Module 8 Control Lecture Notes

Management Science I

Prof. M.Thenmozhi

CONTROLLING

Dr.M. Thenmozhi Professor Department of Management Studies Indian Institute of Technology Madras Chennai 600 036 E-mail: [email protected]

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

EFFECTIVE CONTROL THE MEANING OF CONTROL •

By one definition, management control is the process of ensuring that actual activities conform to planned activities. In fact, control is more pervasive than planning.

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Control helps managers monitor the effectiveness of their planning, their organizing, and their leading activities .An essential part of the control process is taking corrective actions as needed.

Steps in the control process Robert j.Mockler’s definition of control points out the essential element of the control process: •

Management control is the systematic effort to set performance standards with planning objectives, to design information feedback systems, to compare actual performance with these predetermined standards, to determine whether there are any deviations and to measure their significance, and to take any actions required to assure that all corporate

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Resources are being used in the most effective way possible in achieving corporate objectives.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

BUDGETING SYSTEM FOR CONTROLLING FUNCTION

REVENUE CENTERS

OUTPUTS

INPU TS

EXPENSE CENTERS

PROFIT CENTERS

OUTPUTS MINUS INPUTS

INVESTMENT CENTER

OUTPUTS COMPARED WITH ASSETS

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

ESTABLISH STANDARDS AND METHODS FOR MEASURING PERFORMANCE: •

Ideally, the goals and objectives established during the planning process will already be stated clear, measurable terms that include specific dead lines. This is important for a number of reasons.

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First, vaguely worded goals, such as “To improve employee skills”, are just empty slogans until managers begin to specify what they mean by “Improve” and what they indent to do reach this goal-and when.

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Second precisely worded goals are easier to evaluate for accuracy and usefulness than empty slogans.

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Finally, Precisely Measurable objectives are easy to communicate and to translate into standards and methods that can be used to measure performance.

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This ease of communicating precisely worded goals and objectives is especially important for control, since some people usually fulfill the planning roles and other people are assigned to control roles.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

In service industries standards and measurements might include the amount of customer have to wait in line at a bank, the amount of time they have to wait near the telephone is answered or the number of new clients attracted and measurement can include sales and production targets, work attendance goals, waste product produced and recycled and safety records.

MEASURE THE PERFORMANCE •

Like all aspects of control, measurement is an ongoing repetitive progress. The frequency of measurements depends on the type of activity being measured.

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In a manufacturing plant, levels of gas particles in the air for example could be continuously monitored for safety, whereas

progress on long term expansion

objection might be reviewed by top management only once or twice year. DETERMINE WHETHER THE PERFORMANCE MATCHES THE STANDARDS •

It’s an easiest step in the control process .

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Now it’s a matter of comparing measured results with the established targets are standard previously set. If performance matches the standards the managers can assume that everything is under control.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

The figure shows that they don’t have to intervene actively in the organizations operations. The figure illustrates another important point –namely that control is a dynamic process.

WHY CONTROL IS NEEDED •

One reason that control is needed is that the best of plans go away. But controls also help managers monitor environmental changes and their effects on the organization progress.

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To create better quality –

Total quality management leads to dramatic improvements in control.

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Process flaws are spotted and the process is corrected to drive out mistakes. Employees are empowered to inspect and improve their own work.

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To cope with changes –

Changes are an inevitable part of any organization environment. Markets shift.

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Competitors often from around the world-offers new products and services that capture the public imagination. New materials and technology’s emerge .

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

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Government regulations are enacted or amend.

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The control function aid managers in responding to the resulting threats, or opportunities by helping managers detect changes that are affecting the organization product and service.

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To create faster cycles: –

It is one thing to recognize that the customer demand for improved, design, quality or delivery time. It is another to speed up the cycles involved in creating and delivering new products and services to customers.

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To facilitate elegation and team work: –

Key performance and key result areas (KRA) are those aspects of unit or organization that must function effectively for the entire unit or organization should get succeed.

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These areas usually involves major organization activities or group of activities that occur throughout the organization or unit.

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This figure shows some of key performance areas for production, marketing, personnel Management, and finanace, and accounting.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

These key performance areas, in turn help define the more detailed control systems and standards.

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In today’s organization, many KRAS are cross functional an organization might define KRAs for a team focused on customer service in terms of customer response to a satisfaction survey.

IDENTIFYING STRATEGIC CONTROL POINTS: •

In addition to key performance area it is also important to determine the critical points in the system where monitoring or information collecting should occur

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once such strategic control point should be located; the amount of information that has to be gathered and evaluated can be reduced considerably.

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The most important in selecting strategic control point is to focus on most significant element in the given operation.

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Usually small portion of objects, individuals causes large expense and problem for the managers to face.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

Examples: –

For example 10 manufactured products may well yield 60 percent of its sales. 2 percent of an organization’s employee may account 80 percent of its employee grievances and 20 percent of the police precincts in city may account for 70 percent of the city’s violence and crimes.

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Another useful consideration is the identification of places where change occurs in a productive process. For Example in an organizations system for filling customer’s orders

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Examples: –

A change occurs when a purchase order become a invoice, when an inventory items becomes an item to be shipped, or when the item to be shipped becomes part of truckload. Since errors are more likely to be made when such change occur, monitoring change points is usually a highly effective way to control an operation.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

FINANCIAL CONTROLS •

Manager’s uses a series of controls and systems to deal with differing problems and element of their organization.

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The method and systems can take many forms and can be intend for various groups.

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However finance control have special prominence since money is easy to measure and tally.

FINANCIAL STATEMENTS •

Financial statements are used to track the monetary value of goods and services into and out of the organization . They provide a means for monitoring three major financial condition of an organization: 1. Liquidity: The ability to convert assets into cash in order to meet current financial Needs and obligations. 2. General financial condition: The long Term between balance between debt and equity. 3. Profitability: The ability to earn a profit over an extended period of time.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

Financial statements are widely used by managers, shareholders, financial institutions, investment analysts, union, and other stake holders to increase the performance.

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Managers, for example, could compare company’s current performance with a past performance and to those of competitors of how well the organization is doing the overtime.

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Given enough information they might be able to see trends that require corrective action.

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Bankers and financial analysts on the other hand they will use the statements to decide whether they should invest in the firm.

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It’s important to remember that the financial statement do not show all the relevant information.

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Recent Technological or scientific break through shows up on financial statements For example nor changes in environment of the organization for example shifts changes as per the consumer taste even though these could be more crucial than a financial Performance.

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Depending on the company financial statements could cover the previous year, previous quarter or previous month.

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The most common financial statements used by large, small organization alike are income statement, balance sheet, cash flow statement.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

BALANCE SHEET •

In its simple form balance sheet

describes the company in terms of Asset

Liabilities, and worth. A company asset will ranges from the money in the bank to the Good will value of its name in the market place. •

The left side of the balance sheets lists these order in the descending order of liquidity.

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A distinction is made between current asset and fixed asset.

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Current Assets: covers items such as cash, account receivable, marketable securities

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And inventories assets that could be turned in to cash reasonably predictable value with in a relatively short period of time.

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Fixed Assets: show the monetary value of company’s plant, equipment, property, plants, and other item used on a continuing basis to produce its goods or services.

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Liabilities :are also made up two groups: current liabilities and long term liabilities

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

Current liabilities: are debts, account payable short-term loans and unpaid taxes that will have to be paid off during the current fiscal period.

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Long term liabilities include mortgages, bonds, and other debts that are being paid off gradually.

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The company’s net worth value remains as residual value remaining after total liabilities have been subtracted from total assets.

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The Electronic spread sheet has made balance sheet much easier .

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In addition to that computer packages have been developed specifically to process accounting transaction and prepare the resulting balance sheets and other financial statements.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

INCOME STATEMENT It summaries the companies financial statement at the given interval of time. •

The income statement then says “Heres how much money I have made over a given period instead of “hears how much money we are worth now.

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Income statements starts with a figure for gross receipts or sales and then subtract all cost the costs involved in realizing those sales, such as the cost of goods sold, administrative expenses taxes, interest, and other operating expenses.

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What is left is the net income available for stockholders dividends or reinvestment in the business.

CASH FLOW •

In addition

to the standard balance sheet and income statement, many

companies report financial data in the form of a statement of cash flow or a statement of sources and uses of funds. •

Theses statements show where cash or funds came during the year and where they are applied they should not confused with the income statement.

Cash flow statements show how cash or funds were used rather than how much profit or loss was achieved.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

BUDGEDERY CONTROL METHODS •

Budget are formal quantitative statements of the resources set outside for carrying out planned activities over give period of time.

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As such they are widely used for carrying out planned activities over given period of time.

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As such they are widely used means for planning and controlling activities at every level of the organization.

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Thier are number of reason for their wide usage.

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First budget: are stated in momentary terms, which are easily used as a common denominator for a wide variety of organizational activities-hiring and training personnel, purchasing equipment, manufacturing, advertising and selling.

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Second: the monetary aspect of budgets means that they can directly convey information on key organizational recourses-capital-and on a key organizational goal-profit. They are therefore heavily favored by a profit oriented companies.

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Third budget: establish clear and unambiguous standards of performance for a set time period.-usually year.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

At stated intervals during that time period ,actual performance will be compared directly with the budget.

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Deviation can detect quickly and acted upon.

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In addition to being major control devices, budgets are one of the major means of coordinating the activities of the organization.

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The interaction between managers and subordinate that take place during the budget development process will help define and integrate the activities of organization members.

RESPONSIBILITY CENTERS: Any organizational or functional unit headed by a manager who is responsible for the activities of that unit is called a responsibility center. All responsibility center uses the resources for something. Typically responsibility is assigned to a revenue, expense ,profit and or invest center.

Indian Institute of Technology Madras

Management Science I

•

Prof. M.Thenmozhi

Control systems can be devised to monitor organizational functions or organizational projects. Controlling a function involves making sure that a specified activity (such as production or sales) is properly carried out.

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Controlling a project involves making sure that a specified end result is achieved (such as the development of a new product or the completion of a building).

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Budgets can be used for both types of systems;

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Any organizational or functional unit headed by a manager who is responsible for the activities of that unit is called a responsibility center.

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All responsibility centers use resources (inputs or costs) to produce something (outputs or revenues).

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Typically, responsibility is assigned to a revenue, expense, profit, and/or investment center are 20-4).

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The decision usually depends on the activity performed by the organizational unit and on the manner in which inputs and outputs are measured by the control system.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

We will describe such centers briefly here. •

REVENUE CENTERS: Revenue centers are those organizational units in which outh puts are measured in monetary terms but are not directly compared to input costs. –

A sales department is an example of such a unit. The effectiveness of the center is t not judged by the extent to which revenue (in the form of sales) exceeds the cost of

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The center (in salaries or rent, for example). Rather, budgets (in the form of sales quotas) are prepared for the revenue center and the figures are compared with sales orders or actual sales.

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In this way, a useful picture of the effectiveness of individual salespeople or of the center itself can be determined.

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EXPENSE CENTERS: In expense centers or cost centers, inputs are measured by In re the control system In monetary terms, but outputs are not. The reason is that –

These centers are not expected to produce revenues. Examples are maintenance, administration, service, and research departments.

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Budgets will be devised only for the input portion of these centers' operations.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

PROFIT CENTERS: In a profit center, performance is measured by the numerical difference between revenues (outputs) and expenditures (inputs). –

Such a measure is do used to determine how well the center is doing economically and how well the manager in charge of the center is performing.

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A profit center is created when- ever an organizational unit is given responsibility for earning a profit.

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In a divisionalized organization, in which each of a number of divisions is completely responsible for its own product line, the separate divisions are considered profits.

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INVESTMENT CENTERS: In an investment center, the control system again measures the monetary value of inputs and outputs, but it also assets how –

those outputs compare with the assets employed in producing them./Assume, for X

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It example, that a new hospital requires a capital investment of $20 million in property, buildings, equipment, and working capital.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

In its first year, the hospital has $2 million in labor and other input expenses and $4 million in revenue.

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For two reasons the hospital would not be considered to have earned a $2 million profit.

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First, an allowance must be made for the depreciation of building and equipment.

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Second, management must account for the interest that could have been earned from alternative investments.

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By assessing these factors as well, the company obtains a much more accurate picture of profitability.

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Managers can identify the return on an investment, not merely the actual inflow and outflow or, and submitted to the budget committee for further review.

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Finally, the master budget is sent to top magement (the president, chief executive officer, or board of directors) for approval.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

THE BUDGETING PROCESS •

The budgeting process usually being when the managers receive

top

management economic forecasts and sales and profit objectives for the coming year along with the time table stating when budget must be completed. •

The forecasts and objectives provided by top management with in which other managers budget will be developed.

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In a few organizations the presence is for “top-down” budgeting. Budget are imposed by top managers but little or no consultation with lower level managers .

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Most companies, however most companies how ever prefer the process of bottom up budgeting; budgets are prepared at least initially by those who implemented by them.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

(ii). THE ROLE OF BUDGET Personnel. •

Although developing

is the responsibility of managers, they may receive

information and technical assistance from the staff of a planning group or from a formal budget department or committee. •

These groups are likely to exist in large, divisionalized organizations in which the division budget plays a key role in planning, coordinating, and controlling activities.

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17 The budget department, which generally reports to the corporate controller, pro-vides budget information and assistance to organizational units, designs budget systems and forms, integrates the various departmental proposals into a master budget for the organization as a whole, and reports on actual performance relative to the budget

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The budget committee, made up of senior executives from all functional areas, reviews the individual budgets, reconciles divergent views, alerts or approves the budget proposals, and then refers the integrated package to the board of directors.

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Later, when the plans have been put into practice, the committee reviews the control reports that monitor progress.

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In most cases, the budget committee must approve any revisions made during the budget period.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

SOME PROBLEMS IN BUDGET DEVELOPMENT •

During the budget-development process. when the organization's limited resources are allocated, managers could fear that , they will not be given their fair share.

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Tension can grow as competition with other. Managers increases.

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Anxieties might also arise because managers know they will J be judged by their ability to meet or beat budgeted standards.

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Hence, they are concerned about what those standards will be and may overstate their needs to create some slack.

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Conversely, their senior managers are concerned with establishing aggressive budget objectives.

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As a result, the senior managers will often try to trim ADITING

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To much of the general public, the-term auditing is associated with detecting fraud.

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Although the discovery of fraud is, in fact, one important facet of auditing, it is from the only one.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

Auditing has many important uses, from validating the honesty and irness of financial tamnts.

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To providing a critical sis for man- agreement decisions.

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Will discuss two types put; audit external c auditing and internal auditing.2O

EXTERNAL AUDITING •

The traditional external audit is largely a verification process involving the independent appraisal of the organization's financial accounts and statements.

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Assets and liabilities

verified, and financial reports are checked for

completeness and accuracy. •

The audit is conducted by accounting personnel employed by

chartered

accountants. •

The auditors' purpose is not to pre- pare the company's financial reports.

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Their job is to verify that the company, in preparing its own financial statements and valuing its assets and liabilities, has followed generally accepted accounting principle’s and applied them correctly.

Indian Institute of Technology Madras

Management Science I

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Prof. M.Thenmozhi

The external audit plays a significant role in encouraging honesty, not only in the preparation of statements, but also in the actual operation of the organization.

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It is, in fact, a major systematic check against fraud within the organization.

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For people outside the organization, such as bankers and potential investors, the ex- ternal audit provides the major assurance that publicly available statements are accurate.

EXTERNAL AUDIT •

The external audit takes place after the organization’s operating period is finished and its financial statements are completed.

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For this reason, and also because it generally focuses on a comparatively limited set of financial statements and transactions, the external audit does not usually make a major contribution to control of the ongoing operations of the organization.

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

INTERNAL AUDIT •

However, knowing that the audit will inevitably occur is a strong deterrent against actions that may lead to embarrassment if they are discovered during or after the audit.

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The internal audit is carried out by members of the organizations .

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Its objectives are to Provide reasonable assurance that the assets of the organization are being properly Safe guarded and that financial records are being kept reliably and accurately enough For the preparation of financial statements.

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Internal auditing also assists managers in evaluating the organization s operational efficiency and performance of its control system.

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Because it concentrates on the operation of the organization this process is also known as operational auditing

Indian Institute of Technology Madras

Management Science I

Prof. M.Thenmozhi

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In this role the we can see the management process is a self correcting.

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The internal audit may be carried out as a separate project by assigned members of the financial department or in large organizations, by full time internal auditing staff.

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The range and depth of audit will also vary, depending on company size and policy.

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It can range from a relatively narrow survey to a board comprehensive analysis that gone beyond appraising the control system to look at policies, procedures, the use of authority, and the overall quality and effectiveness of the managerial methods being used .

Indian Institute of Technology Madras