Management control ESCP PDF

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Management control ESCP LECTURE NOTES...

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Session!1!MC!Overview!! ! Management! control! is! the! approach! that! enables! the! company! to! produce! desire! results! and! dealing!with!the!dangers!brought!on!by!financial!difficulties!+!internal!difficulties.!! ! 1) Planning!! ! 2) Monitoring! Formulate! strategic! activities! sand! oversee! 3) Analysis!! their!achievements.!!! ! Common!language!à!multiple!meanings!of!the!word!control! Controllo!e!gestione!à!relevant!meaning:!to!oversee!and!guide! ! • Main!motivation!device:!results!control!! • Responsibility!center!! • Control!by!exception! ! Main!function!of!MC!is!REGULATION.!! !

! Planning!tools!are:! -!strategic!plan!! -!medium!term!! -!budget!! ! Controlling!entails,!the!creation!of!a!path!à!operational!plan!&!Budget!! ! Management!by!exceptions=!results!will!be!evaluated!in!term!of!variances!from!the!plan.!If!plan!is! right,!reliable!the!manager!will!focus!on!bad!variances.! ! Results!analysis!tools! -!variance!analysis!methods,!structures!by!different!models!(traditional!variance!analysis,!volume! mix!yield!price!model!and!dashboards.!So!the!control!process!implicitly!relies!upon:!performance! measurement! system,! which! itself! reflects! a! certain! conception! of! performance.! à! THE! CHOICE! MUST!BE!EXPLICIT!AND!WELL!SUITED.!! !

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! ! The!different!levels!are!complementary.!! -!vertical!coordination!! -!Horizontal!coordination! -!motivation:!main!motivation!device!is!results!control.!Responsibility!center,!control!by!exception.!! ! ! Congruency!! Controllability!! Contractual! principle!! Simplicity!! ! Management!control!is!a!managerial!process.!The!controller!has!a!supportive!role=!to!facilitate!this! process.!People!involves!in!the!process:!managers!and!controllers.!! ! Distinction!between!company-wide/local!performance!measures! Concept!of!reporting!! ! Applix!case!! ! Context:!fierce!competition!! Company!objectives:!to!distribute!Applix!brand!products!and!to!develop!the!SME!market! ! Changes:! • give!agency!managers!new!powers!to!influence!performance! – discounts!on!selling!prices!! – customer!payment!terms! – allowed! to! supplement! Applix! products! with! complementary! yet! non! competing! products! – inventory!management!! – marketing/advertising!budget!! – control!over!agency’s!direct!costs!(staff,!rent,!maintenance)! ! • Change!the!criteria!upon!which!agency!managers!are!evaluated!(sales!contribution)! ! Results:! ú Turnover!increased!by!15%! ú Finance!costs!skyrocketed!! !

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Accounts!receivable!increased!by!20%! Profit!decreased!

! Analysis!! ! Increase!in!turnover!means!that!decentralization!has!worked!well! Higher!finance!cost,!which!is!directly!linked!to!increase!in!sales!! Decrease!in!operating!income,!the!risk!that!managers!would!neglect!their!agency’s!direct!costs!is! low!because!that!would!decrease!their!bonus.! ! Diagnosis! Either! managers! have! been! granted! too! much! decision! making! authority! or! the! performance! measurement!system!is!not!suitable.!Either!it!is!not!in!line!with!strategy!or!it!is!not!suited!to!the! level!of!decentralization.! Session!2!Measuring!an!Organization’s!Performance!!! ! Measurement!systems!(company!wide!indicators!&!Local!indicators)! ! Financial!Indicators:! o activity!indicators!! o profitability!indicators! o return!on!investment!indicators!! o value!creation!indicators!! o cash!flows! ! Activity!indicators! -!sales! -!growth!rate! ! Profitability!indicators!! -!net!income!(too!aggregate)! other:!! -!EBITDA!! -!Current!operating!income!(COI)! -!Operating!income!(EBIT)! -!NOPAT!! -!Earning!before!tax!! Sales-!Cost!of!goods!sold!=!Gross!profit!! -(meno)!SG&A!=!EBITDA!(Earnings)before)interest,)tax,)depreciation)and)amortization)) -!Depreciation!and!Amortization!=!COI!(Current)Operating)Income))) -!Other!operating!expenses!=!EBIT!(Operating)Income))) -!Interest!expenses!=!EBT!(Pretax)income))) -!Extraordinary!items!-!Income!taxes!=!Net!income!! ! !

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Advantages! -!more!analytical!than!net!income!! !!!!!!-! exclude! from! net! income! items! that! could! pollute! analysis! to! performance! (financial!cost,!not!cash!items)! ! Limitations! -!depend!on!the!level!of!sales/size!of!the!company!! ! ! Ratios/sales! • Gross!profit!ratio!=!Gross!profit/!Sales!! • Operating!profit!margin!=!Operating!income!/!Sales!(Return!on!sales,!ROS)!! • Net!operating!profit!margin=!NOPAT/Sales!! • Net!profit!margin!=!net!income/sales!! ! Gross!profit!ratio!=!gross!profit/sales!! Operating!profit!margin!=!operating!income/sales!(return!on!sales,!ROS)! Net!operating!profit!margin=!NOPAT/sales!! Net!profit!margin=!net!income/sales! ! Advantages!à!more!comparable!! ! Limitations!à!ignore!required!investment!! ! ! Return!on!investment!indicators!! ! The!financial!balance!sheet!! ! ! ! ! ! ! ! ! ! ! ! Working)capital:!what!is!requires!for!the!funding!of!on-going!operations! Capital)employed:!what!has!been!invested!in!the!company!in!both!fixed!assets!and!working!capital! ! Working!capital:!CA-non!financial!current!liabilities!à!+!FA=!Capital!Employed! ! • ROE=!net!income/shareholder!equity!! Sums!up!the!overall!financial!performance!of!the!company!! Useful!to!compare!companies,!but!it!is!impacted!by!the!company’s!financial!policies.!! • ROA=!net!income!/!assets!! !

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ROCE=!NOPAT/Capital!Employed!! Measures!the!operating!return!on!investment!from!the!managers’!standpoint!! Advantages!à!more!complete!measure!of!performance!! Limitations!à!it!can!be!distorted!by!accounting!standards!and!it!doesn’t!take!into!account! risks!! • ROI! Advantagesà!it!is!objective,!reliable,!it!can!be!aggregated!and!inexpensive!to!obtain.!! Limitations! à! accounting! values! may! be! distorted! by! accounting! and! be! different! from! economic!values.!! Value!Creation!Indicators:! • EVA:!economic!value!added!=NOPAT!–!k.CE! NOPAT!is!taken!after!adjustments!and!restatements!and!K=WACC! Advantagesà!! o relation!with!internal!and!external!value!creation! o more!focused!on!performance!levers!than!MVA!! o includes!cost!of!equity!! o has!not!the!drawbacks!of!ration!indicators! ! Limitationsà! o restatements,!less!comparable!and!less!objective!! o no!proven!correlation!between!EVA!and!MVA!! o not!that!new!(residual!income)! ! Cash!Flows! EBITDA!! Net!cash!flows=NOPAT!+!depreciation!–!changes!in!working!capital!–!net!investments!! ! Nectar!Case!study! Case:! Frank! Henderson! is! hired! as! managing! director! of! Lemon! Fizz! division! of! the! Nectar! Corporation!on!the!1st!of!July!200n-2.!This!was!done!to!prepare!for!the!succession!of!the!managing! director!of!the!division,!scheduled!to!retire!on!the!1!st!of!January!200n.!In!order!to!prepare!for!his! future!responsibilities,!Frank!Henderson!has!been!charged!with!supervising!business!operations!in! 200n!-!1!and! 200n!and!actively! monitoring!results! with!respect! to!the!budget.! As!planned,! Frank! Henderson!is!appointed!managing!director!of!the!Lemon!Fizz!division!on!1st!January!200n.!He!is!in! charge!of!preparing!the!budget!for!year!200n+1.!! ! Analyzing!the!results!obtained!by!Frank:!! ! Sales!below!budget,!less!commercial!dynamism!than!the!year!before! Variable!costs!à!good!control!on!VC,!but!decrease!in!repairs! Gross!margin!à!below!budget,!but!ratio!increase,!better!management?!! ! Controllable!costs!à!very!well!controlled!decrease!by!28%,!ratio!vs!sales!also!decreases! Direct!impact!on!contribution!à!40%! ! ROI!à!ratio!improvement,!contribution!margin!increases,!investments!more!than!controlled! Total!assets!à!receivables!same!evolution!than!sales,!inventory!level!decreases,!fixed!assets!below! budget,!cash!increases!! •

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Risks:!! -!obsolesce!if!there!is!no!investment,!or!performed!maintenance!! -!stock!outs!! ! Investment!center!à!active!control!on!contribution! CONTRACTUAL!! YES! CONGRUENCY! NO! MORE!CONTROL!NEEDED!ON!Capex!! CONTROLABILITY!! YES!! SIMPLICITY!

YES! ROI!

! § So!in!conclusion!would!you!give!Frank!Henderson!his!incentive?! More!control!on!capex!budget! more!indicators! EVA! use!if!non-financial!indicators:!quality,!customer!satisfaction!! Session!3!Entity!Performance!measurement!systems:!Responsibility!accounting! ! !! ! ! ! ! ! ! ! The!measurement!system!can!be!splitted!into!two!parts:!the!overall!performance!measures!and!the! entities’!performance!measures.!As!a!consequence!we!have!PMS!at!the!organizational!level!and!at! the!entity!level!as!it!is!shown!in!the!picture!below.!! ! ! ! ! ! ! ! ! ! ! The!Problems!that!can!arise!here!are!two:!! 1) How!can!we!delimit!and!measure!the!entities’!contribution!to!organizational!performance?! 2) How!to!integrate!the!specific!issue!of!internal!transactions?! !

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! While!on!the!Financial!accounting! side!we!have!a!more!straightforward! division!and!the!financial! statements!of!the!subsidiaries!are! simply!reported!to!the!mother!company!in!order!to!create!the! consolidated! statements,! on! the! management! control! side! the! local! performance! measurement! system!may!be!splitted!again!in!three:!Local!indicators!(!regarding!entity!managers),!cost!accounting! (evaluation! of! business! performance),! or! responsibility! accounting! (evaluation! of! managers’! performance).! ! Responsibility!accounting:!! ! • The! main! function! of! the! RA! are! to! motivate! managers! (setting! objectives,! evaluating! performance,!calculating!bonuses,!etc.)! • The! type! of!entities! are! defined! as! responsibility! centers! which!may! be! evaluated! on! the! basis! of! multiple! criteria! and! depends! on! how! the! responsibilities! are! structured! in! the! company.!

! ! ! Measurement!principles!are:!! • Congruency! • Controllability! • Contractual!principle! • Simplicity! ! !

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The!main!difficulties!when!applying! ! 1) controllability!principles:!! • the!basic!typology!is!too!crude! • Some!costs!->!shared!responsibilities! • The! structure! of! responsibilities! is! sometimes! complex! (matrix! organizations,! cetralised! policies,!etc.)!! 2) Contractual!principle:! • Multiple!roles!assigned!to!objectives:!budgetary!slack! • Changes! in! business! environment! between! the! time! objectives! are! negotiated! and! performance!evaluation! ! Conflicts!between!principles!of!RA:!! • Controllability!/congruency!(Example:!cost!of!central!services)! • Controllability/simplicity!(Example:!finance!costs)! ! Conflicts!between!different!types!of!local!PMS:!!! • Responsibility!accounting! • Cost!accounting! • Performance!indicators!for!entity!managers! • Legal!reporting! ! In!practice!there!is!often!a!compromise!between!these!different!perspectives.! !

Western!Life!case!study:!Debriefing! ! Restaurant!chains! ! • Control!both!costs!and!revenues:!They!are! neither!a!revenue!centers!nor!cost!centers,!but! basically!profit!centers! • Do!not!control!all!the!costs:!They!are!not!“full”!profit!centers! • Control!some!assets!(raw!material!inventories,!receivables)!but!not!all!of!them!(investment,! payables):!They!are!more!than!profit!centers! ! QUESTION!1:!What!type!of!responsibility!centers!are!we!dealing!with!at!Western!Life?! • Just!because!you!can!measure!profit!at!the!entity!level!does! not!make!this!entity!a! profit! center!->!Concept!of!CONTROLLABILITY! • Entity!may!be!viewed!as!a! “business!unit”!or!a! “responsibility!center”!and!this!influences! how!the!performance!measurement!system!should!be!built:!here,!3!BU!and!5!RC.! • Reality!is!often!more!complex!than!the!basic!typology!(cost!/!revenue!/!profit!/!investment! /!!centres)!->!controllers!must!analyze!the!company’s!structure!in!detail! ! Headquarters:! • Directly!controls!some!cost!items:!cost!center! • But! makes! the! main! investment! decisions:! Close! to! an! investment! center! but! yet! not! an! investment!center!because!it!should!be!a!profit!center!first! ð HYBRID!STATUS! !

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! QUESTION!2:!Is!it!appropriate!to!evaluate!the!performance!of!Grill!Express’!manager!based!on!the! chain’s!results?! ! Purchasing!department:! • It!is!considered!a!profit!center!(by!its!manager!and!by!the!controller)! • But! it!works! only! for! the! company’s!business! units:! does! not! control!its! sales,! it! is! a! cost! center!which!also!control!some!investment! ð HYBRID!STATUS! An!entity!does!not!need!to!be!a!profit!center!to!contribute!to!the!profit!objectives!of!the!company! (cost!reduction!objectives,!qualitative!objectives,!etc.)! ! Does!really!Manager’s!performance!=!Chain’s!results?! ! • A!restaurant!chain’s!results!are!not!only!determined!by!its!manager’s!decisions:!Manager’s! performance!can!only!be!evaluated!in!comparison!to!a!standard,!but!which!standard?!Shall! we! compare! Grill! Express’! income! with! that! of! the! other! chains?! (benchmark):! Problem! because!their!sizes!are!very!different.! • Comparing!the!ROS!(Return!on!sales)!improves!the!analysis,!but!it!does!not!take!into!account! the!differences!in!restaurant!concepts:!Standards!based!on!a!benchmark!have!limitations! ! • A!comparison!of!Grill!Express’!current!income!with!past!income!improves!the!analysis!but:! o It!does!not!take!into!account!changes!in!the!business!environment! o It!does!not!include!any!plan!for!improvement! o Standards!based!on!past!results!also!have!limitations! ! QUESTION!3:!Do!you!think!the!measurement!system!is!appropriate?!What!would!you!do!differently?! ! The!best! standard!for! evaluating!a! manager’s!performance! is!the! NEGOTIATED!BUDGET! which!is! supposed!to!integrate:! ! • Past!results! • Changes!in!business!environment! • Results!of!comparable!entities! • Realistic!improvements! ! Business!Unit!PMS:! ! • Questions!/!present!system:!! o Allocation!of!corporate!headquarters’!costs! o Problems!in!the!distinction!between!direct!and!indirect!costs! o How!many!cost!allocation!bases?!Which!ones?!! o Do!we!have!to!allocate!headquarters’!costs?! • How!to!treat!the!purchasing!costs?! o Why!a!transfer!price?! o What!cos>! o Mark-up?! ! !

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You! only! need! to! define! the! standard! with! which! to! compare! the! unit’s! performance,! but! also! adequately!STRUCTURE!the!measure! ! Should!overhead!costs!be!allocated?!! • The! answer! depends! on! whether! the! entities! are! considered! as! Business! segments! or! responsibility!centers! • Business! units:! overhead! costs! =! indirect! costs! that! are! linked! to! units,! important! not! to! forget!them,!allocation! • Responsibility!centers:!controllability!criteria! ! ð Difference!between!where!a!cost!is!generated!(cost!accounting)!and!where!it!is!controlled! (responsibility!accounting)! ð Difference!between!where!a!cost!is!recorded!and!where!it!is!controlled.! ! Revenue!and!direct!charges:! ! • Revenues!are!controlled!by!the!restaurant!chain!managers! • Most! direct! costs! are! also! controllable! by! the! restaurant! chain! managers! (operational! position)! • But!some!of!them!are!controlled!by!headquarters:!restaurant!chain!advertising!costs!and! depreciation!costs!! ! ð Difference!between!controllable!costs!and!direct!costs! ! Direct!costs:!! ! The!purchasing!costs!are!controlled!both!by!the!purchasing!department!and!by!the!restaurant!chain! managers:! ! • Unit!prices!are!controlled!by!the!purchasing!department! • Quantities!are!controlled!by!the!restaurant!chain!managers! ! One!“solution”:!first!charge!the!purchasing!cost!to!the!purchasing!department,!then!“transfer”!this! cost!to!the!chains,!based!on!a!“price”!=!standard!cost!(no!mark-up).! ! Overheads:!! ! • Some!of!the!overheads!are!clearly!not!controllable!by!restaurant!chain!managers! o General!management!costs! o Butchers!and!purchasing!department’s!salaries! o Depreciation!costs! o Rent! o Advertising!costs! • Finance!costs!are!also!controlled!by!different!responsibility!centers:! o Financing!decisions!are!made!by!headquarters! o But!financing!needs!are!controlled!by!all!responsibility!centers! • Controllability! principle:! finance! costs! should! be! allocated! to! the! responsibility! centers! which!generate!them:! !

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o But!here,!priority!is!given!to!the!simplicity!principle!due!to!the!amounts! o Financial!costs!will!be!allocated!to!headquarters! ! Headquarter!fees:! ! • Who!controls!the!cost!of!central!services?!! o The!cost!itself!is!controlled!by!headquarters! o But!the!chains!can!influence!then!through!their!consumption!of!these!activities! o Accountability!for!those!costs!should!be!split!between!headquarters!and!restaurant! chains! • But!here!the!chains’!consumption!cannot!be!quantified! o In! this! case,! central! costs! are! often! totally! allocated! either! to! headquarters! or! to! entities!=>!Conflict!between!concruency!principle!and!controllability!principle! o =>!Here:!allocation!to!headquarters! • Controllability!principle!is!not!always!easy!to!apply! ! QUESTION!4:!Will!these!PMS!improvements!change!Mr!Soudan’s!conclusions?! ! The! manager! in! charge! of! Grill! Express! has! met! his! objectives.! He! even! has! improved! his! gross! margin,!whereas!the!other!chains!have!poor!results.! ! The!15%!decrease!in!pre-tax!profit!stems!mainly!from:! • Material!overconsumption!by!WS!and!Cocoon! • Variances!in!central!costs!at!headquarters! Session!4!Evaluation!of!financial!PMS!! ! Are!financial!indicators!good!performance!measurement!systems?! Advantages:! • Due!to!their!accounting!basis:!Objective,!reliable,!easy!to!aggregate,!not!expensive!to!obtain! • Comprehensive!view!of!performance! Limitations:! • Focused!on!performance!for!shareholders:!What!about!other!stakeholders?! • “Results”!metrics:!do!not!respond!quickly!/!quality!of!managers’!decisions!and!short!term! bias! • TOO!COMPREHENSIVE:!What!are!the!causes!of!results?! ! At!the!entity!level:! ! • Financial!typology!of!responsabilities!(cost!center!etc.):!same!limitations!as!at!the!org.!level! • Inadeguate!view!of!an!entity’s!contribution! o Limitations!of!costs!center!/!revenue!center!concepts! o Limitations!of!profit!center!/!investment!center!concepts! • Not!sufficient!for!decentralized!control! !

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Exercise! in! class:! Define! the! performance! of! an! organization! based! on! an! analysis! structured! as! follow:! Stakeholders! and! its! expectations,! strategy,! vision,! mission,! key! success! factor,! financial! indicators,!and!nonfinancial!indicators.!! Session!5!Dashboards! ! Positioning!in!the!management!control!process! ! ! ! ! ! ! ! ! ! ! 1.!Definition!and!Objectives! Dashboards!is!defined!as!a!set!of!indicators!which!are!not!exclusively!financial!in!nature!(KPI).!There! are!various!forms!of!presenting!a!dashboard.!It!is!usually!presented!as!a!list!of!indicators!with!various! values.!! • is!a!set!of!KPIs! o at!organizational!level!(corporate!dashboards)! o at!local!level!(dashboards!for!functional!&!operational!entities)! a!good!dashboard!is:! -balanced!representation!of!performance!! -orient!measure!to!a!longer-term!representation!of!performance! -facilitate!decision!making!by!managers!! ! Principles:) •!KPIs!must!comprehensively!cover!the!organisation’s!entire!set!of!objectives!and!goals.!! they!need!to!encompass!the!diversity!of!the!organization’s!objectives.!! ! •!They!must!focus!both!on!outcomes!as!well!as!the!performance!levers!that!can!be!used!to! achieve!these!outcomes.!! It!means!to!not!be!misled!by!short-term!bias!à!beneficial!decisions!may!result!in!a!decline!in! financial!results!in!the!short!term,!as!their!impact!will!only!be!fully!felt!in!the!long!term!and!in!a! relatively!diffuse!way. •!They!must!include!both!financial!and!non-financial!indicators.! The!non-financial!character!of!indicators!is!also!beneficial!because!it!separates!the! performance!measure!from!the!accounting!metric!which!always!takes!a!certain!amount!of! time!to!procedure.!! •!The!indicators!chosen!must!be!consistent!with!the!organisation’s!strategy.!! •!They!must!be!limited!in!number. •!They!must!deliver!their!information!quickly. •!They!must!be!presented!in!a!legible!and!vivid!way.!! !

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! ! Why!a!Dashboard?!For!many!reasons…! • conceptually:!overcoming!shortcomings!of!financial!measurement!systems!! o performance!from!point!of!view!of!shareholders!only! o ST!orientation!&!biases! o limited!capacity!for!explanation…!! • practically:!overcoming!shortcomings!of!certain!common!mgt.!practices!! ! Three!...