INTRODUCTION TO CONTROLLING CHAPTER 10 INTRODUCTION TO CONTROLLING Copyright © 2005 Prentice Hall, Inc. All rights reserved.

What Is Control Control The process of monitoring activities to ensure that they are being accomplished as planned and of correcting any significant deviations. In other words, it is the process of monitoring, comparing and correcting work performance as and when required. All managers must control, even if they think their units are performing as planned because they cannot really know how well or bad they are performing unless they control. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

The Control Process The Process of Control – a 3 step process Measuring actual performance. Comparing actual performance against a standard. Taking action to correct deviations or inadequate standards.

Step 1. Measuring Actual Performance Sources of Information: Personal observation Statistical reports Oral reports Written reports Step 2. Comparing Actual Performance Against the Standard Determining the degree of variation between actual performance and the standard. Although some variation in performance can be expected in all activities, it is critical to determine an acceptable range of variations. Significance of variation is determined by: The acceptable range of variation from the standard (forecast or budget). The size (large or small) and direction (over or under) of the variation from the standard (forecast or budget).

Acceptable Range of Variation Copyright © 2005 Prentice Hall, Inc. All rights reserved.

Step 3. Taking Managerial Action 3 possible courses of action: 1. “Doing nothing” Only if deviation is judged to be insignificant. 2. Correcting actual (current) performance Immediate corrective action to correct the problem at once to get performance back on track. Basic corrective action looks at how and why performance deviated before correcting the source of the deviation. 3. Revise the Standard In some cases, variance may be a result of an unrealistic standard – a goal that is too low or too high. In this case, the standard, not the performance – needs corrective action.

Controlling for Organizational Performance What Is Performance? The end result of an activity What Is Organizational Performance? The accumulated end results of all of the organization’s work processes and activities. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

Organizational Performance Measures Organizational Productivity (or Efficiency) Productivity: the overall output of goods and/or services divided by the inputs needed to generate that output. Output: sales revenues Inputs: costs of acquiring and transforming resources into outputs Ultimately, a measure of how efficiently employees do their work. Organizational Effectiveness Measuring how appropriate organizational goals are and how well the organization is achieving its goals.

Organizational Effectiveness Measures Industry and company rankings Rankings are a popular way for managers to measure their organization’s performance. These rankings give managers (and others) an indicator of how well their company performs in comparison to others. Industry rankings on: Profits Return on revenue Return on shareholders’ equity Growth in profits Revenues per employee Revenues per dollar of assets Revenues per dollar of equity

Types of controls for controlling organizational performance Feedforward Control A control that prevents anticipated problems before actual occurrences of the problem. Concurrent Control A control that takes place while the monitored activity is in progress. Feedback Control A control that takes place after an activity is done. Corrective action is after-the-fact, when the problem has already occurred. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

Feedforward/Concurrent/Feedback Controls Copyright © 2005 Prentice Hall, Inc. All rights reserved.

Tools for Controlling Organizational Performance: 1. Financial Controls Every business wants to earn profits. For achieving this goal, managers need financial controls. They might analyze financial statements by calculating financial ratios. Traditional Controls Ratio analysis Liquidity - measure an organization’s ability to meet its current debt obligations. Leverage - examine the organization’s use of debt to finance its assets and whether it’s able to meet the interest payments on the debt. Activity - assess how efficiently a company is using its assets. Profitability - how efficiently and effectively the company is using its assets to generate profits. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

2. Information Controls Managers need the right information at the right time and in the right amount to monitor and measure organizational activities and performance. They use information to determine whether deviations are acceptable and also to develop appropriate courses of action. Information comes from the organization’s management information system. Management Information Systems (MIS) A system used to provide management with needed information on a regular basis. Data: an unorganized collection of raw, unanalyzed facts (e.g., unsorted list of customer names) Information: data that has been analyzed and organized such that it has value and relevance to managers

Controlling Organizational Performance: Balanced Scorecard A measurement tool that uses goals set by managers in four areas to measure a company’s performance: Financial Customer Internal processes People/innovation/growth assets Is intended to emphasize that all of these areas are important to an organization’s success and that there should be a balance among them Balanced Scorecard is a performance measurement that looks at four areas: financial, customer, internal processes, and people, innovation, and growth assets.

Benchmarking of Best Practices The search for the best practices among competitors or non competitors that lead to their superior performance. Benchmark: the standard of excellence against which to measure and compare. A control tool for identifying and measuring specific performance gaps and areas for improvement. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

Contemporary Issues in Control Corporate Governance The system used to govern a corporation so that the interests of the corporate owners are protected. Two areas where reforms has taken place after some well known corporate financial scandals are: Changes in the role of boards of directors – the original purpose of a board of directors was to have a group, independent from management, looking out for the interests of the shareholders, who were not involved in the day-to-day management of the organization. However, it didn’t work that way as board members had a good relationship with managers in which each took care of the other. This has now changed. (ii) Increased scrutiny of financial reporting – New laws have now made it mandatory for more corporate financial disclosures and transparency. These have led to information which are more accurate and reflective of a company’s financial condition. Copyright © 2005 Prentice Hall, Inc. All rights reserved.

THE ENRON CASE – failure of corporate governance The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy firms in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was attributed as the biggest audit failure. Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron's board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues. As the depth of the deception unfolded, investors and creditors retreated, forcing the firm into bankruptcy in December 2001.Shareholders lost nearly $11 billion when Enron's stock price, which hit a high of US$90 per share in mid-2000, plummeted to less than $1 by the end of November 2001.