| Summer 2005 |
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INFOLETTER
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Partner's Perspective |
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The Balanced Scorecard: A Better Way to Measure
Performance
By James E. Merklin, CPA, CFE, M.Acc., Partner
As a business owner or manager, you're probably used to measuring the
financial performance of your business via such metrics as sales revenue,
profitability, return on investment (ROI) and return on equity (ROE). But while
traditional financial reporting systems tell you how your company has done in
the past, they may not shed much light on how you'll perform in the future.
Such a historical view may have been adequate for most companies before the
information age, when much of a firm's assets were in property, plant and
equipment. Investment in customer relationships wasn't such a critical component
for success. It may be inadequate, though, for many 21st century companies whose
value lies in innovative processes, human capital and strong customer
relationships. These companies recognize that the key to creating future value
lies in their investment in customers, suppliers, employees, processes and
technology.
A Complete Measurement System: The Balanced Scorecard
In an effort to develop a new measurement system that would help companies
determine vision and strategy for the future, Drs. Robert Kaplan and David
Norton have created what they've termed the Balanced Scorecard. The key
distinction of this performance measurement system is that it adds a number of
critical non-financial measures to the equation.
The Balanced Scorecard identifies four key perspectives (or measures) through
which you should view your company (see diagram):
- Financial perspective—These are the traditional financial measures
such as operating income, return on investment and return on equity. Ask
yourself, "What are the metrics we need to improve in order to succeed
financially?"
- Business processes perspective—Think of these as the "quality"
measurements of such standard business processes as procurement, production
and fulfillment. Ask yourself, "What are the business processes we must excel
at in order to satisfy our customers?"
- Learning and growth perspective—This encompasses the "people and
employees" measurements: employee satisfaction, retention, skill sets, etc.
Ask yourself, "How will we sustain our ability to change and improve?"
- Customer perspective—These are the "marketing" measurements, such
as customer satisfaction, retention, market share, etc. Ask yourself, "How
should we appear to our customers?"
Leading companies today are using the Balanced Scorecard as a way to measure
their progress against their goals—or in other words, to benchmark—and plan
their goals and strategies for the future. In the same way that Total Quality
Management (TQM) provided a new way to think about quality from a macro
perspective, and Six Sigma provided a way to analyze error rates and accuracy,
the Balanced Scorecard is giving companies a way to balance the financial
analysis of their business with other key performance indicators.
It's important to note that the four perspectives of the Balanced Scorecard
are not just a collection of independent factors; rather, there is a logical
connection between them, as the diagram illustrates. For example, learning and
growth by employees will likely lead to better business processes, which in turn
should lead to more value for the customer, which will ultimately result in
improved financial performance.
Creating an Action Plan
As you implement the Balanced Scorecard, break each of the four perspectives
down into the following parts:
- Objectives: List major objectives to be achieved for each perspective. For
example, under the financial perspective, your objective might be "profitable
growth."
- Measures: These are the observable parameters that will actually measure
progress toward the objectives. One measure of profitable growth might be
"growth in net margin."
- Targets: Set specific target values for each measurement. The target in
our example of profitable growth might be "a two percentage point growth in
net margin."
- Initiatives: These are the specific action steps that must be taken in
order to meet the objective. One initiative for profitable growth could be
"reduce overhead by 20 percent."
You can use a simple grid like this to create an action plan to implement
your Balanced Scorecard:
| Objectives |
Measures |
Targets |
Initiatives |
| Financial |
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Business
Processes |
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Learning and
Growth |
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| Customer |
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The Evolution of the Balanced Scorecard
Since its conception more than a decade ago, The Balanced Scorecard has
evolved from its original design as a performance measurement system into more
of an overall management system that enables companies to translate their
strategies into action. By translating strategic objectives into quantifiable
measures, management has a clearer understanding of its strategy and is better
able to develop a coherent consensus.
And when high-level strategy is communicated clearly and efficiently to all
the stakeholders throughout the organization, fuzzy and non-specific
"objectives" become action items that employees can actually accomplish and be
held accountable for. Achievable and measurable targets are set for each
perspective, company-wide initiatives are developed to align everyone's efforts
to reach the targets, and management receives direct feedback on the progress of
implementation and the success of the strategy itself.
Hundreds of companies in both the public and private sectors, as well as
non-profits and government agencies, have used the Balanced Scorecard (or some
variation thereof) to clarify their vision and strategy and translate them into
action that's both specific and measurable. When implemented fully and properly,
it can take strategic planning beyond the theoretical and academic and make it
the centerpiece of all of your company's business planning efforts.
If you have interest in seeing how the Balanced Scorecard can work for your
business, I would be happy to help you in an evaluation of the benefits and the
set up of a program. Please feel free to call, or email me at
jimm@bobermarkey.com
if you would like to discuss this. BMF&C
A Structured Approach to Next
Generation Education
By Lori A. Sheets, CPA,
Senior Manager
 If
you and your children have decided that they will ultimately
join your family business, it's time to consider their
education. Not just their formal schooling—in fact, your
children may already have completed that part of their lives.
Rather, what about other preparation they may need to join the
company?
The failure rate of businesses run by second and third generations is very
high. The first generation—those who started the business—obviously excelled at
their chosen field and probably worked extremely hard. There's no guarantee that
the next generation will share these qualities.
One way to increase the probability of success is to implement a structured
approach to next-generation education and training. With a clear path to follow,
there will be no misunderstandings about what is expected of the child when he
or she joins the family firm. Consider this five-step approach:
- Set benchmarks. While not all kids mature at the same time, it's
fine to set benchmarks they should reach in specific timeframes. For example,
educational goals might include an undergraduate or graduate degree to be
earned by a certain year. If your business requires special degrees or
training, the plan should specify the coursework, certification or licensing
required along with timeframes. Once the child joins the firm, you'll want a
plan that details in-house training. This plan should specify a career path—a
certain number of months or years in certain departments or positions, for
example.
- Get buy-in. Once the education plan is drafted, it should be signed
by both you and your child. This formality underscores the seriousness with
which you both regard preparation to join the company.
- Provide regular counsel. As the child moves along his or her
education and career path, have a non-family mentor monitor progress and
provide guidance. This mentor should be someone you both trust to be brutally
forthright.
- Share the inner workings. Don't be afraid to share information
about your family business shareholder agreements, buy-sell agreements and
other financial details. When the time is right, invite your child to attend
management meetings. Treating your child like a trusted business associate
will build his or her confidence.
- Be realistic. Parents don't always have a fair perspective on their
children's strengths and weaknesses. For feedback, look to others, including
the mentor mentioned above. Be realistic about what's working and what's not.
Realize that your child may or may not have the skills and talents your
business needs. You may need to step in with extra help or, in some cases,
accept the fact that the child is not a fit for the family business.
By designing and implementing a structured plan, you'll increase the
likelihood of a smooth transition as the next generation joins the family
business. If you would like assistance in development of an education and
training plan for the next generation, please call your partner/manager contact
at Bober, Markey, Fedorovich & Company, or you can call or email me at
loris@bobermarkey.com.
BMF&C
News for Benefit Plans
By Cindy H. Mitchell, Tax Supervisor
 The
New Roth 401(k) Plan
Beginning in January 2006, a new deferral option will be available for
electing retirement plans. Employers may offer a new plan that does not exclude
contributions from income, but rather provides for tax-free distributions. This
new option is called a Roth 401(k) or Roth 403(b) plan. Although the concept of
tax-free distributions for employee benefit plans was enacted in 2001 tax
legislation, it will not be available for deferrals until after Dec. 31, 2005.
The Roth 401(k) plan is combining the best of both worlds. Like a Roth IRA,
contributions to a Roth 401(k) are funded with after-tax dollars and
distributions are tax-free. Like a traditional 401(k) plan, the maximum amount
you can contribute to the Roth 401(k) plan in 2006 is $15,000, plus an
additional $5,000 for those more than 50 years old. A Roth IRA is limited by
your adjusted gross income (AGI), so many highly compensated executives cannot
contribute, but a Roth 401(k) plan has no AGI limitation. Like a traditional
401(k) plan, a Roth 401(k) plan will be subject to non-discrimination testing,
ADP and ACP testing.
The Roth 401(k) plan sounds good, but it will not be advantageous for all
participants or all employers. One drawback for employers is a separate
accounting requirement. Employers must account for designated Roth contributions
separately. And, employer-matching contributions may not be designated as Roth
contributions and must be taxed upon distribution. This requirement alone may
keep some plans from offering the Roth 401(k) feature. There are also many
factors for employees to consider such as current age, current tax rate,
expected retirement age and expected retirement tax rate. As a general rule, the
younger the participant, the more advantageous a Roth 401(k) plan can be.
The IRS is expected to provide additional guidance on Roth 401(k) plans soon,
including plan amendment requirements and additional guidance on the separate
accounting requirements. Once this guidance is issued, plan sponsors should act
quickly since the Roth 401(k) is subject to the same sunset provisions as many
other provisions in the 2001 tax legislation. Unless specifically extended by
Congress, the Roth 401(k) option is set to expire after 2010.
New Distribution Requirements
In late 2004, the IRS issued a notice that may affect your plan if it
provides for mandatory lump-sum cash-out distributions. Effective March 28,
2005, these mandatory distributions of $1,000-$5,000 must now be rolled over
into an IRA account in the participant's name rather than automatically sending
them a check as previously allowed. The IRS has provided some administrative
relief to this deadline, allowing sponsors until December 31, 2005 to complete
automatic rollover distributions that are subject to the cash-out rules.
Generally, a plan sponsor has several different options to consider, as
follows:
- The sponsor can amend the plan to include an automatic IRA-rollover
requirement described above.
- The sponsor can amend the plan to reduce the mandatory cash-out limit
to $1,000 instead of $5,000.
- The sponsor can amend the plan to eliminate the mandatory cash-out
entirely.
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Whichever option is chosen, the plan must be amended by the last day of the
plan year including March 28, 2005. Therefore, calendar year plans must be
amended by December 31, 2005. We would encourage you to visit with your plan's
legal counsel to ensure this important change is made if needed.
New Grace Period for Cafeteria Plans
Flexible Spending Accounts (FSAs) offer employees the chance to use pre-tax
dollars to pay for medical expenses such as health insurance co-pays, dental
check-ups, prescription glasses and even over-the-counter drugs. These plans
essentially allow employees to get a tax deduction that many times they cannot
take as an itemized deduction on their federal tax returns. One of the big draw
backs to FSAs has been the "use it or lose it" rule, under which employees have
had to forfeit any funds deferred during the year but not used to reimburse
medical expenses.
In May 2005 the IRS announced that employers will be able to give their
employees a grace period of up to 2 1/2 months to use up any additional funds
that have been deferred in the previous year. This means that any expenses
incurred from January 1st to March 15th can be turned in for reimbursement using
either the prior year's deferrals (if any remaining funds exist) or the current
year's deferrals. With this new grace period, fewer employees will have to
forfeit unused funds from their FSA. Plan sponsors wishing to adopt this grace
period for the current plan year must amend the cafeteria plan document before
the end of the current plan year.
If I can help you further evaluate any of these benefit plan changes, please
call or email me at
cindym@bobermarkey.com. BMF&C
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In this feature of InfoLetter, each quarter we provide a profile of
one of our professionals who is available to work with our clients and
friends.
Cindy S.
Johnson, CPA, CIT
Director of Family Business Services |
Cindy Johnson’s experience is focused on serving privately held middle market
and high growth clients in a variety of industries, including wholesale
distribution and service industries with a specialty in manufacturing and
construction. She has extensive experience in working with closely held and
family held businesses, tax planning, internal control and operations reviews,
and preservation of family wealth and family transition planning. Cindy has
administrative responsibility for our small business services group, which
includes review and analysis of interim and annual financial information, tax
planning, and business advisory services.
A Magna Cum Laude graduate of Kent State University with a Bachelor of
Business Administration Degree in Accounting, Cindy joined Bober, Markey,
Fedorovich & Company in 1987. Prior to joining the firm, Cindy was the assistant
controller for a general contractor for five years.
Cindy is a member of the American Institute of Certified Public Accountants
(AICPA) and the Ohio Society of Certified Public Accountants (OSCPA),
past-president of the Akron/ Canton Chapter of the OSCPA, a member of the AICPA
Information Technology Section, chair of the PKF North American Network
Technology Committee, chair of the Board of Trustees of Summit County Children’s
Services, member of the Board of Trustees and treasurer of Inter-Lake Yachting
Association, past treasurer of Project: LEARN of Summit County, a past member of
the Summit County Social Service Advisory Board and a 2000 graduate of
Leadership Akron.
"When we work with a client, our goal is to be a valued team member who
understands the client’s business as well as the economic environment in which
the business operates. This enables us to bring higher value to our clients and
therefore contribute to enhanced profitability." BMF&C
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