers in such regions may be discouraged (Hansen, Mowen, & Guan, 2009, p.65-6). (ii). A low (50% of current level) fixed basic salary with the potential to exceed current salary from a bonus based on divisional Residual Income, This kind of remuneration is flexible as it is unique to individual company divisions. The variance in divisional circumstances based on their country of location and surrounding market uniqueness makes it more realistic that this flexibility be put into practice. Managers are also motivated to strive to improve in their performance as this ensures they benefit from increased earnings. Divisions therefore grow and increase their earnings as managers enhance their performance This remuneration method however increases the costs of labor as managers are paid more in case of better performances. The profit margin of such companies is cut into by these increments in cost (Weygandt, Kieso, & Kimmel, 2010, p.81). Managers in divisions which are not advantaged are usually discouraged and desire to shift to company divisions with better remuneration schemes. They find it hard living with the fact that their counterparts elsewhere get better remunerations yet they all perform similar tasks. (iii). A low (50% of current level) fixed basic salary with the potential to exceed current salary from a bonus based on company-wide (rather than divisional) Residual Income Two advantages are derived from this type of remuneration. Uniformity is ensured thus no special regard is given to a division’slocation. This eliminates potential discontent from managers working in divisions which would have been located in disadvantaged places. Maximum outputs from the divisions are also ensured as managers strive to realize maximum possible incomes. The method is however disadvantaged by two factors. This includes the fact that bonus payment system increases the cost of capital incurred by the organization. The uniformity in remuneration may also prove not to be effective in divisions located in areas where other similar organizations have much higher payment systems. Different regions have unique characteristics that may not act in favor of equal remuneration. Variance in costs of living of different regions and countries and different costs of doing business make in important to consider flexibility (Grant, 2003, p.111). Calculation of Economic Value Added Economic Value-added (EVA) is the most fruitful performance metric used by consultants and companies. It is a financial performance method used to determine real economic profit of a firm. It can be easily determined as the profit after taxes minus a charge for the opportunity cost of invested capital. EVA can be used to carry out capital budgeting, study equity securities, determine manager motivation, shareholder and investor communication, performance measurement and setting organizational goals. Economic Value Added is determined by: 1. Calculating Net Operating profit after Tax 2. Determining the amount of Capital invested 3. Calculation of weighted average capital cost 4. Determining capital charge to economic value added and net operating earnings after tax. EVA therefore is net operating profit after tax (multiple of rate of returns and capital)–a capital charge (weighted average cost of capital or cost of capital) Suitability of Economic Value Added Economic value added (EVA) overcome the challenges encountered when using traditional measures of determining company performance. Most of these traditional measures are profit based and fail to take full account of the significance had by cost of capital unlike Economic Value Added (EVA). The EVA calculation however proves to be tedious and technical as it is based on an organizations risk index. Risk index is a relatively subjectivenature. Creation or destruction of value in terms of EVA by a company influenced by the choice of adjustment to standard accounting techniques may lead to a given degree of manipulation of EVA calculations (Rachlin, 2007, p.43). The few limitations of the method are however overshadowed by the benefits that can be realized from enhanced focus on company creation. The method would come in handy in management of finances, employee incentive programs, guiding decisions and tuning employee culture to be in line with the expectations of the organization owner. Conclusion Adaptation of the above recommendations would result in sustainability and growth in this new division. Investors and shareholders are urged to excise patience as the new division grows to realize its full potential. Bibliography Aswathappa, K. (2005). Human resource and personnel management: text and cases. New Delhi, Tata McGraw-Hill. Das, B., & Pramanik, A. K. (2009). Economic value added. New Delhi, Deep & Deep Publications. Grant, J. L. (2003). Foundations of Economic Value Added, Second Edition. Hoboken, NJ, John Wiley & Son http://public.eblib.com/choice/publicfullrecord.aspx?p=157535userid=^u Hansen, D. R., Mowen, M. M., & Guan, L. (2009). Cost management: accounting and control. Mason, Ohio, South-Western. Phillips, J. J. (2014). Measuring return on investment. Alexandria, Va, American Society for Training and Devel. Rachlin, R. (2007). Return on investment manual: tools and applications for managing financial results. Armonk, N.Y., Sharpe Professional. Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2010). Managerial accounting: Tools for business decision making. Hoboken, NJ, Wiley.opment. http://www.lib.sfu.ca/cgi-bin/validate/books24x7.cgi?isbn=1562860089 Read More