MCS UNSMCS UNSChapter 5:Building Profit Chapter 5:Building Profit

PlanPlan

Chapter Review NotesChapter Review Notes

Internal ControlsChp 13

Business Strategy

Core Values

Chps 13

Belief Systems

Chps 12 & 13

Boundary Systems

StrategicUncertainties

Interactive Control Systems

Chp 10

Diagnostic Control Systems

Chp 10

Core ValuesRisks to be

Avoided

Critical PerfVariables

Chp 2 Chp 14

Course Map – Where are we? Organizing for Performance

Chp 3

Designing Employee Goals and Incentives

Chp 11

What to ControlChp 4

Building and Evaluating Budgets

Chps 5, 6, 7

Measuring PerformanceChps 8 & 9

4 LEVERS OF

CONTROL

Today’s Topic

Why did I bother to make you Why did I bother to make you spend Time on this ?spend Time on this ?

►Profit Plans are Key Tools ..They focus Profit Plans are Key Tools ..They focus attention on the Real Questions attention on the Real Questions

►His Profit Wheel is pretty Cool . It His Profit Wheel is pretty Cool . It simplistically connects the thoughts simplistically connects the thoughts that do flow through Real Life . that do flow through Real Life .

►Simons approach is boring but realSimons approach is boring but real

Using Profit Wheel’s to test Using Profit Wheel’s to test strategystrategy

• Prepare a Profit Plan – Be Clear on Prepare a Profit Plan – Be Clear on AssumptionsAssumptions

• Do you have enough cash to fund the Do you have enough cash to fund the plan ?plan ?

► Make the ROE comparisonMake the ROE comparison► Bring in Dr DoomBring in Dr Doom

Test the Assumptions againTest the Assumptions again Is Damage being done to Core Is Damage being done to Core

Competencies ?Competencies ?

Key Questions a Plan is Key Questions a Plan is supposed to answersupposed to answer

►Does the Strategy Create Economic Does the Strategy Create Economic Value?Value?

► Is there enough Cash to Survive?Is there enough Cash to Survive?► Is there enough value to be able to tap Is there enough value to be able to tap

into other sources of funding?into other sources of funding?

Budgeting TermsBudgeting Terms

►Profit Plan = Master BudgetProfit Plan = Master Budget

►Preparing profit plans = budgetingPreparing profit plans = budgeting

►Forecasts, Prognoses, Estimates Forecasts, Prognoses, Estimates generally shorter term, prepared to generally shorter term, prepared to

update budgetupdate budget

MAY ACTUALSMAY ACTUALS MAY BUDGETMAY BUDGET MAY MAY ESTIMATEESTIMATE

Why Build a Profit PlanWhy Build a Profit Plan

Translating the strategy of business Translating the strategy of business into a detailed plan to create valueinto a detailed plan to create value

Evaluating whether sufficient resource Evaluating whether sufficient resource are available to implement the are available to implement the intended strategyintended strategy

Creating a foundation to link economic Creating a foundation to link economic goal with leading indicators of goal with leading indicators of strategic implementationstrategic implementation

Business BudgetingBusiness Budgeting►the following benefits from preparing the following benefits from preparing

budgetsbudgets:: Makes the strategy concrete Makes the strategy concrete Tests the strategy’s attractiveness Tests the strategy’s attractiveness Assumptions are shared and challenged (are Assumptions are shared and challenged (are

the numbers optimistic, pessimistic, or the numbers optimistic, pessimistic, or realistic?)realistic?)

Once agreed to, gets everyone on same pageOnce agreed to, gets everyone on same page People learn by discussing/preparing budgetsPeople learn by discussing/preparing budgets Can easily do scenario (what if) analysisCan easily do scenario (what if) analysis Not written in stone…Not written in stone… Provides control tool Provides control tool

Business BudgetingBusiness Budgeting

► Characteristic of business budgets:Characteristic of business budgets:

1.1. Link between profit, cash and return is Link between profit, cash and return is explicit explicit with business budgetswith business budgets

Profit, Cash and ROE WheelsProfit, Cash and ROE Wheels

2.2. Business budgets are prepared formallyBusiness budgets are prepared formally

3.3. Potential conflict between using Potential conflict between using budgets as planning tools and budgets budgets as planning tools and budgets for control in businessfor control in business

Notes from Chp 4 (67-74)Notes from Chp 4 (67-74)

1.Three Wheels of Profit 1.Three Wheels of Profit PlanningPlanning

Op. Cash

A/R

Sales

Inventory

Op. Expenses Inv in Assets

Profits

Asset Util. S/H Equity

Return on Eq.

Cash Wheel

Profit Wheel

ROE Wheel

Profit WheelProfit WheelOp. Cash

A/R

Sales

Inventory

Op. Expenses Inv in Assets

Profits

Asset Util. S/H Equity

Return on Eq.

Cash Wheel

Profit Wheel

ROE Wheel

Profit WheelProfit Wheel►Continues until profit is acceptableContinues until profit is acceptable

►The role of Controller in the budget The role of Controller in the budget reviewreview““Good finance people are the ones who Good finance people are the ones who

can help give real meaning to operating can help give real meaning to operating plans. When you say you’re going to plans. When you say you’re going to get a 6% improvement in productivity, get a 6% improvement in productivity, they’re the ones who are suppose to they’re the ones who are suppose to ask where, What are the projects? When ask where, What are the projects? When are they going to get done? How much are they going to get done? How much money are we providing?”money are we providing?”

(Simons, 2000: (Simons, 2000: 89)89)

Cash WheelCash WheelOp. Cash

A/R

Sales

Inventory

Op. Expenses Inv in Assets

Profits

Asset Util. S/H Equity

Return on Eq.

Cash Wheel

Profit Wheel

ROE Wheel

Cash WheelCash Wheel

►Ensure cash flow (including borrowing Ensure cash flow (including borrowing capacity) is positive otherwise revise capacity) is positive otherwise revise budgetbudget

►Have to do the cash budget by monthHave to do the cash budget by month

ROE WheelROE Wheel

Op. Cash

A/R

Sales

Inventory

Op. Expenses Inv in Assets

Profits

Asset Util. S/H Equity

Return on Eq.

Cash Wheel

Profit Wheel

ROE Wheel

ROE WheelROE Wheel

►Have to meet risk/return criteria of Have to meet risk/return criteria of investorsinvestors

ROEROE = = Net IncomeNet Income x x SalesSales x x AssetsAssets

SalesSales Assets S/H Equity Assets S/H Equity

Profitability Ratio

Asset Turnover

Financial Leverage x x

2. Formal Budget Process2. Formal Budget Process►Takes 2-4+ months - involves most levelsTakes 2-4+ months - involves most levels

►Supervised by the Controller’s Office (or Supervised by the Controller’s Office (or Budget Office in larger firms)Budget Office in larger firms) Coordinates key information inputs (forecasts Coordinates key information inputs (forecasts

of price/volume/inv and production)of price/volume/inv and production) Provides macro level guidelines (exchange Provides macro level guidelines (exchange

rates, interest rates, inflation, etc) rates, interest rates, inflation, etc) Prepares budget forms and sets timetablePrepares budget forms and sets timetable Offers assistance to divisionsOffers assistance to divisions Analyzes budget for slack and do-abilityAnalyzes budget for slack and do-ability Consolidates all drafts to check if enough Consolidates all drafts to check if enough

profitprofit

3. Budgets: Planning vs 3. Budgets: Planning vs Control ExerciseControl Exercise

►You are a factory worker making paper You are a factory worker making paper planes planes

►The week after the big order, the Plant The week after the big order, the Plant Manager approaches you regarding next Manager approaches you regarding next year’s budgetyear’s budget

►You have been averaging 300 per weekYou have been averaging 300 per week►She needs to know how many units per She needs to know how many units per

week should she budget for next year? week should she budget for next year? ►What do you answer?What do you answer?

3. Budgets: Planning vs 3. Budgets: Planning vs ControlControl

►Tension between planning vs Tension between planning vs controlcontrol

“ “These budget-based systems These budget-based systems reward people for lying, and punish reward people for lying, and punish them for telling the truth”them for telling the truth”

►Suggestions as to how to solve this?Suggestions as to how to solve this?