Controlling

Lecture 11

October 30, 2011

Chapter Objective

Explain different financial and non-financial systems Describe some of the important elements for establishing financial controls Explain balance sheets, income statements and ratios Explain different control systems

Advanced Organizer
Managing Engineering and Technology
Management Functions Planning Decision Making Organizing Leading Controlling Managing Technology Research Design Production Quality Marketing Project Management Personal Technology Time Management Ethics Career

Controlling Definition

Compelling Events to Conform to Plans Process of measuring performance and taking action to ensure the desired results It is a critical function as it ensures that all the management functions Planning, Organizing, Leading are performed as planned

Control Process

Establish Performance Standards

Planning

Measure Actual Performance Compare Performance with Standards Measurement of Variance Feedback and Analysis Corrective Action

Control: Closed Loop vs. Open Loop

Closed Loop
Automatic or cybernetic (communication &control) Monitors or manages process by internal, self-regulating system Essential feature is strong feedback system Home thermostat system

Open Loop
Requires external monitoring or agent to activate control Cruise control on an automobile

Timing of Control

Feedback Control (Output)

Measures system output and variance with predetermined standard Adjusts system to maintain variance within a specified range

Screening Control (Concurrent)

Control applied concurrently with effort being controlled - baseball coach guidance

Feed-forward Control (Steering or Preliminary)

Attempts to predict the impact of current actions/events Current decisions are refined to facilitate goal attainment Eg: preventive maintenance

Characteristics of Good Control Systems

Effective Efficient Timely Flexible Understandable Tailored Highlight deviations Lead to corrective actions

Three Types of Control

Financial Human Resource Social

Financial Control: Budgets

Plans and resource allocation for future Budgeting process force managers to thnk future operations in quantitative terms Most common and universally used control systems -first step in financial control Financial Budgets: Identify sources of cash and intended uses

Cash Budgets estimates of future revenue and

expenditures

Capital Expenditure Budgets investment on plant,

machinery etc.

Operating Budget expenses, revenue, profit budget

Responsibility Centers
Cost Centers Managers primary concern is control of costs Revenue Center Managers primary concern is attaining revenue target Profit Center Manager has more freedom to manipulate costs to increase profit

Budgeting Process

Top Management
Estimates of future sales and production Priorities used to meet new objectives

Middle Management
Prepares proposed revenue and expense budgets designed to attain estimated sales/production levels

Audits of Financial Data

Third step in financial control Investigations of an organizations activities Verify accuracy of firms financial data May be internal or external Internal audits also evaluate organizational efficiency

Financial Control --- Cost Accounting

Finding the cost of alternative methods Historical accounting systems to determine the profitability and hence tax liability

Product A B Units 4,000 1,000 Labour Hour/Unit 1 1 Rate 10 10 Amount 40,000 10,000 50,000

Set up cost say $4000 for each product Supervisory cost $1 for each labor hour Higher profitability required for Product B

Financial Control Three Major Statements

Balance Sheet
Shows the firms financial position at a particular instant in time Assets and liabilities Shows financial performance of a firm over a period of time

Income Statement Cash Flow

Shows where cash comes from and what it is used for

Balance Sheet
ASSETS Current Assets Cash Securities (at cost) Accounts Receivable

Sterling Chemicals Inc. , December 31, 2008

150,000 100,000 250,000 400,000

Inventories (at lower cost or market) Raw materials and supplies Work in progress Finished goods Prepaid expenses 200,000 180,000 300,000 680,000 30,000

Total current assets

Property, plant and equipment Less: Accumulated depreciation and depletion Net property, plant and equipment Total Assets 4,500,000 2,400,000

1,360,000

2,100,000 3,460,000

Balance Sheet
Current Liabilities Accounts Payable

Sterling Chemicals Inc. , December 31, 2008

LIABILITIES AND STOCKHOLDERS' EQUITY

100,000 30,000 250,000 120,000 500,000 1,000,000 1,500,000

Installments due within one year of debt Federal income and other taxes Other accrued liabilities

Total current liabilities

Long Term Debt Total Liabilities Stockholder's equity Capital stock Retained earnings Total equity Total Liabilities and Equity 500,000 1,460,000

1,960,000 3,460,000

Income Statement

Sterling Chemicals Inc. , January 1-December 31, 2008

Gross Sales Less returns and allowances Net Sales Lesss expenses and cost of goods sold Cost of goods sold Depreciation and depletion Selling expenses General and administrative expenses Operating Profit Plus interest and other income Gross Income (EBIT) Less interest expenses Income before taxes (EBT) Provision for income taxes Net Income Retained earnings, January 1, 2008 Dividend paid Retained earnings, December 31, 2008 3,200,000 150,000 2,000,000 250,000 100,000 200,000

3,050,000

2,550,000 500,000 60,000 560,000 20,000 540,000 260,000 280,000 1,500,000 1,780,000 320,000 1,460,000

Ratio Analysis

Ratios of two financial numbers taken from financial statements and compared to industry averages Framework for 1) historical comparison within the firm and 2) external benchmarking relative to industry Can also be used for target setting for a firm They must be used carefully especially considering the firms business There are major 4 types of ratios
Liquidity: Measures ability to meet short term obligations Leverage: Measures the level of debt in a firms financial structure Activity: Measures how effectively a firm uses its resources Profitability: Measures profit producing performance of firm

Ratio Analysis, cont.

Liquidity Ratio:
Measures ability to meet short term obligations Current ratio is most widely used measure of liquidity ratio. A CR of around 2.0 is used a high CR shows that the assets are not efficiently unemployed

Leverage:
Measures the level of debt in a firms financial structure Relative importance of stockholders and outside equity as a source of capital

Activity:
Measures how effectively a firm uses its resources or assets to produce sales or how fast inventory is turned into sales

Profitability:
Measures profit producing performance of firm Net income as percentage of sales Earning per share is also used widely

Ratio Analysis, cont.

Liquidity Ratio Current Ratio Current Assts Current Liabilities Current Assts - Inventory Current Liabilities 1,360,000 500,000 =2.72 680,000 500,000 1,500,000 3,460,000 =1.36

Acid Test Ratio Leverage Ratio Debt-to-Assets ratio Activity Ratios Inventory turnover ratio

Total Debt Total Assets

=0.434

Cost of goods sold Inventory Net sales Total assets Net sales Accounts receivable

2,000,000 =2.94 680,000 3,050,000 =0.88 3,460,000 3,050,000 =7.63 400,000 280,000 =9.18% 3,050,000

Assets Turnover

Accounts receivable turnover Profitability Ratio Profit margin

Net income Net sales

Non-financial Controls

Management Audits Human Resources Accounting

Evaluate efficiency Check the policies and procedures Quantifies the value of human resources investment Costs of recruiting Costs of training Costs of process improvement

Non-financial Controls

Social Controls
Standards the existence of standards (and knowledge by general workers about it) Comparison with outcomes (including feedback of performance to the individual not just to manager) Corrective action individual have the tools, the autonomy, and the motivation to make self corrections

Other Non-financial Controls

Effectiveness of research activities Systems for drawing release and engineering design Inventory control Quality control