decentralized organization
decision-making authority is spread throughout the organization rather than being confined to a few top executives
3 primary types of responsibility centers
1 cost centers
2 profit centers
3 investment centers
profit center
control over both costs and revenue, but NOT over use of investment funds
investment center
control over cost, revenue, and investments in operating assets
net operating income
income before interest and taxes
NOI is sometimes referred to as
EBIT (earnings before interest and taxes)
operating assets
cash, AR, inventory, PPE
examples of assets not included in operating assets
-land held for future use
-investment in another company
-building rented to someone else
(all not held for operating purposes!)
margin
net operating income/sales
turnover
sales/avg. operating assets
ROI
margin x turnover
ROI forumula
NOI/avg. operating assets
net book value
acquisition costs less acc. dep'n
most companies use net book value of...
depreciable assets to calculate average operating assets
problems with companies using net book value of depreciable assets to calculate avg. operating assets
asset's net book value decreases over time as acc dep'n increases
-this decreases the denominator in the ROI calculation, thus increasing ROI
-consequently, ROI mechanically increases over time
replacing old depreciated equipment w/ new equipment increases
book value of depreciable assets and decreases ROI
margin is ordinarily improved by increasing _____, reducing ________, or increasing _____
-selling prices
-reducing operating expenses
-increasing unit sales
excessive funds tied up in operating assets depress ______, and lower ______
-turnover
-ROI
residual income definition
net operating income that an investment center earns above the minimum required return on its operating assets
residual income equation
net operating income - (avg. operating assets X minimum required rate of return)
Economic Value Added (EVA)
adaptation of residual income adopted by many companies
-many huge companies use EVA
when residual income or EVA is used to measure performance, the objective is to maximize
the total amount of residual income or EVA, NOT to maximize ROI
-important distinction! (otherwise companies would divest all of its products except the single product with the highest ROI
residual income approach's major disadvantage
can't be used to compare the performances of divisions of different sizes
-larger divisions often have more residual income than smaller divisions (simply because bigger)
delivery cycle time
amount of time from when customer order is received to when the completed order is shipped
throughput (manufacturing) cycle
amount of time required to turn raw materials into completed products (aka manufacturing cycle)
value-added time
process time
non-value added time
wait time
inspection time
move time
queue time
throughput (manufacturing cycle) time variables
process time
inspection time
move time
queue time
manufacturing cycle efficiency (MCE) equation
value-added time (process time) / throughput (manufacturing cycle) time
throughput time is considered a key measure in
delivery performance
any non-value-added time results in an MCE of less than...
1
an MCE of .5 means...
half of the total production time consists of inspection, moving, and similar non-value-added activities
in many manufacturing companies, MCE is less than...
.1 (10%)
-means 90% of the time a unit is in process is spent on activities that DON'T add value to the product
5s audit
sort
straighten
shine
standardize
sustain
balanced scorecard may contain
financial measures (such as ROI, residual income, and operating measures)
balanced scorecard definition
consists of an integrated set of performance measures that are derived from and support a company's strategy
4 different categories on balanced scorecard
financial
customer
internal business processes
learning and growth
transfer price
price charged when one segment of a company provides goods or services to another segment of the same company
suboptimization
occurs when managers don't act in best interests of overall company or even their own division
seller's perspective of transfer price
transfer price must be (> or =) variable cost per unit + total contribution on lost sales/number of units transferred
purchaser's perspective of transfer price (if outside supplier exists)
< or = cost of buying from outside supplier
purchaser's perspective of transfer price (if no outside supplier)
< or = to profit to be earned per unit sold (not including the transfer price)
relevant costs
costs that differ between alternatives
relevant benefits
benefits that differ between alternatives
avoidable cost
cost that can be eliminated by choosing one alternative over another
relevant costs are often called
avoidable costs
vertical integration
when a company is involved in more than one activity in the entire value chain
bottleneck
a constraint
-ex: a machine or process limiting overall output
joint products
2 or more products produced from a common input
split-off point
point in the manufacturing process where the joint products can be recognized as separate products
joint cost
describes the costs incurred up to the split-off point
capital budgeting
term used to describe how managers plan significant investments in projects that have long-term implications
screening decisions
relate to whether a proposed project is acceptable--whether it passes preset hurdle
ex: company may have policy of accepting prjects only if they provide a return of at least 20% on the investment
preference decisions
relate to selecting among several acceptable alternatives
ex: a choice of which machine to purchase
the 2 approaches to making capital budgeting decisions using discounted cash flows
-net present value method
-internal rate of return method
annual cost savings - initial investment = ...
net present value
working capital
cash, AR, inventory less current liabilities
out-of-pocket costs
actual cash outlays for salaries, advertising, and other operating expenses
internal rate of return
rate of return of an investment project over its useful life
internal rate of return calculated by
finding the discount rate that equates the present value of a project's cash outflows with the present value of its cash inflows
-in other words, IRR is discount rate that results in a net present value of zero
factor of the internal rate of return equation
investment required/annual net cash flow
net present value method has several important advantages over the internal rate of return method
NPV method is simpler
project profitability index equation
net present value of the project / investment required
payback period equation
investment required / annual net cash inflow
simple rate of return equation
annual incremental net operating income / initial investment
postaudit
checking whether or not expected results are actually realized