Chapter 15 Essentials of Control

2 Time Element in Controls Preventive controls (takes place before performance of an activity, such as parts specification) Concurrent controls (monitors activities while they are carried out, such as surveillance) Feedback controls (evaluates an activity after it is performed, such as financial statement)

3 External versus Internal Controls External control strategy a. Assumes employees need to be controlled b. May lead to effort but not commitment Internal control strategy a. Assumes goal commitment is possible b. Requires group goal setting

4 Steps in the Control Process Set Standards Measure Actual Performance Compare Performance to Standard Take Corrective Action if Necessary Do Nothing Solve the Problem Revise Standard

5 Nonbudgetary Control Techniques Qualitative control techniques (based on judgments of performance, including audits) Quantitative control techniques (based on numerical measures of performance) Quantitative controls include Gantt chart, PERT, break-even analysis, economic-order quantity, and variance analysis.

6 Suggestions for Preparing a Budget 1. Leave wiggle room (budget conservatively for income, liberally for expenses). 2. Research the competition. 3. Embrace reality (look at history). 4. Do not neglect intuition (a little creativity and optimism can be okay).

7 Financial Ratios for Control Gross profit margin = Sales – Cost of Sales Sales Profit margin = Net Income Sales Return on equity = Net Income Owners’ Equity Revenue per employee = Number of employees Total revenues

8 Other Measures of Financial Health Economic value added (EVA) measures profits versus minimum expectations. EBITDA = earnings before interest, taxes, depreciation, and amortization. Pro forma earnings exclude non- recurring costs. Net debt is company debt minus cash on hand.

9 Cash Flow Statement 1. Cash provided by (or used in) operating activities. 2. Cash provided by (or used in) financing activities. 3. Cash provided by (or used in) investing activities. 4. Summary (lists cash at beginning and end plus changes in cash position).

10 Cost Cutting to Improve Financial Health Can improve competitiveness. Might be triggered when expenses in relation to sales are too high. Squeezing suppliers can backfire. Company can appear cheap. Cost cutting can focus on people, material and equipment, and money management.

11 The Balanced Scorecard Organizational health is measured from four perspectives: 1. Learning and growth 2. Business process 3. Customer 4. Financial Compensation is based on achieving all four perspectives. Vision and Strategy

12 Activity-Based Costing (ABC) Presents comprehensive view of all costs in creating a product or service and getting it to market. Activities are ranked in terms of value they add to organization or its outputs. Costs are assigned based on the use of. company-wide resources such as R&D Cost per Unit = Total Cost Total Output

13 Computer-Aided Monitoring of Work Computer-based system gathers data about work habits and productivity. Also tracks down information leaks. Telephone workers are frequently monitored. Workers are frequently fired for Internet abuse. Advance notice improves acceptance.

14 Characteristics of Effective Controls 1. Employees must accept controls. 2. Measures must be appropriate. 3. Provides diagnostic information. 4. Allows for self-feedback and self- control. 5. Must provide timely information.

15 Characteristics of Effective Controls, continued 6. More effective when employees have control over results measured. 7. Must not contradict each others (such as quality and quantity). 8. Should allow for random variation from standard. 9. Cost effective (provide good return on investment)