Paul Niven's latest book Balanced Scorecard Step by Step: Maximizing Performance and Maintaining Results was written to fill the considerable void that exists between Balanced Scorecard theory and application.

He says, "Much has been written on the methodology of the Scorecard, but unfortunately little has been offered in the way of actual implementation advice aimed at those involved in the development of the system. BetterManagement.com has graciously asked me to share selected excerpts in a series corresponding to the five parts of the book. Each excerpt will cover a topic designed to help you better understand the Balanced Scorecard and, more important, offer some practical advice you can put to work immediately as you develop your own performance measurement system."

He says, "Much has been written on the methodology of the Scorecard, but unfortunately little has been offered in the way of actual implementation advice aimed at those involved in the development of the system. BetterManagement.com has graciously asked me to share selected excerpts in a series corresponding to the five parts of the book. Each excerpt will cover a topic designed to help you better understand the Balanced Scorecard and, more important, offer some practical advice you can put to work immediately as you develop your own performance measurement system."

"Greater financial disclosure" is currently a very popular phrase in the press and in boardroom discussions around the world as regulators, Boards of Directors, CEOs, and increasingly jittery financial markets seek to restore order in the post-Enron era. Undoubtedly increased transparency of financial transactions is warranted and will greatly assist everyone from investors to managers in making more informed decisions. However, there is no guarantee that greater financial disclosure alone will move an organization any closer to the successful implementation of strategy in a world of hyper-competition and change. It's important to consider that financial yardsticks represent classic "lagging" indicators of performance whose outcomes depend almost entirely on interactions with other key stakeholder groups, including: customers, employees, suppliers, and communities.

Despite the fact that almost 75% of the modern corporation's value is derived from intangible assets such as employee knowledge and customer information, a whopping 60% of performance measures employed are financial in nature. Researchers in one study found that "Many companies view non-financial factors as important but are not capturing data on these factors." ¹ It appears that our measurement systems have failed to keep pace with the rapidly changing organizational world in which we all dwell. Has an over-reliance on financial measures kept us in the measurement "dark ages"? In this excerpt from "Balanced Scorecard Step by Step: Maximizing Performance and Maintaining Results" I examine this almost exclusive dependence on financial measurement, discuss the limitations of financial metrics, and ponder whether or not they should ultimately find a place in your Balanced Scorecard.

Financial Measurement and Its Limitations

As long as business organizations have existed, the traditional method of measurement has been financial. Bookkeeping records used to facilitate financial transactions can literally be traced back thousands of years. At the turn of the 20th century financial measurement innovations were critical to the success of the early industrial giants like General Motors. That should not come as a surprise since the financial metrics of the time were the perfect complement to the machine-like nature of the corporate entities and management philosophy of the day. Competition was ruled by scope and economies of scale with financial measures providing the yardsticks of success.

Financial measures of performance have evolved and today the concept of economic value added or EVA is quite prevalent. This concept suggests that unless a firm's profit exceeds its cost of capital it really is not creating value for its shareholders. Using EVA as a lens, it is possible to determine that despite an increase in earnings, a firm may be destroying shareholder value if the cost of capital associated with new investments is sufficiently high.

The work of financial professionals is to be commended. As we move into the 21st century, however, many are questioning our almost exclusive reliance on financial measures of performance. Perhaps these measures are better served as a means of reporting on the stewardship of funds entrusted to management's care rather than charting the future direction of the organization. Let's take a look at some of the criticisms levied against the over-abundant use of financial measures:

• Not consistent with today's business realities: Today's organizational value creating activities are not captured in the tangible, fixed assets of the firm. Instead, value rests in the ideas of people scattered throughout the firm, in customer and supplier relationships, in databases of key information, and cultures of innovation and quality. Traditional financial measures were designed to compare previous periods based on internal standards of performance. These metrics are of little assistance in providing early indications of customer, quality, or employee problems or opportunities.

• Driving by rear view mirror: Financial measures provide an excellent review of past performance and events in the organization. They represent a coherent articulation and summary of activities of the firm in prior periods. However, this detailed financial view has no predictive power for the future. As we all know, and experience has shown, great financial results in one month, quarter, or even year are in no way indicative of future financial performance.

• Tend to reinforce functional silos: Financial Statements in organizations are normally prepared by functional area: individual department statements are prepared and rolled up into the business unit's numbers, which are ultimately compiled as part of the overall organizational picture. This approach is inconsistent with today's organization in which much of the work is cross-functional in nature. Today we see teams comprised of many functional areas coming together to solve pressing problems and create value in never imagined ways. Our traditional financial measurement systems have no way to calculate the true value or cost of these relationships.

• Sacrifice long-term thinking: Many change programs feature severe cost cutting measures that may have a very positive impact on the organization's short-term financial statements. However, these cost reduction efforts often target the long-term value creating activities of the firm such as research and development, associate development, and customer relationship management. This focus on short-term gains at the expense of long-term value creation may lead to sub-optimization of the organization's resources.

• Financial measures are not relevant to many levels of the organization: Financial reports by their very nature are abstractions. Abstraction in this context is defined as moving to another level leaving certain characteristics out. When we roll up financial statements throughout the organization that is exactly what we are doing - compiling information at a higher and higher level until it is almost unrecognizable and useless in the decision making of most managers and employees. Employees at all levels of the organization need performance data they can act on. This information must be imbued with relevance for their day-to-day activities.

Given the limitations of financial measures, should we even consider saving a space for them in our Balanced Scorecard? With their inherent focus on short-term results, often at the expense of long-term value creating activities, are they relevant in today's environment? The answer is yes for a number of reasons. As will be discussed shortly, the Balanced Scorecard is just that: balanced. An undue focus on any particular area of measurement will often lead to poor overall results. Precedents in the business world support this position. In the 1980s the focus was on productivity improvement, while in the 1990s quality became fashionable and seemingly critical to an organization's success. In keeping with the principle of what gets measured gets done, many businesses saw tremendous improvements in productivity and quality. What they didn't necessarily see was a corresponding increase in financial results, and in fact some companies with the best quality in their industry failed to remain in business. Financial statements will remain an important tool for organizations since they ultimately determine whether improvements in customer satisfaction, quality, on-time delivery, and innovation are leading to improved financial performance and wealth creation for shareholders. What we need is a method of balancing the accuracy and integrity of our financial measures with the drivers of future financial performance of the organization.

¹Bonnie Stivers and Teresa Joyce, "How Non-Financial Measures are Used," Management Accounting, February 1998.