Cost Analysis, Profit Planning, and Control

1. Cost Analysis, Profit Planning, and Control MBA 603 Chapter 14 - Service Organizations

2. Overview • 2003 finds that the service sector is roughly 80% of GDP for the United States. • Service Organizations have many different facets than manufacturing operations in terms of : • Measuring costs • Measuring Productivity • Measuring Returns on Assets

3. Characteristics • Absence of Inventory Buffer in service organizations does not provide protection from sales fluctuations. • They must minimize unused operating capacity. • Costs are very fixed in the short run. • Key variable is matching current capacity.

4. Characteristics - Continued • Service organizations attempt this matching process in two ways: • They try to stimulate demand in non-peak periods by lowering prices and increased marketing programs (Cruise Lines). • They adjust their workforce to demand levels by scheduling training in slack periods and giving time off when people work more during peak business seasons (CPA Firms).

5. Characteristics - Continued • Difficulty in Controlling Quality - manufacturing companies can inspect products and measure quality while, service companies cannot until the service is rendered. • Labor Intensive - manufacturing companies can add equipment and automation to reduce headcount, while service companies are labor intensive and depend on staffs to be effective.

6. Characteristics - Continued • Multi-Unit Organizations - Service organizations that operate many units in various locations, each unit is small. • Multi-Unit Organizations - similarity of units provide common basis for analyzing budgets and performance. • Multi-Unit Organizations - Units differ in the mix of services , resources used, and need to be analyzed carefully.

7. Professional Service Organizations • Service Organizations such as law firms, accounting firms, advertising agencies, etc., have Special Characteristics. • Goals of a Professional Organization are: • Maximize skill of professional staff by providing adequate compensation for the staff. • Increase the size of the organization and equate it with success and potential higher compensation.

8. Professional Service Organizations - Continued • Professionals prefer to work independently, rather than as part of a team. • They are usually not good managers because they focus on their professional skills through training. • They usually do not focus on financial implications of their decisions or work habits.

9. Professional Service Organizations _ Continued • Output and Input Measurement is difficult for professional organizations. • Revenues earned is one measurement tool. • Work done by staff members are usually non-repetitive - no 2 consulting jobs are alike. • Professional do not like to keep track of their time - tradition or concealment? • How to effectively charge clients is a problem.

10. Professional Service Organizations - Continued • Small Size is a normal profile for a service organization , usually in one location. • Because of the small size there is less of a need for profit centers and formal reporting systems. • Budgets are utilized in most professional organizations to control costs and maximize revenues, etc.

11. Professional Service Organizations - Continued • Marketing and production are clearly defined in manufacturing and only senior management cares. • Marketing is key also in professional organizations but harder to conduct because of ethical codes, laws, and industry standards. • It is hard to assign credit for sales contracts etc., with rewards being subjective.

12. Management Control Systems • Pricing in professional organizations is traditionally established in many firms. • Fees are related to time spent by level of management expertise with a loading for overhead costs. • The profit component is affected by producing a satisfactory product, including the risk of not doing it well and those staff members not generating revenue.

13. Management Control Systems - Continued • Strategic Planning and Budgeting in professional organizations usually are not as sophisticated as manufacturing firms. • Since most service firms are people orientated they develop their long range plans around staffing needs. • Capital Asset purchases are analyzed in a similar fashion as most manufacturing firms, but with an emphasis on productivity gains.

14. Management Control Systems - Continued • Control Of Operations is focused on scheduling the time of professionals. • Billed time ratio - ratio of hours billed to total professional hours available is a key monitoring metric. • Work being performed by project teams has control focused on on projects. • A written plans for each project are designed and timely reports prepared to measure overall performance.

15. Management Control Systems - Continued • Performance Measurement and Appraisal for the majority of professionals is very difficult. • Judgements by superiors are common with more organization utilizing formal collection processes as a basis for personnel decisions. • Appraisals by ones professional peers or subordinates is employed. • Budgets are used to measure cost performance and control of discretionary expenses. • Some firms use internal audit procedures to control quality.

16. Financial Service Organizations • These organizations include commercial banks, thrift institutions, insurance companies, and securities firms. • They primarily manage money. • Some act as: • Intermediaries • Risk Shifters • Traders

17. Financial Service Organizations - Continued • Several observations about the financial services sector: • 2002 saw financial service organizations produce $400 billion or 5% of GDP • Deregulation has blurred the industry and geographical boundaries. • Information technology has revolutionized the industry creating new products and trading methods. • Controls for the sector have become critical. • New forms of financial instruments (derivatives) have created huge losses.

18. Financial Service Organizations - Continued • Corporate scandals of 2002 created push for investment banking firms to spin off their research departments. • Pros of Spin Off: • It will insure objective research data. • Cost is being subsidized by investment banks but, if people have to pay for it quality will rise. • Investor confidence will rise if people believe it is unbiased data.

19. Financial Service Organizations - Continued • Cons of Spin Off: • Costs will rise upon separation. • Best researchers will join investment banks that pay well which will leave independent firms with lower caliber employees. • To keep costs low, research firms will issue shorter less detailed reports than now.

20. Financial Service Organizations - Continued • Special Charateristics are present in control systems in financial service industry. • Monetary Assets re the backbone of all these entities. • Quality here refers to the quality of services rendered because money has the same value for all firms. • Firms invest extra controls to safeguard financial assets, especially money.

21. Financial Service Organizations - Continued • Time Period for Transactions is a crucial control factor in the industry. • Some loans and bonds take many years to be completed as transactions which means a system has to be devised to monitor their safety. • In buying and selling securities, the volume and speed of the transaction need to be monitored for improprieties from traders and groups of investors.

22. Financial Service Organizations - Continued • Risk and Reward are part of financial services daily business operations, greater risk-greater $’s. • Interest rates and insurance premiums may be bad.

23. Health Care Organizations • These organizations are hospitals, clinics, retirement and nursing homes, medical laboratories, etc. • They account for 14% of GDP and about the size of all manufacturing in the U.S.. • Many are profit oriented organizations.

24. Non-profit Organizations • Absence of Profit Measures: This factor makes evaluation of operating performance difficult. • Contributed Capital: It replaces the owner’s equity section of a normal balance sheet presentation. • Fund Accounting: A unique set of accounting methods that are self-balancing and represent committed funds or budgets.

25. Non-profit Organizations - Continued • Governance: A board of trustees oversee operations at monthly meetings and must be stronger than normal for profit organizations. • Product Pricing: This area is weak in non-profits because of the lack of profit drive and a full cost approach must be used. • Strategic Planning and Budget Preparation:These processes are more important and difficult than normal business enterprise operations.

26. Non-profit Organizations - Continued • Operation and Evaluation: Managers tend to spend whatever is in their budgets, so it is imperative that the trustees monitor operations visa the budget very tightly.