ENGINEERING MANAGEMENT

ENGR. EDMUNDO A. OBINA

1st Semester, S.Y. 2020-2021

Republic of the Philippines

ISABELA STATE UNIVERSITY
Echague, Isabela

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Chapter 9 Controlling

Overview/Introduction

The long-term existence of many companies, most often, is placed in jeopardy when
some aspects of their activities go out of control. Consider the following examples:

1. A news report indicated that the fire which destroyed the P800 million
Superferry 7 luxury ship on March 26, 1997 was caused by illegal connections
made on its electrical system.' If this is true, the losses could be attributed to
inadequate management control.

2. The tragedy that happened at the Ozone Disco in March 18, 19961 clearly
manifested management’s lack of control over the day-to-day operations of
the firm. Even the failure to detect earlier the violations in the Building Code
spells lack of effective government control.

3. The management of a telephone company could not stop the unauthorized

use of lines assigned to many of its subscribers. Customers become angry
when they are billed for calls they never made.

The examples presented constitute a very small percentage of unwanted occurrences

that happen everyday in the business world. Apart from the destruction of lives and
property, normal business operations are hampered causing discontinuities in
employment and the provision of products and services. These could not have happened
if only adequate controls were instituted.

Learning Outcome/Objective

At the end of this chapter, the students shall be able to:

1. Discover the importance of Controlling

2. Classify the steps in the control process

3. Enumerate the types of Control

4. Recognize the compose Components of Organizational Control System

5. Evaluate strategic Control Systems

6. Identify Control Problems

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Learning Content/Topic

A. WHAT IS CONTROLLING?

Controlling refers to the “process of ascertaining whether organizational

objectives have been achieved; if not, why not; and determining what activities should
then be taken to athlete objectives better in the future.” Controlling completes the
cycle of management functions. Objectives and goals that are set at the planning
stage are verified as to achievement or completion at any given point in the organizing
and implementing stages. When expectations are not met at scheduled dates,
corrective measures are usually undertaken.

B. IMPORTANCE OF CONTROLLING

When controlling is properly implemented, it will help the organization achieve

its goal in the most efficient and effective manner possible.

Deviations, mistakes, and shortcomings happen inevitably. When they occur in

the daily operations, they contribute to unnecessary expenditures which increase the
cost of producing goods and services. Proper control measures minimize the ill effects
of such negative occurrences. An effective inventory control system, for instance,
minimizes, if not totally eliminates losses in inventory. T

The importance of controlling may be illustrated as it is applied in a typical

factory. If the required standard daily output for individual workers is 100 pieces, all
workers who do not produce the requirement are given sufficient time to improve; if
no improvements are forth-coming, they are asked to resign. This action will help the
company keep its overhead and other costs at expected levels. If no such control is
made, the company will be faced with escalating production costs, which will place
the viability of the firm in jeopardy.

C. STEPS IN THE CONTROL PROCESS

The control process consists of four steps, namely:

1. establishing performance objectives and Standards

2. measuring actual performance

3. comparing actual performance to objectives and standards, and

4. taking necessary action based on the results of the comparisons.

Establishing Performance Objectives and Standards

In controlling, what has to be achieved must first be determined. Examples of

such objectives and standards are as follows:

1. Sales targets — which are expressed in quantity or monetary terms;

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 2. Production targets — which are expressed in quantity or quality;

3. Worker attendance — which are expressed in terms of rate of absences;

4. Safety record — which is expressed in number of accidents for given

periods;

5. Supplies used — which are expressed in quantity or monetary terms for

given periods.

Once objectives and standards are established, the measurement of

performance will be facilitated. Standards differ among various organizations. In
construction firms, project completion dates are useful standards. In chemical
manufacturing firms, certain pollution measures form the basis for standard
requirements. After the performance objectives and standards are established, the
methods for measuring performance must be designed. Every standard established
must be provided with its own method for measurement.

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 Measuring Actual Performance

There is a need to measure actual performance so that when shortcomings

occur, adjustments could be made. The adjustments will depend on the actual
findings.

The measuring tools will differ from organization to organization, as each have
their own unique objectives. Some firms, for instance, will use annual growth rate as
standard basis, while other firms will use some other tools like the market share
approach and position in the industry.

Comparing Actual Performance to Objectives and Standards

Once actual performance has been determined, this will be compared with what
the organization seeks to achieve. Actual production output, for instance, will be
compared with the target output. This may be illustrated as follows:

A construction firm entered into a contract with the government to construct a

100 kilometer road within ton months. It would be, then, reasonable for management
to expect at least 10 kilometers to be constructed every month. As such, this must be
verified every month, or if possible, every week.

Taking Necessary Action

The purpose of comparing actual performance with the desired result is to

provide management with the opportunity to take corrective action when necessary.
If in the illustration cited above, the management of the construction firm found out
that only 15 kilometers were finished after two months, then, any of the following
actions may be undertaken:

1. hire additonal personnel;

2. use more equipment; or

3. require overtime.

D. TYPES OF CONTROL

Control consists of three distinct types, namely:

1. feedforward control

2. concurrent control, and

3. feedback control.

Feedforward Control

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 When management anticipates problems and prevents their occurrence, the
type of control measure undertaken is called feedforward control. This type of control
provides the assurance that the required human and nonhuman resources are in
place before operations begin. An example is provided as follows:

The manager of a chemical manufacturing firm make. sure that the best people
are selected and hired to fill jobs. Materials required in the production process are
carefully checked to detect defects. The foregoing control measures are designed to
prevent wasting valuable resources. If these measures are not undertaken, the
likelihood that problems will occur is always present.

Concurrent Control

When operations are already ongoing and activities to detect variances are
made, concurrent control is said to be undertaken. It is always possible that deviations
from standards will happen in the production process. When such deviations occur,
adjustments are made to ensure compliance with requirements. Information on the
adjust-ments are also necessary inputs in the pre-operation phase.

Examples of activities using concurrent control are as follows:

The manager of a construction firm constantly monitors the progress of the

company's projects. When construction is behind schedule, corrective measures like
the hiring of additional manpower are made.

In a firm engaged in the production and distribution of water, the chemical

composition of the water procured from various sources is checked thoroughly before
they are distributed to the consumers. The production manager of an electronics
manu-facturing firm inspects regularly the outputs consist-ing of various electronics
products coming out of the pro-duction line.

Feedback Control

When information is gathered about a completed activity, and in order that

evaluation and steps for improvement are derived, feedback control is undertaken.
Corrective actions aimed at improving future activities are features of feedback
control.

Feedback control validates objectives and standards. If accomplishments

consist only of a percentage of stan-dard requirements, the standard may be too high
or inappropriate.

An example of feedback control is the supervisor who discovers that continuous

overtime work for factory workers lowers the quality of output. The feedback infor-
mation obtained leads to some adjustment in the over-time schedule.

Organizational control systems consists of the following: 1. strategic plan 2. the

long-range financial plan 3. the operating budget 4. performance appraisals 5.
statistical reports 6. policies and procedures Strategic Plans A strategic plan
(discussed in Chapter 3) provides the basic control mechanism for the organization.
When there are indications that activities do not facilitate the accomplishment of

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 strategic goals, these activities are either set aside, modified or expanded. These
corrective measures are made possible with the adoption of strategic plans.

E. COMPONENTS OF ORGANIZATIONAL CONTROL SYSTEMS

Organizational control systems consists of the following:

1. strategic plan

2. the long-range financial plan

3. the operating budget

4. performance appraisals

5. statistical reports

6. policies and procedures

Strategic Plans

A strategic plan (discussed in Chapter 3) provides the basic control mechanism for
the organization. When there are indications that activities do not facilitate the
accomplishment of strategic goals, these activities are either set aside, modified or
expanded. These corrective measures are made possible with the adoption of
strategic plans.

The Long-Range

Financial Plan The planning horizon differs from company to company.' Most
firms will be satisfied with one year. Engineering firms, however, will require longer
term financial plans. This is because of the long lead times needed for capital projects.
An example is the engineering firm assigned to construct the Light Rail Transit (ST)
within three years. As such, the three-year financial plan will be very useful.

As presented in Chapter 3, the financial plan recom. mends a direction for

financial activities. If the goal does not appear to be where the firm is headed, the
control mechanism should be made to work.

The Operating Budget

An operating budget indicates the expenditures, revenues, or profits planned

for some future period regarding operations. The figures appearing in the budget are
used as standard measurements for performance.

Performance Appraisals

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 Performance appraisal measures employee per-formance. As such, it provides
employees with a guide on how to do their jobs better in the future. Performance
appraisals also function as effective checks on new policies and programs. For
example, if a new equipment has been acquired for the use of an employee, it would
be useful to find out if it had a positive effect on his performance.

Statistical Reports

Statistical reports pertain to those that contain data on various developments

within the firm. Among the information which may be found in a statistical report
pertains to the following:

1. labor efficiency rates

2. quality control rejects

3. accounts receivable

4. accounts payable

5. sales reports

6. accident reports 7

7. power consumption report

Figure 9.3 shows a sample statistical report.

Policies and Procedures

Policies refer to `the framework within which the objectives must be pursued.'
“A procedure is a plan that describes the exact series of actions to be taken in a given
situation.”

An example of policy is as follows:

"Whenever two or more activities compete for the company's attention,

the client takes priority."

An example of a procedure is as follows:

“Procedure in the purchase of equipment:

1. the concerned manager forwards a request for purchase to the

purchasing officer;

2. the purchasing officer forwards the request to top management for

approval;

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 3. when approved, the purchasing officer makes a canvass of the
requested item; if disapproved, the purchasing officer returns the form
to the requesting manager;

4. the purchasing officer negotiates with the low-est complying bidder."

It is expected that policies and procedures laid down by management will be

followed. When they are breached once in a while, management is provided with a
way to directly inquire on the deviations. As such, policies and procedures provide a
better means of controlling activities.

F. STRATEGIC CONTROL SYSTEMS

To be able to assure the accomplishment of the stns• tegic objectives of the

company, strategic control systems become necessary. These systems consist of the
following:

1. financial

2. financial ratio analysis

Financial Analysis

The success of most organizations depends heavily on its financial

performance. It is just fitting that certain measurements of financial performance be

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 made so that whatever deviations from standards are found out, corrective actions
may be introduced.

A review of the financial statements will reveal important details about the
company's performance. The balance sheet contains information about the
company's assets, liabilities, and capital accounts. Comparing the current balance
sheet with previous ones may reveal important changes, which, in turn, provide clues
to performance.

The income statement contains information about the company's gross income,
expenses, and profits. When also compared with previous years' income statements,
changes in figures will help management determine if it did well.

Figures 9.4 and 9.5 show samples of financial statements.

Financial Ratio Analysis

Financial ratio analysis is a more elaborate approach used in controlling

activities. Under this method, one account appearing in the financial statement is
paired with another to constitute a ratio. The result will be compared with a required
norm which is usually related to what other companies in the industry have achieved,
or what the company has achieved in the past. When deviations occur, explanations
are sought in preparation for whatever action is necessary.

Financial ratios may be categorized into the following types:

1. liquidity

2. efficiency

3. financial leverage

4. profitability

Liquidity Ratios. These ratios assess the ability of a company to meet its current
obligations. The following ratios are important indicators of liquidity:

1. Current ratio — This shows the extent to which current assets of the
company can cover its current liabilities. The formula for computing current
ratio is as follows:

Current ratio = current assets/current liabilities

2. Acid-test ratio — This is a measure of the firm's ability to pay off short-term
obligations with the use of current assets and without relying on the sale of
inventories. The formula is as follows:

Acid-test ratio = current assets - inventories/current liabilities

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 Efficiency Ratios. These ratios show how effectively certain assets or liabilities
are being used in the produc-tion of goods and services. Among the more common
efficiency ratios are:

1. Inventory turnover ratio — This ratio meas-ures the number of times an

inventory is turned over (or sold) each year. This is computed as follows:
Inventory turnover ratio • cost of goods sold/inventory

2. Fixed asset turnover — This ratio is used to mea-sure utilization of the

company's investment in its fixed assets, such as its plant and equipment*
The formula used is as follows:

Fixed asset turnover net sales/net fixed assets

Financial Leverage Ratios. This is a group of ratios designed to assess the

balance of financing obtained through debt and equity sources. Some of the more
important leverage ratios are as follows:

1. Debt to total assets ratio — This ratio shows how much of the firm's assets
are financed by debt. It may be computed by using the following formula:

Debt to total assets ratio - total debt/total assets

2. Times interest earned ratio — This ratio measures the number of times that
earnings before interest and taxes cover or exceed the company's interest
expense. It may be computed by using the following formula:

profit before tax + interest expense

Time interest earned ratio =
interest expens

Profitability Ratios. These ratios measure how much operating income or net
income a company is able to generate in relation to its assets, owner's equity, and
sales. Among the more notable profitability ratios are as follows:

1. Profit margin ratio — This ratio compares the net profit to the level of sales.
The formula used is as follows:

Profit margin ratio = net profit/net sales

2. Return on assets ratio — This ratio shows how much income the company
produces for every peso invested in assets. The formula used is as follows:

Return on assets ratio = net income/assets

3. Return on equity ratio — This ratio measures the returns on the owner's
investment. It may te arrived at by using the following formula:

Return on equity ratio = net income/equity

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G. IDENTIFYING CONTROL PROBLEMS

Recognizing the need for control is one thing, actually implementing it is

another. When operations become complex, the engineer manager must consider
useful steps in controlling. Kreitner mentions three approaches:

1. executive reality check 2

2. comprehensive internal audit

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 3. general checklist of symptoms of inadequate control

Executive Reality

Check Employees at the frontline often complain that management imposes

certain requirements that are not realistic. In a certain state college, for instance,
requests for purchase of classroom materials and supplies take last priority. This is
irregular because requests of such kind must be of the highest priority considering
that the organization is an educational institution. Ironically, because certain officers
of the non-academic staff have direct access to the president, their purchase requests
almost always get top priority. Later on, when the president made an inspirational
speech on quality teaching, many members of the faculty just shrugged their
shoulders and listened passively.

One school, the Central Luzon State University, provides a good example on
how the executive reality check may be exercised. It requires its executives to handle
at least one subject load each. What the executives will experience in the classroom
will make him more responsive in the preparation of plans and control tools.

The engineer manager of a construction firm could, once in a while, perform the
work of one of his laborers. In doing so, he will be able to see things that he never
sees inside the confines of his air-conditioned office. Because the said action exposes
the engineer manager to certain realities, the term "executive reality check' is very
appropriate.

Comprehensive Internal Audit

An internal audit is one undertaken to determine the efficiency and effectivity of

the activities of an organization. Among the many aspects of operations within the

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 organization, a small activity that is not done right may continue to be unnoticed until
it snowballs into a full blown problem.

An example is the resignation of an employee after serving the company for 15

years. After one week, another employee with ten years of service also resigned. Both
were from the same department. If after another week, a third employee is resigning,
a full investigation is in order. Even if the source of the problem is identified, it may
already have caused considerable losses to the organization. A comprehensive
internal audit aims to detect dysfunctions in the organization before they bring bigger
troubles to management.

Symptoms of Inadequate Control

If a comprehensive internal audit cannot be availed of for some reason, the use
of a checklist for symptoms of inadequate control may be used.

Kreitner has listed some of the common symptoms its follows:"

1. An unexplained decline in revenues and profits

2. A degradation of service (customer complaints).

3. Employee dissatisfaction (complaints, grievances, turnover).

4. Cash shortages caused by bloated inventories or delinquent accounts

receivable.

5. Idle facilities or personnel.

6. Disorganized operations (work flow bottlenecks, excessive paperwork).

7. Excessive costs.

8. Evidence of waste and inefficiency (scrap, rework).

It must be noted that behind every symptom is problem waiting to be solved.

Unless this problem is clearly identified, no effective solution may be derived. Never.
The less, problems are easily recognized if adequate control measures are in place.

SUMMARY

Controlling is one of the main functions of management. It comes after planning,

organizing, and directing. Controlling is aimed at determining whether objectives were
realized or not, and if not, by providing means for achievement.

Controlling is important because it complements the other management functions.

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 Controlling is a process consisting of various steps, namely: establishing
performance objectives and standards, measuring actual performance, comparing actual
performance with objectives and standards, and taking necessary action based on the
results of the comparison.

Control/ may be classified either as feed forward, concurrent, or feedback.

Organizational control systems consist of the strategic plan, the long-range financial
plan, the operating budget, performance appraisals, statistical reports, policies and
procedures.

Strategic control systems consist of financial analysis, and financial ratio analysis.

There are means to identify control problems. They are the executive reality check,
the comprehensive in internal audit, and the general checklist of symptoms of in adequate
control.

QUESTIONS FOR REVIEW AND DISCUSSION

1. Why is controlling a very important management function?

2. What is controlling? Is it applicable to the day-to-day activities of the engineer

manager?

3. Why is the establishment of performance objectives and standards an important

step in the control process?

4. Compare and contrast the three distinct types of control.

5. How do strategic plans provide a basis for control?

6. What are policies? In what ways do they facilitate control?

7. When the engineer manager reviews the financial statements of the company
under his super-vision, what benefits does he derive?

8. What are financial ratios? How may they be categorized?

9. What is measured in the debt to total assets ratio? How may it be computed?

10. Do you consider idle facilities or personnel" as a symptom of inadequate control?

Why or why not?

FOR RESEARCH

List down the control activities that may be useful to any of the following:

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 a) the construction of a bridge

b) the manufacture of microchips

c) the installation of a power plant

d) the manufacture of tricycles

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Chapter 10 Managing Production and Service Operations

Overview/Introduction

Organizations are designed mainly to produce products or services. If these organizations

must survive and grow, the operations function must be undertaken in the most
economical manner possible. As most companies are expected to make profits, any
activity, including those for operations must be managed to contribute to the
accomplishment of such objectives.

Learning Outcome/Objective

At the end of this chapter, the students shall be able to:

1. Identify the of operations management;

2. Explain operations and the Engineer Manager

3. Enumerate the types of Transformations

4. Distinguish the Important Parts of Productive Systems

Learning Content/Topic

A. WHAT OPERATIONS IS?

Operations refers to any process that accepts inputs and uses resources to
change those inputs in useful ways."' As shown in Figure la I, the inputs include land,
labor, capital, and entrepreneurship. The transformation process converts the inputs
into final goods or services.

Examples of final goods and services are as follows:

1. Industrial chemicals like methylene chloride, borax powder, phosphoric

acid, etc , which are produced by chemical manufacturing firms;

2. Services like those for the construction of ports, high-rise buildings, roads,
bridges, etc , which are produced by constructions firms;

3. Electrical products like transformers, circuit breakers, switch gears, power

capacitors, etc., which are produced by electrical manufacturing firms;

4. Electronic products like oscilloscope, microwave tests systems, transistors,

cable testers, etc., which are produced by electronics manufacturing firms;

5. Mechanical devices like forklifts, trucks, loaders, etc., which are produced
by manufacturing firms;

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 6. Engineering consultancy services like those for construction management
and supervision project management services, etc., which are produced by
engineering consultancy firms.

B. WHAT OPERATIONS MANAGEMENT IS

Operations is an activity that needs to be managed by competent persons.

Aldag and Stearns accurately defined operations management as 'the process of
planning, organizing, and controlling operations to reach objectives efficiently and
effectively. 'As the terms-plan-rune, "organizing", and "controlling” have already been
discussed in the previous chapters, elaborations on the terms "efficiency and
"effectiveness" will be made.

Efficiency is related to “the cost of doing something, or the resource utilisation

involved.” When a person performs a job at lesser cost than when another person
performs the same job, he is more efficient than the other person.

Effectiveness refers to goal accomplishment. When one is able to reach his

objectives, say produce 10.000 units in one month, he is said to be effective.
Operations management must be performed in coordination with the other functions
like those for marketing and finance. Although the specific activities of the operations
divisions of firms slightly differ from one another, the basic function remains the same,
i.e., to produce products or services. Figures 10.2 and 10.3 show typical
responsibilities of the operations divisions of two different firms.

C. OPERATIONS AND THE ENGINEER MANAGER

The engineer manager is expected to produce some output at whatever

management level he is. If he is assigned as the manufacturing engineer, his function
is “to determine and define the equipment, tools, and pro-cesses required to convert
the design of the desired product into reality in an efficient manner".

The engineer in charge of operations in a construction firm is responsible for

the actual construction of what-ever bridge or road his company has agreed to put up.
Ile is required to do it using the least-expensive and the easiest methods.

The engineer, as operations manager, must find ways to contribute to the

production of quality goods or services and the reduction of costs in his department.

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 The typical operations manager is one with several years of experience in the
operations division and possesses an academic background in engineering.

D. TYPES OF TRANSFORMATION PROCESS

The engineer manager must have some knowledge of the various types of
transformation process. They are as follows:

1. Manufacturing processes

a) job shop

b) batch flow

c) worker-paced line flow

d) machine-paced line flow

e) batch/continuous flow hybrid

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 f) continuous flow

2. Service processes

a) service factory

b) service shop

c) mass service

d) professional service

E. MANUFACTURING PROCESSES

Manufacturing processes are those that refer to the making of products by hand
or with machinery.

Job Shop. A job shop is one whose production is “based on sales orders for a
variety of small lots.” Job shops are very useful components of the entire production
effort, since they manufacture products in small lots that are needed by, but cannot
be produced economically by many companies. Depending upon the customer's
needs, a job shop may produce a lot consisting of 20 to 200 or more similar parts.

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 Job shops produce custom products, in general. Products may be
manufactured within a short notice. The equipment used are of the general purpose
type.

The type of layout used by job shops is the process layout, where similar
machines are grouped together. The typical size of operation is generally small. Job
shops are labor intensive and machines are frequently idle. Figure 10.4 shows a
process flow diagram for a job shop.

Batch Flow. The batch flow process is where lots of generally own designed
products are manufactured. It is further characterized by the following:

1. There is flexibility to produce either low or high volumes.

2. Not all procedures are performed on all products.

3. The type of equipment used are mostly for general purpose.

4. The process layout is used.

5. The operation is labor intensive, although there is less machine idleness.

6. The size of operation is generally medium-sized.

Examples of factories using the large batch flow are wineries, scrap-metal
reduction plants, and road-repair contractors.

Worker-Paced Assembly Line. An assembly line refers to a production layout

arranged in a sequence to accommodate processing of large volumes of standardized
products or services. Shown in Figure 10.6 is a diagram of the work flow in an
assembly line.

The quality and quantity of output in a worker-paced assembly line depends to

a great extent to the skill of the labor utilized. Examples of worker-paced assembly
lines are food marts like McDonalds and Shakeys.

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 The worker-paced assembly line is characterized by the following:

1. The products manufactured are mostly standardized.

2. There is a clear process pattern.

3. Specialized equipment is used.

4. The size of operation is variable.

5. The process is worker-paced.

6. The type of layout used is the line flow.

7. Labor is still a big cost item.

Machine-Paced Assembly Line. This type of pro-duction process produces

mostly standard products with machines playing a significant role. Among its other
features are as follows:

1. The process is of clear, rigid pattern.

2. Specialized type of equipment is used.

3. The line flow layout is used.

4. Capital equipment is a bigger cost item than labor.

5. Operation is large.

6. The process is machine-paced.

Examples of machine-paced assembly line are auto-mobile manufacturers like

General Motors and Ford Motors. Shown in Figure 10.7 is an example of a machine-
paced assembly line process.

Continuous Flow. The continuous flow processing is characterized by 'the rapid

rate at which items move through the system?' This processing method is very

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 appropriate for producing highly standardized products like calculators, typewriters,
automobiles, televisions, cellular phones, etc.

Its other characteristics are as follows:

1. There is economy of scale in production, resulting to low per unit cost of

production.

2. The process is clear and very rigid.

3. Specialized equipment are used.

4. The line flow layout is used.

5. Operations are highly capital intensive.

6. The size of operations is very large.

7. Processing is fast.

Figure 10.8 shows a continuous flow process diagram of a paper-making

factory.

Batch /Continuous Flow Hybrid. This method of pro-cessing is a combination of

the botch and the continuous flow. Two distinct layouts are used, one for batch and
one for the continuous flow. The typical size of operation is also very large giving
opportunities for economies of scale.

Examples of companies using the batch/continuous flow hybrid are breweries,

gelatine producers, and tobacco manufacturers. A simplified production process
using the batch/continuous flow hybrid is shown in Figure 10.9.

Service Processes

Service processes are those that refer to the provision of services to persons
by hand or with machinery.

Service Factory. A service factory offers a limited mix of services which results
to some economies of scale in operations. This also affords the company to compete
in terms of price and speed of producing the service.

The process layout preferred by the service factory is the rigid pattern of line
flow processing. McDonalds and Shakeys are also examples of service factories.

Service Shop. A service shop provides a diverse mix of services. The layout
used are those for job shops or fixed position and are adaptable to various
requirements.

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 Service shops abound throughout the Philippines. Examples are Servitek and
Megnshell. Among the services provided by these shops are car engine tune-up,
wheel balancing, wheel alignment, change oil, etc.

Shown in Figure 10.10 is a diagram of the process flow of a car repair service
shop.

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 Mass Service. A mass service company provides services to a large number of
people simultaneously. A unique processing method is, therefore, necessary to satisfy
this requirement. To be able to serve many people, mass service companies offer
limited mix of services.

The process layout used is typically fixed position where customers move
through the layout. Shown in Figure 10.11 is a diagram of the process flow for sales
transactions and material receipt in a mass service retailing institution.

Professional Services. These are companies that pro-vide specialized services

to other firms or individuals. Examples of such firms are as follows.

1. Engineering or management consulting services which help in improving the

plant layout or the efficiency of a company.

2. Design services which supply designs for a physical plant, products, and
promotion materials.

3. Advertising agencies which help promote a firm's products.

4. Accounting services.

5. Legal services.

6. Data processing services.

7. Health services.

Professional service firms offer a diverse mix of services. There is a lower

utilization of capital equipment compared to the service factory and the service shop.
The process pattern used is very loose. The process layout used is identical to the
job shop.

Professional service firms are, oftentimes, faced with delivery problems brought
about by non-uniform demand. Strategies that may be used depending on the
situation are as follows:

1. The use of staggered work-shift schedules.

2. The hiring of part-time staff.

3. Providing the customer with opportunity to select the level of service.

4. Installing auxiliary capacity or hiring subcon• tractors. 5. Using multiskilled

floating staff. 6. Installing customer self-service.

F. IMPORTANT PARTS OF PRODUCTIVE SYSTEMS

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 Productive systems consist of six important activities as follows:

1. product design

2. production planning and scheduling

3. purchasing and materials management

4. inventory control

5. work flow layout

6. quality control

Product Design

Customers expect that the products they buy would perform according to
assigned functions. A good product design assures that this will be so. Customers
avoid buying products with poor product design. An example is that certain brand of
ballpen which fails to write after one or two days of actual use. This happens because
of poor product design.

Product design refers to “the process of creating a set of product specifications

appropriate to the demands of the situation.”

Companies wanting to maintain or improve its market share keeps a product

design team composed of engineers, manufacturing, and marketing specialists.

Production Planning and Scheduling

Production planning may be defined as “forecasting the future sales of a given

product, translating this fore-cast into the demand it generates for various production
facilities, and arranging for the procurement of these facilities.”

Production planning is a very important activity because it helps management

to make decisions regarding capacity. When the right decisions are made, there will
be less opportunities for wastages. Scheduling is the “phase of production control
involved in developing timetables that specify how long each operation in the
production process takes.” Efficient scheduling assures the optimization of the use of
human and nonhuman resources.

Purchasing and Materials Management

Firms need to purchase supplies and materials required in the various

production activities. The management of purchasing and materials must be
undertaken with a high degree of efficiency and effectiveness especially in firms
engaged in high volume production. The wider variety of supplies and materials
needed adds to the necessity of proper managing and purchasing of materials.
Materials management refers to “the approach that seeks efficiency of operation

30 | Engineering Management
 through integration of all material acquisition, movement, and storage activities in the
firm”

Inventory Control

Inventory control is the process of establishing and maintaining appropriate

levels of reserve stocks of goods. As supplies and materials are required by firms in
the production process, these must be kept available when they are needed. The
much reserves of stocks will penalize the firm in terms of high storage costa and other
related risks like obsolescence and theft Too little reserves, on the other hand, may
mean lost income opportunities if production activities are hampered. A balance
between the two extremes must be determined.

There are ways of achieving proper inventory control. They are as follows

1. determining reorder point and reorder quantity

2. determining economic order quantity

3. the use of just-in-time (JIT) method of inventory control

4. the use of the material requirement planning (MRP) method of planning and
controlling inventories.

Work-Flow Layout

Work-flow layout is the process of determining the physical arrangement of the

production system. In the transformation process, the flow of work may be done either
haphazardly or orderly.

The job of the operations manager is to assure that a cost-effective work-flow

layout is installed. A good work-flow layout will have the following benefits:

1. Minimize investment in equipment.

2. Minimize overall production time.

3. Use existing space most effectively.

4. Provide for employee convenience, safety, and comfort.

5. Maintain flexibility of arrangement and operation.

6. Minimize material handling cost.

7. Minimize variation in types of material-handling equipment.

31 | Engineering Management
 8. Facilitate the manufacturing (or service) process.

9. Facilitate the organizational structure.

Quality Control

Quality control refers to the measurement of products or services against

standards set by the company. Certain standard requirements are maintained by the
management to facilitate production and to keep customers satisfied.

Poor quality control breeds customer complaints, returned merchandise,

expensive lawsuits, and huge promotional expenditures.

SUMMARY

The management of operations is very crucial to the survival of firms. Operations

refer to the changing of inputs into useful outputs. In the effort to manufacture products
(or services), operations management must contribute its share in the accomplishment of
the company's objectives.

The function of the operations manager is to plan, organize, and control operations
in order to achieve objectives efficiently and effectively. The engineer manager is,
oftentimes, assigned to perform the tasks of the operations manager.

The transformation process may be classified generally as manufacturing or service

processes. These two are subclassified into various types, each with built-in advantages
depending on certain conditions.

Production systems consist of various parts that complement one another in the
productiontask. The en-gineer manager needs to be familiar with these various parts.

QUESTIONS FOR REVIEW AND DISCUSSION

1. What is meant by 'operations"? Does the term cover production of farm products?

2. Why is operations management an important activity? Who are qualified to

become operations managers?

3. What are the types of transformation process? In what ways are they similar and
different?

4. What is a job shop? What makes it a useful transformation process?

5. What is the batch flow process? What possible advantages does it offer?

32 | Engineering Management
 6. What is the worker-paced assembly line? Why is it called as such?

7. Why is the machine-paced assembly line very popular among large corporations?

8. What is a service factory? Provide an example.

9. What types of services are offered by professional service firms? What

production problems do these firms encounter?

10. What are the important parts of productive systems? Point out the relationships
between these parts.

RESEARCH

Draw the transformation process of on existing company. Indicate where

improvements in the flow could be introduced.

33 | Engineering Management
Chapter 11 MANAGING THE MARKETING FUNCTION

Overview/Introduction

Engineer managers are engaged in the production of tangible or intangible goods.

Some of these engineer managers are directly responsible for marketing the company's
products or services. If he is promoted as general manager, both the production and
marketing functions become his overall concern.

At whatever management level the engineer manager works, he must be concerned

with convincing others to patronize his outputs. If he is the general manager of a
construction firm, he must convince people with construction needs to avail of the services
of the company. If he is the staff officer of a top executive, he must convince his boas to
continuously rely on him regarding the staff services he provides.

If the foregoing statements are true, the engineer manager has a marketing problem.
He needs to under-stand certain concepts related to the marketing discipline.

Learning Outcome/Objective

At the end of this chapter, the students shall be able to:

1. Define Marketing Concept

2. Classify the Four P’s of Marketing

3. Understand the strategic Marketing for Engineers

Learning Content/Topic

A. WHAT IS THE MARKETING CONCEPT?

Marketing is a group of activities designed to facilitate and expedite the selling

of goods and services.

The marketing concept states that the engineer must try to satisfy the needs of
his clients by means of a set of coordinated activities. When clients are satisfied with
what the company offers, they continually provide business.

B. THE ENGINEER AND THE FOUR P'S OF MARKETING

The engineering organization will be able to moot the requirements of its clients
(or customers) depending on how it uses the four P's of marketing which are as
follows:

1. the product (or service)

2. the price

34 | Engineering Management
 3. the place, and

4. the promotion.

The Product

In the marketing sense, the term 'product' includes the tangible (or intangible)
item and its capacity to satisfy a specific need.' When a customer buys a car, he is
actually buying the comfortable ride he anticipates to derive from the car. This is not
to mention the psychological benefits attached to the ownership of a car.

The services provided by the engineer manager will be evaluated by the client
on the basis of whether or not his or her exact needs are met. When a competitor
comes into the picture and sells the same type of service, the pressure to improve the
quality of services sold will be felt. When improvement is not possible, "extras" or
“bonuses" are given to clients. An example is the construction company that provides
“free estimates" on whatever inquiries on construction are received.

The Price

Price refers to “the money or other considerations exchanged for the purchase
or use of the product, idea, or service.'" Some companies use price as a competitive
tool or as a means to convince the customer to buy.

When products are similar in quality and other characteristics, price will be a
strong factor on whether or not a sale will be made. This does not hold true, how-ever,
in the gelling of services and ideas. This is because of the uniqueness of every service
rendered or every idea generated.

When a type of service becomes standardized, price can be a strong

competitive tool. When a construction firm, for instance, charges a flat 10 percent
service fee for all of its construction services, a competitor may charge a lower rate.
Such action, however, will be subject to whether or not the industry will allow such
practice.

The Place

35 | Engineering Management
 If every factor is equal, customers would prefer to buy from firms easily
accessible to them. If time is of the essence, the nearest firm will be patronized.

It is very important for companies to locate in places where they can be easily
reached by their customers. Not every place is the right location for any company.

When a company cannot be near the customers, it uses other means to

eliminate or minimize the effects of the problem. Some of these means are:

1. hiring sales agents to cover specific areas;

2. selling to dealers in particular areas;

3. establishing branches where customers are located;

4. establishing franchises in selected areas.

Manufacturing companies can choose or adapt all of the above-mentioned

options. Service companies like construction firms adapt the modified versions. An
example is the engineer manager of a construction firm who gives commissions to
whoever could negotiate a construction contract for the firm.

The Promotion

When engineer managers have products or services to sell, they will have to
convince buyers to buy from them. Before the buyer makes the purchasing decision,
how-ever, he must first be informed, persuaded, and influenced. The activity referred
to, in this case, is called promotion.

McCarthy and Perreault define promotion as “communicating information

between seller and potential buyer to influence attitudes and behavior.”

There are promotional tools available and the engineer manager must be
familiar with them if he wants to use them effectively. These tools are as follows:

1. advertising

2. publicity

3. personal selling

4. sales promotion

Advertising. Nylen defines advertising as “a paid message that appears in the

mass media for the purpose of informing or persuading people about particular
products, services, beliefs, or action.” The mass media referred to include television,
radio, magazines, and news-papers. If the engineering manager wants to reach a large
number of people, he may use any of the mass media depending on his specific needs
and his budget. Each of the public advertising carriers, i.e., radio, television,

36 | Engineering Management
 magazines, and newspapers, has their own specific audiences and careful analysis
must be made if the engineering manager wants to pick the right one.

An example of an advertising message is shown in Figure 11.2.

Publicity. The promotional tool that publishes news or information about a

product, service, or idea on behalf of a sponsor but is not paid for by the sponsor is
called publicity.' The mass media is also the means used for publicity. If the engineer
manager knows how to use it, publicity is a very useful promotional tool. His message
may be presented as a news item, helpful information, or an announcement.

An example of a publicity release is shown in Figure 11.3.

Personal Selling. A more aggressive means of promoting the sales of a product

or service is called personal selling. It refers to the "oral presentation in a conversation
with one or more prospective purchasers for the purpose of making a sale."

37 | Engineering Management
 Personal selling may be useful to the marketing efforts of the engineer manager.
If, for instance, he is the general manager of a firm manufacturing spare parts, he may
assign some employees to personally seek out spare parts dealers and big trucking
companies to carry their product lines.

Sales Promotion. Any paid attempt to communicate with the customers other than
advertising, publicity, and personal selling, may be considered sales promotion. This
includes displays, contests, sweepstakes, coupons, trading stamps, prizes, samples,
demonstrations, referral gifts, etc.

Contests and sweepstakes are very popular sales promotion tools. An example
is shown in Figure 11.4.

38 | Engineering Management
C. STRATEGIC MARKETING FOR ENGINEERS

Companies, including those managed by engineer managers, must serve

markets that are best fitted to their capabilities. To achieve this end, a very important
activity called strategic marketing is undertaken.

Under this setup, the following steps are made:

1. selecting a target market

2. developing a marketing mix

39 | Engineering Management
 Selecting a Target Market

A market consists of individuals or organizations, or both, with the desire and

ability to buy a specific product or service. lb maximize sales and profits, a company
has the option of serving entirely or just a portion of its chosen market. Within markets
are segments with common needs and which will respond similarly to a marketing
action. Figure 11.5 shows an example of the various segments of a given market.

An analysis of the various segments on the chosen market will help the
company make a decision on whether to serve all or some of the segments. The
segment or segments chosen become the target market.

In selecting a target market, the following steps are necessary:

1. Divide the total market into groups of people who have relatively similar
product or service needs.

2. Determine the profit potentials of each segment.

3. Make a decision on which segment or segments will be served by the

company.

As shown in Figure 11.5, a company may choose any or all of the residential,
industrial, and government segments. This decision will depend, however, on the
profit potentials of each segment and the capability of the firm.

A smaller company may find it most profitable to supply only the construction
material needs of the residential segment. A bigger company, however, may find it
more profitable to perform actual construction in addition to selling construction
materials.

Factors Used in Selecting a Target Market. A target market must have the ability
to satisfy the profit objectives of the company. In selecting a target market, the
following factors must be taken into consideration:

1. the size of the market, and

2. the number of competitors serving the market.

The total demand for the product or service in a given area must be determined
first if the company wants to serve that particular market. If there are existing
businesses serving the market, the net demand must be considered. Figure 11.6
illustrates an example of the relationship between demand and supply of a particular
product. The figures presented indicate that there is still room for another company in
the market for telephone lines in Cabanatuan City.

Developing a Marketing Mix

40 | Engineering Management
 After the target market has been identified, a marketing mix must be created
and maintained. The marketing mix consists of four variables: the product, the price,
the promotion, and the place (or distribution).

Given a marketing environment, the engineer man-ager can manipulate any or

all variables to achieve the company's goals. As such, the quality of the product may
be enhanced, or the selling price made a little lower, or the promotion activity made a
little more aggressive, or a wider distribution area may be covered. Any or all of the
foregoing may be undertaken as conditions warrant.

As shown in Figure 11.7, all marketing activities are focused on the target
market.

SUMMARY

To survive, companies must continuously generate income. To be able to do so,

they must be able to sell enough quantity of their products or services. Engineering firms
are no exception.

The proper management of the marketing function helps the engineer manager
convince customers to patronize the firm. Specifically, the engineer manager must know
how to use effectively the four P’s of marketing which are the product, the price, the place,
and the promotion.

QUESTIONS FOR REVIEW AND DISCUSSION

41 | Engineering Management
 1. How may the marketing concept be explained? Is it applicable to engineering
firms?

2. What is meant by the term 'product?

3. How may the engineer manager meet the threat of a competitor's product?

4. Why is price said to be a strong competitive tool?

5. What are some of the possible measures to make products easily available to
customers?

6. How may the engineer manager convince the buyer or client to patronize the firm?

7. What is advertising? What are the types of advertising media?

8. May the engineer manager use publicity in promo- ting his firm? Cite an example.

9. In selecting a target market, what must the engineer manager do?

10. What factors must be used in selecting a target market?

RESEARCH

Choose an engineering firm with an existing marketing unit. Draw the organization chart
of the firm showing the marketing unit and its relationship with other units.

42 | Engineering Management
Chapter 12 Managing the Finance Function

Overview/Introduction

Engineering firms need funds to finance their operations. To be assured of continuous

supply of funds, there is a need to manage properly the finance function. When funds are
made available in right amounts at the right time, the engineering organization may be
expected to function properly. When funds are not enough to finance planned activities,
the risk of (adore to achieve objectives becomes apparent.

The engineer manager mug understand that the finance function is a very important
management concern. This is true because without adequate funds it will be difficult, if not
impossible to proceed with the production of products or services, the distribution of
output, research and development, and others.

Learning Outcome/Objective

At the end of this chapter, the students shall be able to:

1. Define finance function;

2. Recognize the determination of Fund Requirements

3. Identify the sources of Funds

4. Evaluate the best source of financing

5. Define firm’s financial health

6. Identify the indicators of financial health

7. Classify Risk Management and Insurance

Learning Content/Topic

A. WHAT THE FINANCE FUNCTION IS?

The finance function is an important management responsibility that deals with

the “procurement and administration of funds with the view of achieving the objectives
of business" If the engineer manager is running the firm as a whole, the most be
concerned with the determination of the amount of funds required, when they are
needed, how to procure them, and how to effectively and efficiently use them.

In the performance of his duties, the engineer man-ager, at whatever

management level he is, must do his share in the achievement of the financial
objectives of the company.

43 | Engineering Management
 The finance function is one of the three basic management functions. The other
two are production and marketing.

B. THE DETERMINATION OF FUND REQUIREMENTS

Any organization, including the engineering firm, will need funds for the following
specific requirements:

1. to finance daily operations

2. to finance the firm's credit services

3. to finance the purchase of inventory

4. to finance the purchase of major assets

Financing Daily Operations

The day by day operations of the engineering firm will require funds to take care
of expenses as they come. Money must be made available for the payment of the
following:

1. wages and salaries

2. rent

3. taxes

4. power and light

5. marketing expenses like those for advertising, entertainment, travel

expenses, telephone and telegraph, stationery and panting, postage. etc.

6. administrative expenses like those for auditing, legal, services, etc.

Any delay in the settlement of the foregoing expenses may disrupt the effective
flow of work in the company. It may also erode the public's confidence in the ability of
the company to operate on a long-term basis. Creditors, for instance, may withhold
the extension of credit to the company.

Financing the Firm's Credit Services

It is oftentimes unavoidable for firms to extend credit to customers. If the

engineering firm manufactures products, sales terms vary from cash to 90-day credit
extensions to customers. Construction firms will have to finance the construction of
government projects that will be paid many months later.

44 | Engineering Management
 When a new chemical manufacturing firm finds difficulty in convincing
distributors to carry their products, a credit extension may solve the problem. A new
problem, however, will be created, i.e., how the credit arrangement will be financed.

Financing the Purchase of Inventory

The maintenance of adequate inventory is crucial to many firms. Raw materials,

supplies, and parts are needed to be kept in storage so they will be available when
needed. Many firms cannot cope with delays in the availability of the required material
inputs in the production process, so these must be kept ready whenever required.

The purchase of adequate inventory, however, will require sufficient funding and
this must be secured.

Sometimes, inventories unnecessarily tie-up large amount of funds. The

engineer manager must devise some means to make sure this situation does not
happen.

Financing the Purchase of Major Asset

Companies, at times, need to purchase major assets. When top management

decides on expansion, there will be a need to make investments in capital assets like
land, plant, and equipment.

It is obvious that the financing of the purchase of major assets must come from
long-term sources.

C. THE SOURCES OF FUNDS

To finance its various activities, the engineering firm will have to make use of its
cash inflows coming from various sources, namely:

1. Cash sales. Cash is derived when the firm sells its products or services.

2. Collection of Accounts Receivables. Sonic engineering firms extend credit

to customers. When those are settled, cash is made available

3. Loans and Credits. When other sources of financing are not enough, the
firm will have to resort to borrowing.

4. Sale of assets. Cash is sometimes obtained from the sale of the company's
assets.

5. Ownership contribution. When cash is not enough, the firm may tap its
owners to provide more money.

6. Advances from customers. Sometimes, customers are required to pay cash

advances on orders made. This helps the firm in financing its production
activities.

Short-Term Sources of Funds

45 | Engineering Management
 Loans and credits may be classified as short-term, medium-term, or long-term.
Short-term sources of funds are those with repayment schedules of less than one
year. Collaterals are sometimes required by short-term creditors.

Advantages of Short-Term Credits. When the engineering firm avails of short-

term credits, the following advantages may be derived:

1. They are easier to obtain. Creditors maintain the view that the risk
involved in short-term lending is also short-term. Thus, short-term
credits are made easily available to qualified borrowers.

2. Short-term financing is often less costly. Since short-term financing is

favored by creditors, they make it available at less cost

3. Short-term financing offers flexibility to the borrower. After the borrower

has settled his short-teen debt, he may consider other means of
financing, if he still requires it. Long-term financing, in contrast,
eliminates this option. He is stuck with the long-term funds even if he no
longer requires it.

Figure 12.2 The Firm’s Finances and Cash Flow

Disadvantages of Short-Term Credits. Short-term financing has also some

disadvantages. They are as follows:

46 | Engineering Management
 1. Short-term credits mature more frequently. This may place the engineering
firm in a tight position more often than necessary. When the frequency of
the firm's cash inflows are more than twelve months apart, the firm could
be in serious trouble meeting its short-term obligations.

2. Short-term debts may, at times, be more costly than long-term debts. When
short-term debts are used to finance long-term expenditures, the frequent
renewals, adjustment of terms, and shop-ping for new sources may prove
to be more costly.

Supplies of Short-Term Funds. Short-term financing is provided by the

following:

1. trade creditors

2. commercial banks

3. commercial paper houses

4. finance companies

5. factors, and

6. insurance companies.

Trade creditors refer to suppliers extending credit to a buyer for use in

manufacturing, processing, or reselling goods for profit.' The instruments used in trade
credit consist of the following: (1) open-book credit. 12) trade acceptance, and 13)
promissory notes.

The open-book credit is unsecured and permits the customer to pay for goods
delivered to him in a specified number of days. For financially weak engineering firms,
the open-book credit is a very useful source of financing.

The trade acceptance is a time draft drawn by a seller upon a purchase payable
to the seller as payee, and accepted by the purchaser as evidence that the goods
shipped are satisfactory and that the price is due and payable. Under the terms
granted in the trade acceptance, the seller allows the buyer to pay within a certain
number of days. The arrangement provides the buyer some relief in financing his
short-term requirements.

A promissory note is an unconditional promise in writing made by one person

to another, signed by the maker, engaging to pay, on demand or at a fixed or
determinable future time, a certain sum of money to, or to the order of, a specified
person or to bearer.

Commercial banks are institutions which individuals or firms may tap as source
of short-term financing. Commercial banks grant two types of short-term loans: (I)
those which require collateral, and 12) those which do not require collateral. Examples

47 | Engineering Management
 of commercial banks granting short-term loans are City Trust. Premier Bank, and
Land Bank.

Commercial paper houses are those that help business firms in borrowing funds
from the money market Under this scheme, the business firm in need of funds issues
a commercial paper, which is a short-term promissory note, generally unsecured, and
issued by large, established firms. The commercial paper is sold to investors through
the commercial paper house.

Business finance companies are financial institutions that finance inventory and
equipment of almost all types and sizes of business firms, Examples of finance
companies in the Philippines are Philacor Credit Corporation and Consolidated Orix
Leasing and Finance Corporation.

Factors are institutions that buy the accounts receivables of firms, assuming
complete accounting and collection responsibilities. Engineering firms which maintain
sizable amounts of accounts receivable may avail of the services of factors when they
are in dire need of cash.

Insurance companies are also possible sources of short-term funds. Industry

reports indicate that insurance companies in the Philippines regularly make
investments in short-term commercial papers and promissory notes.

Long-Term Sources of Funds

There are instances when the engineering firm will have to tap the long-term
sources of funds. An example is when expenditures for capital assets become
necessary. After the amount required is determined, a decision has to be made on
the type of source to be used.

Long-term sources of funds are classified as follows:

1. long-term debts

2. common stocks, and

3. retained earnings.

Long-term debts are sub-classified into term loans and bonds. 71,rm Loans. A
term loan is a "commercial or industrial loan from a commercial bank, commonly used
for plant and equipment, working capital, or debt repayment"' Term loans have
maturities of 2 to 30 years.

The advantages of term loans as a long-term source of funds are as follows:

1. Funds can be generated more quickly than other long-term sources.

2. They are flexible, i.e., they can be easily tailored to the needs of the
borrower

48 | Engineering Management
 3. The cost of issuance is low compared to other long-term sources.

Bonds. A bond is a certificate of indebtedness issued by a corporation to a

lender. It is a marketable security that the firm sells to raise funds. Since the ownership
of bonds can be transferred to another person, investors are attracted to buy them.

The type of bonds are shown in Figure 12.3.

Common Stocks. The third source of long-term funds consists of the issuance
of common stocks. Since common stocks represent ownership of corporations, many
investors are placing their money in them.

When properly utilized, common stocks can be cheaper and more stable
sources of long-term funds. Unlike bonds and term loans which must be repaid at a
certain date, common stocks do not have maturity and repayment dates.

Retained Earnings. Retained earnings refer to "corporate earnings not paid out
as dividends.” This simply means that whatever earnings that are due to the stock-
holders of a
corporation are Figure 12.2 The Firm’s Finances and Cash Flow
reinvested.
Because these retained earnings can be used by the firm indefinitely, they become
an important source of long-term financing.

Figure 12.3 Types of Bonds

In like manner, the sole owner of an engineering firm may decide to reinvest
whatever profits he derives from his business. The same decision may be adapted
by the owners of a partnership.

49 | Engineering Management
D. THE BEST SOURCE OF FINANCING

As there are various fund sources, the engineer manager, or whoever is in

charge, must determine which source is the best available for the firm.

To determine the best source, Scholl and Haley recommends that the following
factors must be considered:

1. flexibility

2. risk

3. income

4. control

5. timing

6. other factors like collateral values, flotation cants, speed, and exposure.

Flexibility

Some fund sources impose certain restrictions on the activities of the borrowers.
An example of a restriction is the prohibition on the issuance of additional debt
instruments by the borrower.

As some fund sources are less restrictive, the flexibility factor must be
considered. In general, however, short-term fund sources offer more flexibility than
long-term sources. This is so because after settling the debt, short-term borrowers
may shift to other types of linen-dog. Long-term borrowers are given this opportunity
only after a longer period of waiting.

Risk

When applied to the determination of fund sources, risk refers to the chance
that the company will be affected adversely when a particular source of financing is
chosen.

Generally, short-term debt “subjects the borrowing firm to more risk than does
financing with long-term debt.” This happens because of two reasons: t.

1. they can be renewed at all.

2. since repayments are done more often, the risk of defaulting is greater

Income

50 | Engineering Management
 The various sources of funds, when availed of, will have their own individual
effects in the net income of the engineering firm. When the firm borrows, it must gene-
rate enough income to cover the cost of borrowing and still be left with sufficient
returns for the owners.

It is possible that the owners were enjoying higher rates of return on their
investments before borrowing was made. The reverse may happen, however, at other
times. Nevertheless, the effects on income must be considered in determining the
source of funding to be used.

Control

When new owners are taken in because of the need for additional capital, the
current group of owners may lose control of the firm. If the current owners do not want
this to happen, they must consider other means of financing.

Timing

The financial market has its ups and downs. This means that there are times
when certain means of financing provide better benefits than at other' times. The
engineer manager must, therefore, choose the best time for borrowing or selling
equity.

Other Factors

There are other factors considered in determining the best source of funds.
They are as follows:

1. Collateral values: Are there assets available as collateral?

2. Flotation cast: How much will it cost to issue bonds or stocks?

3. Speed: How fast can the funds required be raised?

4. Exposure: To what extent will the firm' be ex• posed to other parties?

E. THE FIRM'S FINANCIAL HEALTH

In general, the objectives of engineering firms are as follows:

1. to make profits for the owners:

2. to satisfy creditors with the repayment of loans plus interest;

3. to maintain the viability of the firm so that customers will be assured of

a continuous supply of products or services, employees will be assured
of employment, suppliers will be assured of market, etc.

51 | Engineering Management
 The foregoing objectives have better chances of achievement if the engineering
firm is financially healthy and has the capacity to be so on a long-term basis.

F. INDICATORS OF FINANCIAL HEALTH

The financial health of an engineering firm may be determined with the use of
three basic financial statements. These are as follows:

1. Balance sheet — also called statement of financial position;

2. Income statement –• also called statement of operations;

3. Statement of changes in financial position.

To be able to determine the financial health of a firm, the appropriate financial

analysis must be undertaken. A full discussion of financial statements and analysis
are indicated In Chapter 9. Examples of balance sheet and income statements are
also presented in Chapter 9. An example of a statement of changes in financial
positions is shown in Figure 12.4

52 | Engineering Management
G. RISK MANAGEMENT AND INSURANCE

The engineer manager, especially those at the top level, is entrusted with the
function of making profits for the company. This will happen if losses brought by
improper management of risks are avoided.

Risk is a very important concept that the engineer manager must be familiar
with. Risks confront people everyday. Companies are exposed to them. Newspapers
report on a daily basis the destruction of life and property. Companies that could not
cope with losses are forced to shut down, according to reports.

Fortunately, the engineer manager is not entirely helpless. He can use sound
risk management practices to avoid the threat of bankruptcy due to losses.

Risk Defined

Risk refers to the uncertainty concerning loss or the injury. The engineering
firm is faced with a long list of exposure to risks, some of which are as follows:

1. Fire

2. Theft

3. floods 4

4. accidents

5. non-payment of bills by customers (bad debts)

6. disability and death

7. damage claim from other parties.

Types of Risk

Risks may be classified as either pure or speculative. Pure risk is one in which
"there is only a chance of loss?'" This means that there is no way of making gains
with pure risks. An example of pure risk is the exposure to loss of the company's motor
car due to theft. Pure risks are insurable and may be covered by insurance.

Speculative risk is one in which there is a chance of either loss or gain. This type
of risk is not insurable. An example of a speculative risk is investment in common
stocks. If one wants to make gains in the common stock market, the nuances and
intricacies of investments must be learned and properly applied. Also, operating the
engineering firm is a kind of speculative risk. If profits are expected, then proper
management techniques must be used.

What is Risk Management?

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 Risk management is an organized strategy for protecting and conserving assets
and people.'" The purpose of risk management is "to choose intelligently from among
all the available methods of dealing with risk in order to secure the economic survival
of the firm"

Risk management is designed to deal with pure risks, while the application of
sound management practices are directed towards speculative risks that are inherent
and cannot be avoided.
Methods of Dealing with Risk

There are various methods of dealing with risks. They are as follows:

1. the risk may be avoided

2. the risk may be retained

3. the hazard may be reduced

4. the losses may be reduced

5. the risk may be shifted

A person who wants to avoid the risk of losing a property like a house can do
so by simply avoiding the ownership of one. There are instances, however, when
ownership cannot be avoided like those for equipment, appliances, and materials
used in the production process. In this case, other methods of handling risk must be
considered.

Risk retention is a method of handling risk wherein the management assumes

the risk. A planned risk retention, also called self-insurance, is a conscious and deli-
berate assumption of a recognized risk. In this case, management decides to pay
losses out of currently available funds. Unplanned risk retention exists when
management does not recognize that a risk exists and unwisely believes that no loss
could occur.

Hazards may be reduced by simply instituting appropriate measures in a variety

of business activities. An example is prohibiting unauthorized persons to enter the
cashier's office. This will reduce the hazard of theft. Another example is prohibiting
company drivers from taking alcohol or drugs while on duty. Newspaper re-ports on
the accidental killing of three persons including Princess Diana is a well-publicized
case of drunken driving.

When losses occur in spite of preventive measures, the severity of loss may be
limited by way of reducing the concentration of exposures." Examples of efforts on
loss reduction are as follows:

1. physically separating buildings to minimize losses in case of fire;

2. using: fireproof materials on interior building construction;

54 | Engineering Management
 3. storing inventory in several locations to minimize losses in cases of fire and
theft;

4. maintaining duplicate records to reduce Accounts receivable losses;

5. transporting goods in separate vehicles instead of concentrating high

values in single shipments;

6. prohibiting key employees from traveling together; and

7. limiting legal liability by forming several separate corporations.

Another method of handling risk is by shifting it to another party. Examples of

risk shifting are hedging, subcontracting, incorporation, and insurance.

Hedging refers to making commitments on both sides of a transaction so the

risks offset each other.

When a contractor is confronted with a contract bigger than his company's

capabilities, he may invite sub-contractors in so that some of the risks may be shifted
to them.

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 In a corporation, a stockholder is able to make profits out of his investments but
without individual responsibility for whatever errors in decisions are made by the
management. The liability of the stockholder is limited to his capital contribution.

To shift risk to another party, a company buys insurance. When a loss occurs,
the company is reimbursed by the insurer for the loss incurred subject to the term of
the insurance policy.

Shown in Figure 12.5 is an example insurance products sold by a company.

SUMMARY

Financing the engineering firm is a very important management activity. There is a

need to assure everyone concerned that funds are available when they are needed.

The first area of concern is the determination of fund requirements. If the amount
needed is already known, the next step is to determine the appropriate source of financing.

The various fund sources have their own individual strengths and limitations. It is
wise to find out through analysis which will benefit the engineering firm most.

56 | Engineering Management
 When the internal sources of funds are not enough to finance operations, external
sources like those granting loans and credits may be tapped.

In the determination of the best source of financing, the following factors must be
considered: flexibility, risk, income, control, timing, and others.

To achieve its goals, the engineering firm must be financially healthy. There are
certain indicators of financial health. They are broadly classified into the following
categories: liquidity, efficiency, financial leverage, and profitability.

An important aspect of managing the finance function is risk management. When

assets and human resources are protected and conserved, the engineering firm is well on
its way to achieve its objectives.

The various ways of handling risks are: risk avoidance, risk retention, hazard
reduction, hazard reduction, and risk shifting.

QUESTIONS FOR REVIEW AND DISCUSSION

1. What is the finance function? How important is it to the engineering firm?

2. What are the specific fund requirements of firms?

3. What are the various sources of the firm's cash in-flow?

4. What is the difference between short-term and long-term sources of funds?

5. What are the suppliers of short-term funds? Describe briefly each.

6. Describe briefly the long-term sources of funds?

7. How may one determine the best source of financing?

8. How may the financial health of the company be determined?

9. What is meant by “risk?” Why must it be managed properly?

10. Describe briefly the methods of dealing with risks.

RESEARCH

Identify an engineering firm of your choice. Deter-mine the methods used by the firm in
handling risk. Do you consider these methods adequate? If not, suggest the
appropriate method that must be used.

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58 | Engineering Management