Chapter 2. The Fundamentals of Profit Planning and Control. Omar Maguiña Rivero

Transcription

1 Chapter 2 The Fundamentals of Profit Planning and Control

2 Learning Objectives After studying this chapter, the student will be able to: 1. Describe the fundamentals of a comprehensive PPC. 2. Explain the primary application features of PPC. 3. Discuss the main advantage and some application problems of PPC. 4. Describe basic accounting terms

3 1. Overview of PPC PPC is viewed as a process designed to help management effectively perform significant phases of the planning and control function.

4 Steps of the PPC model 1. Development and application of broad and long-range objectives of the enterprise. 2. Specification of enterprise goals. 3. Development of a strategic long-range profit plan in broad terms. 4. Specification of a tactical short-range profit plan detailed by assigned responsibilities (divisions, departments, projects) 5. Establishment of a system of periodic performance reports detailed by assigned responsibilities and 6. Development of follow-up procedures.

5 Most Relevant Aspects of PPC 1. Requires major planning decisions by management 2. Involves persistent management control activities 3. Recognizes many of the critical behavioral implications throughout the organization The concepts and techniques of PPC, have wide application in individual business enterprises, governmental units, charitable organizations, and virtually all group activities.

6 2. Fundamentals Concepts of PPC 1. A management process that includes planning, organizing, staffing, leading and controlling 2. A managerial commitment to effective management participation by all levels in the entity 3. An organization structure that clearly specifies assignments of management authority and responsibility at all organization levels 4. A management planning process 5. A management control process 6. A continuous and consistent coordination of all the management functions

7 2. Fundamentals Concepts of PPC (cont.) 7. Continuous feedforward, feedback, follow-up, and re-planning through defined communication channels 8. A strategic (long-range) profit plan 9. A tactical (short-range) profit plan 10.A responsibility accounting system 11.A continuous use of the exception principle 12.A behavioral management program

8 3. Managing Planning using PPC The fundamental purpose of management planning is to provide a feedforward process for operations and for control. Feedback is also an important ingredient for both replanning and control. Feedforward, Feedback, and Replanning

9 Types of Projections 1. A reference projection (static case) 2. A wishful projection (the highly optimistic case) 3. A planned projection (the most likely case)

10 Objectives Goals Strategies Profit Plan Strategic Profit Plan Tactical Profit Plan

11 Objectives versus Goals Objectives state the desire broad, long range future state of the enterprise. Goals represent the broad objectives brought into sharper focus by explicitly specifying: Time dimensions for attainment Quantitative measurements Subdivision of responsibilities

12 Time Devoted to Planning versus Control Position Proportion of Time Spent on Chairman of the Board President Executive Vice-President Division Head Department Head Assistance Department head Supervisor Foreman Assistant Foreman Worker The Planning Function The Control Function

13 4. Time Dimensions in PPC Planning horizon: Refers to the period of time into the future for which management should plan. Because all managerial decisions are futuristic, each management is faced with the basic question of time dimension in planning and decision making. How far in the future should the plans extend?

14 Project Planning Focus on each separate project, which may represent either an operational or a nonoperational commitment. Examples: Construction of a new plant or phasing out a current product. Such activities and programs should be planned over their life spans and must be integrated with other activities, programs, and operations of the enterprise.

15 Periodic Planning Environmental necessity for management to plan, evaluate, and control operations within relatively short and consistent periods of time, such as one year Periodic planning encompasses two categories: the tactical or short-range profit plan and the strategic or long-range profit plan One-five approach

16 4. Time Dimensions in PPC

17 The Planning Calendar A management time schedule should be established for initiating and completing certain phases of the planning process Managerial Planning should be viewed as a continuous process at all level of management Certain aspects of planning are best accomplished in a formal way and on a definite time schedule

18 5. Management Control Using PPC Accounting PPC focuses on performance report to determine the causes of both high and low performances. Items Sales Product A MONTH OF MARCH Week 10 Actual Results Planned Results Variation (Unfavorable) Units Amount $ 103,000 $ 100,000 $ 3000 Sales Product B Units (20) Amount $ 24,000 $ 30,000 $ (6,000)

19 Performance Reporting 1. Classified by assigned responsibility 2. Controllable and non-controllable items are designated 3. Timely reports are issued 4. Emphasis is given to comparison of actual results and planned results. Performance reports also should call attention to the possible causes of variances when possible

20 Responsibility Accounting The accounting system must be designed to provide financial information separately for each organizational unit, that is, by assigned authority and responsibility Classifications of cost and revenues used in the profit plan and in the accounting system must be in harmony

21 Activity Costing Decomposition of organization s production process into a discrete activities, and then associating costs with each activities Management is in a better position to determine the costs and benefits of continuing activities and also identify redundant activities

22 Zero-Base Budgeting Process of conducting a thorough, top-to bottom- analysis of the need for expenditures in a budget period A zero-based budget requires managers to justify all of their budgeted expenditures, rather than the more common approach (incremental budgeting) of only requiring justification for incremental changes to the budget or the actual results from the preceding year

23 The Exception Principle Managers should concentrate on the exceptional or unusual items that appear in daily, weekly, and monthly reports. Comparison with the actual results of the prior period is insufficient for the following reasons: 1. Conditions have been changed 2. Accounting classifications may be different 3. Performance in the prior period may have been unsatisfactory

24 6. Organization Adaptation Using PPC Responsibility Centers are classified in respect to the extend of responsibility as follows: 1. Cost Center A manager is responsible for the controllable costs incurred in the subunit 2. Revenue Center A manager is responsible for the revenues. Example: Sales districts 3. Profit Center A manager is responsible for revenue, costs and profit of the center 4. Investment Center A manager is responsible for revenue, cost, profit, and the amount of resources invested in the assets used by the center

25 7. Coordination Using PPC Coordination is the synchronization of individual actions with the result that each subdivision of an entity effectively works toward the common objectives, with due regard for all other subdivisions and with unity of effort. Such a result is often referred to as goal congruence Coordination is attained through effective performance of the management functions. Communication is fundamental to coordination

26 8. Formal versus Informal Budgets Primary reasons for formalization: 1. Management process cannot be effectively accomplished in a random manner 2. The environment must be described by a reasonable degree of stability and consistency upon which people can rely from day to day 3. Objectives, plans and goals, must be written in terms of financial impact on the firm, if not, they frequently turn out to be vague

27 8. Formal versus Informal Budgets (cont.) 4. For effective communication and mutual understanding, formalization of certain objectives, goals, policies, and procedures is essential 5. Formalization requires the establishment and observance of deadlines for decision making, planning and procedures is essential 6. Formalization provides a logical basis for flexibility in implementing the planning and control process

28 8. Formal versus Informal Budgets (cont.) Many aspects of the management process cannot be implemented in a formal way. Informality has merit at all levels of management, and the executive should strive to attain an appropriate degree of balance between the two extremes.

29 9. Flexibility in Applying PPC The PPC approach anticipates exceptions, adjustments, and re-planning as situations evolves The budget must not constrain rational decisions that should be made with respect expenses merely because and expenditure was not anticipated

30 10. Realistic Expectations in PPC A Behavioral Problem Budget goals should represent realistic expectations. To be realistic, expectations must be related: 1. To their specific time dimension 2. To assumed (projected) external and internal environment that will prevail during that time span

31 Objectives and Goals should be Attainable Goals that are set too high that they are practically impossible to attain discourage serious effort to reach them. Alternatively, goals set so low that they require no effort will provide no motivation.

32 Behavioral Impact of Budget on People Employees may consciously strive not to exceed budgeted performance in order to lessen the likelihood that the budgeted performance level will ultimately be set higher Informal groups may be created which serve as springboard for bringing grievances to management on a number of issues

33 Padding the Budget Participation in developing a profit plan may result in subtle (and often obvious) attempts to pad the budget 1. Sales budget are understated 2. Overestimating expenses 3. Requesting more cash than needed Padding of the budget is also referred as budgetary slack.

34 11. Establishing the Foundation for PPC 1. Commitment by top management and a deep understanding of PPC implications and operations 2. Characteristics of the enterprise and the environment must be identified and evaluated 3. Assignment of managerial responsibilities 4. Evaluation and reorganization of the accounting system 5. A policy determination must be made about the time dimensions to be used for profit planning and control purposes 6. A program of budget education should be developed

35 12. Application of PPC to Various Types of Organizations PPC can be adapted to any organization, regardless of size, special circumstances, or conditions A PPC system must be tailored to fit the particular enterprise, and it must be continually adapted as the enterprise and its environment

36 13. Some Arguments against PPC 1. Is difficult, if not impossible to estimate revenues and expenses in our company realistically 2. Our management has no interest in all the estimates and schedules 3. It is not realistic to write out and distribute our goals, policies, and guidelines to all the supervisors 4. Budgeting places to great demand on management time and requires too much paper work

37 13. Some Arguments against PPC (cont.) 5. It takes away management flexibility 6. It takes all kind of behavioral problems 7. It places the management in a straitjacket 8. It adds a level of complexity that is not needed 9. It is too costly, aside from management time 10. The managers, supervisors, and other employees hate budgets

38 13. Some Arguments for PPC 1. It forces early considerations of basic policies 2. It requires adequate and sound organization structure; that is, there must be a definite assignment of responsibility for each function of the enterprise 3. It compels all members of management, from the top down, to participate in the establishment of goals and plans 4. It compels departmental managers to make plans in harmony with the plans of other departments and of the entire enterprise

39 13. Some Arguments for PPC (cont.) 5. It compels management to plan for the most economical use of labor, material, and capital 6. It instill at all levels of management the habit of timely, careful, and adequate consideration of the relevant factors before reaching important decisions 7. It tends to remove the cloud of uncertainty 8. It forces periodic self-analysis of the company 9. It forces recognition and corrective action 10. It forces management to consider expected future trends and conditions