Balanced Scorecard: the four perspectives. Financial perspective
Introduction of Balanced Scorecard system in early 1990 was a response to business challenges of that time. The system was the first to add non financial indicators to a set of KPIs to be evaluated under performance management concept. Inclusion of non financial indicators did not mean that creators of BSC rejected financial indicators.
It would be wrong to say that since financial KPIs have no impact on customer and employee satisfaction, they should not be used by companies in their metrics systems. Kaplan and Norton claimed that those companies which refuse to use all 4 perspectives (financial, customer, internal processes, learning and growth) are doomed to fail in BSC implementation.
Use of Balanced Scorecard helped managers break obsession with accounting and financial figures. However, as they say, everything in moderation. There are cases when top management gets carried away with customer satisfaction and growth of intangible assets.
Financial perspective. Goals and Measures
First, it needs saying that all measures and objectives in all other three perspectives focus on financial goals/objectives. The ultimate goal of any company is making profits. Every measure and KPI should be selected in such a way so that it is well integrated in the strategy of improving financial performance. So, it is possible to say that financial goals are result of improvements in the 3 other perspectives.
As a rule financial objectives can be easily linked to all 3 BSC perspectives (sure, there can be exceptions but they are not numerous). In this sense financial objectives play two roles: they define expectations as to company financial performance (as set in the strategy) and at the same time act as targets for objectives and measures in the 3 other perspectives.
Identical financial measures for all business units and departments?
There is much debate over the use of identical financial objectives for all business units of a company. Supporters of this method claim that in such a way everyone will be evaluated according to the same metrics, thus supporting “fair play” principle. However, this approach fails to recognize different strategies of different business units, departments and divisions. Thus, it is highly recommended that heads of departments and business units adjust financial indicators to strategies of their business units/departments. Sure thing, these strategies must be subordinated to a general company strategic vision.
Different financial objectives for businesses in different life cycles
Obviously, businesses undergoing different stages of development require different financial objectives. These stages can be quite numerous, but in order to simplify them let’s identify the key three of them:
- Growth. It should be noted that growth businesses undergo early stages of development. This means that such business posses services and products with a certain potential for growth. Growth businesses may have negative cash flow and low returned on the invested capital. Thus, in order to realize this potential a company needs to develop infrastructure, distribution networks, production systems etc. So, what are financial objectives for growth businesses? Well, this is revenue growth, growth of sales in targeted markets and customer groups.
- Sustain. In general most business units and departments in a company are in a sustain stage. This means that such departments still attract investments and apply reinvestment techniques. The ultimate goals here may be keeping current market share and in some cases gradually increasing it. Thus, most of financial objectives in sustain stage will involve goals related to profitability such as operating income and gross margin.
- Harvest. Some business units may have already reached the state of maturity and thus the company management wants to harvest investments made throughout the first two stages. At this stage the company rarely attracts new investments (maybe to maintain equipment or perform similar tasks but not to expend). Thus, a key goal here would be maximizing cash flow streaming back to the company and reduction of working capital requirements.
Thus, it is evident that each of the stages requires own financial objectives which are dictated by requirements of a business life cycle. So, financial goals for growth businesses include growth of sales in existing and new markets, from existing and new product. Sustain stage implies traditional financial objectives such as operating income, ROCE, gross margin while financial objectives at harvest stage focus on increasing cash flow.
In general, financial objectives fall under the following categories:
- Revenue growth and mix. This is mainly about reaching new customers and markets, expanding products and services and changing them, introducing new pricing policies etc.
- Productivity improvement/cost reduction. This may include reduction of indirect costs, sharing common resources with other departments, lowering direct costs.
- Investment strategy/assets utilization means a greater utilization of fixes assets base and improving return on investment.
One should also not forget about risk management as a part of financial perspective objectives. Most successful companies integrate risk management and tolerance systems into their financial goals. For instance, if a company decides to broaden sources of revenue this is both a strategic goal and the way such a company protects itself from changes in the external environment which serves as a risk management objective.
Financial objectives are long term goals for a company. One of the greatest advantages of Balanced Scorecard is that this system makes the financial goals clear, comprehensive and explicit. Moreover, BSC can adjust such goals to different cycles of business life. Financial indicators in Balanced Scorecard represent profitability, revenue increase and asset returns. This proves strong ties of Balanced Scorecard with a long-term strategy of organizations.
At that, even using financial indicators and objectives alone, it is possible to establish effective metrics and specify long tern financial goals.
Finally, it should be noted that all objectives in other 3 perspectives are directly or indirectly related to financial perspective and relevant financial objectives. Every measure eventually ends up in a particular financial goal, the most common of which is increasing competitive advantage, gaining larger market share and making a company more attractive to shareholders.
Read more about other perspectives of the Balanced Scorecard: