Management Control System–Week 3


Before Choosing an evaluative methodology, a manager must determine the following:

· How to determine investment priorities (what tangible and intangible benefits must be taken into account?)

· How to assess the risk of each investment

· How to establish a process for managing the realization of expected benefit? This is a long term issue, and

· How to justify the investments (how it fits within the overall strategy?)

Capital vs Labor intensive

Capital intensive : FC(up), VC(down)

Labor Intensive : FC(down), VC(up)

· Untuk menentukan mana yang lebih digunakan

o Buatlah diagram untuk membandingkan titik dimana Labor intensive dan capital intensive bertemu

o Berdasar titik tersebut, maka dapat ditentukan dimana tempat yang lebih menguntungkan capital intensive atau labor intensive.

Why relate profits to investments

· Unless an organizzatio is a 10% service organization, profits are generated ONLY if you have investments

· Therefore, earning a satisfactory return on the investments employed is necessary.

· The investors in stock compute such a return routinely (eg. FORD and GM)

Why relate profits to investments? The manager’s responsibility

· First, a manager should invest in asset only if asset will produce adequate returns

· Second, when an asset is not providing adequate return (the expected return could change over the years), it is time to "disinvest" or reduce further investments into this asset.

Ways to relate profits and investment

· ROA

o Ratio of two numbers

o ROI = Income/avg asset(or investment)

· EVA

o EVA = Net inome – (operating assets*cost of capital)

o Cost of capital

· The minimum return of an organization must earn on its investment to meet investor expectations

· Specific to each organization and depends on several factors such as the type of industry in which it operates, how risky the organization is, the rate at which it can borrow from outside and more (borrowing, inthis context, refers to both debt and equity)

· If an investment return more than the cost of its capita, the investment is positive and if not, it is negative and as well not invested.

How asset values can distort ROA and EVA computations

· ROA and EVA computations are simple

· Depending on the asset based used, they can give misleading signals

· Most long term assets are depreciated

· Everyone comfortable with depreciation computations?

· Depreciation reduces the book value of the assets as they age.

ROI can lead to poor decisions

· Encourages division managers to retain assets beyond their optimal life and not to invest in new asset which would increase the denominator

· Can cause corporate managers to over allocate resources.

· Can lead to different inventory policy

How to deal with this issue

· Don’t use net book value of the asset but use gross book value (original purchase price ignoring depreciation)

Advantage of using EVA (residual income)

· Ranks projects on profits in excess of the cost of capital

· Use the same profit objectives

· Finds any investment that return over the cost of capital as worth investing

What are intangible asset?

· Not all investments are intangible asset

o Contoh : investasi pada pemain bola

· Firm invest intangible asset?

o Introduce new products

o Develop customer relationships

o Approach new customer segments

o Improve product quality and services

o Manage cost, reduce lead times and more

· Measure intangible asset?

o Relative value.

o Balance scorecard

o Competency model

o Subsystem performance

o Benchmarking

o Brand equity valuation

o Calculated intangible value

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