Financial Goal Setting-12012013- Final (2)

7/30/2019 Financial Goal Setting-12012013- Final (2)

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Financial Goal setting

K.Viswanathan

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Financial Goal settingFinancial Management is concerned with the planning and control of

the firms financial resources. It is a decision making process

concerned with acquiring, financing and managing assets toaccomplish the overall goal of a business organisation. The financial

managers have a key role in raising finances, acquiring funds,

allocation of capital and management of cash.

Financial management has to be in tune with the long term goals of

the firm. Management control systems are also concerned with the

long term objectives of the firm. Hence a firms management control

systems have to be closely associated with its financial management.

A firms financial goals will be set in quantitative terms and are set

within a time frame. The primary goals of financial planning are to

achieve optimum return on investments, value addition, growth in

earnings per share, growth in price-earning ratio, have optimum

leverage ratio and utilise long term and short term funds efficiently.

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Financial Goal settingFinancial forecasting:

Financial forecasting is the process of predicting future events which

will affect the future functioning of an organisation significantly.Through financial forecasting, the requirements and utilisation of thefunds of an organisation are estimated in advance. Financialforecasting helps in making decisions on capital investments, annualproduction levels, required operational efficiency, required working

capital, assessment of cash flow, raising of long term funds,estimation of sales and funds required for running the business etc.

Forecasting reduces uncertainties since it considers all macro andmicro economic factors and comes to some estimates of the financialrequirements and the ways of meeting them.

It starts with predicting future events which will have a significanteffect on the firms business in the future, leading to its success orfailure. Thus forecasts will lead to setting up of the goals of the firmand these goals can later on be converted to operational plans foraction.

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Financial Goal settingTechniques of Financial forecasting:

1. Percentage Sales method

2. Days Sales method

3. Simple linear Regression Method

4. Multiple Regression Method

5. Projected Funds Flow statement

6. Projected Cash Flow statement

7. Projected Income statement

8. Projected Balance Sheet

Benefits of forecasting:

1. Helps in planning, controlling and decision making

2. Indicates the macro and micro economic factors taken into account3. Leads to optimum utilisation of funds and resources

4. Leads to formation and adoption of required policies

5. Serves as a warning system to indicate if and when things are goingwrong.

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Financial Goal settingApproaches to Financial Forecasting:

The objectives of financial forecasting are:

1. Maintenance of Liquid Assets

2. Maximisation of profitability

3. Ensuring fair return to shareholders

4. Building reserves for growth and expansion

5. Ensure operational efficiency and optimum utilisation of available

resources6. Ensure financial discipline in the organisation

There are two approaches to financial planning:

(a) Traditional Approach:

The traditional approach limits the role of financial management toraising and administration of funds and covers the following:

(i) Arrangement of funds from financial institutions

(ii) Arrangement of funds through financial instruments

(iii) Taking care of the legal and accounting aspects between the

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Financial Goal settingb. Modern Approach:

The modern approach is an analytical way of looking at the financialproblems of a firm. The modern approach aims to arrive at:

(1) Total volume of funds required by the firm

(2) Total assets required by the firm

(3) The methods of financing the requirements of the firm

It takes into account four broad decision areas:

(i) Fund requirement decision(ii) Financing decision

(iii) Investment decision

(iv) Dividend decision

Both the capital expenditure and working capital requirements arecarefully assessed. The finance manager calculates the differentcapital expenditure projects and selects the best out of them so as toconform to the overall objectives of the firm. The criteria forevaluating the different investment proposals and the priorities forselection are determined before selecting them.

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Financial Goal settingEconomic Value added :

Economic Value Added or EVA is an estimate of a firm's economic profit beingthe value created in excess of the required return of the company s investors(being shareholders and debt holders). Quite simply, EVA is the profit earned bythe firm less the cost of the firms capital. The idea is that value is created whenthe return on the firm's economic capital employed is greater than the cost of thatcapital.

Calculating EVA

EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latterbeing the product of the cost of capital and the economic capital. The basicformula is:

where:

is the Return on Invested Capital (ROIC)

c is the weighted average cost of capital

K is the economic capital employed;

NOPAT is the net operating profit after tax, with adjustments and translations,generally for the amortization of goodwill, the capitalization of brand advertisingand other non-cash items

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Financial Goal settingEVA Calculation:

EVA = net operating profit after taxes a capital charge [the residual

income method]therefore EVA = NOPAT (c capital), or alternatively

EVA = (r x capital) (c capital) so that

EVA = (r-c) capital[the spread method, or excess return method]

where:r = rate of return, and c = cost of capital, or the Weighted Average Cost of

Capital (WACC).

NOPAT is profits derived from a companys operations after cash and taxes

but before financing costs and non-cash book-keeping entries. It is the total

pool of profits available to provide a cash return to those who providecapital to the firm.

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

It can be calculated as the sum of interest-bearing debt and equity or as the

sum of net assets less non-interest-bearing current liabilities (NIBCLs).4/26/2013 8


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Financial Goal settingEVA Calculation: ( Contd)

The capital charge is the cash flow required to compensate investors

for the riskiness of the business given the amount of economiccapital invested.

The cost of capital is the minimum rate of return on capital required

to compensate investors (debt and equity) for bearing risk, their

opportunity cost.Another perspective on EVA can be gained by looking at a firms

return on net assets (RONA).

RONA is a ratio that is calculated by dividing a firms NOPAT by the

amount of capital it employs (RONA = NOPAT/Capital) after makingthe necessary adjustments of the data reported by a conventional

financial accounting system.

EVA = (RONA required minimum return) net investments

If RONA is above the threshold rate, EVA is positive.4/26/2013 9


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Financial Goal settingFree Cash Flow:

In corporate finance , free cash flow (FCF) is cash flow available fordistribution among all the securities holders of an organization. Theyinclude equity holders, debt holders, preferred stock holders,convertible security holders, and so on.

Free Cash Flow Calculations:

There are many ways to calculate FCF:

1. EBIT x (1-Tax Rate)+ Depreciation and/ or Amortisation- NetIncrease in Working Capital- Capital expenditure

2. When Net profit and Tax shield rate applicable are available, youcan calculate it as under:

Net Profit + Interest expenses Net Capital Expenses (Capex) Net increase in Working Capital Tax Shield on Int. Expenses

where Net CAPEX= CAPEX Depreciation & Amortisation

Tax Shield Rate = Net Interest expenses x Effective Tax Rate

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Financial Goal settingFree Cash Flow Calculations: (Contd)

3. When PAT and Debit/Equity ratio are available:

Profit after Tax- changes in capital expenditure (1-d) + depreciationand / or amortisation (1-d) Increase in Working capital ( 1-d)

where d = Debt/ Equity Ratio

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Financial Goal settingDefinition of 'Return On Equity - ROE'

The amount of net income returned as a percentage of shareholders

equity. Return on equity measures a corporation's profitability byrevealing how much profit a company generates with the money

shareholders have invested.

ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder's Equity x 100Net income is for the full fiscal year (before dividends paid to

common stock holders but after dividends to preferred stock.)

Shareholder's equity does not include preferred shares.

Also known as Return on Net Worth" (RONW).

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Financial Goal settingEarning per Share : (EPS)

EPS is the portion of a company's profit allocated to each outstanding

share of common stock. Earnings per share serves as an indicator of acompany's profitability.

Calculated as:

Net Income (after Interest) Dividend on preference stock

Average outstanding sharesWhen calculating, it is more accurate to use a weighted average

number of shares outstanding over the reporting term, because

the number of shares outstanding can change over time. However,

data sources sometimes simplify the calculation by using the numberof shares outstanding at the end of the period.

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Financial Goal setting'Earnings Per Share - EPS'

Earnings per share is generally considered to be the single

most important variable in determining a share's price. It is also amajor component used to calculate the price-to-earnings valuation

ratio.

Exercise :

Assume that a company has a net income of Rs.25 lakhs. If thecompany pays out Rs.1 lakh in preferred dividends and has 10 lakhs

shares for half of the year and 15 lakhs shares for the other half,

what is its EPS?

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Financial Goal setting'Earnings Per Share - EPS'

Earnings per share is generally considered to be the single most important

variable in determining a share's price. It is also a major component used to

calculate the price-to-earnings valuation ratio.

Exercise :

Assume that a company has a net income of Rs.25 lakhs. If the company

pays out Rs.1 lakh in preferred dividends and has 10 lakhs shares for half of

the year and 15 lakhs shares for the other half, what is its EPS?

The EPS would be Rs.1.92 (24/12.5). First, the Rs. 1 lakh is deducted from

the net income to get Rs.24 lakhs, then a weighted average is taken to find

the number of shares outstanding (0.5 x 10 lakhs + 0.5 x 15 lakhs = 12.5lakhs).

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Financial Goal settingP/E Ratio:

If there is one number that people look at than more any other number, itis the Price to Earning Ratio (P/E).

The P/E looks at the relationship between the stock price and thecompanys earnings. The P/E is the most popular stock analysis ratio,although it is not the only one you should consider.

You calculate the P/E by taking the share price and dividing it by thecompanys EPS (Earnings Per Share as shown previously)

P/E = Stock Price / EPSFor example: A company with a share price of Rs.40 and an EPS of 8 wouldhave a P/E of: (40 / 8) = 5

What does P/E tell you?

Some investors read a high P/E as an overpricedstock.

However, it can also indicate the market has high hopes for this stocksfuture and has bid up the price.

Conversely, a low P/E may indicate a vote of no confidence by the marketor it could mean that the market has just overlooked the stock. Investorscan make their fortunes spotting these overlooked but fundamentally

strong stocks before the rest of the market discovered their true worth.4/26/2013 16


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Financial Goal settingInter-relationship between P/E and EPS:

EPS plays a major role in calculation of P/E. EPS is the denominator in thecalculation of P/E ratio. Hence higher the EPS lower will be the P/E and

vice-versa. EPS will be low if the remainder of the net income afterpayment of dividend to the preference shares is low or if the averagenumber of outstanding equity shares is high.

An important aspect of EPS that's often ignored is the capital that isrequired to generate the earnings (net income) in the calculation. Two

companies could generate the same EPS number, but one could doso with less equity (investment) - that company would be more efficient atusing its capital to generate income and, all other things being equal, wouldbe a "better" company. Investors also need to be aware of earningsmanipulation that will affect the quality of the earnings number. It is

important not to rely on any one financial measure, but to use it inconjunction with statement analysis and other measures.

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Financial Goal settingReturn on Investment : (ROI)

It is one of the several approaches to building a financial business

case. It is a performance measure used to measure the efficiency of an

investment or different investments.

ROI is measured as follows:

Gains from investment-Cost of InvestmentCost of Investment

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Financial Goal settingReturn on Investment (ROI) (Contd)

The calculation for return on investment and therefore the definition,can be modified to suit the situation -it all depends on what you

include as returns and costs. The definition of the term in thebroadest sense just attempts to measure the profitability of aninvestment and, as such, there is no one "right" calculation.

For example, a marketer may compare two different products by

dividing the gross profit that each product has generated by itsrespective marketing expenses. A financial analyst, however, maycompare the same two products using an entirely different ROIcalculation, perhaps by dividing the net income of an investmentby the total value of all resources that have been employed to makeand sell the product.

This flexibility has a downside, as ROI calculations can be easilymanipulated to suit the user's purposes, and the result canbe expressed in many different ways. When using this metric, makesure you understand what inputs are being used.

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Financial Goal settingOrganisational Hierarchies and behaviour:

Normally the hierarchy consists of a CEO at the top,

and the managers of the various business units,functions, departments and other sub-divisions underhim. The CEO and in some organisations the topmanagement decides the overall strategies which willhelp the organisation to reach its goals. Themanagement control process is the process by whichmanagers at all levels ensure that the people underthem implement the intended strategies.

Management Control systems are tools to implementstrategies. Strategies differ between organisationsand control systems should be tailor made to meetthe requirements of strategies.

Strategies are plans to achieve organisational goals.Some typical organisational goals are as under:4/26/2013 20

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Understanding Strategies1. Profitability:

Profitability is expressed in the broadest and most conceptually

sound sense by an equation which is the product of two ratios:

The first ratio is the profit margin percentage; The second ratio is the

investment turnover. The product of the two is the Return on

Investment.

Profitability should be long run. Some CEOs believe there is close

correlation between market share and return on investment.

Other CEOs insist on Companys size as their goal. If the investment is

too large, even if the company makes good amount of profit, its

return on investment will be comparatively less.4/26/2013 21

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Financial Goal setting2. Maximising Shareholder Value:

Achieving satisfactory profit is a better way of stating thecorporations goal. There is no way to know what can bemaximum shareholder value. Although optimising theshareholders value is a major goal, that is not the only goal inmany organisations. (Henry Ford Example- satisfactory profit )

A course of action which decreases expenses without affecting

the market share is sound.A course of action which increases the expenses with greaterthan proportionate increase in revenue is welcome.

A course of action which increases profit with less thanproportional increase in shareholders investment (or no

additional investment at all) is also welcome.

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Financial Goal setting3. Minimising Risk:

Profitability and risk are inversely interlinked. There is always anupper limit for risk exposure to which a firm may want tosubject itself to.4. Multiple stake holder approach: (Acer Group Example-customer, employee, share holder)

Organisations have stakes in three markets-

Capital - shareholdersProduct - purchasers of goods and services

Factor - employees and raw materials ( Employee satisfaction-Lincoln Electric)

Management Control systems should identify goals for each ofthese groups and develop scorecards to track theirperformance.

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Financial Goal settingConcept of strategy:

Strategy describes the general direction in which an organisationplans to move to attain its goals. A firm develops its strategies bymatching its core competencies with industry opportunities.

Strategies can be at two levels:

1. Strategies for the whole organisation

2. Strategies for the business units within the organisation.

There should be consistency between the two.

At corporate level the issues are:

1. The definition of business in which the firm will participate

2. The deployment of resources among these businesses.

There can be three kinds of firms:

1. Single industry firm- Suryajyothi spinning mills

2. Related diversified firm- Proctor and Gamble

3. Unrelated diversified firm Reliance Group4/26/2013 24

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Financial Goal settingConcept of strategy:

1. Single industry firm- Uses core competencies to pursue growth within

the industry

2. Related Diversified firm- They have (a) ability to share common

resources (b) ability to share common core competencies. Use common

sales force, logistics, procurement and manufacturing functions- using

economies of scale and economies of scope.

3. Unrelated diversified firms Very few operating synergies, exceptperhaps financing . They grow through acquisition.

Business Unit Strategies:

Competition between diversified firms does not take place at the corporatelevel. Rather a Business unit of one firm (Proctor and Gambles Pampers

Unit will compete with similar business unit of another firm (KimberleyClarkes Huggies unit). Revenues are earned and costs are incurred by thebusiness unit itself. The strategy of a business unit depends on

a. Its mission (what are all its overall objectives?)

b. Its competitive advantage (how should the business unit compete in itsindustry to accomplish its mission ?)

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Financial Goal settingBusiness Unit Mission:

One of the important tasks of management in a diversified firm is to usethe cash generated in one business unit to finance the unit in the other

business units. Several planning models have been developed to enablemanagers to effectively deploy the resources. The most widely used onesare Boston Consulting Groups two-by-two growth-share matrix andGeneral Electric Company / Mc Kinsey & Companys three-by-three industryattractiveness-business strength matrix . While the models differ in the

methodologies they use to develop the most appropriate missions for thevarious business units, they have the same set of missions from which tochoose: build, hold, harvest and divest.

Build: It implies an objective of increased market share even at the expenseof short term earnings and cash flow

Hold: To protect the business units market share and competitive positionHarvest: Objective is to maximise the short term earnings and cash floweven at the expense of market share

Divest: Decision to withdraw from business either through a process ofslow liquidation or outright sale.

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Financial Goal settingStrategic Implications

Resource allocation recommendations can be made to grow, hold, orharvest a strategic business unit based on its position on the matrixas follows:

Grow: Strong business units in attractive industries, average businessunits in attractive industries, and strong business units in averageindustries.

Hold: Average businesses in average industries, strong businesses inweak industries, and weak business in attractive industries.

Harvest: Weak business units in unattractive industries, averagebusiness units in unattractive industries, and weak business units inaverage industries.

There are strategy variations within these three groups. For example,within the harvest group, the firm would be inclined to quickly divestitself of a weak business in an unattractive industry, whereas it mightperform a phased harvest of an average business unit in the same

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Financial Goal settingIn the McKinsey/ GE matrix market (Industry) attractiveness replaces market

growth as the dimension of industry attractiveness, and includes a broader range

of factors other than just the market growth rate. Secondly, competitive Business

strength replaces market share as the dimension by which the competitiveposition of each SBU is assessed.

Recommended Business Strategies

Industry

Attractiveness

High Invest/ Grow strongly

(Build)

Invest/ Grow

selectively (Build)

Dominate / Delay/

Divest

Average Invest/ Grow

selectively (Build)

Earn/ Protect

(Hold)

Harvest / Divest

Low Earn/ Protect (Hold) Harvest / Divest Harvest / Divest

Strong Average Weak

Business Strength

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Financial Goal settingBusiness Units Competitive Advantage:

The following questions need to be considered:

1. What is the structure of the industry in which the Business Unit is operating?

2. How should the Business Unit exploit this structure ?

3. What will be the basis for the units competitive advantage?

Michael Porter has described two analytical approaches:

(i) Industry Analysis (ii) Value Chain analysis

(i) Industry Analysis:Industry profitability is a significant predictor for a firms performance. Thestructure of an industry is to be analysed in terms of the collective strength of thefollowing forces:

1. Intensity of rivalry among existing competitors

2. The bargaining power of customers

3. Bargaining power of suppliers

4. Threat from substitutes

5. Threat from new entry

If the above forces are powerful, the industry will be less profitable. In industrieswith higher profitability, these forces are less powerful (soft drinks and

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Financial Goal setting(i) Industry Analysis : (Contd)

Generic Competitive Advantage

Two generic ways of responding to the opportunities in the external environment

Low Cost: Cost leadership can be achieved through such approaches as economies ofscale in production, experience curve effects, cost control, cost minimisation etc.

Differentiation: Finding out what is the USP of the product- includes brand loyalty,superior customer service, dealer network, product design , product features etc.

(ii) Value Chain Analysis:

The best competitive advantage is derived from providing better customer value for anequivalent cost or equivalent customer value for a lower cost. The value chain is thecomplete set of activities from extraction of raw materials to post delivery support tothe customers.

Value chain analysis seeks to determine where in the companys operations customervalue gets enhanced or costs get lowered. For each value added activity the questionsare

1. Can we reduce costs of the activity, holding value (revenues) constant?

2. Can we increase value (revenues) holding costs constant?3. Can we reduce assets in the activity, holding both costs and revenues constant?

4. Most importantly can we do all these simultaneously?

A value chain analysis thus helps the firm to understand the entire value deliverysystem.

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Financial Goal settingBehaviour in organisations

What is Goal Congruence?

Senior management wants the organisation to attain theorganisations goals. But individuals have their own goals. The centralpurpose of the management control system is to ensure (in so far asit is feasible) a high level of goal congruence- i.e. actions taken by thepeople serve the purpose of attaining the goals of the organisationincidentally fulfilling their own individual goal achievement.

An adequate control system will not encourage individuals to actagainst the best interest of the organisation. For example, if thesystem emphasises cost reduction and a manager responsibleresponds by reducing cost at the expense of quality or reduces costin his own unit by imposing more-than- offsetting increase in another

unit, we can say the manager is motivated, but in the wrongdirection. So we need to consider:

1. What actions motivate people to take actions/ decisions in theirown self- interest?

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Financial Goal settingInformal factors that influence Goal Congruence:

It is important for the designers of formal systems to take intoaccount the informal processes , such as work ethics, management

style and culture because in order to implement organisationstrategies effectively, the formal mechanism should be consistentwith the informal ones.

External Factors:

Set of attitudes collectively referred as work ethic, manifested in

employees loyalty to the organisation, their diligence, their spirit andtheir pride in doing a good job (rather than just putting in time).

Sometimes attitudes and norms are industry specific. For examplerail road industry is different from aviation industry. Sometimes theygo with the national culture- for ex. India and China have reputation

for excellent work culture- team work, obeying orders etc.Silicon valley in USA- has created companies like Hewlett Packard,Microsoft, Apple Computer, Sun Micro systems, Oracle, Cisco systemsand Intel. They have maintained the reputation of Silicon Valley asthe centre of Technological innovations.

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Financial Goal settingInternal factors:

Organisations own culture- Most important. Common beliefs, sharedvalues, norms of behaviour and assumptions that are implicitly accepted

and explicitly manifested throughout the organisation. Organisationsculture exists for many years. Some things are simply not done, throughnobody knows why.

Eg. Johnson & Johnson and the Tylenoid crisis

Management Style:

Since an institution is the lengthened shadow of a man, juniors followmanagers, who follow the CEO.

Several types of managers- Charismatic and outgoing, less ebullient, somespend time looking and talking to people, some rely on reports.

Informal organisation:

The lines of an organisation chart depict the formal-official authority and

responsibility of each manager. But more often, there could be indirect andinformal control over the manager from a person other than to whom themanager is reporting. Thus the realities of management control cannot beunderstood without recognising the importance of informal relationshipswithin the organisation.

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Financial Goal settingInformal Control Systems :

Internal factors: (Cont)

Perception and communication:Operating managers receive the information about the goals of theorganisation from a number of formal sourcesofficialcommunications, meetings etc. and informal sources likeconversations. Still, many a time the common goal cannot be stated

with absolute certainty and clarity. For example, the budgetmechanism may convey the impression that managers are supposedto aim at the highest profits possible in a year by adopting all costcutting measures, but the management may not actually want costcutting applied in employee training and efficiency improvement

measures. Thus the information operating managers receive as towhat they are supposed to do is vastly less clear than theinformation received by the cooling system of the air-conditionerfrom the thermostat.

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Financial Goal settingFormal Control Systems :

Rules :

These are all types of formal instructions and controls includingstanding instructions, job descriptions, standard operating

procedures, manuals and ethical guidelines. Rules may range fromthe most trivial to the most sophisticated (rules for issuance of paperclips to budget approval for huge expenditure)

Some rules are for ever. Some rules can have exceptions, based oncircumstances and best judgment of people. Such departuresnormally require approval.

Some rules require certain actions to be taken periodically eg. firedrills.

Some rules prohibit unethical, illegal and undesirable actions- eg.Reporting late, coming to work drunk etc.

Some rules should never be broken under any circumstances eg.not accepting bribe.

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Some specific types of rules are as under:

Physical controls :Security guards, locked store rooms, vaults, computer pass words,television surveillance, frisking of workers leaving premises andother such physical controls.

Manuals:

Judgment has to be used in deciding what rules should be written inthe manuals. Some rules have to be treated as guidelines rather thanfiats and sometimes discretions have to be allowed. Manuals inbureaucratic organisations are more detailed than in otherorganisations; large organisations have more manuals than smallerones; organisations with more dispersed geographical unitsperforming similar functions have more manuals than single siteorganisations.

Manuals and rule books therefore have to be re-examined and

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System Safeguards:

Safeguards are built into the information processing system to ensurethat the information flowing through the system is accurate and toprevent (or minimise) fraud of every sort. These include cross-checking totals with details, requiring signatures and other evidencesof checking and authorisations, separation of duties, counting cash

and other portable assets frequently and other proceduresmentioned in audit manuals. Checking is also performed by internalas well as independent external auditors to ensure objectivity.

Task Control systems :

These are controls to ensure that tasks are carried out efficiently and

effectively. Many of the tasks are controlled by rules. If tasks areperformed by systems automatically, the automated system itselfprovides the controls.

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Formal Control Process:

A strategic plan implements the organisations goals andstrategies. All available information is used in making thisplan. The strategic plan is converted into an annual budgetthat focuses on planned revenues and expenses for

individual responsibility centres. The performance of theresponsibility centres are measured and reported. Actualresults are compared with the budgets to determine if theperformance was satisfactory and rewards and corrective

actions are the results of these.

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Financial Goal settingFormal Control Systems :Types of organistions:A firms strategy has major influence on its structure, which in turn

influences the organisations management control systems. Thestructure of an organisation can be any one of the following three:(i) Functional (ii) Business or (iii) Matrix1. A functional structure:This is a structure with each manager having responsibility for aspecified function such as production, marketing etc.

The advantages are the opportunity to use specialised knowledge animprove competency.The disadvantages are1. There is no way of separating the contributions of the different

employees or sections

2. Disputes between lower levels are to be resolved at the highestlevels3. Functional structures are inadequate for a firm with diversified

products , lack of cross functional co-ordination)4. They create silos and prevent cross functional coordination.

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Types of organisations:

2. A Business unit structure:

In this structure, business managers are responsible for most ofthe activities of the particular unit- functioning semi-independently

Each Business unit is with various functions; better co-

ordination; better resolution of disputes at their level itself;performance measured by the profitability of the individualunits;

Headquarters is overall in charge; allocates funds for theoperation of each Business Unit . Approves budgets and judges

performance of each unit, sets their compensation and ifrequired removes the persons. Head quarters establishes thecharter, decides on the product for each unit and thegeographical territory in which they operate and also thecustomers to whom they can sell.

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2. A business unit structure (Contd)Head office establishes company wide policies, assists inproduction and marketing and in specialised areas such aslegal, human resources, public relations, treasury and

controlling matters.The advantage of this model are

1. It provides training ground in general management.

2. Better decision making due to close proximity to thesources of raw materials and resources and markets.

3. The unit can react to a threat or opportunity by itselfand therefore can take required steps more quickly.

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Financial Goal settingFormal Control Systems :Types of organisations:

2. A business unit structure (Contd)The disadvantages are :1. The staff may have to duplicate those functions

which may normally be required to be done in headquarters;

2. Whereas the Business Manager is a generalist,people under him are sometimes specialists leadingto friction.

3. It is uneconomical to use real skilled specialists in

small business units.4. There can also be disputes between Business Unitsdue to infringement of one unit upon the charter ofanother and business unit staff and head officepersonnel.

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Financial Goal settingFormal Control Systems :Types of organisations:3. A matrix structure:In this structure,the functional units have dualresponsibilities. The organisation is divided into differentfunctions, e.g. Purchase, Production, R & D, etc. Eachfunction has a Functional (Departmental) Manager, e.g.Purchase Manager, Production Manager, etc.The organisation is also divided on the basis of projects e.g.Project A, Project B, etc. Each project has a ProjectManager e.g. Project A Manager, Project B Manager, etc.Thus there will be two managers a project manager and afunctional manager.The employee has to work under two authorities (bosses).The authority of the Functional Manager flows downwardswhile the authority of the Project Manager flows across(side wards). Thus the authority flows both downwardsand across. Therefore, it is called "Matrix Organisation".

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3. A matrix structure:Advantages of Matrix Organisation

Sound decisions- all decisions by experts

Development of skills possible

Top management need not concern itself with day to dayactivities

Responds to changes in environment quickly

Specialisation is possible.Optimum utilisation of resources

Motivation

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3. A matrix structure:Limitations :

Increased workload

High operational cost

Absence of unity of command

Difficulty of balance

Power struggle

Morale

Complexity

Shifting of responsibility

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Type of Organisation and Management Control System Design:

It is important that once the nature of the organisation isdecided, the Management control structure should be createdto suit the requirements. The system designer should fit thesystem to the organisation and not the organisation to thesystem.

Functions of the Controller:

Controller is the person responsible for designing and operatingthe Management Control system. In many organisations, it isthe Chief Financial Officer(CFO). The following are his functions:

1. Designing and operating information and control systems

2. Preparing financial statements and reports (including taxreturns) for shareholders and other external parties.

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Functions of the Controller: (Contd)

3. Preparing and analysing performance reports , interpreting thesereports for the managers and analysing the programme andbudget proposals from various segments of the company andconsolidating them into an overall annual budget.

4. Supervising internal audit and accounting control procedures to

ensure validity of the information, establishing adequatesafeguards against theft and fraud and performing operationalaudit.

5. Developing personnel in the controller organisation andparticipating in the education of management personnel in

matters relating to the control function.

6. Prior to advent of computers, the controller was also responsiblefor processing information. Now the function is taken over byChief Information Officer (CIO), who may report to the CFO or

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Financial Goal settingRelation to Line organisation:

Control function is a line function. Controller is responsible for designand operation of the system which collects and reports information.

He is responsible for developing and analysing controlmeasurements and recommending suitable actions to managementin respect of such controls. He may also control spending limitationslaid down by CEO, control the integrity of the accounting system andsafeguard the companys assets from theft and fraud.

But he does not make or enforce management decisions. Thisresponsibility of making decisions and implementing them flowsfrom CEO down through line organisation.

Controller also plays a strategic role in the preparation of strategic

plans and budgets and scrutinises performance reports only toensure accuracy and to call line managers attention to itemsdeserving further enquiry.

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Financial Goal settingBusiness Unit Controller:

He has divided loyalty. On the one hand he owes some allegiance to thecorporate controller who is responsible for the overall operation of the

control system. On the other hand he also owes allegiance to themanagers of his own units, for whom he provides staff assistance.

In some companies he has a direct reporting relation to the BusinessUnit manager and a dotted line (administrative) relationship to thecontroller. In some other companies he reports to the controller

directly.

In case he reports to the Business Unit Manager, the worry is that hemay not present all facts relating to failure of control, if any, adequately.

If he reports to Controller, he could be treated by the unit as a spy of

the head office planted in the Business Unit and not as a trusted aide.However his position requires that he should not condone or participatein the transmission of any misleading information or in the concealmentof unfavourable information. He has an ethical responsibility for hispost.

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Financial Goal settingSome important University questions on this topic :

1. Briefly describe Functional, Divisional and Matrix organisations? How do theseorganisations price their products? What criteria are used to measure their

performance?2. Define Management Control system. Which level managers are involved in it?

How does MCS differ from simpler control processes?

3. Briefly describe the overall framework of management control. How does itrelate to Strategic Planning and operations control ?

4. How do corporate level strategies differ from Business Unit level strategies?How is budgeting done at SBU under different strategic missions?

5. Explain briefly the various stages of management control process, citing salientfeatures of each.

6. Organisations with Business Divisions (Profit centre) format have observedthat Divisional controllers experience divided loyalty in carrying out their

functions, causing a possible dysfunction. How could such a situation beresolved? Define the role of controller with your suggestions.

7. What do you understand by Goal congruence? What are the informal factorsthat influence goal congruence?

8. Write short note on MCS in a Matrix Organisation.

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Thank You

Financial Goal Setting-12012013- Final (2)

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Transcript of Financial Goal Setting-12012013- Final (2)