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to expand capacity and increase its fixed costs to support a
10 percent gain in sales volume for its service lines”but not
by more than the projected profit increase. Increasing sales
prices generally does not require a business to increase its
fixed costs. So the clear advantage is on the side of increasing
sales prices. Of course, the key question is whether a business
could pass along a 10 percent sales price increase without
adversely affecting the demand for its services.

Suppose the business is considering cutting sales prices
10 percent on all three of its service lines. One question the


managers should ask is this: How much would the increases
in sales volumes have to be simply to maintain the same
profit? Of course, the business would really prefer to stimulate
demand to increase profit, not just keep it the same. But cal-
culating these same-profit sales volumes provides very useful
points of reference. Each manager should forecast sales
demand at the lower prices and compare the predicted sales
volume against the same-profit volumes.
The profit report format presented in Figure 16.4 is a
good tool for this sort of analysis. (This is the same profit
pathway used in Chapter 11 for analyzing trade-off decisions
for a product-based business, except that cost-of-goods-sold
expense is deleted.)
Figure 16.5 shows the unit margins at the lower sales
prices and the required sales volumes needed just to maintain
the same profit. The required sales volumes are determined
by dividing the contribution margin targets (from Figure 16.4)
by the lower unit margins caused by the lower sales prices.
Fixed costs are held the same, but as previously mentioned,
one should be very careful in making this assumption when
sales volumes are increased.
What about the opposite trade-off ? Suppose sales prices
were increased 10 percent, causing decreases in sales volume.
The same method of analysis can be used to determine how
far sales volume could drop and profit remain the same. (If you
do these calculations the answers are standard = 9,719 units

Service Line
Standard Basic Premier
Sales price $100.00 $75.00 $150.00
Revenue-driven expenses $8.50 $3.00 $11.25
Unit-driven expenses $6.50 $5.00 $8.75
Unit margin $85.00 $67.00 $130.00
Sales volume 100,000 150,000 50,000
Contribution margin $8,500,000 $10,050,000 $6,500,000
Fixed operating expenses $7,500,000 $9,050,000 $5,500,000
Profit $1,000,000 $1,000,000 $1,000,000
FIGURE 16.4 Profit model for a service business.


Service Line
Standard Basic Premier
Sales price $90.00 $67.50 $135.00
Revenue-driven expenses $7.65 $2.70 $10.12
Unit-driven expenses $6.50 $5.00 $8.75
Unit margin $75.85 $59.80 $116.13

Contribution margin target $8,500,000 $10,050,000 $6,500,000
Required sales volume 112,063 168,060 55,974
Present sales volume 100,000 150,000 50,000
Sales volume increase needed 12,063 18,060 5,974
FIGURE 16.5 Sales volumes needed at 10 percent lower sales prices.

decrease, basic = 14,555 units decrease, and premier = 4,822
units decrease.) Whether a service business would willingly
sacrifice sales volume and market share in order to increase
its sales prices is another matter.

In most ways, the financial statements of service businesses
are not all that different from those of product companies
(though there are some differences, of course). In a service
business income statement, there is no cost-of-goods-sold
expense or gross margin. In a service business balance sheet,
there are no inventories or accounts payable for inventories.
Having said this, a service business may sell incidental
products with its services (popcorn and candy at a movie
theater, for example) and therefore report a relatively small
amount of inventories. Some service businesses are very
capital-intensive (e.g., transportation companies, telephone
companies, and gas and electricity utilities). Other service
companies need relatively little in the way of long-term oper-
ating assets (e.g., CPAs and law firms).
The tools of financial analysis are essentially the same for
both product and service businesses. Naturally the models
and tools of analysis have to be adapted to fit the characteris-
tics of each business. The chapter demonstrates techniques of
profit analysis for service businesses. The profit consequences


for a change in sales volume versus a change in sales price for
service businesses are not nearly as divergent as those of
product businesses. Sales price improvements have an edge
over sales volume improvements for both types of businesses,
but the advantage is not nearly so pronounced for service
I should mention in closing that the ratios used for inter-
preting profit performance and financial condition (Chapter 4)
and the techniques for analyzing capital investments (Chap-
ters 14 and 15) apply with equal force to service businesses
and product businesses.


Management Control

Management decisions constitute a plan of action for accom-
plishing a business™s objectives. Establishing the objectives
for the period may be done through a formal budgeting
process or without a budget. In either case, actually achiev-
ing the objectives for the period requires management con-
trol. In the broadest sense, management control refers to
everything managers do in moving the business toward its
objectives. Decisions start things in motion; control brings
things to a successful conclusion. Good decisions with bad
control can turn out as disastrously as making bad decisions
in the first place. Good tools for making management deci-
sions should be complemented by good tools for manage-
ment control.
Previous chapters concentrate on models of profit, cash
flow, and capital investment that are useful in decision-
making analysis. This chapter shifts attention to manage-
ment control and explores how managers keep a steady
hand on the helm during the business™s financial voyage,
often across troubled waters. This chapter also presents a
brief overview of business budgeting. This short summary
on budgeting is not an exhaustive treatise on the topic, of


Management control is both preventive and positive in nature.
Managers have to prevent, or at least minimize, wrong things
from happening. Murphy™s Law is all too true; if something
can go wrong, it will. Equally important, managers have to
make sure right things are happening and happening on time.
Managers shouldn™t simply react to problems; they should be
proactive and push things along in the right direction. Man-
agement control is characterized not just by the absence of
problems, but also by the presence of actions to achieve the
goals and objectives of the business.
One of the best definitions of the management control
process that I™ve heard was by a former student. I challenged
the students in the class to give me a very good but very con-
cise description of management control”one that captured
the essence of management control in very few words. One
student answered in two words: “Watching everything.” This
pithy comment captures a great deal of what management
control is all about.

Management theorists include control in their
conceptual scheme of the functions of managers,
although there™s no consensus regarding the exact meaning of

control. Most definitions of management control emphasize
the need for feedback information on actual performance that
is compared against goals and objectives for the purpose of
detecting deviations and variances. Based on the feedback
information, managers take corrective action to bring per-
formance back on course.
Management control is an information-dependent process,
that™s for sure. Managers need actual performance informa-
tion reported to them on a timely basis. In short, feedback
information is the main ingredient for management control.
And managers need this information quickly. Information
received too late can result in costly delays before problems
are corrected.

In general, management control information can be classified
as one of three types:


1. Regular periodic comprehensive coverage reports (e.g.,
financial statements to managers on the profit perform-
ance, cash flows, financial condition of the business as a
whole and major segments of the business)
2. Regular periodic limited-scope reports that focus on criti-
cal factors (e.g., bad-debt write-offs, inventory write-
downs, sales returns, employee absenteeism, quality
inspection reports, productivity reports, new customers)
3. Ad hoc reports triggered by specific problems that have
arisen unexpectedly, which are needed in addition to regu-
lar control reports
Feedback information divides naturally into either good
news or bad news. Good news is when actual performance is
going according to plan or better than plan. Management™s job
is to keep things moving in this direction. Management con-
trol information usually reveals bad news as well”problems
that have come up and unsatisfactory performance areas that
need attention.
Managers draw on a very broad range of information
sources to keep on top of things and to exercise control. Man-
agers monitor customer satisfaction, employee absenteeism
and morale, production schedules, quality control inspection
results, and so on. Managers listen to customers™ complaints,
shop the competition, and may even decide that industrial
intelligence and espionage are necessary to get information
about competitors. The accounting system of a business is one
of the most important sources of control information.
Managers are concerned with problems that directly
impact the financial performance of the business, of course”
such as sales quotas not being met, sales prices discounted
lower than predicted, product costs higher than expected,
expenses running over budget, and cash flow running slower
than planned. Or perhaps sales are over quota, sales prices
are higher than predicted, and product costs are lower than
expected. Even when things are moving along very close to
plan, managers need control reports to inform them of con-
formity with the plan.

Control reports should be designed to fit the specific
areas of authority and responsibility of individual


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