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Chapter 8

Controlling

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D ecision Mak ing

P lanning

O rganizing

Leading

C ontro lling

Managem ent Functions

R esearch

D esign

Production

Q uality

Marketing

Project Managem ent

Managing Technology

Tim e Managem ent

E thics

C areer

Personal Technology

Managing Engineering and Technology

Advanced Organizer

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Chapter Objective

• Describe some of the important elements for establishing financial controls

• Explain balance sheets, income statements, ratios.

• Explain different non-financial control systems

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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.”

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Steps in the Control Process

4. Corrective Action

2. Measuring Actual Performance

3. Comparing Performance with Standards

1. Establish Standards

Planning

Controlling

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Steps in the Control Process

• Establish Standards– Technical: Quality, Quantity, MTBF– Market: Sales, ROI, Earning Expectation– Planning: Objectives, Schedules, Budgets,

Policies– Safety: OSHA– EEO– Historical

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Steps in the Control Process

• Establish Standards—by Benchmarking– Internal Benchmarking: productivity– External Benchmarking

• Financial Ratios• Performance Metrics• Best Practices• Critical Success Factors• Target Pricing• Balanced Scorecard: new products, new projects,

patents, new partners, new customers, new technology

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Steps in the Control Process

• Measuring Actual Performance– Data collection and analysis– Time study, work sampling, performance rating

• Comparing Performance with Standards– Establish limits of tolerance– Note variations (deviation within limits) and

exceptions (deviation outside limits) – Provide recognition and warning

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Steps in the Control Process

• Corrective Action– Short-term: Consultants, temporary workers– Long-term: Training, modifying procedures and

policies

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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.

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Timing of Control

• Feed-back control• Screening or concurrent control• Feed-forward (or preliminary or

steering) control

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Timing of Control

• Feedback Control (Output)– Measures system output and variance

with predetermined standard– Adjusts system to maintain variance

within a specified range

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Timing of Control

• Screening Control (Concurrent)– Control applied concurrently with effort

being controlled

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Timing of Control

• Feed-forward Control (Steering or Preliminary)– Attempts to predict the impact of

current actions/events– Current decisions are refined to

facilitate goal attainment

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Characteristics of Effective Control

• Effective• Efficient• Timely• Flexible• Understandable• Tailored• Highlight deviations• Lead to corrective action

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Types of Control

• Financial

• Human Resource

• Social

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Financial Controls

Financial statements provide the basic information for the control of cash and credit, which are essential to the survival of a company.

• The balance sheet• The income statement • The cash flow statement

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Balance Sheet

Balance sheet shows the firm's financial position at a particular instant in time (a financial "snapshot.“)

Total Assets = Total Liability + Owner’s Equity

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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

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Balance Sheet

• Liabilities are what the firm "owes" – Current liabilities (must be paid within a

year)– Long-term debt

• Net worth or Equity– Original investment (what was paid in for

common and preferred stock) – Retained earnings (the cumulative profits

over the years after dividends are paid).

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TABLE 8-1 Balance Sheet, Sterling Chemicals, Inc.,

December 31, 2005

AssetsCurrent assets

Cash $150,000Securities (at cost) 100,000 $250,000Accounts receivable 400,000Inventories (at lower of cost or market)

Raw materials and supplies 200,000Work in progress 180,000Finished goods 300,000 680,000

Prepaid expenses 30,000Total current assets 1,360,000

Property, plant, and equipment 4,500,000Less accumulated depreciation 2,400,000Net property, plant, and equipment 2,100,000

Total Assets $3,460,000

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Liabilities and Stockholders' Equity

TABLE 8-1 Balance Sheet, Sterling Chemicals, Inc.,

December 31, 2005

Stockholders' equityCapital stock 500,000Retained earnings 1,460,000 1,960,000

Current liabilitiesAccounts payable $100,000Installments due within 1 year 30,000Federal income and other taxes 250,000Other accrued liabilities 120,000Total current liabilities 500,000

Long-term debt 1,000,000Total Liabilities $1,500,000

Total liabilities and equity $3,460,000

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Income Statement

Income 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).

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Gross sales $3,200,000Less returns and allowances 150,000Net sales $3,050,000

TABLE 8-2 Income Statement Sterling Chemicals, Inc.,

December 31, 2005

Less expenses and costs of goods soldCost of goods sold 2,000,000Depreciation and depletion 250,000Selling expenses 100,000General and admin. expenses 200,000

2,550,000Operating profit 500,000Plus interest and other income 60,000Gross income 560,000

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Gross income 560,000Less interest expense

20,000

TABLE 8-2 Income Statement Sterling Chemicals, Inc.,

December 31, 2005

Income before taxes 540,000Provision for income taxes 260,000

Net income 280,000Retained earnings January 1, 2005 1,500,000 1,780,000

Dividends paid 320,000Retained earnings December 31, 20051,460,000

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Cash Flow Statement

Cash 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).

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Interest Payments to Debt Holders

Int.on

Debt

Operating CostsPayments to suppliers,Employees, and others

Operating Revenue

NetIncome

Depr.

TaxableIncome

After-taxCash Flow

Income

Tax

Div.RE

Cash Flow Statement(Income Statement)

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Depr. REDisposal ofProperties

New Debt/ Capital

Cash Flow Statement

Increase in Working CapitalWorking Capital = Current Assets – Current Lib.

Sources:

Uses:

Capital Expenditures

Repayment of debt & equity

Others

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The letters labeling the boxes stand for UUsesses, SSourcesources, AAssetsssets, and LLiabilitiesiabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities.

The letters labeling the boxes stand for UUsesses, SSourcesources, AAssetsssets, and LLiabilitiesiabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities.

SS

UU

Cash Flow Statement

AA LL +

+

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Ratio Analysis

Financial 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, and

• compared with earlier values from the same firm to evaluate trends.

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Liquidity Ratios

Liquidity ratios measure the ability to meet short-term obligations.

sLiabilitie Current

AssetsCurrent ratio Current

sLiabilitie Current

Inventory- AssetsCurrent ratio test Acid

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Leverage Ratios

Leverage ratios identify the relative importance of stockholders and outside creditors as a source of the enterprise's capital.

AssetsTotal

Debt Total ratio assets-to-Debt

Equity Total

Debt Total ratioequity -to-Debt

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Activity Ratios

Activity ratios (also known as operating ratios) show how effectively the firm is using its resources.

Inventory

sold good of Cost turnoverInventory

assets Total

sales Net turnover Asset

receivable Accounts

sales Net turnover receivable Accounts

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Profitability Ratios

Profitability ratios describe the organization's profit.

sales Net

income Net margin Profit

assets Total

income Net assets total on Return

goutstandin shares of No.

(P.S.) Dividends-income Net share per Earning

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Budgets

Financial budgets describe where the firm intends to get its cash for the coming period and how it intends to use it.

• Cash budgets • Capital expenditure budgets• Balance sheet budget

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Responsibility Centers

• Expense or cost centers (expense budget)• Revenue center (revenue budget)• Profit centers (profit budget)

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Budgeting Process

• Top-down approach• Bottom-up approach• Combination

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Cost Accounting

  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

Allocating cost among products

$4,000 $1,000$4,000 $4,000

$48,000 $15,000$12 $15

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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 records

• internal or external.

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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.

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Human Resource Controls

Amount of Supervision

Productivity

High Skills

Low Skills

Nonfinancial Controls

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Non-financial Controls

Social Controls•Standards•Comparison with outcomes•Corrective action

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Non-financial Controls

• Effectiveness of research activities• Systems for release of drawing release• Inventory control• Quality control• Project control