Management tool of business rationality

Management control should become the management tool ensuring business rationality and essential information for decision making in the risky business. Risk should always be treated as an element of the stochastic reality in which the company operates. Hence, it is necessary to complete the management control with the analysis of the impact of individual strategic options on the risk exposure and company financial situation, non-linear planning and stochastic approach for objectives setting and key risk measures indication, taking into account the investments at risk and development of risk adjusted performance measurement. Above mentioned adjustments should lead to an improvement in the predictability of the plans execution and better management of activity options, optimizing the capital requirement for financing operational activity. It is essential to identify, analyze and control the potential plans deviation of different decision options. Hence, it is important to build competences within management processes that will secure the precise risk analysis. The implementation of risk controlling elements to management control and the risk impact consideration in managerial information makes risk issues important for every manager. There were desribed in the blog various proposals for the development of risk issues into management control, which makes crucial to create the necessary competencies not only in management control, but also in various management levels. It supports to secure the execution of the company's strategic and operational goals thanks to both relevant managerial information presenting the impact of risk on the company's performance and efficient steering decisions-making at risk. Managers receive support for taking effective decisions concerning the allocation of resources within the company and an instrument for measuring performance based on RAPM. It creates a mechanism combining risk exposure with economic results and supporting risk reaction, what allows to develop the most effective strategies for the operation of the companies in the extremely volatile global business environment.

#managementcontrol@Risk

The essential task of management control is to secure relevant information concerning results at risk. Proper perception of risk requires not only treating risk as a negative factor that may worsen the planned economic results, but also as an opportunity. Hence, it is important to manage the relation of potential profits generated as a result of risk-taking to the costs of capital involved. Risk creates opportunity to work out additional profits, which are a reward for risk exposure. An alternative to potential profits is the possibility of incurring a loss as a result of unfavorable for the company environment developments, or faulty internal processes. Hence, the proper risk analysis becomes crucial for the preparation of right managerial information in order to eliminate intuition from risk-taking, which is the reason of many errors and losses. Decisions based on intuition and the assumption of linear phenomena usually contribute to the results significantly different from the plans. Intuition that is not supported by appropriate regulations and risk analyses does not mean the reliable support. Management control task should care that economic profit becomes the result of planned activities and not randomness. Managers should be aware of the importance of risk controlling for the proper management in the enterprise and appropriate risk-taking objectives should be included in the performance evaluation.

Management control developed by risk controlling

Management control developed by risk controlling should precisely reflect the economic picture of company operations and assess the future results and financial situation at risk. Hence, it is important to secure the implementation of the following tasks within the management control process:

● forecasts of the results should be completed by risk component - managers are focused on the execution of planned profits at risk. The controlling system follows the execution of planned goals. The incentive system supports the achievement of the company goals and ensures the convergence of the goals of owners and managers. The basis for the incentive system are usually corporate goals, which are measured e.g. by EBIT or EBITDA. This approach should be adjusted by measures related to the return on risk. Managers should be interested in information on the risk-taking profitability of their decisions. The prerequisite is the required security of profits generation, which means efficient risk management at least, what requires to limit managers in risk-taking within the company risk tolerance and to secure the expected return on risk capital;

● consideration of risk in the strategy - risk that arises in the globalized business environment cannot be ignored during the strategy development. The strategy execution is exposed to the long-term trends of the world economy development. Hence, the identified opportunities may not occur and the implementation of strategy may be disrupted by risk materialization. Global risk of VUCA word disrupts the creation of a strategy characterized by a high level of certainty. The analysis of the associated risk becomes extremely important and requires stochastic, variant structure of strategy construction. The right risk analysis becomes crucial for success of strategy, because it is the basis for creating variants of the strategic decisions securing the highest return on investment for owners in specific situation at risk. It is necessary to stop linear planning, based on forecasts prepared as extrapolation of the past. Such an approach makes difficult to implement effective tools for supporting the achievement of goals in the future described by the randomness and discontinuity of market trends;

● development of the activity picture by probable variants of volatility - despite the very turbulent environment, enterprises do not change the practice of planning and monitoring the achievement of objectives, based on linear and deterministic prepared plans. The randomness of the environment conditions should encourage decision-makers to project various variants of the risk reaction instruments preventing the deviations of planned values (stochastic approach to planning in the VUCA word). Managers and controllers assume often that the planned value is also the most likely or expected value, although it works often only as the benchmark used to control the plans execution. While it should be considered in the execution of target value the distributions of results, presented in specific ranges specifying both positive and negative deviations from the target as alternative approach to analyzing future performance;

● consideration of risk analysis in decision-making processes - risk analysis is important to assess the enterprise's ability to take risk. The knowledge of the risk exposure and its impact on the company's performance also allows to define the capital requirement in the company. The risk analysis should therefore become an element developing the controlling analyzes and the capital structure. The risk analyses should contain stress tests in order to identify the risks threaten the continuity of company operation. This practice should be carried out in a systematic and continuous manner. It requires to develop the competences, knowledge and tools that allow to fit elements of risk analysis into the management control.

● application of risk adjusted performance measurement in the decision-making process – evaluation of decisions performance should base on return on capital adjusted by risk capital. Management control becomes the central unit that prepares managerial information for decision-making, consideration of expected return for different options that have different risk costs. It is necessary to develop competences for the implementation of RAPM type of measurement and for interpretation of the results by managers.

Consideration of risk in management control

Understanding the risk associated with the company’s operations is the basis for managing the range of plan’s deviations in order to strengthen the creation of value added. The adjustment of management controls by risk component must ensure that the value of the company and its financial rating are increased and the unintended spending of funds is avoided. Decision options should be evaluated based on risk-return assessment supported by risk management tools: development of traditional measures by risk analysis with decision templates and risk-oriented training for controllers and managers. The insufficient integration of the risk issues and management control results from:

● the lack of risk targets in the performance measurement and incentive system,

● the lack of risk consideration in the value-based results assessment,

● the lack of technical and methodological skills in risk analysis among controllers and decision makers.

Practice indicates that the areas of management control and risk management operate independently in many companies, not only due to the lack of resources, but also due to the lack of awareness concerning the need to integrate information from the risk area with decision-making and performance assessment.

The coherence of the management process is ensured by systematic consolidation of all factors influencing the enterprise profits and taking them into account in the performance measurement. Management supported by state of the art management control developed by a risk component, becomes more comprehensive and effective. The impact of risk on company’s operations should be considered during budgeting, capital allocation and measuring business results. It is essential in order to achieve this aim to use risk analyses, designing an efficient risk reaction and measuring the risk-return profile. Therefore, the area of management control should be developed by risk controlling, responsible for controlling risk-taking and noticing managers concerning the impact of risk on results of activity. Hence, risk controlling naturally becomes a complementary area to the traditionally perceived controlling. Risk controlling should be defined as a management method focused on controlling the risk-taking by company managers towards stabilization of the economic results improvement (both by taking advantage of the opportunities and by neutralizing the undesirable consequences of risk exposure). The main task of risk controlling is to stop to perceive risk only as a negative situation and to start to manage the effectiveness of risk-taking, including all factors that may lead to both losses and profitability increase. This requirement determines the target risk controlling structure.

Risk controlling consists of the following elements:

● capital adequacy and correct allocation of risk capital to individual responsibility centers, which in practice is transformed into risk limits recommendations;

● risk monitoring and control of risk exposure, which should be linked to the guidelines for achieving the required risk-return profile;

● risk adjusted performance measurement.

Market opportunities are inextricably linked to risk-taking. An efficiently designed risk controlling should be enabled to take advantage of opportunities, creating conditions for generating stable economic profits. This can be achieved only, if the strategy implemented in the organization ensures an optimal balance between the goals of growth and profitability and the associated risks. Management control should secure compliance of the projection of management results and the applied risk control policies with the volatility of the factors influencing the company's success. Risk controlling should participate in defining the risk tolerance, risk limits, accepted risk reaction instruments and reporting channels.

• Top management receives the necessary information about the risk exposure and potential impact of risk on the results of company operations.
• Managers are informed about the expectations concerning risk taking and noticed concerning the impact of their decisions on the execution of plans.

The foundation for the development of management control is constantly controlling the impact of risk on the profitability of the company. Addition of risk impact to performance measurement allows to rationalize decisions also in the area of risk taking.

Management in the risky environment - continued

Risk management gets increasing importance in the world of global randomness and volatility. Risk materialization that is often triggered by global processes or local events, may result in many companies going out of business. However, the occurrence of risk may become an opportunity for a company that is properly prepared to develop and expand the business. Management control should support managers to develop the potential to use the opportunities by providing a sustainable improvement of economic results under conditions of risk materialization. Relevant managerial information becomes the foundation to create shock-proof companies, which are not only adapted to operate effectively in the era of global revolution on the economy characterized by high risk, but also prepared to take advantage of the opportunities. Proper control of the operating activities, based on reliable and complete data becomes important for efficient decision-making at risk. Management control supports managers to monitor the effectiveness of business strategies, the correctness of decisions and the productivity of invested capital. Effective control of managers' decisions ensures relation of activity with the company goals and the action automation thanks to the implementation of a feedback system based on reliable reporting of results.

-> As shown by K. Jajuga risk management is the process of making decisions and implementing actions leading to an acceptable value of risk in the company, with the exposure structure supporting the plans execution. More: K. Jajuga: Zarządzanie ryzykiem, Wydawnictwo Naukowe PWN, Warsaw 2009, p. 15,18.

Importance of management control

Management control should contribute in the company to the achievement of goals and secure the adaptation potential, which is the result of positive balance of resources exchange with the environment. Financial resources are an essential element for company functioning. The proper flow of relevant information is essential for the effective resources use and proper correlation of this process with the plans execution. Management control generates steering interactions, creates norms and determines the rationalized selection criteria for the decision-making. It means creating the necessary influence within company to achieve a required certainty of results. Companies operate on the basis of organizational culture defining routines, schemes and operational goals of organizational units. However, businesses unable to adjust flexibly the operational routines will not survive. Crucial conditions for an organization's survival in the volatile environment is its ability to adapt to changing operating conditions. It is always connected to funds spending. Company should ensure constant inflow of funds exceeding the reduction of resources, if it wants to avoid divestment of its strategic resources on the basis, of which it carries out its core activity. The positive balance of resource exchange with the environment creates the necessary flexibility of the operations of the company and creates conditions for generating added value. Properly functioning management control is a source of benefits for the company both in terms of internal efficiency improvement and market dominance. This scheme increases following market development complexity in order to secure the ability to analyze increasing volume of data. Management control should be future-oriented, focusing the attention of managers on the main areas and main factors for generating economic profits and creating criteria for assessment of the company's success. A properly designed management control provides the company management with access to information indicating, which areas of the company are profitable, create value at risk and should be optimized in order to achieve planned targets.

The main objective of management control is securing the execution of the company's goals. Hence, two above-presented complementary and properly functioning areas of management control allow to introduce the mechanism of efficient adaptation in the company to business environment’s volatility and to ensure the consistency of strategy goals and decisions at risk of individual managers. There is necessary to ensure the integration of management control with elements of risk management and adjusting its structure to the specific needs of entities.

Management control should equip decision-makers with tools to control the stability of economic results based on the introduction of new elements to the management process, adapting this process to the usage of the risk-taking in order to create a competitive advantage. Management control creates potential to improve management towards quick adaptation to market changes. That is why economic profit should be the result of consistent execution of plans and right decisions, programming the positive impact of randomness and not the result of randomness itself. Management focused on creating conditions for a stable improvement of economic profits should be developed by identification of risk factors influencing the operational activity of companies, risk analyses, limitation of risk exposure and measurement of the efficiency of risk-taking. Hence, tasks of management control should be presented in following way:

● support for managers that take risk;

● monitoring the efficiency of risk taking;

● risk adjusted performance masurement;

● risk reporting developed by risk impact on economic performance.

Management control equipped by above-presented tools contributes to the stabile control of economic results, linking profit improvement to the rationalization of the capital costs of the company activity.

Management control creates an information system that processes economic data concerning the company's activity. The value of information is generated only when it secures efficient use of resources. As underlined by C. Drury information gets value only when it creates the potential to make effective decisions. Decision-makers are able to assess the results of different options of activity based on access to relevant information. The company’s success is determined by the ability to create and deliver the timely and right managerial information. Management control should ensure that appropriate data and information is correctly reported, analyzed and clearly presents cause-and-effect relationships. The prerequisite is the consistency of reported data. Decision-makers creating the structure of managerial information should define, which drivers are important to the success of the enterprise and how many measures should be observed. The method of preparation of managerial information should reflect the way of the resource consumption in the organization. Effective management requires following elements in place:

● access to precise information on costs,

● monitoring of factors having a significant impact on the execution of objectives,

● reporting system of measures providing feedback interactions concerning the effectiveness of actions towards compliance with the goals.

Such an information system provides support for management decisions, based on both quantitative data and descriptive information.

Management in the risky environment

Companies operate in a global economy that exposes all of them to continuous changing risks that not only concerns the company, but also affects the activity of other entities, hence each company is exposed to the risk of decisions of others. The impact of risk in an increasingly global economy becomes critical to the structure of management control. Companies operate in a progressing complexity and instability. The fundamental management challenge is the adoption of the organization to the new conditions of operational activity characterized by increasing risks that will support companies to adapt to the new circumstances in the business environment. The operational activity of companies is exposed to constant changes resulting from the requirement of continuous development in the conditions of the emergence of new risks, which forces them to react flexibly in new situations. New instruments supporting economic results management must be provided in such a situation of word characterized by increasing discontinuity and absolute uncertainty. Following T. Pszczołowski management should be defined as the activity of managers aiming to execute enterprise plans using resources in order to achieve the organization's goals by making wise decision. The primary goal is the creation of the economic profit being a synergistic effect developed in a company. Related decisions are always at risk, in some cases affecting the far future. The goal becomes the anticipated, future values of economic results linked to related actions of managers. Hence, the management control instruments shall be developed by risk starting with building tools for the strategy operationalization, through cost settlement, to the final measurement of managers' performance.

Necessary developments of management control

The necessary developments of management control in companies towards the increase of plans’ execution certainty are imperative for securing the undisturbed, continuous increase of the economic profits. These developments should enable conscious and effective management the impact of risk on the functioning of companies. Disregarding risk in management control may lead to faulty decision-taking concerning running the business, contracts, loss of market opportunities and the lack of hedging the significant risks for the operational activity. The main task of management control is to prepare decisions that may be at risk in the highly volatile business environment. Decision-makers in each company require to obtain timely and reliable information. Managers operate in conditions of ignorance due to risk, which should be managed also by adjusting management control by a risk component. Obtaining correct data about risk and its impact on the economic results becomes the foundation for making effective decisions. However, there is paid insufficient attention in management control practice to issues of risk analysis, risk simulation, planning security or risk adjusted performance measurement. It requires the development of competences supporting the implementation of elements of risk management into everyday management operations.