Management Control Fundamentals PDF

Management Control Chapter 1. Fundamentals of Management Control ______________________________________________________________________________ CHAPTER 1. FUNDAMENTALS OF MANAGEMENT CONTROL 1.1. The control function in the firm 1.2....

Management Control Chapter 1. Fundamentals of Management Control ______________________________________________________________________________ CHAPTER 1. FUNDAMENTALS OF MANAGEMENT CONTROL 1.1. The control function in the firm 1.2. The purposes of management control 1.3. Main elements of a management control system 1.4. Functions of a controller 1.5. Management control by responsibility centres 1.6. Corporate Social Responsibility and management control OBJECTIVES OF THE CHAPTER - To define the scope and objectives of management control. - To identify the elements of a control system. - To analyse the evolution of the role of a controller and to determine what their attitudes and competences should be. - To know what control by centres of responsibility is. - To define Social Responsibility and to understand its links with management control. 1.1. THE CONTROL FUNCTION IN THE FIRM The instability of the environment in which companies carry out their activities and the changes derived from adapting to increasingly competitive and complex markets have highlighted the importance of the control function and have led to its rapid development in recent years, becoming increasingly important in business management. A number of factors have increased the need for greater, more rigorous and exhaustive control, which could be summarised as follows: The greater instability of the environment, due to greater globalisation of markets, which makes them more vulnerable, as the current economic crisis has shown, and to greater customer demands. Increased organisational complexity, often resulting from greater size or greater diversity of activities, requires greater delegation of responsibilities, which can lead to a dispersion of efforts. Decentralisation can lead to a lack of coordination or overall vision of the firm. The complexity of business processes due to, among other factors, suppliers and customers joining the company's value chain, the increase in size of organisations, the greater number of product ranges with shorter life cycles and more specifications, the existence of smaller batch sizes and the permanent development of new technologies. The higher the level of decentralisation, the greater the need for control, and also the greater the level of competition, the greater the company's need to maintain or improve its competitive position, and the larger its size, the greater the risk of dispersion of effort and loss of global or overall vision. 1  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ 1.1.1. Concept of management control. Management control aims to provide the reliable and timely information that the various managers need to be able to make decisions in the best possible conditions, within their scope of action, and to enable management to evaluate and monitor the level of achievement of the planned objectives. To this end, management control analyses the company's results and performance, anticipates the future, forecasts trends, prepares budgets, designs indicator systems (scorecards), analyses risks, carries out economic viability and sustainability studies, supervises internal auditing and prepares reports so that management can establish strategies. In order to carry out all these tasks, management control handles a large amount of data on the market, trends, financial statements, cost accounting, indicators on the variables critical to the success of the company, etc. In this way, its actions include the analysis of deviations in actual results compared to those expected, the analysis of the causes of these deviations, the monitoring of objectives, and the diagnosis of the situation of the company and its environment. In addition, control maintains an overview of the organisation as a whole, ensuring that the actions of managers are carried out in a coordinated manner. According to Anthony and Govindarajan (2003), “Management control is the process by which managers influence other members of the organization to implement the organization's strategies”. Management control fosters an efficient and effective performance of individual tasks to achieve business objectives. The concept of effectiveness is related to the company's ability to achieve its objectives, and efficiency to the ability to do so while minimising the resources consumed. Management control must establish the mechanisms to be as effective and efficient as possible, without losing sight of the company's sustainability. However, there are other definitions, such as that of Pérez Carballo (1999): “control is the function that aims to ensure the achievement of the objectives and plans set in the planning phase”, or that of AECA (2003): “the function that ensures that the predetermined results and objectives are achieved, complying with the established programmes. Control derives from the necessary adaptation of the company to the environment.” In these definitions we can see some points in common: the need to establish a strategy and to set objectives derived from it. Without a clear definition of objectives it is impossible to exercise the control function. It is important to define where the company is going so that employees do not feel adrift. Objectives set the direction, they are the reference point for clarifying what is expected from them. The concrete definition of the objectives will also express what performance levels are desirable. Often the evaluation of objectives reveals that they are unachievable due to problems and limitations such as lack of personnel capacity, lack of skills or lack of other resources, and in turn the need to adopt solutions such as employees' training, relocation of employees, etc., thus generating an improvement of capacities. Control is fundamental to guarantee the survival of the company, it should not be perceived as a sanctioning mechanism for inappropriate behaviour; it should be action oriented, it should detect opportunities and problems, and motivate to adopt solutions and provide suggestions, not punish. The controller should not be an uncomfortable subject who watches over. They should not be a mere inspector or supervisor, but a leader who motivates towards the achievement of objectives. Incentives are a source of motivation, which is why management control must be linked to the incentive system; but motivating does not have to be equivalent to providing economic incentives; it is possible to motivate through the delegation of responsibilities, participation, information, etc. 2  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ 1.1.2. Types of control. Management control can be exercised at different levels, from the most general to the most specific, coinciding with the time horizon of the planning from which the objectives to be controlled derive: - Strategic level. This is the management control that refers to long-term objectives, related to the strategy implemented by the organisation. These are usually general and qualitative objectives, e.g. to improve employee motivation or customer satisfaction. Quantitative objectives can also be defined, but in this case they are often not very specific, e.g. to reduce delivery time. - Tactical level. This usually refers to the company's lines of action as set out in programmes and medium-term plans. The objectives are more concrete and of a more quantitative nature, e.g. to reduce the delivery time of our product by 5% or to reduce the number of defective products to 0.5%. - Operational level. The objectives to be controlled are very short term. These are very specific and quantitative objectives, e.g. meeting the production plan for the next day or fulfilling new orders received within ten days. Likewise, the types of control are related to different approaches to management: - Performance control. Performance should be understood both in economic (financial) terms (e.g. measured through cash flow, margins or profits) and from the point of view of intangible (non-financial) aspects (e.g. related to customer satisfaction, reputation, brand image, relations with society, social media presence, etc.). Although the latter results are more difficult to measure, they offer greater opportunities in the long term, e.g. improved employee training leads to an improvement in performance that lasts over time. - Values or clan control. Values control is about ensuring that the company's actions are consistent with its core values. Values affect the culture of the organisation. A value is the result of internalised beliefs about how to act. Values are classified into ethical values (justice, solidarity, participation, communication, etc.) and competence values (excellence, creativity, initiative, quality, etc.). - Competences control. It is the capabilities of the resources available to the company that determine the company's competitiveness. Within a company's resources, human resources occupy a priority position, given the possibilities for continuous improvement offered by their capabilities, and therefore, these capabilities must be controlled with a view to their possible training, orientation, selection, etc. Companies that want to be excellent should combine the three types of management control, since each of them is exercised on a relevant aspect of company management. For each aspect (performance, values and competences) it is necessary to set objectives that must be periodically reviewed and their degree of achievement assessed, for which objectives must be defined according to the three levels of temporality, in the long, medium and short term (strategic, tactical and operational). 1.2. THE PURPOSES OF MANAGEMENT CONTROL The control function is not only carried out by management but by all members of the organisation, which is why it is necessary for management control to serve the following purposes: 3  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Informing: transmitting and communicating to all the people involved in the organisation what the objectives and their degree of achievement are. Information is the key to achieving subsequent goals. Motivating: to involve all members in the achievement of the proposed objectives. The control system will motivate if the objectives and the control system are known and accepted by those responsible. On the other hand, if it is used as an instrument of motivation, the incentive system must be linked to the achievement of the objectives. Coordinating: directing all efforts towards the achievement of the objectives, aiming at an efficient use of resources. The system must ensure that the whole organisation is moving in the same direction, that interdependencies between organisational units and the existence of partial objectives for each manager do not interfere with the achievement of the overall objectives of the organisation. Evaluating: assessing the degree of achievement of objectives and identifying the source of deviations. The company must measure the performance of each of the organisational units and design mechanisms to periodically review the evolution of the key aspects of the business. However, management control should not only be an instrument of evaluation, but also of suggestion, participation, incentive and adoption of corrective measures. Evaluation must be capable of suggesting learning, and to this end it must be accompanied by permanent feedback. Acting: adopting measures in response to changes in the environment, to the causes of deviations, etc. The control system must be action-oriented. There is no point in controlling if measures are not taken to ensure that the actions of the responsible managers are in line with the objectives set. Without action, control loses all meaning as a management tool. The important thing about control is not the control itself, but the subsequent corrective actions, which allow progress to continue. 1.3. MAIN ELEMENTS OF A MANAGEMENT CONTROL SYSTEM In order to define a management control system, attention must be paid to the control process on the one hand, and the control structure on the other (Figure 1). The control process is understood as the set of steps necessary to carry out the control, i.e. to implement the control system. The control process involves implementing a set of measures to ensure that the intended objectives are achieved, and is carried out in a series of stages. The starting point of this process is usually the definition of strategy and objectives. The company organises itself and then implements its plans. The process never ends, because in order to achieve continuous improvement, the objectives must be continuously measured and evaluated, and then, in the light of deviations from the objectives set, action is taken, decisions are made and the cycle is repeated. The control structure, on the other hand, refers to the elements that make up the control system, as the company has a wide range of instruments that allow it to control the different aspects and variables to be controlled. In turn, the identification of the control structure, i.e. the choice of the tools that the company decides to use to exercise management control, is part of the control process, as a stage of it. For this reason, the control structure is included in the control process in Figure 1. The control structure can be formal or informal. It depends on the company's strategy, organisational structure, people in management, power structure, culture, etc. Formal controls are systematic, regular and organised, and developed according to a pre- established pattern (e.g. budgeting). Informal control mechanisms are spontaneous, sporadic 4  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ and changing, and do not have a pre-established format (e.g. suggestion boxes). It is possible to combine features of formal and informal systems in the same control system. The greater the complexity, the more dynamic the environment and the larger the organisation, the greater the level of decentralisation, the more rigorous and formal control mechanisms will be required. However, as the interdependence between organisational units increases, the importance of formalised control is reduced as long as the links, connections or induced or chained effects of some units on others are known. Interdependence means less room for manoeuvre and less need for formal controls. Informal controls are more frequent when values such as trust in personnel, autonomy or creativity prevail in the company. Figure 1. Management control system In turn, the control process can be more or less flexible, participatory, with a previously defined periodicity or adapted to the needs of information and changes in the environment, depending on the needs of the organisation, culture, etc. 1.3.1. The control process. The control function is part of the overall administration and management cycle of a company. The starting point of this cycle is the definition of the organisation's mission and goals. To achieve them, it is necessary to define periodically a strategy, which leads to a planning process that requires controlling whether the strategic objectives are actually being achieved. Hence, the process starts at this stage and continues in a way that serves the purpose of management control. It should be a continuous process. 5  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Table 1. Stages in the management control process 1. Formulation of the firm’s strategy Business strategy determines how an organisation will create value over time. 2. Definition of the organizational structure To identify the main organisational units: departments, business lines, divisions, countries in which the firm operates. Graphic representation of this structure in the organisational chart. 3. Definition of responsibility centres and identification of managers Analysis of the organisational structure. Identification of the types of centres, people in charge of each of them, assignment of responsibilities and variables to be controlled. 4. Setting of specific objectives for each organizational unit The general objectives of the organisation, derived from its strategy, are specified in partial objectives for each centre of responsibility. The necessary mechanisms for coordination between managers are articulated. 5. Identification of key variables to control According to its strategy and in view of the values that the company assumes as its own values, the variables to be controlled are determined: costs, margins, quality, innovation, design, sustainability, etc. Key success variables in financial and non-financial terms. 6. Identification of the control structure. Definition of control instruments The firm chooses which instruments it will use to exercise the control function: cost accounting, budgets and deviations, control indicators, financial accounting, etc. Some of these instruments will be analysed throughout this course. Others have already been studied in other subjects of the degree. 7. Evaluation of the objectives’ achievement By calculating deviations, i.e. by comparing objectives with reality, or by comparing the levels achieved this year with those of the previous year, or even by comparing the results obtained by the company with those of the competition (benchmarking). 8. Adoption of corrective actions Based on the analysis of the causes of the deviations, we will act to improve by defining action programmes, action plans, initiatives, suggestions for continuous improvement, etc. Increasingly, control systems are becoming more forward-looking rather than backward- looking, measuring the extent to which long-term strategic objectives are being met, rather than focusing on the pursuit of immediate results. This has led to a radical change in the control process, with strategic planning becoming more central. In turn, the explicit formulation of strategy and the formalisation of the organisational structure facilitate the determination of specific objectives for each of the responsibility centres. The system must be adapted to the strategy and organisational structure in order to be efficient. Some of these stages are only carried out when the control system is designed or in cases where the evaluation shows that the reason for deviations or non-achievement of objectives requires a change in strategy, structure, centres, managers, etc. Not all stages have to follow one after the other: at a given moment it may be necessary to rethink a particular aspect of the control process. For example, it is possible to redefine the specific objectives of an organisational unit (stage 4) without having to redefine the centres of responsibility or their managers (stage 3). It is even necessary to schedule the process to show at which point in time each of the phases is to be carried out, although some of them (e.g. stage 8) can be executed on a permanent basis and others are only carried out at specific times when the situation requires it (e.g. stage 3). 6  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ The key variables to be controlled in stage 5 can be of different nature: costs, quality, innovation, brand image, etc. Cost leadership is no longer the key to competitiveness for many companies. It is necessary to extend the control process to other key variables, such as quality levels, the degree of product innovation, differentiating product attributes, customer satisfaction, staff motivation, response time, corporate social responsibility, etc. For this reason, management control is becoming increasingly complex, as it covers a large number of key issues for competitiveness, where intangible aspects are becoming more and more important. Stage 7 consists of the comparison of the planned objectives with the reality, and is specified in what is known as the calculation of deviations, with these deviations being a fairly widespread control instrument. Finally, we must stress the importance of stage 8 of the process, since without actions that promote continuous improvement, control loses all meaning. What is really important in management control is not the control itself, but the lines of action that emerge from the analysis of deviations from what was planned. Example: Courier company. Goal: to become a leader in the industry. Strategy: increase market share (objective) by adapting the service to customer requirements. Planning: define the activities to be carried out in order to provide an excellent delivery service to the customer: by post, cash on delivery and by hand, the necessary resources and a time schedule for the actions. Organisation: the resources and organisational units that will be involved in these services are organised. The necessary resources are provided. Tasks are distributed and people in charge are appointed. Execution: the provision of the service is carried out. Action is taken. Evaluation: the control system defines the necessary instruments to carry out its function, for example, control indicators such as market share or customer satisfaction are defined. When carrying out the control, it can be shown that: a) Market share increases. The company is developing in line with the objectives set. b) The market share does not reach the objectives. In this case, management control should analyse the causes. It could have happened, for example, that: b.1) Customers have not demanded the service. In this case there has been a failure in planning or in the strategy, or even in the organisation. This has not been adequate. Re-planning is necessary. b.2) The delivery service has not been performed excellently because the organisation is not adequate. The service should be reorganised, because of problems of means, lack of responsibility, because there has been a cultural change, etc. Act: in view of the analysis of the causes of the above deviations, we would act to try to improve and solve the problems. 1.3.2. Control structure. The control structure is made up of the means or instruments that will facilitate the exercise of the control function, including the more traditional ones, such as those shown in Table 2. Many of these control instruments are developed in other disciplines, such as financial management, accounting or operations management. Their use as control instruments demonstrates the cross-cutting or multidisciplinary nature of management control. It is also possible to use instruments specific to this function, such as: The creation of responsibility centres, which implies greater decentralisation and delegation of decision-making. The study of the organisational units defined in the company for the purpose of facilitating control, as well as the different types of responsibility they can assume, will be carried out in section 1.5. 7  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Budgets and budgetary control by calculating deviations and analysing their causes. These instruments will be studied in greater depth in chapters 3 to 5. Control indicators, which are control instruments that, due to their popularity and importance, will be analysed separately in chapter 2, as they are one of the most common control instruments and use the rest of the tools as a source of information. Their importance in control systems derives from the fact that they are easily identified with the objectives and, therefore, their analysis reveals their degree of achievement and the causes of deviations. Incentive systems, which are an essential element in control systems, as they make it possible to achieve one of their aims: to motivate. However, we are not going to analyse them in depth as they are an essential part of the study of another discipline: Human Resources Management. The information system, which facilitates the fulfilment of another of the objectives of control, that of communication and feedback. The information system must be intelligible (known, agreed and accepted by all, as it will serve as an evaluation instrument), inexpensive (limiting the number of variables so that the control efforts do not exceed the advantages of the system), and flexible (capable of adapting the information to changes, to the needs of each moment). Table 2. Traditional management control instruments. Financial Accounting Analysis and reporting of financial transactions within a given period Reference manual that includes the definition of functions, roles and responsibilities, internal Procedures manual policies, etc. Independent, objective assurance and consulting activity designed to add value and improve an Internal Auditing organization's operations run by the company Independent, objective assurance and consulting activity designed to add value and improve an External Auditing organization's operations run by external experts A systematic and independent evaluation of organizational activities. The primary sources of Operational Auditing evidence are the operational policies and achievements related to organizational objectives Financial data to make determinations about how, when and why a business expends and receives Analytical Accounting money Budget Control Real performance is compared with a budget, and the corresponding deviations are analysed. Ratio Analysis A set of indicators are compared with the established goals. A document that summarises the performance of the firm in relation to its more relevant Scorecard objectives. Financial and non-financial indicators are usually included. The control structure will be adapted to the needs and types of control that the organisation wants to implement. Issues related to the environment play an important role in the control structure, both in terms of controllable aspects (e.g. relations with suppliers) and non-controllable aspects (competition, appearance of substitutes, legislation, etc.). Attention must also be paid to intangible elements such as power relations, leadership, etc., or factors such as the degree of customer satisfaction, intellectual and relational capital, or employee motivation, which are currently fundamental elements for being competitive. 1.4. FUNCTIONS OF A CONTROLLER There is no agreed definition of the concept of controller, as it is a figure that has evolved in parallel with business development. However, we can highlight some characteristics of the profile of controllers. The controller is in charge of the company's objectives, coordination and change. They must reduce uncertainty in decision-making by providing decision-makers with the relevant 8  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ information they need. To do this, they have to deal with a large amount of information from different sources and disciplines: financial and cost accounting, financial management, auditing, human resources, marketing, economy, operations management, international markets, etc. This is why the controller must have multidisciplinary knowledge. But the controller's functions have evolved over time. Today, it is not enough for them to provide useful information: they must generate added value by being a critical and proactive person who provides solutions. From a mere financial and operations manager, they have become a “strategist” who participates in the company's management tasks. They have gone from very limited functions related to internal and short-term economic-financial control to broadening their functions towards a more strategic vision of the business. The controller is a data analyst so their profile has also been changing in parallel with the development of communication and information technologies. Massive data analysis (Big Data), or knowledge of Business Intelligence or Business Analytics tools, are now part of the knowledge required to perform this function. The controller's role is not limited to data collection and performance monitoring, but must also motivate action in the event of deviations from the planned objectives. This is why they are often creative, pro-active and have a certain level of prestige. In addition, they are part of the management team and collaborate with them in the general management of the company, thus occupying a management staff position. Today, the controller is considered to be an advisor to top management. In terms of the skills that a controller should have, first is their ability to relate and communicate with the rest of the company, their conciliatory attitude and their ability to promote teamwork. The controller must have a great knowledge of the organisation in order to better understand why the desired effects are produced or not, given the great variety of variables and aspects to be controlled and the incidence of some on others. They must decide which elements of the control structure are the most appropriate, reviewing them and maintaining a balance between financial and non-financial, internal and external. In addition, they must be constantly aware of the new tools that are emerging in the field of management control. The controller does not have all the information. They need the other managers to collaborate with them in feeding the system. In order to gather information, they must be in constant contact with other managers. They must therefore be a credible person with a certain degree of leadership, otherwise they become an uncomfortable subject with whom it will be difficult for others to collaborate, and therefore they will not be able to ensure that the control system fulfils its function. 9  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Figure 2. Relationships of the controller with the rest of the organisation Analysis of overall performance, BSC, reports on performance of responsibility centres, etc. Manufacturing planning and control of Analysis of financing, liquidity, the production process, deviation interest rates, etc. analysis, quality studies, etc. Analysis of marketing campaigns Analysis of staff skills, and return on advertising, etc. quantification of incentives, etc. Sales analysis, by products, sales Analysis of materials, purchases and channels, commercial cost analysis, consumption, inventory control, etc. etc. Expense calculation, cost analysis, analysis of partial results, etc. Source: adapted from ACCID (2010) Manual de Control de Gestión. 1.5. MANAGEMENT CONTROL BY RESPONSIBILITY CENTRES 1.5.1. Concept and questions to consider when defining the responsibility centres. The responsibility centres are a control instrument that arose as a consequence of the need to delegate responsibilities in the management of the organisation. As an instrument, it is one of the possible components of the control structure, but its definition is also part of the control process along with the choice of its manager. From the point of view of the number of decision-makers, companies can be classified as centralised and decentralised. The control system in a centralised structure does not need to be too sophisticated as decision-making is concentrated in a few managers. In general, it will be qualitative and not very formalised. Few control mechanisms are required as little responsibility is delegated and therefore there are few aspects to control. The progressive increase in the size of organisations, the greater complexity of the environment, processes, etc. require greater decentralisation, as the aspects to be controlled are increasingly complex and dynamic, and centralised decision-making cannot respond to all needs. The decentralised structure presupposes a management spirit based on trust, delegation, participation, coordination and motivation, which favours greater autonomy in decision-making. This in turn will involve increasing control mechanisms to avoid dispersion of effort and to ensure that all managers act in the same direction. This will require the identification of the responsibility centres that will form part of the control structure. A responsibility centre is an organisational unit headed by a manager who is responsible for its activities. The following clarifications can be derived from this definition: The definition of responsibility centres is strongly linked to the organisational structure of the company, graphically shown in its organisational chart, be it functional, divisional or matrix, for example. 10  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ In these centres, decision-making is delegated down to a certain level, which implies the need to exercise a control that must be limited to the specific variables on which the decentralised management of the manager can have an impact, and to the objectives set for the particular centre, in line with the general objectives of the organisation. Managers are asked to make the best possible use of the resources available to them. These resources available to the manager may be both controllable and non-controllable, i.e. the manager may not always have control over all the resources needed because of the interrelationships between the centres. The identification of controllable and non-controllable aspects is essential in order to be able to make a fair and adequate assessment of his or her management, as this should only apply to those aspects over which the manager has control (controllable). The definition of responsibilities involves identifying the person in charge and defining the level of delegation of responsibilities that this person assumes, what their functions are and what their scope of action is: over which variables they have the capacity to make decisions. Depending on the variables over which the manager has decision-making capacity, different types of centres emerge. Once the variables over which the manager has the capacity to act have been defined, their contribution to the achievement of the objectives that have previously been set, as well as the management carried out in their centre, will be evaluated. It is necessary to evaluate both aspects: results and management of the manager. This is because brilliant results could be obtained with poor management, for example, if these results have been achieved by demotivating and frustrating the staff. Conversely, it could be that the results were not as expected but the management was adequate. The definition of the variables for which responsibility has been delegated is essential in the control process, because they must be in accordance with the level of delegation of responsibility defined and because they will influence the definition of the control indicators (in financial and non-financial terms) through which the centre will be evaluated. It will also be necessary to define the specific aspects to be controlled, as this will determine the type of centre in question and its responsibilities, as we will see below. The incorporation of these indicators in the information system will enable measurement and provide the information for evaluation. Likewise, the level of compliance with the objectives set in relation to these variables must be linked to the incentive system to motivate the managers. In a furniture factory, the paint shop is a responsibility centre that responds to a manufacturing function: The centre's objective: to increase quality. Key variable to be controlled in the centre: quality, although the costs associated with the search for quality will also be considered. When defining the information system, instruments should be used to facilitate the achievement of this objective, such as procedure manuals, internal auditing, a cost system that allows the quantification of the costs of quality, and the quantification of those non-financial indicators that have been selected to control the qualitative objectives. Control indicators: number of defective products, number of reprocessed units, number of returned units, cost of reprocessing, etc. Coordination mechanisms: meetings with the procurement manager to ensure that the supply of raw materials does not lead to non-compliance with the quality objective. 11  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Finally, the responsibility centres cannot be independent units. Mechanisms must be put in place to guarantee coordination, such as periodic cross-functional meetings, to avoid the pursuit of partial objectives to the detriment of the organisation's global objectives, and to avoid overlapping and minimise the dispersion of efforts. 1.5.2. Types of responsibility centres. The types of responsibility centres are defined according to the different concepts, variables or parameters for which responsibility may lie. The types of centres can be distinguished according to the organisational structure as shown in Figure 3: Figure 3. Types of responsibility centres 1.5.2.1. Cost centres The manager has control only over the quantity and/or price of resources consumed, and therefore has decision-making power over costs, but not over revenues. The manager can make decisions to influence costs through price negotiations with suppliers, programming of production, workforce of the centre, subcontracting of activities, etc. (controllable costs). These are centres that are established when there is a well-defined and quantifiable output, together with knowledge of the amount of input required to produce each unit of output. These are those functions normally referred to as “operational”. The output is identified according to different factors: cost, quantity, quality, time, etc. In terms of the control structure in these centres, cost accounting or analytical accounting will be a key instrument. To control the performance of the manager of a cost centre, efficiency will be evaluated by the relationship between inputs (costs) and outputs (product units), i.e. it will be necessary to define productivity indicators for the centre, and effectiveness according to the degree of achievement of the programmed production, at specific levels of quality and in the determined time. The control system will be based on the analysis of deviations from the resources allocated in the budgets. It will also be necessary to incorporate quantitative indicators into the control structure, e.g. production costs, purchase price, number of units manufactured, direct labour hours, waste rate, machine hours, etc., depending on the delegated functions and in accordance with the established objectives. 12  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ 1.5.2.2. Discretionary expense centres They refer to functions that produce outputs that are not measurable in financial terms and to those in which there is no strong relationship between the resources consumed (inputs) and the results obtained (outputs). “Structure” departments that carry out general tasks: Human Resources, Administration, R&D&I, etc. Efficiency cannot be measured in these centres due to the lack of relationship between inputs and outputs. Effectiveness can only be measured in some cases, according to the degree of achievement of the objectives set by the company. The control system will be bureaucratic after the allocation of resources through the corresponding budget and the control of deviations. In these centres, the degree of compliance with the budget will be controlled. In addition, it will be necessary to introduce quantitative and qualitative control indicators such as quality and the level of service provided. Finally, the manager will be evaluated by other intangible aspects of their management, such as the level of competence of the centre's staff, the satisfaction of the other centres with the service provided, the response time or the degree of technological development achieved. 1.5.2.3. Revenues centres They refer to functions in the company where the manager has control over factors related to sales, such as the sales department. The department may have the capacity to define the sales price, so it will have the capacity to influence the gross revenue, or only the volume and composition of sales, in which case the impact will only be partial. But the evaluation criterion will not only refer to the volume of sales or revenue, it must be accompanied by some indicator of the contribution margin, since, by promoting the sale of a product that generates high revenue, it may be promoting a product with high production costs and, therefore, have a negative impact on the results. The control system will be based on the analysis of deviations from the resources allocated to the centre in its cost budget. Quantitative control indicators (e.g. sales revenue, market share, sales price, distribution through different channels, etc.) will be added to the budget control. In addition, an evaluation will be made on the execution of the revenue budget and on the level of achievement of targets related to sales volume, deviations in market share and market size, and product and customer profitability. In addition, other intangible indicators such as customer loyalty will be added. 1.5.2.4. Profit centres They are divisions of the company in which the manager has decision-making power over production and sales, revenues and costs. To the analysis of efficiency and effectiveness through the same parameters used in the cost centres, we must add the analysis of profit as a measure of the manager's ability to create value from the resources at their disposal. The use of profit as a measure of the centre's performance introduces an element of relativity, since the result depends on the accounting criteria applied in its determination, as well as on the allocation of revenues and costs to each division. The control system will be similar to the cost and revenue centres mentioned above, with the addition of control over the result. Profit is one of the key elements to be controlled, and can be defined as: Earnings before interest and taxes (EBIT) = Revenues - controllable costs 13  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ EBIT is used because the aim is to assess its economic interest regardless of how the investment is financed and regardless of the tax burden, so it will be a more comparable indicator, although it is currently becoming fashionable to use the EBITDA calculation, because it calculates the result independently of financial and tax issues, as well as the quantification of depreciation and amortisation (which are usually aspects that cannot be controlled by managers at this level), obtaining a result regardless of circumstances of various kinds (e.g. tax) that may occur in the companies or centres being analysed. EBIT= Net sales - Operating costs EBITDA = EBIT + depreciation + amortisation EBITDA = Earnings before interest, taxes, depreciation and amortisation. The evaluation of the manager will not only take into account tangible (financial) aspects related to profit, but also other intangible (non-financial) aspects such as brand image, conversion rate in networks, stability of supplier relationships, etc. 1.5.2.5. Investment centres They refer to divisions of the company that, in addition to responsibility for profit, have responsibility and authority over investment, and therefore have decision-making power over costs, revenues and investment in assets. In addition to the analysis of effectiveness and efficiency as profit centres, the profitability of the assets associated with profit generation in each business unit is analysed. Decisions affecting assets can relate to both fixed asset investment and inventories, collection and payment policies, etc. The control system will be similar to that of the profit centres. That is to say, budgetary control, control of results, control of objectives of the different key aspects, to which will be added specifically the analysis of the profitability of controllable assets. Return on investment (ROI) or economic profitability: ROI = Controllable EBIT or EBITDA / controllable investment If ROI is unfavorable the analysis should be complemented with the Residual Income (RI). In case RI is also unfavorable the investment could not be dismissed right away since it could ease the achievement of other general objectives. In the investment centres, it will also be necessary to control non-financial aspects such as the age of investments, payback time, product cycle time, the emergence of new technologies, innovation, etc. Residual Income (RI): Residual income measures the amount of money that is left over after all required costs of capital have been covered for the period being analysed. RI = EBIT– (cost of capital x controllable investment) The identification of responsibility centres will depend on the organisational structure, delegation of responsibilities, organisational culture, etc. A summary of the characteristics of the different types of centres can be found in the table in Annex 1. However, their use as instruments of control may raise different problems: Lack of communication of the company's general objectives. Lack of congruence between the particular objectives and the general objectives of the company. Lack of precision and identification of the competences and limits of each of the responsibility centres. 14  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Lack of clarity in dealing with the interrelationships between the centres. Lack of motivation and recognition of the management of the responsible persons. The evaluation of management based on short-term results is induced, if only financial indicators are used. Costs are increased, in some cases, by duplication of support functions, and in any case, by additional coordination costs. The General Manager's knowledge and control of the centres is weakened. 1.6. CORPORATE SOCIAL RESPONSIBILITY AND MANAGEMENT CONTROL 1.6.1. The concept of Social Responsibility. Organisations carry out their activities in continuous interrelation with their environment, in order to obtain financing, acquire and consume resources, or distribute and sell their products or services, hence they have to be aware of the impacts they generate with their actions on all their stakeholders (owners, customers, suppliers, employees, local community, etc.) and of the expectations of all their stakeholders, i.e. they must manage their commitments with all the agents in the environment, through what is known as Social Responsibility (SR) or Corporate Social Responsibility (CSR). To manage these impacts, the organisation needs to obtain information on the objectives that stakeholders have, what their demands and aspirations are with respect to the company, and to know how it is acting in this respect, so that, in accordance with its strategy and policies, the aspects that most concern them are included in the management control system. To this end, it is necessary to keep channels of communication with stakeholders permanently open, in order to know what their expectations are and involve them in the whole control process. Management control must address what is known as the “triple bottom line” of the company, where social and environmental concerns are added to economic issues, to which corporate governance issues have been added in recent years. One of the most widely accepted definitions of SR is provided by the European Commission (2011): «To fully meet their corporate social responsibility, enterprises should have in place a process to integrate social, environmental, ethical, human rights and consumer concerns into their business operations and core strategy in close collaboration with their stakeholders, with the aim of: – maximising the creation of shared value for their owners/shareholders and for their other stakeholders and society at large; – identifying, preventing and mitigating their possible adverse impacts. » A subsequent Communication from the European Commission (2012) proposes a new definition: “the responsibility of enterprises for their impacts on society”. The renewed EU CSR strategy 2011-2014 argues that in order to assume this responsibility, companies must have a process in place to integrate social, environmental, ethical, human rights and consumer concerns into their business operations in close cooperation with stakeholders. The Commission's review of the EU SR strategy 2011-2014 recommends that SR should be voluntary, including self- and co-regulation. It highlights the long-term approach, the development of the concept of "creating shared value" and the explicit recognition of ethical and human rights considerations, in addition to social, environmental and consumer considerations. This long-term approach has led to the broader concept of “sustainability”. In addition to the European Commission, there are other international bodies that seek to promote socially responsible behaviour, including the following: 15  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ United Nations, through the Global Compact, a voluntary initiative that seeks to promote the sustainable development of organisations, for which it defines 10 principles related to human rights, labour standards, the environment and anti-corruption (www.unglobalcompact.org). OECD (Organisation for Economic Co-operation and Development). Through the guidelines for multinational companies, it establishes a series of recommendations that define the principles that companies must respect in the development of their activity, in order to behave responsibly and respect the legislation in force at all times. Incorporating sustainability into management control means introducing an innovative approach to the controller's role, in which the controller assumes an important role in issues such as good governance, corporate social responsibility, human rights in the supply chain, sustainability reporting, regulatory compliance or the circular economy, among many other issues. In recent years, work has been done on proposals for voluntary and mandatory actions to promote SR and sustainable business conduct, through the implementation of the UN Guiding Principles on Business and Human Rights (UNGPs) and the UN 2030 Agenda for Sustainable Development and the contribution to the Sustainable Development Goals (SDGs). SR, therefore, arises from the transparent dialogue between the company and all its stakeholders. SR affects a series of groups who are not indifferent to the company's actions, but who affect and are affected by its actions, who have expectations regarding the company's activity. In economic terms, organisations must meet the demands of their shareholders or financiers to obtain financial results in the short term, with a minimum risk for the rest of the stakeholders; it is not a question of disregarding the obtaining of profits as a licit objective, since obtaining a certain profitability guarantees the survival of the company, but it is not the only or the main objective. On the social side, firms must pay attention to issues such as respect for human rights, society's demand for greater job security, more employment in acceptable conditions, professional development, the right of employees to participate in decision-making and to receive information, gender equality, balance between work and family, etc.; and on the environmental side, attention must be paid to requests to control the environmental effects of economic activity, for example, the impacts of greenhouse gases or the loss of biodiversity, to be efficient in the consumption of materials and to minimise waste, through the development of the circular economy. In addition, due to recent economic scandals, issues related to ethics, corruption and governance have been incorporated into this analysis, such as the existence of ethical codes, the remuneration of directors, equality plans, employee participation in decision-making, gender diversity in the composition of management bodies, the existence of internal audit committees, etc. In the search for balance in the attention to the different stakeholders, SR is not exempt from conflicts, an example of which has recently become evident in relations with suppliers: who is responsible for the safety of the facilities of the textile factories in India, or with customers: who is responsible for the waste generated after the use of the product, the company or the consumer, or with workers, who should bear the costs of teleworking or work-life balance? 16  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ 1.6.2. The Social Responsibility management control system. In order to manage their impacts, organisations must include the corresponding variables in their control system and thus measure their risks and/or the level of compliance with respect to the objectives established in this respect, as well as verify and communicate these risks and compliance. Variables such as CO2 levels, noise and waste emission rates, the number of women in management positions, the number of disabled people employed, the existence of work-life balance plans, to give just a few examples, are now incorporated into management control. SR management has two types of implications: internal and external. Internal implications refer to the necessary incorporation of sustainability issues into strategy and decision-making, and the external ones refer to the information that the company must provide to external users, as a consequence of the need to be transparent in order to favour an effective dialogue with stakeholders. The incorporation of SR into the management system therefore affects the control process, by incorporating these variables into the system, or by having to identify who is responsible for SR, and the control structure, due to the need to introduce control instruments that make it possible to evaluate SR. From an internal point of view, all issues related to social responsibility and sustainability will be integrated into corporate management in a cross-cutting manner. This means that sustainability is not only the responsibility of management control, but of each and every function of the company, although control has a leading role in trying to steer the whole organisation towards meeting its sustainability goals. Given the multidisciplinary nature of the controller's function, their in-depth knowledge of the organisation and the market, their ability to link financial information with intangibles and their excellent position in the organisational structure as management staff, the head of the control system is a strong candidate to assume this leadership role. The establishment of SR policies, strategies and objectives (e.g. equality plans, social action policies, corporate volunteering, environmental policies, etc.), the implementation of management tools (e.g. codes of conduct or codes of ethics), the adoption of corrective measures in case of non-compliance, internal auditing of commitments, the identification of control indicators for key variables, among other elements, must be ensured by the SR control system. In particular, sustainability should be taken into account in the development of the controller's function, for example, when considering social and environmental costs in decisions, when budgeting for more sustainable initiatives such as work-life balance and equality plans, energy saving or integration of disadvantaged groups, when considering the possibility of making ethical investments in the company's financial plans, when dealing with the management of reputational risks, in the reporting or preparation of sustainability reports, in the use of big data to contribute to the improvement of our world, etc. It is also worth noting that the Sustainable Development Goals (SDGs) are a universal call to action to end poverty, protect the planet and improve the lives and prospects of people around the world. In 2015, all UN member states adopted 17 Goals as part of the 2030 Agenda for Sustainable Development, which sets out a plan to achieve the Goals in 15 years. Companies, aware of their role in building an increasingly sustainable world, are taking steps to contribute to the achievement of the SDGs by incorporating them into their management and control systems. It is increasingly common to find companies setting strategies that contribute to the SDGs, establishing lines of action and medium-term plans, and establishing systems of indicators to measure the evolution and degree of achievement of the goals set. 17  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Figure 4. The Sustainable Development Goals (SDGs) The external information to be provided by the company will respond to the demands for information resulting from shared responsibility. Apart from other communication channels with stakeholders, this information must be reflected in a public report, the vehicle for which may be: a) an integrated report, a periodic report that includes both the annual accounts and the information derived from SR management, b) a sustainability report (also known as SR or social report), expressly drawn up independently for this purpose, or c) an environmental report, which is the case of companies that begin by assuming SR focused on the analysis of their impact on the environment. For the preparation of sustainability reports, the international reference model is the GRI model, which has established a series of fundamental reporting principles such as the principle of stakeholder inclusiveness and the incorporation of all material issues in the report. In the case of the Global Compact initiative, the United Nations requires the preparation of the so-called Progress Report for the organisation to explain what it is doing to respect the principles. Another initiative for the presentation of non-financial and sustainability information is the one that establishes the conceptual framework known as Integrated Reporting (IR) (www.integratedreporting.org). Integrated reporting advocates that the annual accounts and information on SR be incorporated into a single document that should also include information on the organisation's capital (financial, industrial, intellectual, human, social and natural), the company's business model and its value creation proposal from the point of view of sustainability. As can be seen in Figure 7, this non-financial information can also be linked to the SDGs. Finally, at this moment in the European context, EU legislation requires that all large companies and all publicly traded companies (except micro-enterprises that are publicly traded) disclose information about what they see as risks and opportunities arising from social and environmental issues, and about the impact of their activities on people and the environment. 18  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ In accordance with the Corporate Sustainability Reporting Directive (CSRD) 1, which outlines companies' obligations to use standards to meet their legal sustainability reporting requirements, the Commission is adopting common standards that will help companies communicate and manage their sustainability performance more efficiently and thus have better access to sustainable financing. The European Sustainability Reporting Standards (ESRS) will be mandatory for companies that are required by the Accounting Directive to report certain sustainability information. By requiring the use of common standards, the Accounting Directive, as amended by the CSRD in 2022, aims to ensure that companies across the EU present comparable and reliable sustainability information. These European standards have been developed by EFRAG, the European Financial Reporting Advisory Group. As of September 2023, the first set of drafts is accessible (https://www.efrag.org/lab6). Figure 5. Contents of the Integrated Report and linkages to the SDGs 1 Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting (Text with EEA relevance) 19  Chapter 1. Fundamentals of Management Control _____________________________________________________________________________________ Annex 1. RESPONSIBILITY CENTRES COST CENTRES DISCRETIONARY EXPENSE REVENUE CENTRES PROFIT CENTRES INVESTMENT CENTRES CENTRES Variable over Costs Quality and service Sales revenues Revenues and costs Profitability (revenues, costs which the (manufacturing and sales) and investment) (totally or partially depending on manager has whether or not action can be decision-making taken on price) power Organisational Operating departments Support departments. Commercial department Divisions Divisions units (procurement and manufacturing General Services (R&D, functions) Administration, Human Resources, etc.) - All the aforementioned for- Control indicators - Manufacturing cost - Observed level of - No. of units sold - Value of sales profit centres - Productivity quality - Sales mix - No. of units sold - ROI - Consumption of materials - Degree of satisfaction - Profitability of customers - Manufacturing cost - Investment in non-current - Technical and economic with the service - Contribution margin per product - Profit (revenues minus assets deviations provided - Profitability of markets controllable costs) - Average collection time - Waste rate - Deviation in the centre’s - Market share - Waste - Market growth index - Degree of innovation in - Stock turnover budget - Market share - Delivery time investments - Observed level of quality - Lead time - No. of returns - Deviation in the centre’s budget - Age of investments - Absenteeism - Brand awareness - Residual income - Cycle time - Observed level of quality - Meeting delivery deadlines - Effectiveness of promotions - Staff turnover - Customers’ satisfaction - Organising the service - All the aforementioned for- Types of decisions - Programming of purchases - Amount sold - All the aforementioned for - Staff hiring and training profit centres - Programming of manufacturing - Selling price (in some cases) revenue and cost centres - Procedures - Acquisition of production - Bargaining with suppliers - Organising the service - Programming of sales inputs - Outsourcing - Procedures - Price policy - Renewal of equipment - Storage - Target markets - Promotions - Collection and payment - Consumption of materials - Sales force - Delivery policy policy - Staff hiring and training - Sales commission policy - Bargaining with customers 20  Management Control Chapter 2. The Balanced Scorecard ______________________________________________________________________________ CHAPTER 2. THE BALANCED SCORECARD 2.1. Control indicators. 2.2. Scorecards. 2.3. The Balanced Scorecard as an instrument for management control. OBJECTIVES OF THE CHAPTER - To define control indicators and establish some classifications. - To know what a scorecard is and the limitations of current scorecards. - To know what a balanced scorecard is and how it is developed. 2.1. CONTROL INDICATORS Control indicators are one of the most widely used instruments in the field of management control systems. The indicators are informative symptoms of the management of the managers, which focus on those aspects that the company considers to be worthy of periodic evaluation. Indicators allow a diagnosis to be made of the situation of the variables to be analysed and their evolution. Control indicators have many advantages as they are better adapted to new environments than other control instruments, since they are a very flexible tool (changes can be made to the system of indicators quickly and some can be replaced by others that are more appropriate), they are capable of representing a large number of intangible aspects that accounting is not capable of reflecting (employee motivation, customer satisfaction, capabilities, brand reputation, etc.), and they are easy to establish and manage through their incorporation into the organisation's IT system (in some cases, a simple spreadsheet linked to other information systems is sufficient). Indicators are a kind of light or alarm signal that informs about the development of the activity and allows the monitoring and periodic evaluation of the behaviour of key variables, by comparing them with benchmarks or objectives, providing a diagnosis of the situation in the short and long term. They are also known as execution or performance measures. The management control system must integrate indicators of different types because of the wide variety of aspects that need to be monitored. Some of the most common classifications of indicators could be the following (these classifications are not mutually exclusive): a) According to their nature: Indicators of economy: they report on the conditions under which financial, human and material resources are acquired. Related to purchase prices, quality of purchases, delivery time, quantity purchased, conditions of purchase, level of wages, interest rates, etc. For example, the purchase price of raw materials.  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ Table 1. Indicators of economy in the waste collection and street cleaning service of the Barcelona City Council Element to measure Indicators 1. Unit labour cost Total cost of cleaning staff / # of employees 2. Cost of garbage collection per Total cost of the garbage collection service / # of inhabitants inhabitant 3. Savings in the acquisition of Real cost of vehicles / Price of vehicles in tender cleaning vehicles Source: AECA (2002), Principios de Contabilidad de Gestión, nº 26, pp. 49-50. Indicators of effectiveness: they measure the degree of achievement of targets, e.g., actual market share against target market share. They usually relate the current level of the indicator to its target. Table 2. Indicators of effectiveness in the waste collection and street cleaning service of Barcelona City Council Element to measure Indicators 4. Operating effectiveness Tons of garbage collected per day / Tons of garbage foreseen to be collected per day 5. Effectiveness in the expenses Real expenses on street cleaning / budgeted expenses on street cleaning budget 6. Effectiveness in the revenues Real revenues from garbage treatment / foreseen revenues from garbage budget treatment Source: AECA (2002), Principios de Contabilidad de Gestión, nº 26, pp. 49-50. Indicators of efficiency: they measure the performance of resources, relating the resources consumed with the outputs obtained, for example: profitability, productivity, etc. They usually relate costs to results. Table 3. Indicators of efficiency in the waste collection and street cleaning service of the Barcelona City Council Element to measure Indicators 7. Service efficiency Tons of garbage collected per day / Total costs Km. travelled along the garbage collection network / total cost Source: AECA (2002), Principios de Contabilidad de Gestión, nº 26, pp. 49-50. Indicators of excellence: they measure aspects that can differentiate the company from its competitors or that are appreciated by customers: customer loyalty, degree of perception of quality, etc. They are usually related to quality, service, customer service, prestige, brand, image, reputation, etc. 2  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ Table 4. Indicators of excellence in the waste collection and street cleaning service of the Barcelona City Council Element to measure Indicators 8. Frequency in the garbage # of collections in one year / 365 collection 9. Resources at the disposal # of litterbins / # of inhabitants of citizens # of skips / # of inhabitants 10. Users coverage # of real users / # of potential users 11. Complaints # of complaints in one year / # of inhabitants (in thousands) 12. Citizens’ assessment Score obtained by the service in citizens’’ assessment surveys Source: AECA (2002), Principios de Contabilidad de Gestión, nº 26, pp. 49-50. b) Depending on the object to be measured, we can speak of financial and non-financial indicators: Financial indicators: indicators that have traditionally been calculated on the basis of financial accounting information and are derived from annual accounts or cost accounting. Some of these indicators are generally analysed by financial management. They are usually tangible indicators that are expressed in monetary terms (in euros), e.g., profit after tax or gross margin; or as relationships between variables of the system (ratios, percentages), e.g., profitability, productivity, working capital, leverage, cost of production, etc. They are usually quantitative and tangible (measurable) indicators. Table 5. Financial control indicators at Caterpillar's Excavators Division FINANCIAL INDICATORS − Division's total profit − Profit by product range − Divisional revenues by product and major components − Costs by department, products and components − Efficiency ratios (e.g., labour hours/machine hours) − Rate of return on assets (ROI) − Return on sales − Cash flow − Inventory levels − Investment in fixed assets Source: Adapted from Hendricks, J. A.; Defreitas, D. G. y Walker, D. K., (1996), Changing Performance Measurement at Caterpillar, Management Accounting, December, p. 22. Non-financial indicators: these refer to both tangible and intangible aspects that are not usually expressed in monetary terms, and are often the source that explains financial performance. They can be quantitative and qualitative, but do not come from the financial sphere. They are those that provide information on the reason for the results obtained in the short term, and are therefore more suitable for representing the current key aspects for analysing the company's competitiveness, elements such as quality, flexibility, customer service, relations with suppliers, social responsibility and sustainability, etc. Nowadays, intangible aspects are the most strategic and, therefore, 3  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ their control is becoming increasingly necessary, despite the difficulties involved, as in many cases they are subjective issues. Table 6. Non-financial control indicators at Caterpillar's Excavators Division NON-FINANCIAL INDICATORS − No. of materials and components delivered on time − Processing time − No. of defective products − Level of machine flexibility − Degree of customer satisfaction − Degree of employee satisfaction − Process improvement rate − Level of integration of values in the culture Source: Adapted from Hendricks, J. A.; Defreitas, D. G. y Walker, D. K., (1996), Changing Performance Measurement at Caterpillar, Management Accounting, December, p. 22. c) According to their scope we can speak of: Internal indicators: those that analyse the internal variables of the organisation itself. They are related to the production process, its costs, delivery time, the internal quality of operations, etc. For example, the cost of production, wastage rates, the cost per hour of direct labour, the number of defective products, productivity, employee motivation, cycle days, average lead time, etc. External indicators: they measure environmental variables. These variables are increasingly necessary given the instability and uncertainty surrounding business activity. It will be necessary to monitor variables related to markets, competition, customer satisfaction, the existence of complementary or substitute products, etc. It will even be necessary to monitor the macroeconomic variables of the countries where the company operates: inflation rates, legal regulations, currency exchange rates, etc. Once the Key Performance Indicators (KPIs) have been defined, the definition of the indicator (its name) must be accompanied by other information related to the indicator. For each indicator, for example, the following information should be identified: - its objective or goal, - its current level, - its calculation procedure, - its deviations, after comparing the target with reality, - who is responsible, - the sources of data collection - and its periodicity or frequency. Likewise, for better management of the information, it would be necessary to analyse the interrelationships or effects induced on other indicators, as well as the statistical data related to their evolution (mean, median, standard deviation, etc.). On the other hand, for the company to be competitive, it needs to know the current level of this indicator among its competitors (benchmarking), information that will be used to compare itself and take it as a reference when defining its goal. 4  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ Table 7. Definition of an indicator Name: MAINTENANCE COVERAGE Calculation procedure: Equipment undergoing preventive maintenance / equipment scheduled for preventive maintenance * 100 Unit: % Source of information: Equipment ledger and preventive maintenance schedule Frequency of data collection: Weekly Current value (capacity): 80% Goal: 90% Frequency of analysis: Quarterly Responsible person for the analysis Maintenance manager 2.2. SCORECARDS When the company chooses its indicators and brings them together in a single document, this is called a scorecard. The scorecard indicators emphasise all those aspects that the company wants to control in a special way, thus acting, even unconsciously, to convey to the employees an idea of what the management considers really important, because as it is often said in controllers' jargon, "what gets measured gets achieved". In other words, you can only improve what you can measure, in tangible or intangible terms. By putting the emphasis on certain indicators, you give employees an idea of what the company really considers to be important, you are directing their efforts in the right direction. Even more so if the indicator system is linked to the incentive system. A scorecard is a document that contains an integrated and synthetic presentation of the key performance indicators (KPIs) chosen by the company, their targets, degree of achievement, deviations, responsible parties, etc. There are currently many applications that allow the indicators to be organised in a computerised way in what are known as digital dashboards. Figure 1. Digital scorecard or dashboard For the company to have a good system of indicators defined, it should choose indicators of different types in a balanced way. Otherwise, it could be the case that all indicators measure 5  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ the same variables, i.e., they look in one direction only. However, studies show that the indicators in most corporate scorecards have almost all the same characteristics: they are financial, internal, short term focused and poorly structured, as the indicators are presented in an uncoordinated way. Financial indicators are important, but they are not the cause of competitiveness; they are the consequence. The key lies in the non-financial indicators, which are the source of the company's long-term sustainability. Another conclusion of the study is that there is an excess of indicators. Many scorecards have been built by adding and adding more and more indicators, making the result an unmanageable tool. Given the characteristics of the traditional scorecard indicators we have just mentioned, one of the most insistent criticisms they are currently receiving is their lack of linkage with strategy. By not having a strategic focus, they neglect aspects related to the long-term sustainability of the company, ignore intangible aspects, which are key to competitiveness, and focus on financial or monetary issues, which are not the origin of the company's competitiveness but its consequence. Scorecards are more oriented towards results than the origin of those results and could jeopardise the survival of the organisation. 2.3. THE BALANCED SCORECARD AS A MANAGEMENT CONTROL TOOL The Balanced Scorecard (BSC) is a tool that emerged in the field of management control systems, but has very quickly found its way into other areas of business management such as strategic planning or value reporting. Today, the BSC is more often referred to as a strategic management system and not simply as a management control instrument. Its potential lies in the fact that it is an information system that facilitates the monitoring of strategy and also serves as a tool for communicating strategy in a simple and understandable way. On the other hand, the emphasis on information as opposed to control facilitates its implementation as it is perceived as an aid to the activity of the different decision-makers. It is becoming widely accepted in all types of companies, both industrial and service companies, which are successfully using it to evaluate the degree of achievement of their strategies, and to communicate and motivate employees towards long-term results. The BSC changes both the contents of traditional scorecards, adding new categories of indicators, and the procedures for their preparation and implementation (communication, incentives, initiatives, reviews), which are more oriented towards strategy, making the control system truly linked to the strategy and derived from it, as we saw in section 1.3.1. when discussing the management control process. The indicators of the BSC serve to verify that all actions in the company are consistent with the strategic objectives. However, the BSC is more than a control system, it is a management system oriented towards the long term, which allows overcoming the barriers of operability, short term, etc. In order to achieve this objective, the BSC is not developed on its own, but is a tool that is based on the development of so-called "strategy maps" that serve to link the strategy to the BSC. Both instruments (the strategy map and the BSC) have been developed in parallel to strengthen the strategic vision of management control. The BSC is defined as a set of control indicators necessary to manage a company, related to the environment and behaviour, in order to be able to verify and control the process of change and adaptation to the strategy. 6  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ The use of the BSC as a management tool involves addressing the following objectives: 1. Translate the strategy. The development of the BSC can initiate an interesting discussion on what the company's strategic objectives are and how they should be achieved. It helps to move from grand declarations of intent to day-to-day work, as the strategy is translated into specific objectives. 2. Communicate. All employees should be aware of the strategy and objectives. In many companies, regular dissemination of the BSC can facilitate this communication through internal newsletters, noticeboards, web-based e-mails, etc. 3. Plan and align. The starting point is the definition of the strategy, which sets 3–5-year objectives, which are concretised and linked to budget planning, which sets one-year objectives. By being aware of the cause-effect relationships between indicators, employees in different functions of the organisation will be able to better understand how the objectives will be achieved or how their role influences the rest of the organisation. This will ensure that strategic initiatives are effective and facilitate the implementation of the strategy. 4. Increase strategic feedback and education. Clarifying the mission, strategy and objectives improves feedback on whether the strategy is being feasible and delivering the expected results. In addition, the process of defining the BSC provides staff with "education" on strategic direction; it has a huge learning effect. Ultimately, through these objectives, the BSC attempts to overcome the barriers that exist in many organisations to implementing their strategies. 2.3.1. How a balanced scorecard is developed. The starting point for building a BSC is the mission and strategy. This strategy is then translated into the definition of strategic objectives and, if necessary, critical success factors. Finally, the strategic objectives are further specified until the control indicators are defined. The strategic objectives and critical success factors are graphically summarised in the strategic map. The indicators are defined to monitor the achievement of the strategic objectives and are integrated into the balanced scorecard, but both instruments must be permanently linked. In both cases, the information is organised around different perspectives or points of view of the company, which we will explain below. Also, in both cases it is necessary to show the cause- effect relationships between the defined elements, as no perspective works independently. It is not just a matter of presenting a battery of unconnected indicators, but of showing the existing causal relationships, so that it is possible to assess how unit variations in certain indicators affect or are the cause of variations in others, so that these effects can also be simulated. It is necessary to understand the interrelationships between indicators in order not only to obtain information about what is happening, but also to understand why it is happening. 7  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ Figure 2. Elements of the balanced scorecard The phases for its elaboration are: 1st phase: identification of the strategic objectives or critical factors in accordance with the strategy defined by the company that allows it to achieve its mission. These objectives are set out in the so-called strategic map. 2nd phase: definition of the control indicators needed to monitor the strategic objectives. The indicators must be derived from the strategic map to ensure that they are linked to strategic issues and the long term. The indicators are organised around the four basic perspectives of any BSC. 3rd phase: analysis of the cause-effect relationships between the strategic objectives of the strategic map and between the indicators of the scorecard. In this way, the indicators appear in a coordinated way within a chain of links or interrelationships between them. Identifying these relationships is particularly useful when deciding how to allocate scarce resources. These should be allocated to improving those indicators that have the greatest causal relationships with the rest, since improving the first ones will indirectly improve the rest, due to the existence of expansive or multiplying effects (domino effect). 4th phase: definition of specific objectives or goals for the indicators and actions to be taken to facilitate their achievement (strategic initiatives). Strategic initiatives are proposals for specific improvements, suggestions that usually come from the employees, on how to get an indicator to improve its performance, and they require a budget. This budget is clearly strategic in nature. Phase 5: analysis of deviations, comparing actual indicator data with their specific targets. 6th phase: adoption of corrective measures to improve the implementation of the strategy in subsequent financial years. The definition of the scorecard should be accompanied by a proposal for periodic strategic reviews, through planned and properly scheduled meetings that systematically monitor achievements or problems in the implementation of the strategy. This is a continuous process that does not end with the definition of indicators, as these must be reviewed periodically to adapt them to the new concerns of the organisation, and because the deviations that become apparent must lead to action to correct the undesired effects and even to rethinking the strategy and the critical success factors. 8  Chapter 2. The Balanced Scorecard ______________________________________________________________________________ Table 8. Example of anal