Cost Analysis, Profit Planning, and Control

Cost Analysis, Profit Planning, and Control

MBA 603

Chapter 14 - Service Organizations

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

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.

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).


• 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.


• 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.

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.

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.

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.


• 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.


• 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.

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.

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.


• 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.


• 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.

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

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.


• 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.


• 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.


• 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.


• 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.


• Risk and Reward are part of financial services daily business operations, greater risk-greater $’s.

• Interest rates and insurance premiums may be bad.

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.

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.

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.

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.

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Cost Analysis, Profit Planning, and Control