St.

Petersburg State University

Graduate School of Management
Master in International Business Program

USE OF NON-FINANCIAL MEASURES IN

COMPANY EVALUATION

Report prepared by
Niklavs Petersons
Ekaterina V. Kovaleva

St. Petersburg
2009
Table of Contents
Introduction........................................................................................................................ 3
Non-financial measures.................................................................................................. 4
Customer perspective............................................................................................................. 5
Internal business processes.................................................................................................. 5
Learning and innovation........................................................................................................ 6
Practical implementation of non-financial measures...........................................6
Shortcomings of non-financial measures..................................................................8
Conclusion........................................................................................................................... 9
Bibliography..................................................................................................................................... 10

Use of Non-financial Measures in Company Evaluation 2

 Introduction
Currently the main trend in evaluating company activity shows a shift
away from pure financial performance measures. This shift is explained by many
reasons. In particular, inaccuracies in the way of presenting information to
different groups of stakeholders, distortions in accounting systems, and growing
difference between market value and book value of a company that inevitably
leads to changes in corporate evaluation. Moreover, financial reports do not
always provide the possibility to compare whether results are good for the
company or not. The improvements in financial figures can be driven by many
factors that do not depend on the company itself (new laws, subsidies, shift of
bargaining power, and etc.) In addition financial figures might be driven by
creative accounting techniques etc.
Furthermore, another large problem of financial indicators is that they
describe past company activities, which can be compared between companies.
This issue is paradox because, from the one side, financial measures make it easy
for investors to identify which firm has performed better in the past, but
ironically, what investors really need, is to evaluate future potential outcomes
and long-term returns of the company.
In the article «Non-quantitive measures in company evaluation» Á gnes
Horvá th (Horvath 2005) criticizes different evaluation methods such as
discounted cash flow, multiplication indicators (Price/Earnings (P/E),
Price/Sales (P/S), P/EBIT, P/EBITDA)1, economic value added (EVA), and its
shortcomings and reveals the need for establishing non-financial indicators. The
author strongly emphasizes that increase in company value can be observed only
in case the interest of both stakeholders and shareholders are satisfied.
A solution to the shortcomings of the financial measures is to show the
driving force behind them. Non-financial indicators are the main driving force
behind financial measures and thus give an indepth indication of what to
attribute movements in financial measures to.
In our report we, firstly, provide an overview of non-financial measures,
secondly, we will present how they drive the financial measures through the

1
Á. Horváth, "Non-quantitative measures in company evaluation," European Integration Studies
(Miskolc) 4, no. 1 (2005): 61-72.

Use of Non-financial Measures in Company Evaluation 3

strategy map, we will present the balanced scorecard as the method of
implementation of non-financial measures and finally we will discuss the
shortcomings of non-financial measures.

Non-financial measures
As mentioned above, traditional measures of company performance give
some indications of firms’ success, however they are merely indicators of past
strategies, and as such, they are as valuable as driving your car forward and
navigating after what you see by looking in the rearview mirror. Non-financial
measures have several advantages over financial ones.
Firstly, non-financial measures lead to better compliance with long-term
corporate strategy by linking them to the strategy and thereby showing what
measures drive the financial performance. Also non-financial measures help with
the identification of long-term benefits for investors.
Secondly, the non-financial measures take into account intangible assets
(consumer loyalty, intellectual capital, and etc.), as this provides a view on the
actual efficiency and effectiveness of the actual operations.
Finally they contribute to cheating elimination in managerial actions, that
are short term oriented and simply serve to increase the financial measures on
the account of future revenues. As an increase in financial measures based on
cheating will show up in the non-financial measures. An example of this could be
more orders done, however, with higher amounts of complaints and wrong
deliveries.

Below we will go though the customer perspective, internal business processes

as well as learning and innovation of the organization, which are the different
perspectives of non-financial measures.

Use of Non-financial Measures in Company Evaluation 4

Customer perspective
The customer perspective addresses the performance indicators that are vital to
the customers. The customer perspective defines the measures that should be
focused to generate more sales with the most valuable customers. These
indicators include:
 Quality, where own quality relative to industry is measured, number of
defects.
 Price, own price relative to competitive market price, sales volume,
customer willingness to pay.
 Delivery, actual versus planned, number of on-time deliveries.
 Shipments, sales growth, number of customers that make up 90% of
shipments.
 New products, number of new products, rate of technology
improvements, percent of sales from products introduced in last two
years
 Support time, response time, customer satisfaction surveys.

Internal business processes

Another perspective is that of internal business process indicators. Internal
business process indicators focus on all the activities that are used to create and
deliver value to the customer. These indicators include:
 Efficiency of manufacturing, cycle time, lead time, manufacturing
overhead, rate of increase in use of automation.
 New product introduction, rate of new product introduction.
 New product success, new products’ sales, numbers of orders.
 Sales penetration, actual sales versus plan, increases in number of $1
million customers each quarter.
 New businesses, number of new businesses each year.

Learning and innovation

The third perspective is learning and innovation indicators. This is the
cornerstone of any strategy. These indicators include:

Use of Non-financial Measures in Company Evaluation 5

  Technology leadership, product performance compared to competition,
number of new products with patented technology in them.
 Cost leadership, manufacturing overhead as a percentage of sales, rate of
decrease in cost of quality.
 Market leadership, market share in all major markets, number of systems
developed to meet customer requests and requirements.
 Research and development, number of new products, number of patents.

As noted, the above non-financial indicators all drive the actual financial
performance of the company. There if the financial performance is also taken
into consideration, we can actually derive the balanced scorecard and together
with the strategy map, the financial and non-financial measures can be used to
coordinate the strategy as well as give inputs to it.

Practical implementation of non-financial measures

Basically, a strategy map is a cause and effect diagram that reflects
relationships among the balanced scorecard perspectives. Balanced scorecard
(BSC) is an evaluation system, which helps companies to establish corporate
sustainability and better understand and implement strategy. Balanced
scorecard includes Customer, Internal Business Process, Learning & Innovations
and Financial perspective due to financial results still remains a crucial part of
firm success. Furthermore, influential groups of stakeholders (shareholders,
investors, government, and etc.) need truthful financial reports in order to
conduct decision-making process. Financial perspective includes following
performance indicators:
 operating income,
 cash flows, trend in cash flows, interest coverage, asset turnover,
 annual growth in sales and profits, level of sales of critical product groups,
 share price,
 gross margins, etc.
Thus, strategy map reflects the interrelations between financial and non-
financial drivers, which results in higher shareholder value and achievement of

Use of Non-financial Measures in Company Evaluation 6

other financial goals through value-adding on every stage. In the basis of this
diagram is knowledge inflow which leads to innovation, research and
development through continuous learning. As a consequence, the new
technologies in production process and customer support excellence lead to
substantial rise in quality, delivery and shipping terms, customer satisfaction,
and etc. The final outcome of this process is increase in company financial results
and, in the same time, cost reduction.
Sample strategy map

Figure 1, source: own creation

Along with these four perspectives firm can also add the 5 th perspective, which is
unique for the companies activity (environment, community, and etc.) in order to
establish all key performance indicators in balanced scorecard.

Shortcomings of non-financial measures

Although the non-financial measures present an improved understanding of
performance, there are substantial limitations of non-financial measures:
- The system can be divergent with corporate culture and its
implementation, for example, in Russian companies will be a huge

Use of Non-financial Measures in Company Evaluation 7

 struggle with employees resistance because of absence of transparency in
operations
- Due to increase in number of performance measures the process of
evaluation can take substantially more time
- The system should be balanced well and include only performance
indicators which are vital for firms’ activity. Otherwise, numerous
indicators distort the real situation, and attention can be paid to
unimportant factors.
- The company has a large task in order to identify its own “good”,
“satisfactory” or “bad” tags for results because there is no unified system
for non-financial measures comparison. Thus, these tags could be very
subjective. In order to control these tags some firms use such well-known
system as Six-Sigma, JIT, and etc.
- Lack of quantitative data reliability. With use of non-financial measures
alone, the company obtains qualitative data, however, to identify the
“bottlenecks” the firm also needs to conduct quantitative research.

Overall, the problem is that implementation is often quite costly and takes a lot
of time. As always the tradeoff is between the amount of information and the
costs associated with this. However, non-financial measures are unquestionably
important for the measurement of the drivers behind financial performance and
some non-financial measures should be done, the focus should be on the most
reliable and most directly associated with driving the financial performance.

Use of Non-financial Measures in Company Evaluation 8

 Conclusion

Non-financial measures have gained increasing importance as financial

reports do not provide the possibility to identify whether results are truly good
for a company or not.
The advantages of non-financial measures include alignment of strategy
and identification of strategy improvements, visibility of efficiency and
effectiveness, drivers behind financial measures, identification of cheating and
thus improved focus on long term rather than short term goals.
The non-financial measures focus on the customer perspective which
addresses the performance indicators that are vital to the customers, internal
business process indicators that focus on all the activities that are used to create
and deliver value to the customer and finally, learning and innovation indicators
which are the cornerstone of any strategy.
Implementation of the non-financial measures, together with the financial
measures can be done through the use of the strategy map and balanced
scorecard system, which leads to the balancing of short and long-term goals in all
three dimensions of the company performance – customer, internal business
process and learning & innovation.
However, the shortcomings of non-financial measures include problems
with implementation, which is often quite costly and takes a lot of time. As
always the tradeoff is between the amount of information and the costs
associated with this.
Nonetheless there is no doubt that it is vital for company success to
measure the most important non-financial measures. The focus should be on the
most reliable and those that are most directly associated with driving the
financial performance.

Use of Non-financial Measures in Company Evaluation 9

Bibliography

Ahrens, T, Chapman, CS. (2007) Management accounting as practice, ACCOUNT

ORG SOC, Vol: 32, Pages: 1 - 27

Atkinson, Kaplan and Young. (2004) Management Accounting (4th Edition).

Bhimani, et. al (2006) Contemporary issues in management accounting

Blocher, Stout, Cokins and Chen. (2008) Cost Management: A Strategic Emphasis
(4th Edition), The McGraw-Hill Companies.

Drury, et. al (2006) Cost and Management accounting

Horvá th, Á . "Non-quantitative measures in company evaluation," European

Integration Studies (Miskolc) 4, no. 1 (2005): 61-72.

Use of Non-financial Measures in Company Evaluation 10