Introduction:

-> Is the CONTROL part of the Plan & Control Cycle:

GOALS:

-> CEO & Shareholders.

-> Indicators:

• Value-based Indicators;
• Accounting-based Indicators;
• Value Drivers: fast;

-> The hp that we can deploy a long-term strategy is not applicable: it’s difficult to foresight what will happen in 10 years. (we assume we can still do that).

PLAN of ACTIONS (Budgeting):

-> DEF: how define the plan of action that aims at reaching the goals set before, scorecards are used to show the connections among indicators.

-> Indicators:

• Target Values: indicators developed for the employee;
• Budgeting Scorecards: indicators that lead the strategy in the accounting.

-> Useful for monitoring and reporting (Standard & Actual Data).

MEASUREMENT of ACTUAL RESULTS:

-> DEF: ability to cost out what the company did or to cost out an organizational unit, a product, etc…

-> INDICATORS:

• Cost Accounting: in moocs.
• Actual Values;

VARIANCE ANALYSIS > REPORTING SYSTEM:

-> DEF: needed to compute the variance between target & actual values in order to introduce some feedback (corrective actions).

-> Cover the variance analysis and part of the communication of the variance analysis

Example:

-> We have the target and the actual results of 2020:

-> We need to understand the composition of variations of the different targets (what did the company did good/wrong? What feedbacks should be put in place?)

-> We need to use the conceptual map (we can use the scorecards both to define the strategy to define the plan of action, but also to understand the potential variations and the corrective actions. )

FIRST LOOP LEARNING: Variance = Actual – Targets (simplistic knowledge);

SECOND LOOK LEARNING: Test of Hypotheses,  we try to verify the assumptions and if they truly reflect what is happening (every arrow in the balance scorecard is a hypothesis). For example, according to the Jaguar scorecard, we should have had higher gross profit because we increased the customer satisfaction and reduced the time to install. This means that the assumptions were wrong (why the model doesn’t work?)

Management Reporting:

-> DEF: process of communication to a manager who is responsible for the allocation or the use of specified resources of information regarding current & expected performance that are relevant for its decision-making.

• Shape the Value Three to find the right correlation between information and indicators.
• Are the most relevant source of information for managers.

-> CHAR of the INFORMATION:

• Relevant: a good manager have to understand what are

the relevant information (every manager have different

needs: not all the data are relevant);

• Reliable: managers need reliable informations;
• Timely: information are consistent to the time.

Takeaways:

1. Reporting must be based on a reliable understanding of the reasons that generated the variations between actual and targets;
2. Incentives must reinforce favourable behaviours;
3. Accounting-based indicators are relevant but are not enough: try to explain that the main reason of the variations has been the poor quality of raw materials through such indicators;
4. Organizational Units are intertwined and the result of one Unit affect the result of the others (cybernetic view of the company).

MANAGEMENT REPORTS: are the most relevant source of information for managers.

-> Structure & Contents might change according to:

1.ADDRESSEES:

• Board of Directors (C-levels)/ Chief Executive Officer;
• Head of Divisions (Country Manager, Product Manager);
• Headd of Functions (Sales Manager/ Operations Manager).

2.PURPORSES:

• Pure monitoring of actual performance vs variance analysis;
• Identification of the reasons of variances to support correactive actions (changes to existing plans for the months to come)

3.FREQUENCY: dailty vs weekly vs monthly vs quarterly vs annual reporting.

Organigram of a Company:

-> DEF: Represent the structure of the company.

• Top = CEO, under the different functions (= operational, finance, personnel, legal);
• Under the COO there are 3 divisions/ businessess units at the organizational level.

-> In a Cybernetic view, every Business Unit has different responsabilities (that are theoretical)

1.REVENUE CENTRE = An organizational unit whose manager has control over revenues, but not over costs or investment funds

• Has the capability to affect its results (manager can choose only about prices & volumes sales);
• Sales unit.

2.COST CENTRE = An organizational unit whose manager has control over costs, but not over revenues or investment funds;

• Resource consumption is related to volume of production;

• Operations are connected to cost => Costs are in function of volumes;
• Related to Product costs;
• Operations / logistics.

3.EXPENSE CENTRE = An organizational unit whose manager has control over costs, but not over revenues or investment funds;

• Resource consumption is NOT related to volume of production (period costs);
• Accademic term, is not used in the working world;
• Related to Period costs (=> based on the incremental approach or Zero Based Budget).
• Marketing, R&D, Personnel;

4.PROFIT CENTRE = An organizational unit whose manager has control over BOTH costs and revenues, but no control over investment funds.

• Have control over both, is the Business Unit manager.
• OBJ of these is to maximise EBIT.

5.INVESTMENT CENTRE = An organizational unit whose manager has control over costs, revenues, and

investments in operating assets.

• Profit center where the manager have the freedom to decide about capital expenditures.

🔗Connect to budgeting process.

📌Cost center and expense center is a terminology used in academia.

Hierarchy Levels:

-> A Reference Framework for us:

Decentralization of Reporting:

-> To have different responsibilites => we need to provide informatio to managers of units.

=> We Spread the information from the top to the botton, we decentralize the information;

=> ⚠We risk losing the big picture!!!

Reporting Framework:

-> Organization formed by the Corporate with a number of Business Units (organizational level). Inside each BU, we have the different Responsibility Centers (functional layer): revenues center, cost center, expense centers.

✔ PROs

❌CONs

• Top management freed to concentrate on strategy (they can’t waste time in solving every problem in the company –> we should avoid “micromanaging”) • Lower-level managers gain experience in decision making –> training, developing decision-making capabilities • Decision-making authority leads to job satisfaction • Lower-level decision often based on better  information • Improves ability to evaluate managers (top managers have the responsability to prepare future managers)

• May be a lack of coordination among autonomous managers (the more the units are autonomous, the higher the risk of misalignment) • Lower-level managers may take decisions without seeing the “big picture” • Lower-level manager’s goals may not be those of the organization (people have personal goals)

=> The company can decentralize by balancing pros & cons.

• Closer to the problem, faster & easier to solve them.

=> The company can decentralize by balancing pros & cons.

• Closer to the problem, faster & easier to solve them.

Reporting Requirements:

-> It is important to discuss the requirements for the reporting system.

• Completeness: to what extent the report contains all the relevant information
• Measurability: to what extent the report should contain easy, measurable information, like the average cost per unit, or the price. ex. customer satisfaction is not really measurable.
• Long term: to what extent the information should be oriented to the long-term
• Timeliness: to what extent the information should be easily accessible and available in real time
• Specific responsibilities: the capability to understand the performance of each BU
• Stability across time: important for external accountability

Corporate Level:	Business Units:
-> FOCUS ON the compelteness: need to consider all the parameters because they are responsible forall the decisions.	-> FOCUS ON (short-term) achieving targets on the next financial period.
Long-term orientation: managers oversee the straetegy & must understand the implications of choices (guarantee the survival over time). Capability to generate value;	Parts of their salary will be based on their targets => they need to know the formula to reach them. Measurable parameters; Timeliness: must know if something is not working well when they have still time to fix it; Specific responsabilities: they are interested in parameters that are relevant speciically for them.

-> Knowing the pros and cons of the indicators we can create this table:

• Value based indicators (EV and E): long-term oriented +

 complete (include the competitive advantages of the

 company), not easily measurable, they are calculated

 over a long period of time;

• Value drivers: very measurable, very timely (thanks

 to the fact that they give early signs), easy to identify

 the specific responsibility;

• Accounting-based indicators: in the middle.

-> Given these two tables we can create a theoretical reference for organizing the management reporting process:

1)CORPORATE LEVEL:

• Most important indicators: EV & E;
• Indicators connected to shareholders’ perspective (ROE & NPV);
• Can use some value drivers connected to the real competitive advantages of the company;

2)BUSINESS UNIT LEVEL:

• Focused on the short term (12 months);
• Intrested in cash generation;
• Backbone: accountinng-based indicators: must guarantee the results in the financial statements.

3)RESPONSIBILITY CENETRS:

• Need information about costs & revenues;
• Their main interest are value drivers;
• They need to be very fast in making decisions;

-> Managing report is crucial: all parts should work together.

Corporate Level:

-> Typically, management reports for C-level managers, are based on these chapters:

A. The external (exogenous) landscape

-> DEF: pages that describe what’s happening outside the company.

• (macro-economic indicators – GDP values and trends in the main market countries, inflation rates, interest rates, currency exchange rates, other important facts occurred in the period, etc.)

-> All the chiefs are provided with the most relevant parameters, it’s like a short PEST analysis. They need to set the strategy and the actions based on what is happening in the market.

B. The Income Statements

-> DEF: EBIT (IS) is the first reflection of the strategy and the monetarization of the competitive advantages.

• For a Group: Income Statement of the consolidated companies (the Holding, the Subsidiaries)
• For each company: the total Income Statement, the Income Statement of each Strategic Business Unit / Division

-> The Income Statement must be explained and aligned with the strategy.

C. The Cash Flow Statements

• Focus on Cash Flow from Operating Activities
• Relationship with the Cash Flows from Investing and Financing Activities

-> The capability of a company to generate cash is fundamental. Also, is important because it means that the company is able to fund additional investments and grow.

D. Information about the state of progress of the investment plan

(use of capital budget)

-> How is the company proceeding in the investment plan? There could be some delays.

E. Other (complementary) information about:

• State of progress/results of specific (strategic) projects
• Drill-downs on specific geographical markets
• Other (often non-financial) information (market shares, time-to-market, customer satisfaction, carbon footprint, sentiment analysis on social media, etc.)

The starting point is the profitability analysis with a focus on the Income Statement

• The traditional framework includes actual vs budgeted data, where variances (deviations) are also reported (absolute and % values);
• Usually the statement includes at least two sections:
  • Actual vs budget values concerning the last timeframe (in case of monthly reporting: last month);
  • Cumulated actual vs. budget values for the Year-To-Date (YTD);
• In some cases a further section is added, which includes the expected results for the whole year (usually called “forecast” or “pre-closing”) vs. the total budget values (as from initial budget) and/or vs. previous forecast (if any)
• Sometimes actual and budgeted data are compared also with the corresponding actual data of previous year to enable a “Year-To-Year” comparison;

Business Unit:

-> We need to find the IS in the IS of the different segments.

-> Reporting at the Business Unit level relies mainly on accounting-based indicators to be applied to the Income Statement till the EBIT. To generate it, two relevant issues arise:

1. CORPORATE COSTS: are costs, at the corporate level, on behalf of the Business Units, like…

-> R&D: is not a BU but is centralized, Marketing; Legal Offices or HR Functions.

-> These are not BUs but services that the BU pay for have them.

1. Consider intra/inter company exchange, in terms of products, services, consultanci.

-> Using Transfer Pricing we are able to do that.

-> Existing transactions with other BUs within the company.

SPECIFIC RESPONSAIBLITIES: is when a BU is responsable for a project.

❓What creteria do we use to allocate costs? If the final result of the project was a fail, shat happen? Who pay?

Corporate Costs:

-> BU are profit centers:

• Don’t have the ability to make investments;
• GOAL: maximise EBIT;

-> Strategic BU: investment centers:

• Ability to make investment decisions.

=> We will consider BU as profit centers.

-> In our framework we are at the Business Unit Level:

Segment Margin:

-> DEF: is the performance of the BU considering just Revenues & Direct Costs.

Segment Margin = Revenues  – Direct Costs (variable + fixed)

• Identify the results achieved by the BUs

-> Cost Classification:

• Variable costs = DM + DL + manufacturing OVH (es. energy);
• Fixed costs = non-manufacturing OVH (ex. Rent).

=>

Contribution Margin = Revenues – Variable costs;

Contribution Margin per Unit = Price per Unit – Variable Cost per Unit;

EBIT = Contribution Margin – Fixed Costs

-> Type of IS:

• BY NATURE: shows the EBITDA, first proxy of cash flows.

-> Used in small/ medium enterprises;

-> Cost classified according their nature (labor, materials, D&A, rent, etc);

• BY FUNCTION: shows the specific responsibilities of the different organizational units (budgeting process);

-> Used in benchmarking: compare product costs & period costs;

-> Cost classified in period & product costs.

-> ⚠Comparing the EBIT is the same number even if we change the scheme. Only the costs are different (change the cost allocation method). Bottom lines are the same numbers.⚠

-> Why Segment Margin:

1. Break down the problem & going more in detail to identify the reasons behind the variance;
2. Connected to Specific Responsibilities: segment margin only considers direct costs => it maximise the specific responsabilities.

Example to Calrify (2)

-> BU_A, BU_B are the segments margin.

-> EBIT is when we are including all costs.

-> It’s better to analyse the IS as ratio, for this we devide everything by revenues.

-> BU_A can be not larger enought to cover the variable costs. The BU would have a differentiation strategy, but the price is still low.

Corporate Costs:

-> DEF: are costs run at the corporate level ON BEHALF OF THE BUs and typically these costs are not traced.

-> EX: R&D activities, legal activities, brand marketing campaigns, IT security, finance costs, HR unit.

ENTITY: any part of the organization that want to cost out.

Traceable vs Non Traceable Corporate Costs:

1.TRACEABLE/ DIRECT corporate COSTS: are those corporate costs that can be specifically and exclusively identified with a particular BUSINESS UNIT:

• If the R&D department carried out applied research on behalf of BUSINESS UNIT (A), the incurred costs are DIRECT to BU (A)
• Can be specifically identify for every BU;

2.NOT TRACEABLE/ INDIRECT corporate COSTS:  are those costs that cannot be identified specifically and exclusively with a particular BUSINESS UNIT:

• If the R&D department carried out basic research on behalf of the whole company, the incurred costs are INDIRECT to the Bus.

-> ⚠No one want to cover indirect Corporate Costs, because is not clear to whom they are.

-> The CFO decide what are the one traceable and what are not.

Strategies:

-> Let’s have a look for the INDIRECT corporate costs (direct are yet allocated):

1.No Allocation:

-> DEF: associatio of the INDIRECT Corporate Cost and BU is unclear

• Small/medium enterprises (minimal financial litterature);
• Prject/Activities are generating failures;
• The company is the corporate (Brand marketing).

✔PROs	❌CONs
-> No costs for running the system No discussion; No traking & no costs for that.	-> Risk of uncontrolled use of resources. Corporate costs are unknown.

-> EXAMPLE:

• We can divide by 3;
• The Top-Level Management is paying for them => we are not allocating correctly: we are not computing the EBIT but we’re allocating the Segment Margin (performance of the BU while we are considering just revenues & direct costs)

2.Complete Allocation:

-> DEF: corporate level wants to charge different units/ segments to all the costs.

• Corporate level find a way to allocate costs to different BU.
• We are computing the EBIT of the BU and the sum of the EBIT of BU is equal to the one of the company.

-> CRETERIA: cost are allocated accordingly to…

• Serivces Delivered;
• Benefits Generated: benefits that these activities generate for the different BU. ❓How we can measure them? -> We use some default drivers:
  • Revenues (advantages are proportional the revenues);
  • Full Time Equivalent (FTE) amployees.
  • Contribution Margin (Revenues-Variable Costs): we allocate the costs to  the BU that has the contribution margin to sustain them.

✔PROs	❌CONs
Managers know that corporate services are not for free	Need of precision Risk of not using services even if they are needed

-> EX:

Data:

• Capacity internal consulting =200h
• Overall costs = 50 000€

Business Units:

• BU(A)= use 100 h;
• BU(B) = use 60h;

=> PROBLEM: we know the cost per hour only in the end of the period.

3.Partial Allocation:

-> DEF: maximise the specific responsability principle, we are not to allocate all the indirect corporate costs.

• Feasable only if corporate costs are services (we are debating about specific costs)
• Only if cost are allocated by nature
• Contribution margin per unit = selling price per unit – variable cost per unit.
• Contribution margin total = contribution margin per unit * sales.

-> EXERCISE:

• There is a spare capacity (an extra capacity that is not needed).

✔PROs	❌CONs
-> Specific responsibilities -> Clear decision-making Not risk of not asking a services when it’s needed. It’s fair to charge a corporate level of a cost of something that is not used? -> The corporate is responsable for this.	-> It cannot be applied to all types of corporate costs

-> EX: using the same data:

=> Partial Allocatoin (fees):

Cost per hour: 50.000€ / 200h = 250€/h (👁 cost per hour known before consumption); Cost BU(A)= 250€/h * 100h = 25.000€

Cost BU(B) = 250€/h * 60h = 15.000€ Cost NOT allocated = 50.000€ – 40.000€ = 10.000€

=> These cost remain as Corporate costs: the spare capacity is responsability of the corporate level.

Example:

-> The company X, giving the following IS at Nov. 2023, can organize it by Contribution Margin or Segment Margin:

Contribution Margin:	Segment Margin:
-> CM organizes costs in Variable & Fixed; -> Useful for Short-Term decision making; -> CM per unit: m = SPU – VCU -> CM_tot = Revenues-Variable Costs 📌Management is disappointed with the company’s performance & is wondering what can be done to improve profits.

Responsibility Centre Levels:

-> OBJ: reporting at the responsibility centers level (at the single organizational unit’s level).

-> We are moving in our framework:

-> We are moving in our framework:

-> Is formed by:

• Revneue centre;
• Cost centre;
• Expenditure centre;

📌 Goals are not coherent with Cybernetic approach, the goals of these enters should be to meet the targets, not to overperform.

EXPENDITURES CENTRES: they have power over costs which are not connected to the volume of activity (period costs).

-> We budget them using the Zero-based approach or an incremental approach.

-> The traditional reporting is not applicable: we cannot apply the theory about the variation of the volume and efficacy.

=> We do an analysis line by line: no capability to provide additional information to explain what happened.

Variable vs Fixed Costs:

-> DEF: Knowledge of how costs will vary with different levels of activity/volume is essential for decision-making / reporting

• VARIABLE COSTS: vary in direct proportion to the volume of activity.

Thus, the total variable costs are linear, and the variable cost per unit is constant (examples: direct materials, direct labour, sales commissions).

• FIXED COSTS:  remain constant over wide ranges of activity for a specified time period. The total fixed costs are constant for all levels of activity, whereas fixed costs per unit decrease proportionally with the level of activity (examples: depreciation of machines, supervisors’ salaries, rent of office space).

📌Concept of FC & VC is valid only in a specific range of variation of the volume of activity/sales (small, typically 30% variation): when we increase the volue of sales => we need to increase the # of employees/ equipment etc…

-> Costs/ Revenues Relationship:

-> EBIT: difference between red line and green line.

-> BREAK EVEN: point inwhich REVENUES = TOT COSTS, EBIT = 0.

(ACCOUNTING, Break Even: revenues meet total costs; FINANCE, Break Even: cash in-flow meet cash out-flow).

EBIT line: expected value of EBIT in a budgeted process according to a different level of sales.

• Starting point < 0 : Sales = 0, VC = 0, FC > 0.

EBIT budget: EBIT budgeted before, resulted from standard data;

EBIT actual: EBIT that we measure once the real volumes are sold;

EBIT flexible: expected value of ebit once we knoe the real value of sales

•  the real volume of the EBIT that we can compute having Standard Data and real value of the Revenues.

-> We can distinguish two variations:

EFFICIENCY VARIATION = EBIT actual – EBIT flexible	VOLME VARIATION = EBIT flexible – EBIT budget
-> DEF: variation due the efficiency of the company.	-> DEF: variation due to the simply increase of sales.

=> We have to study the reason behind Efficiency Variation:

Short Case:

-> Given the Budted & Actual measurements…

1. Eliminate Period Cost: they are period, don’t depend on the manager in charge o the centre.

-> Is not its Specifically Responsability.

1. We compute the Total Product Costs:

1. Create the FLEXIBLE BUDGET: the expected budget knowing from the beginning the volume of sales

4. Compare the flexible to the actual => The variation is positive.

-> The Efficiency Variance is responsibility of the Cost Center, we have to understand the reasons behind this:

=> We need to generate another FLEXIBLE BUDGET to disentangle the variation due to the variation of the usage and the variation due to the variation of the price.

=> To calculate the FLEXIBLE BUDGET per unit, we need to multiply the actual usage and the standard price.

• This is because the usage is responsibility of the responsibility centers, while the price is not.

• FLEXIBLE BUDGET (budgeted use per unit) –  FLEXIBLE BUDGET: is due to ΔUSE that is responsibility of cost centers.

-> If we look at the difference, the operations manager has been able to reduce the usage of materials per unit (good performance).

• ACTUAL – FLEXIBLE BUDGET (budgeted use per unit): is due to ΔPRICE that is NOT responsibility of cost centers.

-> If we look at the difference, the actual number is higher because this means that the price per unit has increased –> but this is not responsibility of the operations manager (it depends on the procurement manager).

❓Which are most important? Selling Price or Sales?

Revenues = selling price per unit * sales

-> We have to distinghish between company price taker (company that are not in condition to decide the price. They are in competition, in a fluid market) company and price maker.

• In a company price taker the manager is not responsible for the price (they are the majority) => is interest to sales.

-> Sales depend on:

• Demand (market size);
• Market share, could depend on the price.

-> Theory tell us that we are not able to influence the market size => It’s relevant to control the market share.

• Key parameter: is the market shares.

=> Variance of the USAGE is the only one which is a Responsibility of the Cost Centers:

• Δ Volume: responsibility of the sales manager;
• Δ Price: responsibility of procurement manager;
• Δ Cost of labor: responsibility of the HB unit.

-> Connec these with the excercise of budgeting.

-> All the units are ALWAYS interconnected. Don’t have a look to just one unit.

-> Is a very slow analysis, non financial indicators are better.

Conclusion:

=> To Sum Up, we intergate these information with Value Drivers:

-> The variance analysis follows an hierarchical approach:

• I level: Total variance;
• II level: Volume variance and Efficiency variance;
• III level: Use, Price/cost

-> At each level we introduce a device for dividing different contribution to the total variance, an intermediate budget called: flexible budgets: they are a combination of actual and budgeted figures.

1° Level:

Total Variance = Actual Costs – Budgeted Costs:

2° Level:

-> At this second level analysis is usually detailed dividing the contribution of:

• Direct Material Costs;
• Direct Labour Costs;
• Fixed Costs;

3° Level, example direct labour:

Direct Labour Cost (product i) = Cost per unit (€/u) * Volume (u)

-> The third level is only for variable costs to further analyse the

efficiency variance will be divide between:

• Cost/ Price of input (Material, Labour);
• The quantity used for each unit of product.