Balanced Scorecard

A strategic planning and measurement tool/system

Created by Dr.Robert Kaplan and Dr.David Norton in 1992as a performance evaluation tool, using a more balanced set of performance measures. 

It is a strategic measurement and management tool that translates an organization's strategy into four folds. The primary objective of creating this strategic measurement tool was to develop a system that could measure performance and address deficiencies.

The observation on organizations concluded that most organizations failed to understand the significance of objectives set by the organization, leading to the organization's failure.

The Balanced Scorecard (BSC) is a strategic planning and measurement tool/system that is used to:

  • Clarify and communicate strategy

  • Ensure alignment of individuals and departments with the firm

  • Ensure alignment with the budgeting strategy

  • Prioritize works, projects, products/services

  • Seeking continuous feedback for constant improvement in the strategy 

Understanding strategic management and strategic planning are important to understand before we move forward. Because these two concepts are what the BSC is all about.

Strategic management is the continuous process of creating the strategy, analyzing the strategy, its implementation, and monitoring it. It's utilized by organizations to use it and maintain a competitive advantage.

It's also deemed art and science for formulating, implementing, and evaluating cross-functional decisions that aid in achieving organizational objectives.

It is a comprehensive collection of continuing operations and activities that organizations use to coordinate and align with mission & vision statements and strategy.

On the other hand, Strategic planning is a management activity used to set priorities. 

Also helps in focusing energies and resources and strengthening the operations of the organization.

It ensures that employees and stakeholders are both working toward a common goal. It is an organized effort to produce fundamental decisions and actions that shape and guide the enterprise's efforts.

Producing actions that shape and guide what an organization is, who it serves, what it does, and why it does it, with a focus on the future.

Meaning and Definition of BSC

"A balanced scorecard (BSC) is defined as a management system that provides feedback on both internal business processes and external outcomes to continuously improve strategic performance and results."- asq.org

A management system is a way in which an organization manages the interrelated parts of its business to achieve its objectives.

This management system acts as an anchor providing insights into how well the organization is doing.

Internal and external processes both have an impact on profitability and operational efficiencies. Feedback in these processes shall prove to be beneficial.

The feedback must be continuous and rapid for continual improvements in the strategy to achieve desired results.

"The balanced scorecard (BSC) is a strategic planning and management system." - balancedscorecard.org

"To align business activities to the vision and strategy of the business, improve internal and external communications, and monitor business performance against strategic goals." - Norton and Kaplan define the aim of the BSC.

It's imperative to keep track of the performance of the organization and track them against the goals set having strategic values.

This constant analysis helps the managers envision future performances and the deviations that can affect them unfavorably.

For BSCto be successfully implemented, it requires communication and coordination at all levels.

Balanced Scorecard provides organizations with simple tools that help in translating the strategy.

The 4 folds of BSC are:

  • Financial Perspective

  • Customer Perspective

  • Internal Business Process Perspective (IBP)

  • Learning & Growth Perspective (L&G)

The scorecard advocates financial measures that are historical, subjective, and quantitative. 

On the other hand, the other 3 perspectives (Customer, IBP, L&G), are leading indicators of success. Improvements in these perspectives lead to future growth.

They aren't historic or subjective. Rather, focusing on these measures could improve business, on the whole, improving on financial and non-financial aspects.

The primary objective of the BSC is to focus simultaneously on financial information and create abilities and intangible assets required for long-term growth.

This is executed by translating a company's strategy into specific measures within each strategy.

Key Performance Indicators and the BSC

In performance evaluation, the BSC's method is trending in managing the implementation of a firm's strategy.

It's a communication tool for strategy. And it connects the critical success factors to the measurement of a firm's performance.

These critical success factors are termed Key Performance Indicators (KPIs). These are specific financial and non-financial elements of a firm's success.

Achievement of KPIs is critical to a firm's success and competitive advantage.

BSC is a goal congruence tool. The managers are informed about the financial & non-financial measures essential for success.

To effectively deploy the KPIs and implement BSC, a SWOT analysis should be conducted, through which the right measurement indicators can be selected.

A firm identifies KPIs by means of SWOT Analysis.

The SWOT Analysis is a comprehensive study of the strengths, weaknesses, opportunities, and threats of a firm.

Each letter of 'SWOT' denotes all the elements stated above.

  • Strengths are internal to the organization and core competencies.

  • Weaknesses are internal as well-- areas organization is at some kind of disadvantage.

  • Opportunities, elements, and changes in the external environment generate profits and revenues.

  • Threats are elements and circumstances that prove to be disadvantageous to the organization.

The SWOT Analysis highlights the basic factors related to cost, quality, and the speed of product development and delivery.

The organization can also use PEST Analysis to analyze external factors affecting the firm's external environment.

The PEST Analysis is an extensive study of Political, Environmental, Social, and Technological factors that are critical for success and shutting down threats coming from outside.

After the KPIs are decided, a measurement unit is assigned to each subject.

It's based on the premise, "If you can't measure, you can't control it." - Kaplan/Norton.

While developing KPIs some conflicts arise. This is avoided as BSC uses the process of integrating the KPIs into the firm's strategy.

Effective use of the Balanced Scorecard (BSC)

Once the KPIs are defined, they must be linked back to the firm's strategy. Successful BSC creates a shared understanding within the organization and how individuals contribute to the firm's success.

Elements of the BSC come from the organization's strategy. The BSC shows what a strategy is.

Linking the 4 perspectives to strategy requires an understanding of the following 3 principles:

1. Cause-Effect Relationship:

All the KPIs should fit within the overall C-E relationship chains that end with the financial measures. Showing the achievement of a part of the firm's strategy.

These chains should also explain how to measure each element and how to provide feedback.

These C-E chains should progress through each of the 4 perspectives and should explicitly describe the firm's strategy. And finally, incorporate all KPIs into one of these chains.

2. Outcome Measures & Performance Drivers:

Force Chains of KPIs to be successful must be linked to specific outcomes and performance drivers that say how the desired outcome could be met.

  • Lagging Indicators/Outcome Measures: Measure the current and past performances. Only known after an event has already occurred. It confirms and clarifies the pattern and trends over time.

  • Historic in nature: Example: Profitability, Market Share, Employee Skills, etc.

  • Leading Indicators/Performance Drivers: Indicators that might predict future favorable outcomes. They are indicators and drivers specific to the strategy of the Business Unit. Example: Cycle Times, Setup Times, Patents, etc.

3. Linking to Financial Measures:

In an organization, no matter how focused it is on qualitative factors, it is important to link to the financial perspective.

A tangible reward is essential because business growth is due to improving non-financial. But survival is through cash and profits. Thus, in the end, all CE chains should link to the financial measures.

Elements Of The Balanced Scorecard

Financial Measures:

The BSC is often referred to as a management tool rather than a measurement tool because of its application.

Financial measures ensure the overall profitability and individual business unit profitability are in alignment with the company's goals and strategy.

Understanding the cost and revenue drivers is critical to management accountants and financial managers' ability to direct and redirect specific measures.

Expected levels of return on investments, residual income, net income, and other measures like these are used as indicators and managing the financial measures.

Along with making and maximizing profits, it also includes minimizing the risks involved. Maximizing profits is an essential goal of the organization that must be met. 

And it can be achieved by having an in-depth understanding of the financial statements and the cash flows, 

  • Return on Investment (ROI) is an apt measure for assessing the profitability of a business unit based on investment in assets and relative income generated during the year. 

ROI = Income of business unit/assets of the business unit 

This is a popular measure in profitability analysis since it uses all the measures in one. Revenues, investments, and costs are involved. 

The ROI is expressed in percentage terms. The greater the percentage, the better the profitability. ROI can also provide a different perspective when used in the Cost & Benefits analysis viewpoint since we can track the expenses incurred over the tenure of the project.

  • Residual Income (RI) is a measure that has more relevance when assessing a manager's performance since it's a currency amount instead of a percentage.

 RI is the amount remaining after deducting the income of the business unit from the imputed cost of investment. The imputed cost of investment is the total amount of assets times the required rate of return (RROR). 

The rate of return required is the opportunity cost of not being able to invest elsewhere. 

RI= Income of the business unit (-) (assets of business unit x RROR)

Other financial measures may include sales, projected sales, accuracy of sales projections, stock prices, operating earnings, gross margin, net profit margin, interest coverage ratio, and more.

Non-Financial Measures

1. Customer Perspective:

It is a measure that assesses a firm's performance concerning customers. Customers create revenue for the firm. And the managers must identify customers and classify them into market segments.

Customer perspective includes specific outcome measures and specific performance drivers. Since the firm can't focus on every customer, it must focus on performance drivers.

These performance drivers, also known as Value Prepositions, are specific to market segments.

Primary customer outcome measures include

  • Market Share

  • Acquisition

  • Customer Satisfaction

  • Customer Retention

  • Customer Profitability

1. Market Share: It is a proportion of customers that use the firm's product and services of total users in the market segment.

Mathematically, it should be

customer of the organization/total users in the market

2. Customer Acquisition: It is the measure of success of funds spent to acquire a new customer through advertisements and marketing.

Can be measured in absolute terms: No. of new customers.

Or, it can be measured in relative terms: Net gain in customers.

Then, it can be measured in total sales: 

customer acquired/customer market segment.

In another iteration, for new customers' conversion rate:

the number of new customers/total no. prospect contacts

3. Customer Satisfaction: It is the sub-measure of how successful a firm is to meet the needs of customers. It can be assessed by having customers rank their vendors, using surveys, or even customer complaints.

A key part of this perspective is aiming to answer the question, "What are we good at?"

The BSC suggests that the company should start from the current and future customer needs.

Progressing through the CE chain via operations, marketing, and other areas up to sales and services, keeping only elements that add value to the customer.

3 elements under IBP are Innovations, Operations, and Post-sale services.

  • Innovation processes start with SWOT analysis, identifying customers' needs that the company can satisfy.

  • Operations related to the area garnered the majority of performance measurements in the past, and it continues to be important in reducing costs or increasing capabilities.

  • And, finally, post-sale services are a method to add value to the customers even after the sales have been made while gaining feedback on customer satisfaction.

2. Learning & Growth Perspective:

Develops learning and growth measures after identifying financial, customer & IBP strategic needs.

Strategy based on ambitions and innovations is made to achieve new capabilities leading to learning and growth.

It's essentially the last step in the BSC process, but the first step is performed.

Measuring learning and growth in financial terms show only results in the short term. But, in reality, the learning and growth perspective pushes the organization to invest in individuals' continuing professional education.

3 elements under L&G include Employee Skill Set, Information System Capabilities, Empowerment, Motivation & Organizational Alignment.

The employee skill sets to focus on the employee's satisfaction, retention, productivity, and new skills acquired.

Information system capabilities include measures of the time needed to assess areas and processes.

Empowerment, motivation, and organizational alignment are measured in the metric of
no. of the total impact of employee-initiated improvements and innovations.

Functionality, Use, and Interpretation of the BSC:

The functionality starts with understanding each objective, and the objectives set must be associated with one or more measures permitting the firm to assess the performance against the set targets.

For the BSC to be successful and useful, the management must identify a cause-effect relationship between an action taken or an action that can avoid specific outcomes and effects on the KPI.

Achievement of these objectives will enable the organization to achieve objectives from higher perspectives.

Tying these objectives and perspectives embodies the implementation of the Strategy Map.

To achieve the set objectives, the organization must establish relevant criteria to measure outcomes (lagging indicators) and relevant performance drivers (leading indicators).

A detailed Cost-Benefit analysis should be conducted by management before taking any initiatives to achieve the targets set.

The correct order for the Use of the Scorecard starts with

1. Setting strategic objectives consistent with the organization's strategy. These are a set of actionable strategic objectives that answer the question for each perspective.

2. When strategic objectives are in place. The organization designs one or more measures (KPIs) that capture the progress of each objective.

Measures in performance metrics that are used to assess the performance.

3. Before the start of each period, a Target or goal is set for each measure.

Targets are desired levels of performance expected from the firm in the respective areas.

4. Initiatives are set in the final stage. Resources are committed to accomplishing targets.

With these 4 steps, the Organization's strategy is operationalized with BSC.

Implementation of the BSC:

1. Clarify and gain consensus about the vision and strategy

2. Build a strategic management team

3. Communicate the strategy throughout the organization

4. Align departmental goals to the strategy

5. Set strategic targets

6. Perform periodic and systematic strategic reviews

7. Get feedback to learn about the implementation and results.

8. Improve the strategy.

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Researched and authored by Farooq Azam Khan, CMA | LinkedIn

Edited and mentored by Céline Khattar | LinkedIn

Reviewed and Edited by Sakshi Uradi | LinkedIn

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