Financial Goal Setting-12012013 - Final

Financial Goal setting
K.Viswanathan
4/26/2013

Financial 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 to accomplish 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 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 the funds of an organisation are estimated in advance. Financial forecasting helps in making decisions on capital investments, annual production 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 and micro economic factors and comes to some estimates of the financial requirements and the ways of meeting them. It starts with predicting future events which will have a significant effect on the firms business in the future, leading to its success or failure. Thus forecasts will lead to setting up of the goals of the firm and these goals can later on be converted to operational plans for action.
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Techniques 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 account 3. 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 going wrong.
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Approaches 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 resources 6. 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 to raising 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 sources of funds and the company.
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b. Modern Approach: The modern approach is an analytical way of looking at the financial problems 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 are carefully assessed. The finance manager calculates the different capital expenditure projects and selects the best out of them so as to conform to the overall objectives of the firm. The criteria for evaluating the different investment proposals and the priorities for selection are determined before selecting them.
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Economic Value added : Economic Value Added or EVA is an estimate of a firm's economic profit being the 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 by the firm less the cost of the firms capital. The idea is that value is created when the return on the firm's economic capital employed is greater than the cost of that capital. Calculating EVA EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital. The basic formula 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 advertising and other non-cash items
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EVA 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 provide capital 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).
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EVA Calculation: ( Contd) The capital charge is the cash flow required to compensate investors for the riskiness of the business given the amount of economic capital 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 making the 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.
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Free Cash Flow: In corporate finance , free cash flow (FCF) is cash flow available for distribution among all the securities holders of an organization. They include 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- Net Increase in Working Capital- Capital expenditure 2. When Net profit and Tax shield rate applicable are available, you can 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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Free Cash Flow Calculations: (Contd) 3. When PAT and Debit/Equity ratio are available: Profit after Tax- changes in capital expenditure (1-d) + depreciation and / or amortisation (1-d) Increase in Working capital ( 1-d) where d = Debt/ Equity Ratio
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Definition 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 by revealing 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 100 Net 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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Earning 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 a company's profitability. Calculated as: Net Income (after Interest) Dividend on preference stock Average outstanding shares When 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 number of shares outstanding at the end of the period.
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'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?
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'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 = 12.5 lakhs).
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P/E Ratio: If there is one number that people look at than more any other number, it is the Price to Earning Ratio (P/E). The P/E looks at the relationship between the stock price and the companys 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 the companys EPS (Earnings Per Share as shown previously) P/E = Stock Price / EPS For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / 8) = 5
What does P/E tell you? Some investors read a high P/E as an overpriced stock. However, it can also indicate the market has high hopes for this stocks future and has bid up the price. Conversely, a low P/E may indicate a vote of no confidence by the market or it could mean that the market has just overlooked the stock. Investors can make their fortunes spotting these overlooked but fundamentally strong stocks before the rest of the market discovered their true worth. 16 4/26/2013
Inter-relationship between P/E and EPS: EPS plays a major role in calculation of P/E. EPS is the denominator in the calculation 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 after payment of dividend to the preference shares is low or if the average number of outstanding equity shares is high. An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.
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Return 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 Investment Cost of Investment
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Return 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 the broadest sense just attempts to measure the profitability of an investment 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 its respective marketing expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product. This flexibility has a downside, as ROI calculations can be easily manipulated to suit the user's purposes, and the result can be expressed in many different ways. When using this metric, make sure you understand what inputs are being used.
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Organisational 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 under him. The CEO and in some organisations the top management decides the overall strategies which will help the organisation to reach its goals. The management control process is the process by which managers at all levels ensure that the people under them implement the intended strategies. Management Control systems are tools to implement strategies. Strategies differ between organisations and control systems should be tailor made to meet the requirements of strategies. Strategies are plans to achieve organisational goals. Some typical organisational goals are as under:
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Understanding Strategies
1. 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 4/26/2013 21 return on investment will be comparatively less.
2. Maximising Shareholder Value: Achieving satisfactory profit is a better way of stating the corporations goal. There is no way to know what can be maximum shareholder value. Although optimising the shareholders value is a major goal, that is not the only goal in many 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 greater than proportionate increase in revenue is welcome. A course of action which increases profit with less than proportional increase in shareholders investment (or no additional investment at all) is also welcome.
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3. Minimising Risk: Profitability and risk are inversely interlinked. There is always an upper limit for risk exposure to which a firm may want to subject itself to. 4. Multiple stake holder approach: (Acer Group Examplecustomer, employee, share holder) Organisations have stakes in three marketsCapital - shareholders Product - purchasers of goods and services Factor - employees and raw materials ( Employee satisfactionLincoln Electric) Management Control systems should identify goals for each of these groups and develop scorecards to track their performance.
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Concept of strategy: Strategy describes the general direction in which an organisation plans to move to attain its goals. A firm develops its strategies by matching 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 Group
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Concept 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, except perhaps financing . They grow through acquisition. Business Unit Strategies: Competition between diversified firms does not take place at the corporate level. Rather a Business unit of one firm (Proctor and Gambles Pampers Unit will compete with similar business unit of another firm (Kimberley Clarkes Huggies unit). Revenues are earned and costs are incurred by the business 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 its industry to accomplish its mission ?)
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Business Unit Mission: One of the important tasks of management in a diversified firm is to use the cash generated in one business unit to finance the unit in the other business units. Several planning models have been developed to enable managers to effectively deploy the resources. The most widely used ones are Boston Consulting Groups two-by-two growth-share matrix and General Electric Company / Mc Kinsey & Companys three-by-three industry attractiveness-business strength matrix . While the models differ in the methodologies they use to develop the most appropriate missions for the various business units, they have the same set of missions from which to choose: build, hold, harvest and divest. Build: It implies an objective of increased market share even at the expense of short term earnings and cash flow Hold: To protect the business units market share and competitive position Harvest: Objective is to maximise the short term earnings and cash flow even at the expense of market share Divest: Decision to withdraw from business either through a process of slow liquidation or outright sale.
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Strategic Implications Resource allocation recommendations can be made to grow, hold, or harvest a strategic business unit based on its position on the matrix as follows: Grow: Strong business units in attractive industries, average business units in attractive industries, and strong business units in average industries. Hold: Average businesses in average industries, strong businesses in weak industries, and weak business in attractive industries. Harvest: Weak business units in unattractive industries, average business units in unattractive industries, and weak business units in average industries. There are strategy variations within these three groups. For example, within the harvest group, the firm would be inclined to quickly divest itself of a weak business in an unattractive industry, whereas it might perform a phased harvest of an average business unit in the same industry. 4/26/2013 27

In 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 competitive position of each SBU is assessed.
Recommended Business Strategies
Industry Attractiveness
High Average
Invest/ Grow strongly (Build) Invest/ Grow selectively (Build)
Invest/ Grow selectively (Build) Earn/ Protect (Hold)
Dominate / Delay/ Divest Harvest / Divest
Low
Earn/ Protect (Hold)

Strong
Harvest / Divest
Average
Harvest / Divest
Weak
Business Strength
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Business 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. The structure of an industry is to be analysed in terms of the collective strength of the following 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 industries with higher profitability, these forces are less powerful (soft drinks and pharmaceuticals). Otherwise, the forces are strong ( Steel, coal etc.) 4/26/2013 29
(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 of scale 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 an equivalent cost or equivalent customer value for a lower cost. The value chain is the complete set of activities from extraction of raw materials to post delivery support to the customers. Value chain analysis seeks to determine where in the companys operations customer value gets enhanced or costs get lowered. For each value added activity the questions are 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 delivery system.
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Behaviour in organisations
What is Goal Congruence? Senior management wants the organisation to attain the organisations goals. But individuals have their own goals. The central purpose of the management control system is to ensure (in so far as it is feasible) a high level of goal congruence- i.e. actions taken by the people serve the purpose of attaining the goals of the organisation incidentally fulfilling their own individual goal achievement. An adequate control system will not encourage individuals to act against the best interest of the organisation. For example, if the system emphasises cost reduction and a manager responsible responds by reducing cost at the expense of quality or reduces cost in his own unit by imposing more-than- offsetting increase in another unit, we can say the manager is motivated, but in the wrong direction. So we need to consider: 1. What actions motivate people to take actions/ decisions in their own self- interest? 2. Are they in the best interest of the organisation?
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Informal factors that influence Goal Congruence: It is important for the designers of formal systems to take into account the informal processes , such as work ethics, management style and culture because in order to implement organisation strategies effectively, the formal mechanism should be consistent with the informal ones. External Factors: Set of attitudes collectively referred as work ethic, manifested in employees loyalty to the organisation, their diligence, their spirit and their pride in doing a good job (rather than just putting in time). Sometimes attitudes and norms are industry specific. For example rail road industry is different from aviation industry. Sometimes they go 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 systems and Intel. They have maintained the reputation of Silicon Valley as the centre of Technological innovations.
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Internal factors: Organisations own culture- Most important. Common beliefs, shared values, norms of behaviour and assumptions that are implicitly accepted and explicitly manifested throughout the organisation. Organisations culture exists for many years. Some things are simply not done, through nobody knows why. Eg. Johnson & Johnson and the Tylenoid crisis Management Style: Since an institution is the lengthened shadow of a man, juniors follow managers, who follow the CEO. Several types of managers- Charismatic and outgoing, less ebullient, some spend 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 and informal control over the manager from a person other than to whom the manager is reporting. Thus the realities of management control cannot be understood without recognising the importance of informal relationships within the organisation.
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Informal Control Systems : Internal factors: (Cont) Perception and communication: Operating managers receive the information about the goals of the organisation from a number of formal sourcesofficial communications, meetings etc. and informal sources like conversations. Still, many a time the common goal cannot be stated with absolute certainty and clarity. For example, the budget mechanism may convey the impression that managers are supposed to aim at the highest profits possible in a year by adopting all cost cutting measures, but the management may not actually want cost cutting applied in employee training and efficiency improvement measures. Thus the information operating managers receive as to what they are supposed to do is vastly less clear than the information received by the cooling system of the air-conditioner from the thermostat.
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Formal Control Systems : Rules : These are all types of formal instructions and controls including standing instructions, job descriptions, standard operating procedures, manuals and ethical guidelines. Rules may range from the most trivial to the most sophisticated (rules for issuance of paper clips to budget approval for huge expenditure) Some rules are for ever. Some rules can have exceptions, based on circumstances and best judgment of people. Such departures normally require approval. Some rules require certain actions to be taken periodically eg. fire drills. 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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Formal Control Systems : 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 and other such physical controls. Manuals: Judgment has to be used in deciding what rules should be written in the manuals. Some rules have to be treated as guidelines rather than fiats and sometimes discretions have to be allowed. Manuals in bureaucratic organisations are more detailed than in other organisations; large organisations have more manuals than smaller ones; organisations with more dispersed geographical units performing similar functions have more manuals than single site organisations. Manuals and rule books therefore have to be re-examined and reviewed periodically to prevent them from becoming outdated. 36 4/26/2013
Formal Control Systems : System Safeguards: Safeguards are built into the information processing system to ensure that the information flowing through the system is accurate and to prevent (or minimise) fraud of every sort. These include crosschecking totals with details, requiring signatures and other evidences of checking and authorisations, separation of duties, counting cash and other portable assets frequently and other procedures mentioned in audit manuals. Checking is also performed by internal as 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 are performed by systems automatically, the automated system itself provides the controls.
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Formal Control Systems : Formal Control Process: A strategic plan implements the organisations goals and strategies. All available information is used in making this plan. The strategic plan is converted into an annual budget that focuses on planned revenues and expenses for individual responsibility centres. The performance of the responsibility centres are measured and reported. Actual results are compared with the budgets to determine if the performance was satisfactory and rewards and corrective actions are the results of these.
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Formal Control Systems : Types of organistions: A firms strategy has major influence on its structure, which in turn influences the organisations management control systems. The structure of an organisation can be any one of the following three: (i) Functional (ii) Business or (iii) Matrix 1. A functional structure: This is a structure with each manager having responsibility for a specified function such as production, marketing etc. The advantages are the opportunity to use specialised knowledge an improve competency. The disadvantages are 1. 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 highest levels 3. 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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Formal Control Systems : Types of organisations: 2. A Business unit structure: In this structure, business managers are responsible for most of the activities of the particular unit- functioning semiindependently Each Business unit is with various functions; better coordination; better resolution of disputes at their level itself; performance measured by the profitability of the individual units; Headquarters is overall in charge; allocates funds for the operation of each Business Unit . Approves budgets and judges performance of each unit, sets their compensation and if required removes the persons. Head quarters establishes the charter, decides on the product for each unit and the geographical territory in which they operate and also the customers to whom they can sell.
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Formal Control Systems : Types of organisations: 2. A business unit structure (Contd) Head office establishes company wide policies, assists in production and marketing and in specialised areas such as legal, 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 the sources of raw materials and resources and markets. 3. The unit can react to a threat or opportunity by itself and therefore can take required steps more quickly.
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Formal 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 head quarters; 2. Whereas the Business Manager is a generalist, people under him are sometimes specialists leading to friction. 3. It is uneconomical to use real skilled specialists in small business units. 4. There can also be disputes between Business Units due to infringement of one unit upon the charter of another and business unit staff and head office personnel.
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Formal Control Systems : Types of organisations: 3. A matrix structure: In this structure,the functional units have dual responsibilities. The organisation is divided into different functions, e.g. Purchase, Production, R & D, etc. Each function 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 Project Manager e.g. Project A Manager, Project B Manager, etc. Thus there will be two managers a project manager and a functional manager. The employee has to work under two authorities (bosses). The authority of the Functional Manager flows downwards while the authority of the Project Manager flows across (side wards). Thus the authority flows both downwards and across. Therefore, it is called "Matrix Organisation".
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Formal Control Systems : Types of organisations: 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 day activities Responds to changes in environment quickly Specialisation is possible. Optimum utilisation of resources Motivation Higher efficiency 4/26/2013 44

Formal Control Systems : Types of organisations: 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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Formal Control Systems : Type of Organisation and Management Control System Design: It is important that once the nature of the organisation is decided, the Management control structure should be created to suit the requirements. The system designer should fit the system to the organisation and not the organisation to the system. Functions of the Controller: Controller is the person responsible for designing and operating the Management Control system. In many organisations, it is the Chief Financial Officer(CFO). The following are his functions: 1. Designing and operating information and control systems 2. Preparing financial statements and reports (including tax returns) for shareholders and other external parties.
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Formal Control Systems : Functions of the Controller: (Contd) 3. Preparing and analysing performance reports , interpreting these reports for the managers and analysing the programme and budget proposals from various segments of the company and consolidating them into an overall annual budget. 4. Supervising internal audit and accounting control procedures to ensure validity of the information, establishing adequate safeguards against theft and fraud and performing operational audit. 5. Developing personnel in the controller organisation and participating in the education of management personnel in matters relating to the control function. 6. Prior to advent of computers, the controller was also responsible for processing information. Now the function is taken over by Chief Information Officer (CIO), who may report to the CFO or directly to CEO. 4/26/2013 47
Relation to Line organisation: Control function is a line function. Controller is responsible for design and operation of the system which collects and reports information. He is responsible for developing and analysing control measurements and recommending suitable actions to management in respect of such controls. He may also control spending limitations laid down by CEO, control the integrity of the accounting system and safeguard the companys assets from theft and fraud. But he does not make or enforce management decisions. This responsibility of making decisions and implementing them flows from CEO down through line organisation. Controller also plays a strategic role in the preparation of strategic plans and budgets and scrutinises performance reports only to ensure accuracy and to call line managers attention to items deserving further enquiry.
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Business Unit Controller: He has divided loyalty. On the one hand he owes some allegiance to the corporate controller who is responsible for the overall operation of the control system. On the other hand he also owes allegiance to the managers of his own units, for whom he provides staff assistance. In some companies he has a direct reporting relation to the Business Unit manager and a dotted line (administrative) relationship to the controller. In some other companies he reports to the controller directly. In case he reports to the Business Unit Manager, the worry is that he may 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 participate in the transmission of any misleading information or in the concealment of unfavourable information. He has an ethical responsibility for his post.
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Some important University questions on this topic : 1. Briefly describe Functional, Divisional and Matrix organisations? How do these organisations 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 it relate 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 salient features of each. 6. Organisations with Business Divisions (Profit centre) format have observed that Divisional controllers experience divided loyalty in carrying out their functions, causing a possible dysfunction. How could such a situation be resolved? Define the role of controller with your suggestions. 7. What do you understand by Goal congruence? What are the informal factors that influence goal congruence? 8. Write short note on MCS in a Matrix Organisation.
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Thank You
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Financial Goal Setting-12012013 - Final

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Financial Goal Setting-12012013 - Final

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Financial Goal setting