CONTROLLING

- ¢ What is Controlling?

¢ Importance of Controlling

® Steps in the Control Process

* Types of Control

© Components of Organjzational Control Systems

® Strategic Control Systems

¢ Identifying Control Problems

¢ 177
 Chapter 9 of products and services. These could not have happened
if only adequate controls were instituted.

0] OLLING WHAT IS CONTROLLING?

Controlling refers to the “process of ascertaining
The long-term existence of many companies, rnogt whether organizational objectives have been achieved; if
often, is placed in jeopardy when some aspects qf their not, why not; and determining what activities should then
activities ga out of control. Consider the following ex- be taken to achieve objectives better in the future.” Con-
amples: trolling completes the cycle of management functions.
Objectives and goals that are set at the planning stage
1. A news report indicated that the fire which
are verifiedas to achievement or completion at any given
destroyed the 800 million Superferry 7 l_uxury
point in the organizing and implementing stages. When
ship on March 26, 1997 was caused by illegal
expectations are not met at scheduled dates, corrective
connections made on its electrical system." If this
measures are usually undertaken.
is true; the losses could be attributed to inade-
quate management control.
IMPORTANCE OF CONTROLLING
2. The tragedy that happened at the Ozone Disco
in March 18, 19962 clearly manifested manage- When controlling is properly implemented, it will
ment’s Iack of control over the day-to-day opera- help the organization achieve its goal in the most efficient
tions of the firm. Even the failure to detect earlier and effective manner possible.
the violations in the Building Code spells lack Deviations, mistakes, and shortcomings happen
of effective government control. inevitably. When they occur in the daily operations, they
3. The management of a telephone company could contribute to unnecessary expenditures which increase
not stop the unauthorized use of lines assigned the cost of producing goods and services. Proper control
to many of its subscribers. Customers become measures minimize the ill effects of such negative oc-
angry when they are billed for calls they never currences. An effective inventory control system, for
made. instance, minimizes, if not totally eliminates losses in
inventory.
The examples presented constitute a very small
percentage of unwanted occurrences that happefn everyday The importance of controlling may be illustrated as
in the business world. Apart from the destruction of lives it is applied in a typical factory. If the required standard
and property, normal business operations are hampvel_red daily output for individual workers is 100 pieces, all
causing discontinuities in employment and the provision workers who do not produce the requirement are given
sufficient time to improve; if no improvements are forth-
coming, they are asked to resign. This action will help the
‘Dona Z. Pazzibugan, “Crew Blamed for Mega Fire”, Philippine Daily
Inquirer, April 2, 1997, p. 22. P F company keep its overhead and other costs at expected
; “Ruel S. de Vera, “Ozone Spirits Worried About Their Loved Ones’
Philippine Daily Inquirer, April 6, 1997, p. F-1, Higgins, p. G-4.

178 179
 project. cumpletion dates are useful standards. In chemical
levels. If no such control is made, the company will be
manufa_ctunng firms, certain pollution measures form
faced with escalating production costs, which will place
the basis for standard requirements.
the viability of the firm in jeopardy.
Afl:er the performance objectives and standards are
STEPS IN THE CONTROL PROCESS established, the methods for measuring performance
mus? be designed. Every standard established must be
The control process consists of four steps, namely: provided with its own method for measurement.
1. establishing performance objectives and stan-
dards Figure 9.1 Steps in the Control Process

2. measuring actual performance

comparing actual performance to objectives and ESTABLISH PERFORMANCE
standards, and OBJECTIVES AND
STANDARDS
4. taking necessary action based on the results of
the comparisons.

Establishing Performance Objectives and

Standards —o | MEASURE ACTUAL
PERFORMAN
ok
In controlling, what has to be achieved must first be
determined. Examples of such objectives and standards
are as follows:
do nothing
1. Sales targets — which are expressed in quantity
or monetary terms;
; ! DOES ACTUAL
2. Production targets — which are expressed in PERFORMANCE
MATCH THE Yes
quantity or quality;
STANDARDS?
3. Worker attendance — which are expressed in
terms of rate of absences;
4. Safety record — which is expressed in number
of accidents for given periods;
5. Supplies used — which are expressed in quantity
TAKE
or monetary terms for given periods. CORRECTIVE
Once objectives and standards are established, the ACTION
measurement of performance will be facilitated. Standards
differ among various organizations. In construction firms,

180 181
Measuring Actual Performance 2. use more equipment; or

There is a need to measure actual performance so 3. require overtime.

that when shortcomings occur, adjustments could be made.
The adjustments will depend on the actual findings. TYPES OF CONTROL
Control consists of three distinct types, namely:
The measuring tools will differ from organization to
organization, as each have their own unique objectives. 1. feedforward control
Some firms, for instance, will use annual growth rate 2. concurrent control, and
as standard basis, while other firms will use some other
tools like the market share approach and position in the 3. feedback control.
industry.
Figure 9.2 Types of Control and Their Relation to Operations

Comparing Actual Performance to Objectives and

Standards
PRE-OPERATIONS ) < — — — —| Feedforward
Once actual performance has been determined, this Control
~
will be compared with what the organization seeks to s
achieve. Actual production output, for instance, will be ~ X bl A
~
compared with the target output. This may be illustrated |
B |
as follows: ACTUAL >
T AR Concurrent |
A construction firm entered into a contract with the OPERATIONS |
Control
government to construct a 100 kilometer road within ten PHASE
months. It would be, then, reasonable for management |
to expect at least 10 kilometers to be constructed every |
month. As such, this must be verified every month, or if |
|
possible, every week. POST
OPERATIONS e o [ Feadback VT
PHASE Control
Taking Necessary Action
The purpose of comparing actual performance with
the desired result is to provide management with the Feedforward’, Control
opportunity to take corrective action when necessary.
When management anticipates problems and pre-
1f in the illustration cited above, the management of vents their occurrence, the type of control measure
the construction firm found out that only 15 kilometers undertaken is called feedforward control. This type of
were finished after two months, then, any of the following control provides the assurance that the required human
actions may be undertaken: and nonhuman resources are in place before operations
1. hire additonal personnel; begin. An example is provided as follows:

182 183
 The manager of a chemical manufacturing firm makes provemfent are derived, feedback control is undertaken.
sure that the best people are selected and hired to fill jobs. Corrective actions aimed at improving fulure activities
Materials required in the production process are carefully are features of feedback control.
checked to detect defects. The foregoing control measures Feedback control validates objectives and standards.
are designed to prevent wasting valuable resources. If If accomplishments consist only of a percentage of stan-
these measures are not undertaken, the likelihood that fiard requirements, the standard may be too high or
problems will occur is always present. inappropriate.
Concurrent Control Aln example of feedback control is the supervisor
who discovers that continuous overtime work for factory
When operations are already ongoing and activities
workers lowers the quality of output. The feedback infor-
to detect variances are made, concurrent control is said
mation obtained leads to some adjustment in the over-
to be undertaken. It is always possible that deviations from
time schedule.
standards will happen in the production process. When
such deviations occur, adjustments are made to ensure
compliance with requirements. Information on the adjust- COMPONENTS OF ORGANIZATIONAL
ments are also necessary inputs in the pre-operation phase. CONTROL SYSTEMS
Examples of activities using concurrent control are Organizational control systems consists of the
as follows: following:
The manager of a construction firm constantly 1. strategic plan
monitors the progress of the company’s projects. When the long-range financial plan
construction is behind schedule, corrective measures like
the hiring of additional manpower are made.
the operating budget
performance appraisals
Tn a firm engaged in the production and distribution

O
of water, the chemical composition of the water procured statistical reports
from various sources is checked thoroughly before they policies and procedures
are distributed to the consumers.
The production manager of an electronics manu- Strategic Plans
facturing firm inspects regularly the outputs consist- A strategic plan (discussed in Chapter 3) provides
ing of various electronics products coming out of the pro- the basic control mechanism for the organization. When
duction line. there are indications that activities do not facilitate the
accomplishment of strategic goals, these activities are
Feedback Control i
either set aside, modified or expanded. These corrective
When information is gathered about a completed measures are made possible with the adoption of strategic
activity, and in order that evaluation and steps for im- plans.

184 186
The .Long-Range Financial Plan infon?xation which may be found in a statistical report
pertains to the following:
The planning horizon differs from company to
company.* Most firms will be satisfied with one year. 1. labor efficiency rates
Engineering firms, however, will require longer term
quality control rejects
financial plans. This is because of the long lead times

o
needed for capital projects. An example is the engineering accounts receivable
firm assigned to construct the Light Rail Transit (LRT) accounts payable

oe
within three years. As such, the three-year financial plan
sales reports
will be very useful.
As presented in Chapter 3, the financial plan recom-
accident reports

e
mends a direction for financial activities. If the goal does Power consumption report
not appear to be where the firm is headed, the control Figure 9.3 shows a sample statistical report.
mechanism should be made to work.
Policies and Procedures
The Operating Budget
] P'clicies refer to “the framework within which the
An operating budget indicates the expenditures,
objectives must be pursued.” A procedure is “a plan that
revenues, or profits planned for some future period
describes the exact series of actions to be taken in a given
regarding operations. The figures appearing in the budget
situation.”
are used as standard measurements for performance.®
An example of policy is as follows:
Performance Appraisals “Whenever two or more activities compete for
Performance appraisal measures employee per- the company’s attention, the client takes priority.”
formance. As such, it provides employees with a guide on
An example of a procedure is as follows:
how to do their jobs better in the future. Performance
appraisals also function as effective checks on new policies “Procedure in the purchase of equipment;:
and programs. For example, if a new equipment has been 1. the concerned manager forwards a request for
acquired for the use of an employee, it would be useful purchase to the purchasing officer;
to find out if it had a positive effect on his performance.
2. the purchasing officer forwards the request to top
Statistical Reports management for approval;

Statistical reports pertain to those that contain data 3. when approved, the purchasing officer makes
on various developments within the firm. Among the a canvass of the requested item; if disapproved,
the purchasing officer returns the form to the
4James C. Van Horne. Financial Management and Policy, Eight Edition requesting manager;
(Englewood Cliffs, New Jersey: Prentice-Hall, 1989) p. 790.
#James A. F. Stoner, Management (Englewood Cliffs, New Jersey: Prentice- “Rue and Byars, p. 133,
Hall, Inc. 1978) p. 593. "Higgins, p. G-13.
186 187
 4. the purchasing officer negotiates with the low- Financial Analysis
est complying bidder.”
The success of most organizations depends heavily
Figure 9.3 A Sample Statistical Report on its financial performance. It is just fitting that certain
measurements of financial performance be made so that
MORNING STAR CHEMICAL CORPORATION whatever deviations from standards are found out,
Power Consumption Report corrective actions may be introduced.
For the First Quarter 1997
By Department A review of the financial statements will reveal
(in KWH) important details about the company’s performance. The
balance sheet contains information about the company’s
Department January February March Total assets, liabilities, and capital accounts. Comparing the
A 1,000 1,100 1,200 3,300 current balance sheet with previous ones may reveal
B 800 1,400 1,010 3,310 important changes, which, in turn, provide clues to per-
[¢] 1,180 1,650 1,200 4,030 formance.
g2 500 1,100 600 2,200 The income statement contains information about
E 600 455 632 1,687 the company’s gross income, expenses, and profits. When
Total 4,180 5,705 4,642 14,527 also compared with previous years’ income statements,
changes in figures will help management determine if it
Prepared by: did well.
CECILIA AGPALASIN Figures 9.4 and 9.5 show samples of financial
Chief statements.
Accounting Division
Financial Ratio Analysis
It is expected that policies and procedures laid down
Financial ratio analysis is a more elaborate approach
by management will be followed. When they are breached
used in controlling activities. Under this method, one
once in a while, management is provided with a way to
account appearing in the financial statement is paired with
directly inquire on the deviations. As such, poh'cigs_ §nd
another to constitute a ratio. The result will be compared
procedures provide a better means of controlling activities.
with a required norm which is usually related to what
other companies in the industry have achieved, or what
STRATEGIC CONTROL SYSTEMS the company has achieved in the past. When deviations
To be able to assure the accomplishment of the stra- occur, explanations are sought in preparation for whatever
tegic objectives of the company, strategic control sysb?ms action is necessary.
become necessary. These systems consist of the following:
Financial ratios may be categorized into the follow-
1. financial analysis ing types:®
2. financial ratio analysis
“Gup, p. 316.
188
189
Figure 9.4 A Sample Balance Sheet Statement Figure 9.5 A Sample income Statement

MORNING STAR CHEMICAL CORPORATION

MORNING STAR CHEMICAL CORPORATION
Balance Sheet Statement
Income Statement
As of December 31, 1997
For the Year Ending December 31, 1997
(P000) (P000)
Current assets
Cash P 415
Net sales # 12,250
Marketable securities 1,000
Accounts receivable 3,062 Cost of good sold 8,820
Inventory 1,980 Gross profit P 3,430
Prepaid expenses 123 Qperating Expenses
Total current P 6,580 Selling 673
Administrative 653
Noncurrent assets
Depreciation and amortization 600
Gross plant.and equipment £ 11,500
Operating profict 1,504
Accumulated depreciation (2,550)
Other assets and intangibles 50 Interest expense 350
Total assets Profit before taxes 1,154
Taxes 462
Current liabilities Net profit =602
Accounts payable
Notes payable Common dividends P 429
Accrued salaries and wages
Acrrued taxes 1. liquidity
Current portion of long-term debt
Total current 2. efficiency
Noncurrent liabilities 3. . financial leverage
Bank term loan ‘4. profitability
Mortgage
Deferred income tax Liquidity Ratios. These ratios assess the ability of
Total noncurrent a company to meet its current obligations. The following
ratios are important indicators of liquidity:
Stockholders equity
Common stock (par value is #1.00) 1. Current ratio — This shows the extent to which
Pain-in surplus current assets of the company can cover its
Retained earnings current liabilities. The formula for computing
Total stockholders 4 P 7,681 current ratio is as follows:
Total liabilities and stockholders’ equity £15,580
Current ratio = current assets/current
liabilities
190 191
 2. Acid-test ratio — This is a measure of the firm’s Debt to total assets ratio = total debt/total
assets
ability to pay off short-term obligations with the
use of current assets and without relying on the 2. Times interest earned ratio — This ratio mea-
sale of inventories.? The formula is as follows: sures the number of times that earnings before
Acid-test ratio = current assets — inven- interest and taxes cover or exceed the company’s
tories/current liabilities interest expense. It may be computed by using
the following formula: ’ ?
Efficiency Ratios. These ratics show how effectively
Times interest _ profit before tax + interest expense
certain assets or liabilities are being used in the produc-
earned ratio interest expense
tion of goods and services. Among the more common
efficiency ratios are: . Profitability Ratios. These ratios measure how much
operating income or net income a company is able to gen-
1. Inventory turnover ratio — This ratio meas-
erate in relation to its assets, owner's equity, and sales.
‘ures the number of times an inventory is turned
Among the more notable profitability ratios are as follows:
over (or sold) each year. This is computed as
follows: 1. Profit margin ratio — This ratio compares the
Inventory turnover ratio = cost of goods net profit to the level of sales. The formula used
sold/inventory is as follows:
Profit margin ratio = net profit/net sales
2. Fixed asset turnover — This ratio is used to mea-
sure utilization of the company’s investment in 2. Return on assets ratio — This ratio shows how
its fixed assets, such as its plant and equipment.' much income the company produces for every
The formula used is as follows: peso invested in assets. The formula used is as
follows: !
Fixed asset turnover = net sales/nét fixed
assets Return on assets ratio = net income/assets
Financial Leverage Ratios. This is a group of ratios 3. Return on equity ratio — This ratio measures
designed to assess the balance of financing obtained ¢ the returns on the owner’s investment. It may
through debt and equity sources. Some of the more be arrived at by using the following formula:
important leverage ratios are as follows: Return on equity ratio = net income/equity
1. Debt to total assets ratio — This ratio shows how
much of the firm’s assets are financed by debt. IDENTIFYING CONTROL PROBLEMS
It may be computed by using the following for- Recognizing the need for control is one thing, actually
mula: implementing it is another. When operations become
complex, the engineer manager must consider useful steps
5. Fred Weston and Eugene F. Brigham, Essentials of Managerial Finance in' controlling. Kreitner mentions three approaches:'*
(Chicago: The Dryden Press, 1990) p. 287.
1Terry S. Manes, Introduction to Corporate Finance (New York: McGraw-
Hill Book Company, 1988) p. 47. Kreitner, p. 529.
192 193
 executive reality check efficiency and effectivity of the activities of an organization.
comprehensive internal audit
Among the many aspects of operations within the orga-
nization, a small activity that is not done right may
general checklist of symptoms of inadequate continue to be unnoticed until it snowballs into a full blown
control problem.
An example is the resignation of an employee after
Executive Reality Check
serving the company for 15 years. After one week, another
Employees at the frontline often complain that employee with ten years of service also resigned. Both
management imposes certain requirements that are not were from the same department. If after another week,
realistic. In a certain state college, for instance, requests a third employee is resigning, a full investigation is in
for purchse of classroom materials and supplies take last order. Even if the source of the problem is identified, it
priority. This is irregular because requests of such kind may already have caused considerable losses to the
must be of the highest priority considering that the organization. A comprehensive internal audit aims to
organization is an educational institution. Ironically, detect dysfunctions in the organization before they bring
because certain officers of the nonacademic staff have bigger troubles to management.
direct access to the president, their purchase requests
almost always get top priority. Later on, when the pre- Symptoms of Inadequate Control
sident made an inspirational speech on quality teaching,
If a comprehensive internal audit cannot be availed.
many members of the faculty just shrugged their shoul-
of for some reason, the use of a checklist for symptoms
ders and listened passively.
of inadequate control may be used.
One school, the Central Luzon State University,
Kreitner has listed some of the common symptoms
provides a good example on how the executive reality check as follows:'?
may be exercised. It requires its executives to handle at
least one subject load each. What the executives will 1. An unexplained decline in revenues and profits.
experience in the classroom will make him more responsive 2. A degradation of service (customer complaints).
in the preparation of plans and control tools.
" 3. Employee dissatisfactian(ccmplafints,p—ievances,
The engineer manager of a construction firm could, turnover).
once in a while, perform the work of one of his laborers.
In doing so, he will be able to see things that he never 4. Cash shortages caused by bloated inventories
sees inside the confines of his air-conditioned office. or delinquent accounts receivable.
Because the said action exposes the engineer manager to Idle facilities or personnel.
certain realities, the term “executive reality check” is very
appropriate. Disorganized operations (work flow bottlenecks,
excessive paperwork).
Comprehensive Internal Audit 7. Excessive costs.
An internal audit is one undertaken to determine the
1*Kreitner, p. 530.
194 196
 8. Evidence of waste and inefficiency (scrap, QUESTIONS FOR REVIEW AND DISCUSSION
rework).
1. Why is controlling a very important management
It must be noted that behind every symptom is a funetion?
problem waiting to be solved. Unless this problem is clearly
identified, no effective solution may be derived. Never- What is controlling? Is it applicable to the day-
theless, problems are easily recognized if adequate con- to-day activities of the engineer manager?
trol measures are in place. Why is the establishment of performance object-
ives and standards an important step in the
SUMMARY control process?

Controlling is one of the main functions of manage- . Compare and contrast the three distinct types
ment. It comes after planning, organizing, and directing. of control.
Controlling is aimed at determining whether objectives How do strategic plans provide a basis for control?
were realized or not, and if not, by providing means for
‘What are policies? In what ways do they facilitate
. achievement.
control?
Controlling is important because it complements the
‘When the engineer manager reviews the finan-
other management functions.
cial statements of the company under his super-
Controlling is a process consisting of various steps, vision, what benefits does he derive?
namely: establishing performance objectives and stan- What are financial ratios? How may they be
dards, measuring actual performance, comparing actual categorized?
performance with objectives and standards, and taking
necessary action based on the results of the comparison. ‘What is measured in the debt to total assets ratio?
How may it be computed?
Controlymay be classified either as feedforward,
concurrent, or feedback. 10. Do you consider “idle facilities or personnel” as
a symptom of inadequate control? Why or why
Organizational control systems consist of the stra- not?
tegic plan, the long-range financial plan, the operating
budget, performance appraisals, statistical reports, policies
SUGGESTED ITEMS FOR RESEARCH
and procedures.
1 List down the control activities that may be useful
Strategic control systems consist of financial analy-
to any of the following: ;
sis, and financial ratio analysis.
a) the construction of a bridge
There are means to identify control problems. They
are the executive reality check, the comprehensive inter- b) the manufacture of microchips
nal audit, and the general checklist of symptoms of in- c) the installation of a power plant
adequate control. d) the manufacture of tricycles
196 197
Case'9. GOOD MUSIC BROADCASTING CORPORATION: operations so that the overall income will increase. He
Ebb Tide feels that the sales report is useful, but he believes some
Engineer Frederick Panganiban was reading the other data may help him make a better decision.
advertising sales report handed to him by his assistant.
The report contains information consolidated from the
ten radio stations owned and operated by Good Music
Exhibit A
Broadcasting Corporation (GMBC). These stations are
located in the various parts of the country. GOOD MUSIC BROADCASTING CORPORATION
Consolidated Advertising Income
GMBC headquarters and sales office are located in For the Three-Year Period, 1995, 1996 and 1997
Makati. GMBC derives income from advertisements lodged (P000)
by companies like San Miguel Corporation, Ayala Life, and
others. The sales office receives the cassette tapes and . Station ; Adveitising Income
written text containing the advertising messages of the
1995 1996 1997
client companies.
1. Dagupan P 15450 P 16998 P 17,038
The tapes are meant to be played at regular intervals
2. Santiago 12,338 11,465 10,308
in all of the ten radio stations operated by GMBC. The
written text is an alternate advertising form read by the 3. Cabanatuan 10,440 12,444 14,486
radio announcers at regular intervals. An advertising 4. San Pablo 8,988 7,676 6,493
message does not exceed one minute. The advertisers are
5. Naga 11,048 12,121 8,788
billed depending on the frequency of exposure of their
messages. 6. Dumaguete 11,540 10,001 9,494

FEach station is managed by a station manager who 7. Tacloban 12,490 12,500 12,606
reports directly to Engineer Panganiban, the general 8. Cebu 20,465 22,030 24,848
manager. The stations are allowed to accept local adver- 9. Davao 16,370 17,017 18,644
tisements subject to availability of slots after accommo-
10. Zamboanga 13,466 12,506 11,897
dating the national advertisers.
Total P132,595 P134,758 P134,602
A certain portion of the advertising income is credited
to the account of the individual stations depending on the
assignments sent to them by the GMBC headquarters.
The total advertising income of a station consists of the
credited account from the head office plus whatever income
from local advertisers is derived.
Engineer Panganiban is now reviewing the consoli-
dated sales report. He wants some improvement in

188 199