Chap 8 Controlling

Advanced Organizer

Chapter Objective Explain different financial and non- financial systems

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.”

Steps in the Control Process 4. Corrective Action 2. Measuring Actual Performance 3. Comparing Performance with Standards 1. Establish Standards Planning Controlling

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.

3 Perspectives on the Timing of Control Feed-back control. Screening or concurrent control. Feed-forward (or preliminary or steering) control.

Timing of Control Feedback Control (Output) Measures system output and variance with predetermined standard Adjusts system to maintain variance within a specified range

Timing of Control Screening Control (Concurrent) Control applied concurrently with effort being controlled

Timing of Control Feedforward Control (Steering or Preliminary) Attempts to predict the impact of current actions/events Current decisions are refined to facilitate goal attainment

Characteristics of Effective Control Effective. Efficient. Timely. Flexible. Understandable. Tailored. Highlight deviations. Lead to corrective action.

Three Types of Control Financial Human Resource Social

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, and The cash flow statement.

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

Balance Sheet Liabilities are what the firm "owes" current liabilities (must be paid within a year) long-term debt. Net worth or Equity (difference between assets and liabilities) original investment (what was paid in for common and preferred stock) retained earnings (the cumulative profits over the years after dividends are paid).

TABLE 8-1 Balance Sheet, Sterling Chemicals, Inc., December 31, 2001 Assets Current assets Cash$150,724 Securities (at cost) 99,866$250,590 Accounts receivable 416,304 Inventories (at lower of cost or market) Raw materials and supplies 208,046 Work in progress 182,702 Finished goods 289, ,358 Prepaid expenses 29,498 Total current assets 1,376,750 Property, plant, and equipment4,461,150 Less accumulated depreciation 2,402,024 Net property, plant, and equipment 2,059,126 Total Assets $3,435,876

Liabilities and Stockholders' Equity Current liabilities Accounts payable$105,056 Installments due within 1 year 26,836 Federal income and other taxes 239,194 Other accrued liabilities 120,768 Total current liabilities 491,854 Long-term debt 968,664 Total Liabilities$1,460,518 Stockholders' equity Capital stock 505,130 Retained earnings1,470,2281,975,358 Total liabilities and equity $3,435,876

Balance Sheet, Johnson & Johnson and Subsidiaries Med-Year, 2000 Assets Current assets Cash and cash equivalent$2,937M Marketable Securities1,562M Accounts receivable, trade, net4,441M Inventories3,060M Other current assets2,366M Total current assets14,366M Marketable Securities, non-current398M Property, plant, and equipment, net6,692M Intangible assets, net7,395M Other Assets1,454M Total Assets$30,305M

Liabilities and Stockholders' Equity Current liabilities Loans and notes payable$870M Accounts payable1,785M Accrued and other liabilities3,950M Total current liabilities 6,605M Long-term debt 2,434M Other liabilities3,287M Shareholders' equity Common stock1,535M Note receivable from employee stock ownership plan (35M) Accumulated other comprehensive income(350M) Retained earnings17,839M 18,989M Less common stock held in treasury, at cost1,010M Total shareholders' equity17,979M Total liabilities and shareholders' equity30,305M

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).

Sterling Chemicals, Inc., Gross sales$3,246,386 Less returns and allowances 150,050 Net sales$3,096,336 Less expenses and costs of goods sold Cost of goods sold 2,002,376 Depreciation and depletion 258,502 Selling expenses 104,500 General and admin. expenses 180,076 2,545,454 Operating profit 550,882 Plus interest and other income 59,480 Gross income 610,362 Less interest expense 33,260 Income before taxes 577,102 Provision for income taxes 261,142 Net income 315,960 Retained earnings January 1, ,370,988 1,686,948 Dividends paid 216,720 Retained earnings December 31, ,470,228

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).

Statement of Cash Flows operating activities operating activities, investing activities investing activities, and financing activities financing activities. operating activities operating activities, investing activities investing activities, and financing activities financing activities. inflows outflows This statement reports cash inflows and outflows based on the firm’s A summary of a firm’s payments during a period of time.

Statement of Cash Flows Cash Flow from Operating Activities Shows impact of transactions not defined as investing or financing activities. These cash flows are generally the cash effects of transactions that enter into the determination of net income.

Cash Flow From Operating Activities Cash Inflows From sales of goods or services From interest and dividend income Cash Outflows To pay suppliers for inventory To pay employees for services To pay lenders (interest) To pay government for taxes To pay other suppliers for other operating expenses

Statement of Cash Flows Cash Flow from Financing Activities Shows impact of all cash transactions with shareholders and the borrowing and repaying transactions with lenders. Cash Flow from Financing Activities Shows impact of all cash transactions with shareholders and the borrowing and repaying transactions with lenders. Cash Flow from Investing Activities Shows impact of buying and selling fixed assets and debt or equity securities of other entities.

Cash Flow From Investing Activities Cash Inflows From sale of fixed assets (property, plant, equipment) From sale of debt or equity securities (other than common equity) of other entities Cash Outflows To acquire fixed assets (property, plant, equipment) To purchase debt or equity securities (other than common equity) of other entities

Cash Flow From Financing Activities Cash Inflows From borrowing From the sale of the firm’s own equity securities Cash Outflows To repay amounts borrowed To repurchase the firm’s own equity securities To pay shareholders dividends

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.

Liquidity Ratios Liquidity ratios measure the ability to meet short-term obligations. Current ratio = Current Assets / Current Liabilities (Min. 2) Acid test ratio = [Current Assets – Inventory] / Current Liabilities (Min. 1)

Leverage Ratios Leverage ratios identify the relative importance of stockholders and outside creditors as a source of the enterprise's capital. Debt-to-assets ratio = Total Debt / Total Assets Debt-to-equity ratio = Total Debt / Total Equity

Activity Ratios Activity ratios (also known as operating ratios) show how effectively the firm is using its resources. Inventory turnover = [Cost of good sold] / Inventory Asset turnover = [Net sales] / Total assets Accounts receivable turnover = [Net sales] /[Accounts receivable]

Profitability Ratios Profitability ratios describe the organization's profit. Profit margin = [Net income] / [Net sales] Return on total assets =[Net income] / [Total assets] Earning per share = [Net income – Dividends (P.S.)] / [# of outstanding shares]

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

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

Budgeting Process Top-down approach Bottom-up approach Combination

Cost Accounting Allocating cost among products Product AProduct BTotal Production4,0001,0005,000 Direct Labor$40,000$10,000$50,000 Overhead$4,000$1,000$5,000 Set-up Cost$4,000$4,000$8,000 Total Cost$48,000$15,000$63,000 Unit Cost$12$15

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.

NONFINANCIAL CONTROLS Human Resource Controls To assure that human and organizational performance conform to expectations. Performance appraisal (individual) Management audit (group) (Figure 8-2) Human resource accounting (group) Social controls.

Non-financial Controls Social Controls Standards Comparison with outcomes Corrective action

Non-financial Controls Effectiveness of research activities Systems for release of drawing release Inventory control Quality control