Management Control System

Presented by: Ravish prakash

Management Control System

Is the process of evaluating, monitoring and controlling the various sub-units of the organization so that there is effective and efficient allocation and utilization of resources in achieving the predetermined goals

Characteristics of Control System In Organization

Involvement of people Information about the actual state of the organization is compiled by people. It is compared by people. With the desired state decided by people. For significant difference, a course of action is recommended by people Action taken by people

 The management decides the desired state or standards against which performance is compared. It decides what the organization plans to achieve in a given time framework which is known as Planning Process. Actual Performance is compared to Planned Performance in control, so planning and controlling are interlinked and are known as P&C systems

Functions
Planning activities of an organization Coordinating activities of an organization Communication information to different levels of the hierarchical structure Evaluating information and deciding the actions to be taken Influencing people to change their behavior.

Responsibility Centres
A responsibility centre is an organisation unit that is headed by manager who is responsible for its activities. delegation of responsibility for specific to successive lower levels of organisation. motivation of the level of management to which a certain task has been delegated. measurement of the achievement of specified objectives.

The key consideration in determining the responsibility centre is ability to control cost or revenue determining the question of controllability evaluation of responsibility centre as per predetermined criteria

The responsibility centres may be classified as Revenue Centres Expense Centres (III) Profit Centres (IV) Investment Centres

Revenue Centres
In a revenue centre, output (I.e., revenue) is measured in monetary terms, but no formal attempt is made to relate input (I.e., expenses or cost) to output. The main focus of managements efforts will be on revenue generated by it. The sales department is an example for a revenue centre. The effectiveness of the centre is not judged by how much sales revenue exceeds the cost of the centre. Sales budget are prepared for revenue centre and budgeted figures are compared with actual sales. Generally the costs are not related to output.

Expenses Centre
It is the lowest level of responsibility centre in an organization. Its manager is basically responsible for production of a product or service; his decision authority relates to how human resource, machinery and materials should be used to produce the product or service. Expense centre manager has no control over revenues, profits or investment. He has no control over marketing decisions or investment decisions. Total performance of an expense centre manager depends on how effectively and efficiently an expense centre is operated.

 Effectiveness of an expense centre manager will depend on a host of non-financial parameters such as maintaining quality level of output, compliance with production schedules and targets, maintaining morale of the workers and so on. Normally, separate reporting systems are used to report effectiveness. Efficiency is judged in terms of financial performance. It is measured and reported by the responsibility accounting system. Evaluation of the financial performance of an expense centre manager is by comparing the actual expenses of the centre against the budgeted expenses.

Profit Center
A profit centre is an organizational unit responsible for both revenues and costs. Profit centre manager has no control over the investment in the centres assets. Managers are concerned with both the production and marketing of the products. Activities of the manager is much more broader than that of a revenue centre manager because of the responsibility to produce the product most efficiently. Profit centres performance measured in terms of profit. It enhances profit consciousness Example:division of a company that produces and markets different products.

Investment Center
An investment centre is responsible for the production, marketing and investment in the assets employed in the segment. An investment centre manager decides on aspects such as the credit policies, inventory policies, and within broad framework. Investment centre manager responsible for profit in relation to amounts invested in the division. Financial performance of the manager of the division is measured by comparing the actual with projected rate of return on investments of the centres

AUDITING
Audit is the activity of examination and verification of records and other evidence by an individual or a body of persons so as to confirm whether these records and evidence present a true and fair picture of whatever they are supposed to reflect. Audits are most commonly used in the accounting and finance functions

Categories Of Audits
Audit category Financial statement audit Internal audit Brief description
Gives an opinion on the accuracy of the financial statements Ensures compliance with the relevant accounting standards and reporting framework An independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization Need not be limited to books of accounts and related records

Fraud auditing and forensic audit Operational audit

Deters, detects, investigates, and reports fraud Forensic: related to the legal system, especially issues of evidence Audits operational aspects of the enterprise Quality audit, R&D audit, etc

Audit category

Brief description
Audit of computer systems Checks whether the computer system safeguards assets, maintains data integrity, and contributes to organizational effectiveness and efficiency Audit of the management, as a tool for evaluation and control of organizational performance Examines the conditions and provides a diagnosis of deficiencies with recommendations for correcting them Audit of the enterprise's reported performance in meeting its declared social , community, or environmental objectives Environmental compliance audit: a checking mechanism Environmental management audit: an evaluation mechanism

Information systems audit

Management audit

Social audit Environmental audit

The auditing process

Staffing the audit team Creating an audit project plan Laying the ground work Conducting the audit Analyzing audit results Sharing audit results Writing audit reports Dealing with resistance to audit recommendations Building an ongoing audit program

Benefits of Auditing
Identify opportunities for improvement Identify outdated strategies Increase managements ability to address concerns Enhance teamwork Reality check

THE BALANCE SCORECARD

Originated by Drs. Robert Kaplan (Harvard Business School) and David Norton as a performance measurement framework that added strategic non-financial performance measures to traditional financial metrics to give managers and executives a more 'balanced' view of organizational performance.

The balanced scorecard is a strategic planning and management system that is used extensively in business and industry, government, and nonprofit organizations worldwide to align business activities to the vision and strategy of the organization, improve internal and external communications, and monitor organization performance against strategic goals.

"The balanced scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation.

Balanced Scorecard For Financial Institutions

Four Perspectives In Financial Institution Scorecard

Financial
Reduce costs. Improve return on spending (ROS) Increase revenues Reducing risks Customer Objectives Improving the image of a financial organization in the eyes of customers Informing customers in a better way Eliminate mistakes in customer service

Internal Processes
Innovation Delivery of services Service excellence

Learning and Growth Objectives

Strategic jobs and competencies Compensation, reward and accountability system. Focusing on resources

TRANSFER PRICING
Transfer pricing is the rates or prices that are utilized when selling goods or services between company divisions and departments, or between a parent company and a subsidiary. Example from the consulting industry.
A Project manager who's based in Germany, so he's part of Germany's local profit and loss accounting. Now a client in Japan is asking for that particular expertise, so the Japan office is staffing this guy on its project. Well - what's Germany getting out of it? The project is in Japan, the client pays the fees to the Japan office. In this example, the transfer price is the price the Japan office has to pay the Germany office for use of this guy. It's an internal price that may or may not be equal to the external price the client is paying for the guy. But it serves the purpose of giving the German office something to benefit from - an incentive to give the guy up for the duration of the project. If there were no transfer price, Germany would not send the project manager to Japan they would sell his service locally.

Methods of Transfer Pricing

Market-based transfer price: In the presence of competitive and stable external markets for the transferred product, many firms use the external market price as the transfer price. Cost-based transfer price: The transfer price is based on the production cost of the upstream division. A cost-based transfer price requires that the following criteria be specified: Actual cost or budgeted (standard) cost. Full cost or variable cost. The amount of markup, if any, to allow the upstream division to earn a profit on the transferred product. Negotiated transfer price: Senior management does not specify the transfer price. Rather, divisional managers negotiate a mutually-agreeable price

BUDGETS
Budgets are business plans that are stated in quantitative terms and are usually based on estimations. These plans aid an organization in the successful execution of strategies. Due to the uncertainties in the business environment and / or due to wrong estimation, there may be significant deviations between the a c t u a l s and the plans. Budgeting as a control tool, provides an action plan for the organization to ensure least deviations

 Budgets are used to give an overview of the organization and its operations. They are useful in resource allocation whereby resources are allocated in such a way that the processes which are expected to give the highest returns are given priority. Budgets are also used as forecast tools and make the organization better prepared to adapt to changes in the environment

 Budget preparation requires the participation of managers from different functions / departments. This helps in integrating the tactical and operational strategies of the departments with the corporate strategy of the organization. Budgets act as a means to verify the progress of the various activities undertaken to achieve the planned objectives. The verification is done by comparing the a c t u a l s against standards

 They help in the delegation of authority and allocation of responsibility and accountability to more people in an organization. They thus promote division of labor, which , in turn, promotes the process of specialization. Functional specialization leads to the overall efficiency of the organization

Steps in Budget Formulation

Creating a budget department or appointing a budget controller Developing guidelines for budget preparation Developing budget proposals at department/business unit level Developing the budget for the entire organization Determining the budget period and key budgets factors Benchmarking the budget Budget review and approval Monitoring progress and revising the budgets

Types of Budgets
Appropriation budget

Characteristics
A ceiling is set for certain discretionary expenditures Based on the management decision A static amount is established for discretionary and committed fixed costs and a variable rate is determined per unit of activity for variable cost

Examples
Training, advertising, sales promotion and R&D

Flexible budget

The static part: Salaries, depreciation, property taxes, and planned maintenance. The flexible part : direct material, direct labor, and variable overhead .sales commission

Capital budget

Decisions regarding potential investments are made using discounted cash flow techniques A comprehensive plan is developed for all revenue and expenditure

New plant and equipment

Master budget

All revenue and expenditures for any organization

EVA
What is EVA EVA = Economic profit
Not the same as accounting profit Difference between revenues and costs Costs include not only expenses but also cost of capital Economic profit adjusts for distortions caused by accounting methods
Doesnt have to follow GAAP R&D, advertising, restructuring costs, ...

Cost of capital accounted for explicitly

Rate of return required by suppliers of a firms debt and equity capital Represents minimum acceptable return.

Components of EVA
NOPLAT
Net operating profit after tax

Operating capital
Net operating working capital, net PP&E, goodwill, and other operating assets

Cost of capital Weighted average cost of capital % Capital charge

Cost of capital % * operating capital

Economic value added

NOPLAT less the capital charge

Calculating EVA
Net operating profit after tax (NOPAT) - Capital charge (= WACC * Capital) = Economic value added (EVA)