Lectures 7-9 Flashcards
Which are the four types of divisions?
- Cost centres (Divisional expenses)
- Revenue centres (Sales)
- Profit centres (EBIT, Margins)
- Profitability centres (ROA, ROCE, ROE)
How is economic profit different from net profit?
Net profit – Owners’ required return
What is the top-down budgeting approach?
Top management prepares the budget that is implemented throughout the organisation.
When is it good to use top-down budgeting?
- When resources are scarce
* When management has a better picture of the overall situation in the market and economy.
What are the pros and cons of top-down budgeting?
+
Takes shorter time
–
Hierarchical
Undemocratic
Might be less realistic (detailed knowledge of lower levels is not taken into account)
What is the bottom-up budgeting approach?
Top management only provides basic framework and each division prepares its own budget that is afterwards incorporated into the total budget through negotiations
What are the pros and cons of bottom-up budgeting?
\+ Democratic Serves as a good communication tool Engages people More realistic (prepared by people closer to floor)
–
Takes too much time
Is not always optimal from the overall perspective (each division is more interested in its own activities rather than whole company)
Describe the concept of a rolling forecast
Rolling forecast is prepared every quarter and is based on a small number of crucial variables, thus it is very quick to prepare.
Rolling forecasts are best suited for which type of company?
Start-ups and companies in quickly changing environments
Which are the three principle components of the BSC?
Strategy formulation Management control (implementation) Task control (individual tasks)
Name six ways in which financial measures are different from balanced measures
Balanced (financial):
- Stakeholders (owners)
- No comparability (comparability)
- Linked to strategy (aggregate)
- Long & short term (short term)
- Leading & lagging (lagging)
- Easy to identify with (hard)
When obtaining ROA from the leverage formula, based on a ROE from the growth formula, should you use opening, average or closing balance figures?
Opening, since growth formula implies this is a forecast
Which are the four main dimensions (columns) of the BSC
- Shareholders (financial perspective)
- Customers
- Processes
- Innovation/learning/development (employee)
What is at the top of the BSC?
Vision & Strategy
What are rows of a typical BSC?
- Dimension names
- Strategic goals
- Critical success factors
- Critical measures
Name five characteristics of a good BSC
- Tells the story of the company ́s strategy by stipulating a sequence of cause-and-effect relationships.
- Helps communicate strategy to all members of the organisation by translating strategy into understandable and measurable operational targets.
- Emphasizes financial objectives and measures (in for-profit companies
- Limits number of measures used by focusing on the most critical ones
- Highlights suboptimal trade-offs that managers may make when they fail to consider operational and financial measures together
Name five characteristics of a crappy BSC
- Assume precise cause-effect linkages
- Seek improvements across all measures all the time
- Only uses objective measures
- Fail to consider both costs and benefits of initiatives before including them in the scorecard
- Ignore non-financial measures when evaluating managers and employees
Which are the five key adjustments made to EVA?
- The capitalisation (and subsequent amortisation) of R&D costs
- The capitalisation of market-building costs
- The capitalisation of off-balance sheet operating leases
- Add back amortisation of goodwill
- Adjust the capital base and depreciation to compensate for effects of inflation
What in the alternate EVA formula reflects operative actions?
ROCE * (1-t)
What in the alternate EVA formula reflects strategic actions (“doing the right things”)?
CE
What in the alternate EVA formula reflects financing optimization?
WACC
Name four advantages of using EVA
- Invest only if the increase in earnings is enough to cover the cost of capital
- Thus EVA can be used as an incentive compensation system
- Implies delegated decision-making
- Cost of capital is visible to the managers
How does the EVA model differ from the traditional model?
Rather than all surplus (profit) going to shareholders, the economic surplus (after wages and dividends have been paid out) are divided between workers and shareholders
Which are the eight steps of the planning and control process
Establish mission and objectives
–> Undertake a position analysis
–> Identify and assess strategic options
–> Select strategic options and formulate long-term (strategic) plans
–> Prepare budgets
–> Perform and collect information on actual performance
–> Respond to variances and exercise control
–> Revise plans (and budgets) if necessary
Name the three planning time perspectives
Strategic planning > 3 years
Tactic planning > 1-3 years
Operational planning < 1 year
Name eight aims of budgeting
- Making general plans
- Creating goals for profit centres
- Co-ordination and communication
- To follow up the outcome
- Profit forecasting
- Distribution of resources
- Motivating people
- Delegating responsibility
- Bonus systems
Describe a simple model for budget analysis and control
- Analyze the outcome in terms of variances from the budget.
- Determine who should be held accountable for the variance(s)
- Set standards
Name four reasons to use rolling forecasts
- We need a shorter planning process to increase actuality and save planning time
- We need to plan more often to get closer to changes in reality
- We need better grasp of the immediate future
- We need to create a planning process which is actually useful for everybody
Name five advantages with using rolling forecasts
- Speed up traditional planning process
- Adjust much quicker to future changes in the environment
- Get better foresight towards the end of the year
- Planning will be more realistic
- Company becomes more flexible
Name four disadvantages with using rolling forecasts
- Very likely the total work load of planning will increase
- The coordination among profit centers will weaken
- The follow up of past decisions will be more difficult than before
- Demands on personalities will increase
What simple dichotomy can describe the choice between using long time plans and rolling forecasts?
Long-term certainty/determination or short-term freedom/flexibility?
Name four central ideas of Zero based budgeting
- The organization is divided into a number of decision units
- Each decision unit divides its activities into a number of decision packages
- All decision packages are ranked by top management
- After ranking a cut-off line determines what packages can be carried out
Which are the two steps of ranking decision packages?
- Rank packages one unit at a time
2. Rank packages across units
Which things need to be taken into account when evaluating the ROE?
- Comparison to the required rate of return from shareholders perspective
- Growth requirements
- Benchmarking
