3 Chapter ObjectiveDescribe some of the important elements for establishing financial controlsExplain balance sheets, income statements, ratios.Explain different non-financial control systems
4 Definition of “Controlling” “compelling events to conform to plans” -- Goetz“Control techniques and actions are intended to insure, as far as possible, that the organization does what management wants it to do.”
5 Steps in the Control Process 2. Measuring Actual Performance1. Establish Standards4. Corrective Action3. Comparing Performance with StandardsPlanningControlling
6 Steps in the Control Process Establish StandardsTechnical: Quality, Quantity, MTBFMarket: Sales, ROI, Earning ExpectationPlanning: Objectives, Schedules, Budgets, PoliciesSafety: OSHAEEOHistorical
7 Steps in the Control Process Establish Standards—by BenchmarkingInternal Benchmarking: productivityExternal BenchmarkingFinancial RatiosPerformance MetricsBest PracticesCritical Success FactorsTarget PricingBalanced Scorecard: new products, new projects, patents, new partners, new customers, new technology
8 Steps in the Control Process Measuring Actual PerformanceData collection and analysisTime study, work sampling, performance ratingComparing Performance with StandardsEstablish limits of toleranceNote variations (deviation within limits) and exceptions (deviation outside limits)Provide recognition and warning
9 Steps in the Control Process Corrective ActionShort-term: Consultants, temporary workersLong-term: Training, modifying procedures and policies
10 Closed-Loop vs. Open-Loop Control Closed-loop control (also known as automatic or cybernetic control) monitors and manages a process by means of a self-regulating system. Open-loop control (or non-cybernetic control) requires an external monitoring system and/or an external agent to complete the control loop.
11 Timing of Control Feed-back control Screening or concurrent control Feed-forward (or preliminary or steering) control
12 Timing of Control Feedback Control (Output) Measures system output and variance with predetermined standardAdjusts system to maintain variance within a specified range
13 Timing of Control Screening Control (Concurrent) Control applied concurrently with effort being controlled
14 Timing of Control Feed-forward Control (Steering or Preliminary) Attempts to predict the impact of current actions/eventsCurrent decisions are refined to facilitate goal attainment
15 Characteristics of Effective Control EfficientTimelyFlexibleUnderstandableTailoredHighlight deviationsLead to corrective action
17 Financial ControlsFinancial statements provide the basic information for the control of cash and credit, which are essential to the survival of a company.The balance sheetThe income statementThe cash flow statement
18 Balance Sheet Total Assets = Total Liability + Owner’s Equity Balance sheet shows the firm's financial position at a particular instant in time (a financial "snapshot.“)Total Assets = Total Liability + Owner’s Equity
19 Balance Sheet Assets are what the company "owns" Current assets (assets that can be converted into cash within a year)Fixed assets (property, plant, and equipment at original cost, less the cumulative depreciation of plant and equipment [but not land] and depletion of natural resources since they were purchased)Tangibles and Intangibles
20 Balance Sheet Liabilities are what the firm "owes" Net worth or Equity Current liabilities (must be paid within a year)Long-term debtNet worth or EquityOriginal investment (what was paid in for common and preferred stock)Retained earnings (the cumulative profits over the years after dividends are paid).
21 TABLE 8-1 Balance Sheet, Sterling Chemicals, Inc., December 31, 2005 AssetsCurrent assetsCash $150,000Securities (at cost) ,000 $250,000Accounts receivable ,000Inventories (at lower of cost or market)Raw materials and supplies 200,000Work in progress ,000Finished goods , ,000Prepaid expenses ,000Total current assets ,360,000Property, plant, and equipment 4,500,000Less accumulated depreciation 2,400,000Net property, plant, and equipment 2,100,000Total Assets $3,460,000
22 TABLE 8-1 Balance Sheet, Sterling Chemicals, Inc., December 31, 2005 Liabilities and Stockholders' EquityCurrent liabilitiesAccounts payable $100,000Installments due within 1 year ,000Federal income and other taxes 250,000Other accrued liabilities ,000Total current liabilities ,000Long-term debt ,000,000Total Liabilities $1,500,000Stockholders' equityCapital stock ,000Retained earnings 1,460, ,960,000Total liabilities and equity $3,460,000
23 Income StatementIncome statement (also called a profit and loss or revenue and expense statement) shows the financial performance of the firm over a period of time (usually three months or a year).
24 TABLE 8-2 Income Statement Sterling Chemicals, Inc., December 31, 2005 Gross sales $3,200,000 Less returns and allowances ,000 Net sales $3,050,000Less expenses and costs of goods sold Cost of goods sold 2,000,000 Depreciation and depletion ,000 Selling expenses ,000 General and admin. expenses ,000 2,550,000Operating profit ,000Plus interest and other income ,000Gross income ,000
25 Gross income 560,000 Less interest expense 20,000 TABLE 8-2 Income Statement Sterling Chemicals, Inc., December 31, 2005Gross income ,000 Less interest expense ,000Income before taxes ,000 Provision for income taxes ,000Net income ,000Retained earnings January 1, ,500, ,780,000 Dividends paid ,000 Retained earnings December 31, ,460,000
26 Cash Flow StatementCash flow statement (or sources and uses of funds statement) shows where funds come from (net profit plus depreciation, increased debt, sale of stock, sale of assets) and what they are used for (plant and equipment, debt reduction, stock repurchase, and dividends).
27 Cash Flow Statement (Income Statement) Operating CostsPayments to suppliers,Employees, and othersOperating RevenueInterest Payments to Debt HoldersInt.onDebtDepr.TaxableIncomeAfter-taxCash FlowNetIncomeIncomeTaxDiv.RE
28 Cash Flow Statement RE Depr. Sources: Uses: Disposal of New Debt/ PropertiesNew Debt/CapitalDepr.RESources:Uses:Increase in Working CapitalWorking Capital = Current Assets – Current Lib.OthersRepayment of debt & equityCapital Expenditures
29 A L + + S U Cash Flow Statement The letters labeling the boxes stand for Uses, Sources, Assets, and Liabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities.+S+U
30 Ratio AnalysisFinancial ratios are ratios of two financial numbers taken from the balance sheet and/or the income statement.compared with average values for the industry the firm is in to evaluate relative financial health, andcompared with earlier values from the same firm to evaluate trends.
31 Liquidity RatiosLiquidity ratios measure the ability to meet short-term obligations.
32 Leverage RatiosLeverage ratios identify the relative importance of stockholders and outside creditors as a source of the enterprise's capital.
33 Activity RatiosActivity ratios (also known as operating ratios) show how effectively the firm is using its resources.
34 Profitability RatiosProfitability ratios describe the organization's profit.
35 BudgetsFinancial budgets describe where the firm intends to get its cash for the coming period and how it intends to use it.Cash budgetsCapital expenditure budgetsBalance sheet budget
36 Responsibility Centers Expense or cost centers (expense budget)Revenue center (revenue budget)Profit centers (profit budget)
38 Cost Accounting Allocating cost among products Product A Product B TotalProduction 4,000 1,000 5,000Direct Labor $40,000 $10,000 $50,000Overhead $5,000Set-up Cost $8,000Total Cost $63,000Unit Cost$4,000$1,000$4,000$4,000$48,000$15,000$12$15
39 Audits of Financial Data Audits are investigations of an organization's activities to verify their correctness and identify any need for improvement.accounting and financial systems and recordsinternal or external.
40 Nonfinancial Controls Human Resource ControlsTo assure that human and organizational performance conform to expectations.Performance appraisal (individual)Management audit (group) (Figure 8-2)Human resource accounting (group)Social controls.
41 Nonfinancial Controls Human Resource ControlsProductivityLow SkillsHigh SkillsAmount of Supervision
42 Non-financial Controls Social ControlsStandardsComparison with outcomesCorrective action
43 Non-financial Controls Effectiveness of research activitiesSystems for release of drawing releaseInventory controlQuality controlProject control