Management Control System

Introduction
A management control system (MCS) is a system which include the plan of organization ,methods and procedures adopted by management to ensure that its goals are met.

MCS defined as the formal, information based routines and procedures managers use to maintain or alter patterns in organizational activities.

Management Control Systems

Management control systems are a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees.

It is the process by which managers influence other members of the organization to implement the organizations strategies

Management Control Systems

Many management control systems contain some or all of the balanced scorecard perspectives: 1. Financial 2. Customer 3. Internal business process 4. Learning and growth

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Need for management control system

A Management Control System is a formal , defined, disciplined, and Structured process, with quantitative orientation based on performance standards, designed to monitor behaviors. .

Need for management control system

To monitor the fulfillment of responsibilities in each unit within the company. To ensure that all activities that are being carried out are contributing to achievement of Strategic objectives. To evaluate the performance of the organization. To encourage managers to take actions that are in the best interest of the company

CHARACTERISTIC FEATURES OF MANAGEMENT CONTROL SYSTEM : It focuses on programmers and responsibility centers. The control process is a set of actions. It is a total system covering all aspects of a companys operations. The system is normally coordinated and integrated

 The system tends to be rhythmic Line and staff managers are equally involved in the control process. Reciprocity. Expansibility.

Management control system is by no means mechanical. The process involves interactions among individuals.

Boundaries of management Control

Management control are interrelated with two other system or activities: Planning and Control

General relationship among Planning and Control Function

Strategy formulation
Goal, Strategies and Policies

Management Control

Implementation of Strategies

Task Control

Efficient and Effective Performance of individual task

Management Control Activities

Management control involves a variety of activities, including

Planning What Coordinating

the organization should do

the activities of several part of the

organization

Communicating information Evaluating information Deciding what, if any, action should be taken Influencing people to change their
behaviour

MANAGEMENT CONTROL SYSTEM ARE TOOLS TO IMPLEMENT STRATEGIES

THE PRIMARY FOCUS OF THIS SYSTEM IS IMPLEMENTATION OF STRATAGIES IN ORDER TO ACHIEVE ORGANIZATIONAL GOAL.

STRATEGIES DIFFERS BETWEEN ORGANISATION & CONTROLS SHOULD TAILORED TO THE REQUIREMENT OF SPECIFIC STRATEGIES STRATEGIES ARE PLAN TO ACHIEVE ORGANIZATIONAL GOALS

 CORPORATE GOALS ARE DETERMINED BY THE CHIEF EXECUTIVE OFFICER(CEO) OF THE COMPANY IN MANY CORPORATION , THE GOALS ORIGINALLY SET BY THE FOUNDER PERSIST FOR GENERATION e.g.: ALFERED P SALON- GENERAL MOTORS SAM WALTON- WAL-MART

GOALS

GOAL OR OBJECTIVES OF AN ORGANIZATION

1. PROFIT MAXIMIZATION/ PROFITABILITY 2. MAXIMIZING SHAREHOLDERS VALUE/WEALTH MAXIMIZATION

PROFIT MAXIMIZATION
In any business profitability is usually the most important goal It is expressed by an equation: the product of two ratio i.e. profit margin ratio & investment turnover ratio Profit ratio=Revenue-Expenses Revenue Investment Turnover=Revenue Investment

 Return on Investment=Profit X Revenue Revenue Investment = Profit

Investment

In order to earn more profit in long term, one of the Management responsibilities is to arrive at the right balance between the two main sources of finance i.e. Equity and Debt. Investment= Total equity + Total Debt

Wealth Maximization/ Maximizing Shareholders value

This concept indicates that the appropriate goal of a for-profit corporation is to maximize shareholders value. Maximizing implies users a way of finding the maximum amount that a company can earn. Always try to share more benefit to the users, shareholders, employees and labours in order to maximize wealth.

Risk
Profitability of a business is affected by managements willingness to take risks.

The degree of risk taking varies with the personality of Individual manager.

eg. The Asian Financial crisis during 1997-1998 is traceable in large part, to the fact that Banks in Asias emerging markets made whar appeared to be highly Profitable loans without paying attention to the l4vel of risk involve.

Multiple Stakeholder approach

Organization participate in three markets. They are: The Capital Market : A firm raise fund in this market and important constituency is Public , Stockholders The Product Market: A firm sells its goods and services in this market and key constituency is Customer The Factor Market: It compete for resources such as Human capital and raw materials and the prime constituency are Companys employee and suppliers.

The firm has a responsibility to all these multiple stakeholders: Shareholders Customers Employees Suppliers Society Management control system should identify the goals for each of these groups & develop scorecard to track performance

Strategies describe the general direction in which the organization plan to move to attain its goal

A firm develop its strategies by matching its core competencies with industry opportunities

Strategies formulation is a process that senior executives use to evaluate a companys strengths and weaknesses in light of the opportunities and threats present in the environment and then to decide on strategies that fit the company core competencies with environmental opportunities. Strategies can be found at two levels: 1. Corporate Level (Strategies for a whole organization), and 2. Business Unit Level (Strategies for business units within organization ).

Environmental Analysis Competitors Customers Suppliers Regulatory Social/Political Opportunities and Threat Identify opportunity

Internal Analysis
Technology Manufacturing Marketing Distribution Strength and weaknesses Identify core Competencies

STRATEGY FORMULATION

Fix internal competencies with external opportunities

Firms Strategies

TWO LEVEL STRATEGIES

Strategy level Key Strategic issues Are we in the right mix of Industry? What industries or sub industries should we be What should be the mission of the business unit? How should the business unit compete to realize its mission Generic strategic options Primary Organizational level involved Corporate level Single industry Corporate office Related Diversification Unrelated diversification Build Hold Harvest Divest Low cost differentiation Corporate office and business unit general manager Business unit general manager

Business Unit level

Defining Financial Analysis

Financial analysis is the process of evaluating financial and other information for decision-making. A six-step approach is suggested for systematic financial analysis.

Six-step Process
Identify purpose of financial analysis Corporate overview Financial analysis techniques Detailed accounting analysis Comprehensive analysis Decision or recommendation

Corporate Overview
Industry analysis--key economic characteristics, historical context, profit drivers, business risks Firms business strategy-competitive strategy given the industry characteristics

Industry Analysis
Competition--growth rates, concentration ratios, degree of product differentiation, economies of scale (& relative fixed & variable costs), substitute products Legal barriers--patent & copyrights, licensing, regulation bargaining power of buyers (& suppliers) & price sensitivity

Business Strategy
Cost leadership: low cost producer, economies of scale, efficient production, low input prices Product differentiation: specific attributes that customers value (e.g., quality, variety, service, delivery time), brand name Importance of core competencies

Quantitative Financial Analysis

Financial Statements Common-size Analysis Financial Ratios Growth/trend Analysis Quarterly analysis DuPont Model Market Analysis

Decision
What is the recommendation or decision? What is the key rationale for this decision? [This is based on the specific decision: for a credit decision the key factors relate to credit risk, with particular focus on leverage and liquidity.] Be prepared to defend this decision.

What is ROI Analysis?

One of several approaches to building a financial business case (Solution Matrix) A performance measure used to evaluate the efficiency of an investment or A performance measure to compare the efficiency of different investments.

What is ROI Analysis? (cont.)

ROI is a traditional financial measure to determine benefit to the business
Benefit of training Benefit of asset purchase decisions (computer systems or a fleet of vehicles) Marketing, recruiting programs

What is ROI Analysis? (cont.)

ROI is a metric that yields some insights into how to improve business results in the future.

Simple ROI vs. ROI

The benefit (return) of an investment is divided by the cost of the investments; the result is expressed as a percentage or a ratio. This is referred to as simple ROI.
ROI= Gains from investment Cost of investment Cost of Investment Rs.700,000 - Rs.500,000 Rs.500,000 = 40%

Simple ROI Investment Example

ROI is used to compare returns on investment where the money gained or lostor the money investedare not easily compared using monetary values.
For example, a Rs.1,000 investment that earns Rs.50 in interest obviously generates more cash than a Rs.100 investment that earns Rs.20 interest, but the Rs.100 investment earns a higher return. So.

Simple ROI Investment Example

Rs 50/Rs 1,000 Rs.1050 - Rs.1000 = 50 = 5% ROI Rs.1000 Rs.1000 Rs.20/Rs.100 Rs.120-100 = 20 = 20% ROI Rs.100 Rs.100

ROI (or Complex ROI)

In complex business settings, it is not always easy to match specific returns with specific costs (Solution Matrix) New formulas involve calculating: Total Benefit Total Costs x 100 =ROI Total Costs Or Net profit after tax x 100 =ROI Total Investment

Economic Value Added or EVA

EVA, is a way to determine the value created, above the required return, for the shareholders of the company. Its an estimate of firms economic profit.
EVA is the profit earned by the firm less the cost of financing the firm's capital. It is the difference between the Net operating Profit after tax less the money cost of capital.

NEED OF EVA
To measures the overall corporate performance. To know whether the business operation is creating value over the TRUE Cost of Capital To ALL the Capital Employed.

Calculation of EVA
EVA = (r-c)X K = NOPAT c X K

Where: r = NOPAT=return on Invested capital K c = Weighted average cost of capital(WACC) K = Capital employed NOPAT = Net operating profit after tax.

Cost of capital
Cost of capital is the minimum rate of return to compensate investor who are ready to bear the risk of investing in the firm. It depends on Companys financial structure, business risk, current investment level and investor expectation.

Calculation
Cost of capital(Kc) is weighted average of two component: (a)Cost of equity(Ke) (b) cost of debt(Kd) Kc = We*Ke + Wd*Kd We & Wd are respective weight of equity and debt.

Cost of equity is taken based on CAPM model. Cost of debt is always taken post tax.

NOPAT
NOPAT is the profit derived from a companys operations after taxes. It is a companys cash generation capability from recurring business operations.

Capital Employed
Is the amount of cash invested in the business, net of depreciation.

Relationship to market value added(MVA)

The firm's market value added, or MVA, is the discounted sum (present value) of all future expected economic value added: MVA= Market value Invested Capital(Capital Employed) Note that MVA = PV of EVA. MVA = NPV of Free cash flow (FCF) it follows therefore that the NPV of FCF = PV of EVA; since after all, EVA is simply the re-arrangement of the FCF formula.

Hence, EVA is a financial technique to measure whether a company is creating economic value over and above the cost of capital of assets employed.

i.e., it also measures value created during a period of time through increased margins and profitable deployment of underutilized assets.

Free Cash Flow

Free cash flow to the firm (FCFF) is the cash flow available to the firms suppliers of capital after all operating expenses have been paid and necessary investments in working capital and fixed capital have been made.

FCFF is the cash flow from operations minus capital expenditures. To calculate FCFF, differing equations may be used depending on what accounting information is available. The firms suppliers of capital include common stockholders, bondholders, and, sometimes, preferred stockholders.

Cash flow available for distribution among all the securities holders of an organization
Free Cash Flow= EBIT* tax rate + Depreciation Change in working capital Capital Expenditure Or Free cash flow = Net Profit +Interest Expenses change in working capital Net capital expenditure - tax shield on interest expenses

Return on Net Worth/shareholder fund

It is the ratio of net profit to shareholders investment. It is the relationship between net profit(after interest and tax) and share holders/ proprietors. This ratio establishes the profitability from the shareholders point of view.

Calculation
Return on net worth = {Net Profit After interest and tax/ Shareholders fund } * 100 This ratio is used to measure the overall efficiency of the firm.This ratio indicates the extent to which the primary objective (maximize its earning) of businesses being achieved.

It is a small variation of return on equity capital and is calculated by dividing the net profit after taxes and preference dividend by the total number of equity shares. Formula of Earnings Per Share : The formula of earnings per share is: Earnings per share (EPS) = (Net profit after tax Preference dividend) / No. of equity shares (common shares)

Earning Per Share (EPS)

Price Earnings (P/E)

Price earnings ratio (P/E ratio) is the ratio between market price per equity share and earning per share. The ratio is calculated to make an estimate of appreciation in the value of a share of a company and is widely used by investors to decide whether or not to buy shares in a particular company. Formula of Price Earnings Ratio: Following formula is used to calculate price earnings ratio: Price Earnings Ratio = Market price per equity share / Earnings per share

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