THE FUNCTION OF CONTROLLING NOTES

THE FUNCTION OF CONTROLLING

Introduction

Controlling involves the measurement and correction of the performance of employees, and of other organizational resources in order to ensure that everything is going according to plan. Any manager charged with putting plans into action must carry out control. Controls help to point deviations from plans so that corrective action can be taken. Before controlling can be done management must ensure the two prerequisites of the control system:

(a)        Controls require plans: Controls must be based on plans. Managers cannot determine whether their units are achieving what is expected unless they know what is expected in the first place. Managers must first set plans and these plans become standards against which performance is measured.

(b)        Controls require a clear organizational structure: Organizational responsibilities must be clear and definite so that when something goes wrong one can tell at which position it did. Lack of a good structure means that managers may know something is going wrong but they cannot tell exactly where the responsibility for the problem lies. Without clear knowledge of exactly where things are going wrong, corrective action is impossible.

The Steps in the Control Process

The methods used for control of the various resources, techniques and procedures are basically the same regardless of where it is being done or what is being controlled. The process has three major steps:

 

Step One: Establishment of Standards: The first step in the control process is to establish plans which serve as the standards against which performance is measured. In establishing the standards for control purposes, critical points must be selected. These are the points at which if anything went wrong, there would be devastating effects on the organization. It is difficult to control every aspect of the firm. Standards is the measure by which performance is judged as “good” or “bad”, “acceptable” or “unacceptable”. The standards set may be of many kinds and among the best are the verifiable goals and objectives, which stipulate the desired results. These goals and objectives may be in physical terms e.g units to be produced, sales volume, products rejected, profits earned, customer complaints etc.

Step Two: Measurement of Performance: This step involves measurement of actual performance in the light of the standards set. The objective of this step is to answer the question of “how well are we doing in meeting the standards set for our activities?” Where possible standards should be such that they can detect deviations before they actually occur so that appropriate corrective action can be effected

Step Three: Correction of Deviations: Taking the necessary corrective action is actually what completes the control process. Deviations from standards can either be positive or negative. When positive, then performance is better than expected and even if this is good, it is necessary to evaluate the standards and check for their accuracy and adequacy. Correction of negative performance is the point at which control is seen as part of the whole system. Corrective action is the step at which all other managerial functions are integrated into the process of control.

Devices of Control

Broadly, all the devices of control can be classified into

(a) Budgetary control devices: include budgets such as production budget, cash budget, sales budget, capital budget etc

(b) Non-budgetary control devices: consist of managerial statistics, break-even analysis, internal audit, cost accounting, etc.

Budgeting or Budgetary control

A budget is a financial or quantitative statement prepared for a definite period of time. It states the policy to be pursued during that period for the purpose of attaining a given objective. It provides standards for comparison with the results actually achieved. Budgeting is the process of preparing budgets whereas budgetary control is a device or technique of managerial control through budgets. Thus, budgetary control is planning in advance of the various aspects of business can be controlled.

Characteristics of budgetary control

• Planning of activities of each department,
• Co-ordination among various departmental plans,
• Recording of actual performance,
• Comparison between budgets standards and actual performance,
• Determining the deviations
• Finding out the reasons for deviations (if any) and taking of follow-up action.

Essentials of Effective Budgetary control

• Effective Organisation: should be effectively organized and the responsibilities of each departmental managers are clearly defined and the line of authority sharply drawn.
• Quick reporting: The subordinates must send reports on performance without any delay. The managers on their part must analyze the report and take necessary action immediately.
• Support of top management: The top management must have a clear idea of the objectives of budgetary control and should implement the budgetary control programme seriously in order to infuse a sense of seriousness among the subordinates.
• Reward and Punishment: The employees whose performance is according to the budget plans should be suitably rewarded and the employees whose performance is not as per budget should not go unpunished.
• Appropriate Authority: The employees who are entrusted with the responsibilities of implementation of budgetary control should also be given appropriate authority to do so. If a person lacks authority to enforce his decision, it is difficult for him to fulfill his responsibilities
• Flexibility: If the circumstances warrant, the management should not hesitate to alter the budget figures. But at the same time, care must be taken to see that the budget figures are not altered too much or too often.

 

Classification of Budgets

Budgets may be classified on the basis of purposes for which they are prepared. On this basis, we have the following types of budgets.

(1) Cash budget: it gives the estimated receipts and payments for the budget period and indicates the position of cash arising from it. It shows the cash requirements at various times of the budget period and helps the management in planning and arranging cash for the business concern.

(2) Capital Budget: gives the estimates in respect of the capital resources of the business. It also states the plans with the estimated cost for investment, expansion, replacement, etc. Thus the budget serves as a device for planning capital expenditure.

(3) Sales Budget: gives a comprehensive sales programme and plans for a specific period. It states the sales potential in terms of quantity, values, period, product, etc. Sales budget is one of the important budgets because it is the basis for preparing other types of budgets.

(4) Selling and Distribution Cost Budget: This budget gives the cost of selling and distribution of the products during the budget period. It includes costs of selling and distribution such as cost of insurance, packing, storing, transport, advertisement, sales commission, market research etc.

(5) Production Budget: also known as output budget and is based on sales budget. It indicates the quantity of units to be produced during the budget period. This budget helps in maintaining optimum balance between production, sales inventory position of the firm.

(6) Production Cost Budget: it is based on the production budget, lays down the estimated cost of carrying out the plans relating to production. Production cost budget is sub-divided in to various sub-budgets like labour budgets, raw material budget, production overhead budget, etc.

(7) Labour Budget: gives the estimated requirements of labour for carrying out the estimated production during the budget period. It may state both direct and indirect labour requirements. Generally, the personnel department prepares the labour budget in coordination with other concerned departments.

(8) Raw Material Budget: This budget which is prepared by the production department gives the estimated requirements of raw materials of different types for carrying out production during the budget period.

(9) Production Overhead Budget: This budget lays down the estimates of all production overheads to be incurred for carrying out the estimated production during the budget period. It breaks up the production overheads into fixed overheads, variable overheads and semi-variable overheads.

(10) Master Budget: Master budget is summary of all functional budgets and indicates how they affect the business as a whole. A master budget generally includes particulars regarding sales, production, cash position, fixed assets, labour, factory overhead, administration overhead, and selling and distribution overhead, major financial ratios and profit.

Advantages of Budgetary Control

• The various functional budgets state clearly the limits for expenses and also the results expected in a given period thus helping to eliminate any uncertainties that may be faced by the enterprise.
• Limits and authority of each manager are laid down in the budget making it easy to delegate authority and responsibilities in the enterprise.
• Generally, the budgets are prepared by committee consisting of important executives of the enterprise and this provides to the company the benefits of combined expertise.
• Tries to keep the expenditure within control and also to achieve the targets laid down. This keeps everybody always alert and encourages the optimum use of the enterprise resources.
• It helps in finding out the deviations from the predetermined standards thus the management is able take suitable corrective action promptly. It means wastages and losses are reduced to the minimum.
• Budgetary control is concerned with the activities of various departments which are inter-related or inter-connected helping to promote co-operation and team spirit
• Budgetary control involves the communication of management’s policy and objectives to all the managers. Again, the reports of actual performance against the budget, how each manager has fared, what actions are necessary etc., are communicated to the managers. Thus, Budgetary control ensures proper communication in the enterprise.
• Budgetary control involves two functions (a) planning for its own future performance and (b) control to ensure adherence to the plans laid down. Thus, budgetary control ensures proper performance of the above two managerial functions.

Limitations of Budgetary Control

• Since an effective budgetary programme reveals the performance of employees, inefficient employees may not support the budgetary programmes.
• Budgets are based on estimates and hence the effectiveness of budgetary control depends on the accuracy with which the estimates are made about the future.
• Conditions and circumstances under which an enterprise functions are not static and hence, budgetary control to be effective must be so flexible as to suit the requirements of any change in the circumstances. But it is very difficult to attain flexibility in budget making.
• Budgetary control will not be effective if no arrangements are made for proper supervision and administration.
• Budgeting is only one of the tools of management. But often it is taken as a substitute for management rather than as a tool of management which may result to dire consequences for the business.
• Budgetary control programme is very cumbersome and time consuming process.
• The manager is discouraged from undertaking activities for which provision was not been made in the budget, but which are otherwise useful for the enterprise. Thus, the managers are discouraged from taking initiative.

Non Budgetary Control Devices

 

(1) Cost Control

Cost control includes techniques such as (a) Cost Accounting, (b) Standard Costing and (c) Break-even point analysis.

1. Cost Accounting: Profits of a business enterprise depend very much on the cost of production. Because of this, cost accounting and cost control are given the much importance by organizations. Costs are incurred by an enterprise for different types of activities. Management uses a number of systems for determining the cost of products and services. The management by keeping in view the nature of each industry, designs the cost accounting procedures, methods and records for effective cost control and cost reduction.
2. Standard Costing: It involves; (a) Deciding cost standards for various components of costs such as labour overheads, raw materials etc. (b)Management of actual performance, (c) Comparison of actual cost with the standard cost and finding out the variances and (d) Finding out the causes of variances and taking measures to prevent the occurrences of variances in future.
3. Break- even Point Analysis: Break-even analysis is a useful tool of management control over business profits. It is mainly concerned with the cost-volume-profits analysis. It indicates at which level costs and revenue are in equilibrium. It is the point at which total revenue is equal to total cost, i.e., the point of no profit and no loss. It helps in finding out the probable profit at any level of production and the relationship of different volumes, costs sales prices and sales mix to profits.

 (2) Managerial Statistics

Managerial statistics deals with data and methods which are useful to management executives in planning and controlling organisation activities. By using such data, an analysis of past performance is made for control purposes. Managerial statistics also enable the manager to make a comparison between the past and present results with a view to ascertaining the causes of changes that have taken place and for making projection for future.

(3) Internal Audit

In the case of internal audit, the internal auditor who is an employee of the organisation makes an independent appraisal of financial and other operations. In addition, he appraises the company’s policies and plans and performance of management. Further, the internal auditor not only pinpoints defects in the management policies or plans but also gives suggestions for eliminating them.

(4) Production Control

Production control involves planning of production, routing, scheduling, stock control and manufacturing control. It’s the process of planning in advance of operations, establishing the exact route of each individual item, part or assembly, setting starting and finishing dates for each important item, assembly and the finished product, and realising the necessary orders as well as initiating the required follow-up to effectuate the smooth functioning of the enterprise.

(5) Personal Observation

The manager by observing their subordinates while they are engaged in work can exert more fruitful control. By personal observation, the manager will be in a position to know workers attitude towards their work and also correct worker’s mistakes, if any. Further, the worker will not be wasting his time as he knows that he is being observed by his superior.

(6) External Audit Control

External audit is compulsory for all joint-stock companies. External audit ensures that the interests of shareholders and other parties connected with the company are safeguarded against the undesirable practices adopted by the management. The external auditor certifies the annual statements of the company after examining the relevant books of accounts and documents. The external audit is conducted by a qualified Chartered Accountant.

 (7) Inventory Control

Inventory control or material management involves the controlling of inventory used by the enterprise. The enterprise might be using the inventory of different kinds and in different quantities. The controlling of inventory involves the maintaining of stock of the right kind of inventory in the right place and in right quantity and quality.

(8)Special reports and analyses

These are mainly used for particular problem areas. They are not routine and can help review unusual areas that may need significant improvements.

 

Financial Controls

Businesses exercise financial control for several purposes. It has to determine the need for retaining the earning for company growth. For this, it should consider the pros and cons of retaining the earnings. The company also has to take a decision with regard to the utilization of retained earnings for various purposes. Further, there is a need to take a decision as to how the additional funds required by the company will be made available, that is, whether by the issue of shares raising of loans or by retaining profits. For the purpose of exercising financial control, many control techniques are available. Some of them are;

(a) Comparative financial statements.

(b) Financial ratios

Comparative Financial Statements: Analysis of the financial statements helps in judging the (1) profitability and (2) financial soundness of the company. For exercising the overall financial control of the company, balance sheet and income statement of the company are very helpful.

• Balance Sheet: For control purposes, a comparative balance sheet is prepared in such a way as to show; (a) balance of accounts on different dates and (b) the extent of increase or decrease in the balance of accounts over a period of time. From the balance sheet, one can know the increase or decrease in the various assets liabilities and shareholder’s equity or capital over a period of time due to operation of business.
• Income Statement: The income statement helps the manager in finding out the net income generated and losses suffered by the company from its operating activities over a period of time. The operating results may be shown in absolute terms as well as in percentages.

Financial Ratio Analysis: For analysing financial data, ratio analysis is used. From the figures in balance sheet and income statement, financial ratios are computed. Financial ratios are relationships stated in mathematical terms between figures which have a cause and effect relationship or which are connected with each other in some other manner. For example, a ratio of gross profit to sales may indicate the relationship between turnover and profit of the company. Financial ratios provide a measure of financial condition of organisation and hence they are useful in control. Many financial ratios are in use. Some of them are:

1. The net profit ratio: It expresses the profit as a percentage of sales.
2. The operating ratio: This ratio states the ratio of total operating expenses to sales.
3. Return on net worth: This ratio gives the rate of return on the shareholder’s money.
4. Liquidity ratios: shows the capacity of the company to meet its short-term liabilities.
5. Acid test ratio or quick ration: This ration also indicates the ability of an organization to pay current liabilities without relying on the sale of inventories and supplies.
6. Leverage ratio: measures the extent to which an organization has been capitalized by debt. They indicate the extent of borrowings and scope for future borrowings.
7. Debt-equity ratio: indicates the soundness of financial position of the organization.
8. Inventory turnover: This shows often inventory turns over or is replenished each year.
9. Fixed asset turnover: It measures the turnover of fixed assets to net sales and shows the efficiency achieved in the use of fixed assets.

Summary of Controlling

From the study of the managerial function of controlling, certain basic truths or essentials have been implied and can be carried under “principles of controlling”. Because control is just a part of the managerial function, these truths may be similar to truths in other areas of management. So generally the purpose and nature of control can be summarized under the following principles.

1. Principles of purpose of control—Hold that controls are not for the sake of it. They should ensure that plans succeed by detecting deviations and furnishing the basis for correction of such deviations.
2. Principle of future directed controls—The more a control is based on the feed forward rather than simple feedback of information, the more managers have the opportunity to understand or perceive deviations from plans before they occur and take action in time to prevent them. Control like planning should be forward looking although the principle is usually ignored in practice.

 

1. Principle of control responsibility—The main responsibility for the exercise of control rests in the manager charged with the performance of the particular plans involved. Delegation of authority, assignment of tasks, and responsibility for objectives rest in individual managers and must follow that control over this work should be exercised by each of these managers.
2. Principle of efficiency of controls—Control techniques and approaches are efficient if they detect and highlight the nature and causes of deviations from plans with a minimum of costs or other unsought consequences. The benefits of control should outweigh the costs if controls have to be efficient.
3. Principle of Indirect Control—The higher the quality of every manager in the managerial system, the less will be the need for direct controls.
4. Principle of reflection of plans—The more that plans are clear, complete and integrated, and the more that controls are designed to reflect such plans, the more effectively controls will serve the needs of managers. Controls cannot be devised without plans since their task is to ensure that plans work.
5. Principle of Organizational Suitability—Controls should reflect the place in the organization structure where responsibility for action lies. Controls need a clear organization structure. Since it is the function of an organization structure to define a system of roles, it follows that controls must be designed to effect the role where responsibility for performance of the plan lies.
6. Principle of standards—Effective controls require objective, accurate and suitable standards controls should provide a simple specific and verifiable way to measure whether planning programs are being accomplished.
7. Principle of critical point control—Effective control should pay attention mainly to only those areas where deviations would affect the running of the organization substantially (mainly to avoid being wasteful).
8. The exception principle—The more managers concentrate control efforts on exceptions, the more efficient will be the results of their control. Managers should concern themselves only with significant deviations i.e. exceptionally “good” or “bad” situations.
9. Difference with critical point—Critical point control has to do with recognizing the points to be watched while exception has to do with watching the size of the deviation.
10. Principle of Flexibility of Controls—If they are to remain effective in the light of dynamic environments, controls should be flexible. If a plan fails or is changed controls should also be adjusted.
11. Principles of Action—Controls are justified only if they indicate corrective action through appropriate planning, organizing, staffing and leading. If this principle is forgotten controls could become useless and wasteful of managerial and staff time.