-> Last part of the course: PLAN & CONTROL.

TARGETING: means set the goals (that we can connect with the balanced scorecards) and it’s linked with the concept of budgeting.

Timing: till now the analysis was about the past with the ratio analysis. To compute the Enterprise value and the Equity value we need the future financial statements.

-> We can divide the future in two periods: the analytical period and the terminal value.

• Analytical period > HP: we are able to draft the financial reports for the next years.
• Terminal value > We use because for the faurther years, the ability to predict financial report decreases.
• => Different Tools:
• EV & E: when we are inside the organization;
• Relative Evaluation: when we are outside the company & we don’t have enought informations.

From Outside to Indise:

EXTERNAL ACCOUNTABILITY: is the one in charge to do the ratio analysis, indeed we use document that are disclosed outside the company.

INTERNAL ACCOUNTABILITY: is in charge to find the data that are relevant for the actors inside the company (like employees, managers, organization units…).

-> In the internal accountability the level of standardization decreases because every company organize itself in a different way.

• There are no standards;
• Information are internal (POV middle line manager)

TRADE OFF: share everything vs share nothing.

Management Accountability:

-> DEF: is the process* of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management** to paln and control within an entity and to assure appropriate use of and accountability*** for its resources.

*Sequence of different alternatives.

**Both Middle and Top Managers.

***Managers are accountable for the result and the use of resources.

Source: CIMA (Chartered Institute of Management Accounts)

• It comprises the preparation of financial reports for non management groups such as shareholders, creditors, regulatory agencies and tax authorities. (definition by: Chartered Institute of Management Accounts)

-> Capability of manage, analyze, share the data that

     are inside.

-> Usually the role is taken by a consultant.

-> GOAL: have manager that can control.

-> CEO needs data, manager accounting are the one that produce these data.

The Plan & Control Cycle:

PLANNING: we meant the period of the next two years. M-L Manager try to maximize the profit for this period.

-> The idea of Cycle comes from cybernetics.

CYBERNETICS: part of information science that refers to robotics and aim to understand how different part of the same system can work together for a shared goal, which is the movement in a certain direction, in a certain way.

-> IDEA: there are different element in complicated system (the company) that need to move in a coherent way in order to achieve a common rule (maximise EV & E).

• Organizing people =! Organizing mechanical part: with pwople we need leadership, motivation, inventives

=> With Cybernetic approach we meant:

CYBERNETIC APPROACH: the main idea is to align different part of the organization to achieve a common goal, the maximization of the EV –> we do this alignment through the PLAN & CONTROL CYCLE.

-> GOAL:

• Long-Term: maximize the Equity Value (ROI, EBIT, Value Based indicator).

The Plan & Control Cycle

-> CHAR:

• Can be applied for thenext 12 months;
• If the strategic plan is over 10 years we have to create 10 sub period composed by 1 year (because the FS refers to a specific year).

-> All these components need to be allined, armonized to achieve common goal (Cybernetics).

1.Goal:

-> DEF: Short-Term Goals are in term of

• Financial Indicators: ROE, ROI, ROS, ATR, D/E, CF from operating activities
• Non-financial indicators: customer satisfaction, delivery time, carbon footprint

-> Plan and Control Cycle comprehend the next 12 months (for this is short terms goals).

-> They must be intresting: they have to meet the expectation of the stakeholders.

2.Resources:

-> DEF: needed to achieve goals. They are all Resources made available to Managers

• From the Financial Statements: Machinery, patents, brands, money etc.
• Not included in the Financial Statements: Employees, Competencies, Data owned, Network & Relationship etc.

-> Tangible and non tangible.

-> Verify the coherence of Resources & Goals of the company.

3.Paln of Actions:

-> DEF: actions that the different parts of the organizations should implement to make the most out of the resources to meet the goals.

❓What the different Business Units / Organizational Units of the enterprise should do in the next 12 months to meet the expected Goals against the Recourses that will be made available?

4.Measure the Actual Results:

-> DEF: what are the actual result that company have achieve;

• Periodically measured (every 3/4 months, startup every week).

5.Variance Analysis:

-> DEF: we measure the “distance” between actual results and targets (goals) to see potential allinement or misallinement.

❓Why do they differ? Is the result of external or internal contingencies?

• Controlling = regulate the system.
• Uderstand why/ what are the reason for that the real data are different from the goals.

6.Feedback:

-> DEF: What Managers should do differently to align actual results and targets:

• Is the corrective action;
• Change the plan of action: Reducing the goals, increase the resources.
• To do it we need the reason.

-> Overlooking the Plan & Control Cycle, four systems are identified:

BUDGETING SYSTEM:

-> DEF: define the plan of action.

• Is the capability of the company to draft the plan of action.

CONTROL SYSTEM:

-> DEF: Measure the results of the company based on the cost accounting;

• Capability to cost out (margin of the company, of segment) needs to measure.
• Cost accounting

REPORTING SYSTEM:

-> DEF: understanding of the variance but even the communication of it to manager.

• Include variance analysis and part of arrow. Is not just the analysis of the reason of variance but even communication of these to the manager that are in charge to change it.

INCENTIVE SYSTEM:

-> We are not dealing with it.

-> This is included because employees are not mechanical parts but need motivation in order to move in the right direction. This motivation could be based on money, or on reputation, and other kinds of gratification.

Budgeting System:

1.Introduction:

-> In a  company…

• The CEO want to increase the market shares > they are connected to the size and with cost advantages (valid for every company).
• The functions need a direction: once the function knows what to do => they need to start thinking about the actions to be taken to reach that goal.

1.Chief Executive Officer:	2.Production Manager:	3.Marketing Manager:	4.Sales Manager:
-> DEF: need the target Increasing the market share of X%. Without the target is completely useless.   => Functions – Goals: -> DEF: what are the activity that company should do to reach the result.	-> DEF: Increase the production volumes. -> ACTIONS: Buy new equipement; Ousource to have it in less time.	-> DEF: Improve the brand -> ACTIONS: Changing the package; Advertise to promote product quality;	-> DEF: increase the sales. -> ACTIONS: Hire new salsesmen; Reduce the prices.

-> We want to avoid the spaghetti organization effect…

SPAGHETTI ORGANIZATIONS:

• Is not a clear direction: noodles are annoded in a very difficult way;
• Oticon;
• Don’t have a strategy, go beyond the budgeting, have an human approach.

CYBERNETIC APPROACH: All the elements should move in an armonized bay to achieve the company’s goals.

2.Budgeting:

-> DEF: set of procedures and activities aimed at assigning to organizational units targets – i.e. reference values for their performance – and resources needed to achieve these results.

-> CHAR:

• Starts in April and conclude in November;
• Time consuming, long process;
• Is a plan of actions, then these are valorized with currency, but the final goal is to tell to manager:

“These are your targets and these are your resources to achieve them”

-> It’s not only a money matter!

• Is an aid to coordinating what needs to be done to implement that plan;
• Is the quantitative expression of a proposed plan of action by management for a specified period;

-> It involve:

• Managers responsible for organizational units;
• Other employees working within organizational unit affected by target setting;
• Accounting and finance functions supporting the process.

-> The output of the budgeting process is the…

MASTER BUDGET: is a document, a collection of budgets that allow the company to produce the financial reports for the next year.

• Is the output, it expresses management’s operating and financial plans for a specified period;
• Comprises a set of budgeted financial statements;
• Collection of actions collected in three category (typologies of budget):

3.Operating Budgets:

-> CONTENT: define the tycpical management of a business as they define the sales, the revenue, the economic flow of raw materials, labour, services.

-> CHECK: the ECONOMIC equilibrium: Reveneues VS Operating Costs.

-> OUTPUT: Budgeted EBIT.

1.Target Settings:

-> DEF: The CEO negotiates the targets in terms of financial ratios with the shreholdrers.

 

2.Budget of Revenues:

-> DEF: The CEO invites the Marketing Manager & Sales Manager to agree the expected quantities that will be sold for every product-line at a certain price, every month, in the bvarious geographical markets, through the different channels (retail vs internet).

 

3.Budget of Production

-> The CFO invites the…

• Logistic Manager (that oversees the level of the inventories of the finished goods and the sdervice level agreements (SLAs) with the distirbutors/ final customers) to agree the expected inventories to meet the expected SLAs.
• Operations Manager (who oversees the production of finished goods) to verify that the budget of production defined so far will be feasible considering the resources (materials, labour hours, machine hours) that will be made abailable;

-> It must evaluate different alternatives to make the budget of production feasible and, once identified noe, confirms the production-mix to the CFO.

-> The OM considers as cost the typically called standard data.

STANRARD DATA: prediction, estimation, not actual, of the production cost.

• Technical guess, best guess about some data in a condition of normal efficient.
• Tipically you compare them (actual & standard).

-> Type of Companies:

Top-Line Companies: are those companies that are completely focus on the top line.

• Company want to maximise the revenues (penetration of market, market shares).
• The operation manager can’t say that the capacity is not feasable.
• 99% of the companies.

Bottom-Line Companies: companies are focus on capacity available.

• They’re few;
• Are companies with difficult production processes.

-> PROBLEMS:

• Increase machines hours: long term strategy.
• Ending inventories: can be critic for stockout.
• Planned maintenance: risk to be dangerous for employees, could produce low quaility products, could be dangerous for machiens.

-> In short term could be a solution.

• Reduce the machine hours for each unit: these are standard data. Is the best guess in condition of normal efficiency. To do it we have to redesign the product, teach to employees.
• Third-part supplier: important to verify the convenience.

-> If the cost is too high than the price it depends. Not satisfy the demand could be problem for the company.

-> Contribution Margin would be used in short term, but not in long term => Is not useful in this problem.

-> Budgeting involve every manager.

4.Budget of Cost of Goods Sold:

-> The CFO supported by the plant controllers, who know the bills of materials & production cycles, calculate the expected full product cost of every product-line.

 

5.Budgeted Gross Margin:

-> The CFO knowing the budget of revenues and the budget of COGS can budged the gross margin.

 

6.Budget of Period Costs:

-> The CFO involves the Managers of the other Function to budget the period costs:

• Sales & Marketing: all the budget of the Sales/ Marketing department;
• Administrative (the budget that cover all HR, finance unit,…) & General (Other unit like office, canteen, quality office, control office, R&D).

-> There are two approaches:

• Incremental Approach;
• Zero-based Budget (ZBB).

Incremental Approach:

-> DEF: The budgeted period costs of year (t) are calculated on the costs incurred the previous year (t-1).

Budgeted Period Costs (t) = Actual Period Cost (t-1) * (1+α)

a: coefficient that takes into account…

• Inflation: it affect the cost of materials;
• Expected growth of the company (So we need more cost/sources for this growth)

-> They are not able during the budgeting: we do budgeting between april to november of the year. We don’t have yet the cost of the year => We do a frecast.

->IDEA: We assume that we don’t have any formula => We try to leverage the past.

-> In Zero-Inventories approach a < 0. -> We are challenging the managers, they have to find solutions because every year they have less sources & they have to find creative way to reduce costs, to be more efficient.

• E.g. Toyota company.

⚠️We don’t have to stretch too much, otherway people will be frustrated.

✔️PROS: efficient but…

• It’s simple;
• Low cost of implementation.

❌CONS: …blind.

• Not reliable;
• Risk to inflating some cost that will not encour next year;
• Amplifications of errors (una tantum expenses).

ZBB, Zero-Based Budget:

-> DEF: The Budgeted Period Costs are redefined every year

• Each Manager has to:
  • Define the minimum set of resources required for running the Unit;
  • Propose additional “packages” of initiatives.

-> IDEA: every manager is asked the minimum level to achieve all the essential activities for their function. Than they have to tell other opportunities. Is a budget that is based on the minimum lay of activities and after we build the other.

✔️PROS:

• Creative on other activities;
• Efficient;
• Theoretically more precise.

❌CONS:

• Time consuming: company need to interact with managers.
• Risky: people commit errors & managers try to hide some resources or ask more budget.

-> Tipically is difficult to do every year => Usually companies do it every 3/5 years and during these years they use the Incremental Approach.

-> There are other method but is not proved that they are working.

• Activity Based Budgeting (evolution of Activity Based Cost, developed by Kaplan) but is a limitation.

-> Tipically is difficult to do every year => Usually companies do it every 3/5 years and during these years they use the Incremental Approach.

-> There are other method but is not proved that they are working.

• Activity Based Budgeting (evolution of Activity Based Cost, developed by Kaplan) but is a limitation.

7.Budget of EBIT:

-> The CFO, knowing the budged of period costs can budged the operating margin (EBIT).

-> CFO don’t reach the target => Game Over, company is not meeting the target and recycle the process with other assumptions.

• Connect to the bugeting model top-down or bottom-up.
• Many cases you do 15 times (start april, finish november).

-> IDEAS:

• Reduce period costs: because is very difficult to re-engage the Marketing & Sales Manager, is very frustrating and time consuming. And would be very frustrating for them. The numbers that they found wouldn’t change: we use the standard Coist => We can’t modify revenues and COGS in short term.
• If we are near to the target, managers have to change a lot, if the distance would be to wide they have to change everything.
• And we are not able to forecast the correct number of the period cost. they are necessary evil. Are costs that are not incorporated in product, but are necessarily.
• Typically period cost are not more than 30% of revenues.
• When company are in diffiuclt, the first people to be fired are these. They wouldn’t fire the logistc or the operating part: they are the core of the business.
• R&D cost are the maximum costs that you incour to risk activities, the maximum money that company incour without achieving nothing.

Budgeting of Capital Expenditures:

-> OBJ: outlines amount and timing of capital expenditures (CAPEX);

-> CONTENT: define the use of financial resources (cash outflows) to sustain the growth strategy (i.e. planned instalments for the purchase of assets).

-> CHECK: the TECHNICAL equilibrium: Available vs Needed Capacity.

-> OUTPUT: Budgeted CAPEX.

❓Difference between Investment & Strategic Investment?

• Both risky and related to long term and create CA;
• Definition is very blured and not everywhere accepted.
• Investments: in the WACC is not changing, his profile don’t change to much.
• Strategic Investments: are so radical that WACC could change significally and increasing a lot.

-> Is the variation in Cost of Capital.

Financial Budgets:

-> DEF: help us to forecast the budgeting cash flow statement.

CASH BUDGET: document that aim to evaluate the budget inflows and outflows of the organization.

-> Aproaches:

• DIRECT APPROACH: registration, line-by-line fo the cash inflows and cash outflows.

-> Used only by the small enterprises: line are not so mabny and manager know what are the main cash flows for the next year.

• INDIRECT APPROACH: adjust the I.S. in order to pass from an accrual logic (accrual principle) to a cash logic (financial principle).

-> The Cashflow Statement classifies cash inflows/ outflows in three category:

1)CASH FLOW from OPERATING ACTIVITIES:

-> DEF: cashflows generated by the operating, financial & fiscal (taxes) activities.

-> Reflects all the elements in the I.S. (Revneues, Operating Costs, Financial Costs, Taxes)

-> False Friend: we have the cash flow;

-> Consider payment of bend interest.

2)CASH FLOW from INVESTING ACTIVITIES:

-> DEF: cashflows generated by the acquisition or disposal of non-current assets.

-> Consider the capital expenditures;

-> Variation of BS.

3)CASH FLOW from FINANCING ACTIVITIES:

-> DEF: cashflows generated by changes in the equity capital and financial debts.

-> Variation of liabilities & equity.

• Equity: issue in shares or decrease of the equity.
• Liabilities: increase/ decrease of financial debts/ bonds.

-> Variation of BS.

Budgeting Cash Flows Statement:

📌Indirected Approach.

-> The final step is to evaluate the closing CASH availability to verify the financial equilibrium for the next 12 months.

Steps:

1.The EBIT, D&A comes form the operating budgets.

• EBIT = Budgeted EBIT (it understimate the  cash flow, becasue fo the nature of D&A => We need to go for EBITDA);
• D&A is a cost, but is not a cash outflow.

2.∆ NET OPERATING WORKING CAPITAL: not all the revenues/cost are cash in/out-flows.

• Account Receivables:

– AR(t) = how compute this?

-> DSO usually 3 months => Revenues are payed 3 months later.

+ AR(t-1) = yet known, result of last year.

• Inventories: considers the variation of inventories with their relative cost.
• Account Payable:

3.We compute the…

• Cahs Flow from Operating Activities;
• Cash Flow from the Investment Activities;
• Cash Flow from the Financing Activities.

-> In the End the Closing CASH (t) have to be… Closing CASH (t) ≥ 0!

📌 The only that trust you at first business are the 3 F: Family, Friends, Fools.

⚠️ The Cash Flow statement doesn’t highlight the situation of the sub-periods across the year.

-> E.g. cash inflows concentrated at the year end, problem of liquidity at the beginning of the year.

✔️=> We can define a different cash budget detailing the situation throughout the year, per semester, per quarter, per montly.

Budgeted Financial Statements:

-> The last step in the Master Budget is drafting the complete Budgeted Financial Statements:

• Completing Income Statement,
• Defining Balance Sheet,
• Defining Cashflow Statement;

-> Once we will have all Budgeted Financial Statements, we will apply Financial Analysis through Ratios/Absolute Indicators to verify that the plan of action will meet shareholders’ goals.

• For example if the target was a certain value of the ROA we compare the one compute to the target.