Management Control System Maitee 02.05

8/8/2019 Management Control System Maitee 02.05

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Influencing people to change Leading

their behavior

Management control systems can be framed in terms of following three types of controls.

Action controls involve ensuring that employees perform (or do not perform) certain

actions known to be beneficial (or harmful) to the organization

Results controls focus on results that involve rewarding individuals (and sometimes

groups of individuals) for generating good results or punishing for poor results.

Personnel & cultural controls ensure that employees control their own behavior or

control each others behaviors. Such controls aim at helping employees to do a good job

and are based on employees natural tendencies to control themselves.

Action

Controls

Personaland cultural

control

Result

Control


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Management control system can be viewed from functional perspective

Control System framework

Objective

Setting/

StrategyFormulation

Management

Control

Task Control

Marketing

Finance

HRD

Manufacturing

R & D

*

*


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Elements of Control Systems

Planning

Strategic MeasurementUncertainties

Reporting

Planning includes the projects, ideas, programmes and activities

that organization intends to take up over its planning horizon.

It articulates the strategic intent (Prahalad and Hammel) in an environment of strategic

uncertainties created by technology, consumer preferences, competitors strategies etc.

M easurementprocess involves measurement of the actual performance against targets.

Reporting involves achievement reporting by comparing the actual achievement

with the desired achievement.


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Hierarchy of control (Strategy, Management control and operational/ Task control)

Old Framework New Framework

(Anthony & Dearden) ( Anthony & Govindarajan)

Strategic planning Strategy Formulation

Management control Management Control

Operation control Task Control

Management control and strategic planning and control

Strategic planning focuses on a single aspect of the corporate life at a timewhereas management control focuses on all the operations of differentsubdivisions or units of an organization.

The domain of strategic planning comprises unstructured or unprogrammeddecisions whereas management control is rhythmic and regular.

Nature of information required for strategic planning tends to be tailor made forthe problem, largely external, futuristic and less accurate whereas management

control requires integrated, largely internal, historical and accurate information.

Strategic Planning often uses techniques like SWOT analysis (Strengths,weaknesses, opportunities and threats analysis) whereas management control

relies on budgeting.

Time frame of strategic plans tends to be long, say beyond one year whereas the

management control operates by a year, quarter or even smaller timeframes.


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Strategic planning is a creative and analytical activity whereas managementcontrol is largely administrative and persuasive in nature.

Appraisal of strategic plan is extremely difficult compared to management controlwhich is relatively easy to evaluate.

Management control and operational control

Management control focuses on all the operations of a subdivision or unit of an

organization whereas operational control is limited to a single task or transaction

The domain of operational control involves little judgment and greater reliance on

rules whereas in management control there is greater degree of judgment anddecision making.

Information needed for operational control is often tailor made to the operation,

nonfinancial, precise and real time whereas management control often uses

integrated, financial, futuristic and historical information.

Time horizon of operational planning and controls tends to be day to day where as

management control works with weekly monthly or yearly time frame.


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Organization Structure and Control process

Functional Structure

Divisional structure

Matrix structure

Network structure

Functional Structure: Production, Marketing, Finance, HRD etc.

Divisional Structure

Structure based on a product lime or a group of product lines that constituted division.

Matrix Organization

Structured along product/projects and functions

Network structure or horizontal structure

Common in IT structured on the basis of network requirements. Various parts of

organization are interdependent, interwoven


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NEW MANAGEMENT TECHNIQUES FOR MANNAGEMENT CONTROL

Integrating TQM and MCS

Fundamental idea in TQM is PDCA. Plan, DO, Check and Act. The focus was on total

quality and to gain control through quality. TQM has focused on customer through defect

free service. Manufacturing and Marketing has come closer. Kaizan continuous

improvement PDCA cycle is modification of planning coordinating, communicating,Information Evaluation of information Deciding the action influencing people.

Top Mgmt. Middle Mgmt. Supervisors and

Workers

TQM Innovation Kaizan Maintenance

MCS Strategy Formulation Mgmt. Control Task Control

Integral Visioning Decision-action Task Performance

View


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J I T & M C S

JIT aims at eliminating waste

Two approaches:

1. Produce, hold inventories and wait for customer orders

2. Get the customer orders, then produce

In JIT the following are considered important

Reduction in production cycle time

Production flow smoothening

Quality focus

JIT can be considered important operational control mechanism with reduced cycle time

leading to better efficiency and productivity. The goal of the JIT is to have Zero

inventory wherein the optimum lot size is one-- goods are produced or ordered when theyare.

Anthony and Govindarajan (1994) observe that the better phrase would be Minimum

Inventory driven system (MIDS)


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Benchmarking and MCS

Initially developed by Xerox to achieve Leadership through quality

benchmarking is the process of continuously comparing and measuring an organizationagainst business leaders anywhere in the world to gain information which will help the

organization take action to improve its performance.

Benchmarking

Identification and implementation of best practices to achieve customers result and

business performance.

Benchmarking is a process. Benchmarking by itself does not improve performance; it

provides information you can use to improve. It is a discovery process aimed at

exceeding customer expectation.

Benchmarking is broadly classified in following three categories:

Competitive benchmarking:

Attempts to determine what competition is doing with respect to product design.

Focuses on benchmarking product cost.

Process benchmarking

Scope of the process to be benchmarked

How does the process work? How do we measure it?

What do we want to learn about the process from the benchmarking partners?

Strategic benchmarking

Idea is to create and implement a new strategy---either to create a shift in strategy oradoption of new business practice.


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Activity Based costing (ABC) and Management Control

Activity Based Costing is essentially a system of allocation of overheads on the basis of

activity caused by the product. In this system, the word activity is often used instead of

cost centre, and cost driver instead of basis of allocation, and the cost system is called anactivity-based-cost system.

ABC has important implications for management control.

It yields better picture of the product costs facilitating decision making relating to pricing,

product mix, make or buy decisions etc.

Responsibility Centre

Introduction

As the organization grows and becomes larger the business complexities arise and it

becomes necessary to share the authority of decision making and responsibility with

others through delegation .The mangers to whom the authority and responsibility isdelegated have to be held responsible for the consequences of their decision making. This

necessitates evaluation of the performance of the managers.

Responsibility Centre:

A responsibility centre may be defined as an area of responsibility which is controlled

by an individual. Anthony and Govindarajan defined responsibility centre as an

organization unit that is headed by a responsible manger.

Expense Centre

A Cost or expense centre is a segment and division of an organization in which the

managers are held responsible for the cost incurred in that segment.


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In a manufacturing organization, production and service department is the cost centre.

In a marking department, a sales region or a single sales representative may be taken

as expense centre.

Two general types of expense centre

1) Engineered expense centre - Those elements of costs which can be predicted with fairdegree of accuracy e.g. cost of raw materials, direct labor, water and electricity etc.

2) Discretionary costs are costs for which output cant be measured in monetary terms

e.g. the costs incurred for administrative and support units like accounts department, legalDepartment, public relations department research and development departments, most of

the marketing departments.

Revenue Centre

Primarily responsible for generating sales revenue.

Revenue centre manger has no control over cost or the investment in assets.

The performance can be evaluated by comparing the actual revenues with the budgeted

revenue.

Profit Centre

Segment of business often called a division that is responsible both for revenue and

expenses.

The main purpose of profit centre is to earn targeted profit.

Profit centre mangers are more concerned with increasing centers is to earn targeted

profit

Profit centre mangers are more concerned with increasing centers revenue by

increasing production or improving distribution methods. The performance is evaluatedby the variance between actual and budget profits.


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Advantages of profit centre

Quality of decision improves as the mangers are aware of the ground realities

Higher management can focus on macro issues leaving the micro issue to be

talked by operational mangers

Profit consciousness is enhanced

Mangers are free from micro restraints and use their creativity and initiative

Profit centers train the mangers to take responsibility for higher position

Profit centers create a reservoir of managerial talent which the company can use.

Difficulties with Profit center

Managers may be lacking competence

There may be unhealthy competition among various profit centers

There may be disagreement among different profit centers regarding transfer

price sharing of common cost ,sharing of revenues generated by joint efforts

Profit centre mangers might lay emphasis on short term profits by neglectingcrucial areas like man power training and development, maintenance and

research and development effects.


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Investment Centre

An investment centre is responsible for the profits and investment

If a manger controls investment, that area of responsibility can be called as

investment centre.

He is responsible for the returns on investment.

The manger of the investment centre has more authority than the mangers of

revenue centre, cost centre and profit centre.

Performance Measurement of Profit centers

The concept of profit is to be made clear the goal of the organization-- whether

short term or long term profit, current profit or future profit.

Emphasis on current profit may hamper future growth

Again if we emphasize on R & D it will affect the current profit.

Cost of training and development may adversely affect current profit

Cost of training and development may adversely affect current profit

Concept of profit

Book profit --- As per books of account

Real Profit calculated after taking the economic value of resources.

Profit contribution Profit contribution directly by the division. It may also be

Described as additional or incremental profit earned solely as a result ofoperations of the division.

Question of expression of profit

Absolute amount or a margin on sales? Or as a return on investment?


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Transfer price and Profit centers

When internal exchange of goods and services takes place between different

divisions of the firm that requires their valuation in terms of money.

Problem of analysis of profit centre results

Usual practice is to evaluate the performance against budgets. But the varianceoccurs due to the combined effect of a host of factors, unless these influences can be

segregated and understood the major objective of control would not be achieved.

Investment Centre

Investment centre is a responsibility centre in which inputs are measured in terms ofcost expenses and outputs are measured in terms of revenue and the assets employed.

An investment centre manager is responsible for the production, marketing and

investment in the assets employed on that division or segment of the organization. He hasto take decisions related to credit policy inventory policy as well as investments in

equipment to be used for production and Marking

Investment Base

Investment on asset responsibility implies the authority to buy sell and use assets. This

Involves taking decisions related to identification of the assets and liabilities for

determining the base of the investment centre.

Meaning Investment centre performance

Return on InvestmentProfit before Interest andTax

ROI = Net operating Investment


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Residual Income

An alternative measure of financial performance of an investment centre is residual

income. It is an amount that remains after deducting on implied interest charge from

the operating income.

Performance Measurement

Performance measurement is a value adding process, which has a direct impact on the

competitiveness and improvement

Metrics: Metrics are the methods to quantify the measured information

Prioritize indicators:

A clear purpose helps to prioritize the indicators to identify the most important ones.

Choose appropriate measurement methods:

Important purpose of performance measurement

a) Decision support

b) Monitor effects of strategic planc) Performance

d) Diagnosis

e) Manage a continuous improvement processf) Motivation

g) Comparison

h) Record development

Types of Metrics

A. Hard metrics: Facts those are possible to measure directly e.g. input, production, netprofit etc.

Soft Metrics:Used to measure intangible e.g. customer satisfaction, brand loyalty, employee

satisfaction etc.


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B. Financial vs. Non-Financial Metrics:

Financial performance metrics Non-financial performance metrics

Budget vs. Actual variance

Product / Inventory TurnoverProduct group

Labor efficiency

Profitability Capacity Utilization

Cash flow Defect ratio

Return on total capital Lead-time

Overhead absorption Delivery precisian

Bad debts

EBIT, Market penetration

Current Assets turner New product sales

EPS

Three basic types of financial performance targets are:

1) Model Based vs. Historical vs. Negotiated Targets

Model based targets are used in the situation where stable deterministic causal

relationship like input output exists

Historical

Historical targets are derived from the previous year performance and the

managements view of the superiors and subordinates


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2) Internally versus externally externally derived targets

Internally derived performance targets are totally internally focused.

In recent years, two types of externally focused target setting have become common

a) Target Costing

b) Bench marking

In target costing cost targets are price driven e.g. Tata motors introduced a family carcosting 1 lakh. The price and cost are set in such a fashion that on selling of product or

service the company will earn a preset price.

Bench marking is a process in which on organization studies other organizations bestpractices and implement process and systems to entrance its own performance

c) Achievement versus process Metrics:

Achievement metrics lays emphasis on achievement whereas in the process metricsemphasis is on important characteristics of the process that has an impact on the output.

Business performance model based on three performance dimensions

Achievement metrics - direct metrics for business achievement.These are hard facts and

can be measured directly and require little or no interpretation e.g. net profit, return oninvestment, market share, export share etc.

Diagnostics metrics:

Diagnostic metrics are indirect metrics for business achievement

Explain the trends in achievement

Based on trends provide an early warning based on which remedial action can be

taken.

Competence Metrics

These metrics described how well the company is prepared for the future.

Investment level in product and service development


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Time to market new product.

Relationship between achievement diagnostic and competence metrics:

A good measurement system should contain a balance mix of the above three metrics.

Fixed vs. flexible targets

Fixed targets do not vary over a given period

Flexible targets are changed according to the business conditions prevailing

Balanced score card

Traditional method financial parameters

BSC takes into account all parameters- financial, nonfinancial performance

factors

Advantages:

1) It brings strategy and vision at the centre of management focus.

2) It brings together in a single management report many of the seemingly disparate

elements like customer orientation, shortening response time, improving quality etc.

3) BSC provides the management with a comprehensive picture of business operation

4) BSC provides strategic feedback and learning

Major components:

1. Customer Perspective

2. Internal Perspective


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3. Innovation & Learning Perspective

4. Financial perspective

Thus, the scorecard provides a view of organizations overall performance by

integrating financial measures with key performance indicators.

Learning and growth-- People and learning

Internal perspective- performance of key internal processes.

Customer perspective- customer satisfaction

Financial perspective - the results the organization delivers to its shareholders.

Process of creating a balanced scorecard:

Identify vision

Identify Strategy

Identify critical success factors

Identify measures

Evaluate

Create action Plan

Follow up and mange


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Internal failure costs

External failure costs

Framework for TQM Process

Problem identification

Ranking

Analysis

Innovation

Solution

Evaluation

Management by Objective

MBO is a comprehensive management approach focused on objective or expected results

for providing a framework for managerial decisions

In MBO, objectives should be the central focus. Objectives are based on outputs or

results

MBO emphasizes on the development of the systems capability as well as individual

managers competence.

In order to be effective MBO process should be integrated with key activities of the

management process, e.g. planning, organizing, staffing directing, and controlling.

MBO is said to have gone through three phases over the past twenty years:

1) Performance appraisal

2) Planning and control method3) Method of managing producing by objective

Implementation process1) The manager and his key executives study the systems and processes

2) The top manger and subordinates set up measures of organizations performance


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3) Objective setting methods extended up to first line of supervisory level goals are set

through discussions and meetings between members of organizational units and their

superiors coals are mutually agreed upon

4) The required changes are undertaken in appraisal system, reward and compensation

system, delegation of authority and responsibility undertaken.

Activity Based costing

Meaning of ABC

ABC or activity based costing is an accounting methodology that assigns the costs,both overhead and direct, to various products and services on some scientific basis

ABC assigns cost to activities based on their use of resources. It then assigns cost to

cost objects, such as products or customers, based on their use of activities.In traditional costing overhead are first related to cost centers (Production & service

centers) and then to cost objects i.e. products .In ABC overheads are related to activities

or grouped into cost pools. Then they are related to cost objects.

Purpose and benefits of activity based costing

ABC is particularly needed by organizations for product costing where:

Production overheads are high in relation to direct cost

There is great diversity in the product range.

Products use very different amounts overhead resources

Consumption of overhead resources is not primarily driven volume.


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Enterprise Resources planning

ERP solutions peek to streamline and integrate operation processes and information flows

in the company to synergies the resources of an organization. men, material, money andmachine through information.

Meaning of ERP

ERP software attempts to integrate all department and functions across a company into asingle computer system that can serve all those departments particular needs. ERP

combines all computerized departments together with the help at a single integratedsoftware programmed that runs on a single database so that various developments can

easily share information and communicate with each other.

Benefits of Enterprise Resource Planning

1) Product costing

2) Inventory Management

3) Distribution and delivery Reasons for implementation of ERP by companies

1. Improve companys business performance

2. Standardize manufacturing process

3. Integrate financial data

4. To standardize HR information

Value added Analysis

As per porter strategies to create competitive advantage three strategic


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a)Cost leadership b) Differentiation c) Focusing are relevant. To follow any of the

strategic one has to follow value chain.

The process involves certain activity and each activity consumers resources and

influence the cost structure of the company. The value chain shows the total value, value

activities and margin

Emphasis of value chain is to segregate a firm into strategically relevant activities in

order to understand the behavior of cost and the existing potential

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Management Control System Maitee 02.05