In this article we will discuss about the traditional and modern techniques of control used in an organisation.
Traditional Techniques of Controlling:
I. Budgeting (or Budgetary Control System):
A budget is both – a method of planning and an instrument (or device) for controlling. It is a plan in so far as the numerical expression of the standards of performance (i.e. anticipated results) is concerned. However, when the actual operational performance is judged against these standards; the budget assumes the role of a control technique. As such, a budget is properly called a budgetary control; the suffix ‘control’ usually being omitted.
The Concept of ‘Budget’:
A budget might be defined as the expression of a management plan into numerical terms (financial, quantitative or time); being a statement of anticipated results expected of the working of a particular aspect of organizational operational life, for a specific future period of time, say a month, a quarter, a half year, a year or so.
Types of Business Budgets:
Some important types of business budgets are described below:
(i) Sales Budget:
One most important aspect of the revenue budgets of business enterprises is the sales budget.
A sales budget is a statement of an expected volume of sales, flowing to a business enterprise over a specific future period of time.
(ii) Production Budget:
An important budget concerning the operational life of a business enterprise is the production budget.
A production budget is a statement of anticipated production to be done by an industrial enterprise during a specific future period of time; in view of the resource availability for production purposes.
Production budget might be expressed in terms of:
Man-hours; where most of production work is done by manual labor.
or Machine-hours ; where production activities are mechanized.
(iii) Production-Facilities Budgets:
Based on the need and requirements of the overall production budget; budgets for various productions facilities are prepared – as branches of the production budget.
Some of such ancillary budgets are as follows:
(a) Materials budgets i.e., a budget for direct material needed for the budgeted output.
(b) Labor budget i.e., a budget for direct labor needed for the budgeted output.
(c) Factory overheads budget i.e., a budget for factory overheads likely to be incurred, during the production process, to produce the targeted output.
(d) Administrative (or office) overheads budget i.e., a budget for office overheads likely to be incurred, during the handling of the targeted output, at the ‘office-stage’, in the industrial enterprise.
(e) Selling and distribution overheads budget, i.e., a budget for selling and distribution overheads likely to be incurred, at ‘the selling and delivery stage’, during the budget period.
(iv) Cash Budget:
A cash budget is an important branch of the overall Finance Budget. This budget assumes great significance in the operational life of any business enterprises; as cash is needed for various purposes, quite off and on.
A cash budget is a statement of anticipated cash receipts and cash disbursements; occurring during a specific future period of time – to find out the likely surplus or shortage of cash, during that period.
(v) Capital Expenditure Budgets:
A major aspect of financial budgeting concerns with, designing capital expenditure budgets, for items like plants, machines, equipments, furniture, etc.
(vi) Balance-Sheet Budgets:
Balance-sheet budgets are statements of forecast of capital account, liabilities and assets.
In fact, sources of changes in Balance Sheet items are the outcome of the functioning of budgetary control system, as a whole. Hence, Balance Sheet budgets prove the accuracy of all other budgets.
(d) The Budget Organization:
For the best designing and functioning of the budgetary control systems, there is the need for a separate ‘budget-organization’.
The ‘budget-organization’ implies the formulation of a Budget Committee extended into various sub-committees. The main task of the budget committee is to finalize and coordinate the planning and implementation of the budgetary control system.
The Budget Committee, headed by the Chief Executive, consists of various functional heads like the Production Manager, the Purchase Manager, the Finance Manager, the Marketing Manager, the Personnel Manager, the Engineer, the Accountant, the Cost Accountant and other functional experts.
In this Budget Committee, there is a usually a provision for a ‘budget-officer’ who acts as the secretary of the committee; and makes preparations for arranging the meetings of the Budget Committee.
Advantages of the Budgetary Control System:
Some important advantages of the budgetary control system are as follows:
(i) Expression of Planning in Definite Terms:
Since budgets are a numerical expression of business plans; the budgetary control system – built around the concept of budgeting – expresses plans in definite terms. This way, it is easier for managers to communicate plans more precisely to subordinates and operators. Further, people understand plans in a better manner, and can easily take actions for the realization of plans.
(ii) Comprehensive Managerial Technique:
Budgetary control system is a comprehensive managerial technique of managing an enterprise. It is both, a method of planning and an instrument of controlling. Planning and controlling are two extremes of budgetary control; and other managerial functions viz. organizing, staffing, direction naturally fit into the budgetary control structure at their appropriate places.
(iii) Communication of Jobs (or Duties) though Budgets:
The budgetary control system is the mouthpiece of management; as budgets convey to people what jobs are assigned to them or what role they are supposed to play, in the organizational life.
(iv) Instrument of Coordination:
Budgetary control system is an instrument of coordination. Through budgets, the functioning of functional departments, management levels and actions of individuals throughout the enterprise are all endeavored to be coordinated.
(v) Profit-Maximization Attempted through Cost-Control:
Through emphasizing on cost minimization and expenditure control; the budgetary control system helps management to strive for the profit-maximization goals in a legitimate manner.
(iv) Fixation of Responsibility Facilitated:
Budgetary control system judges the organizational operational efficiency; by locating the spots where weaknesses are occurring. Thus, responsibility for weaknesses or shortfalls in performance can be easily fixed through the budgetary control system.
(f) Limitations of the Budgetary Control System:
Budgetary control system is a rose, full of thorns.
Some significant limitations of this system can be stated as follows:
(i) Not Comprehensive:
Budgetary control system is a lop-sided managerial device; in as much as the qualitative aspects of managing cannot be fully and precisely made a part of it. In fact, despite intelligent quantification of qualitative aspects; the real intentions of these aspects cannot be incorporated into the budgetary control system.
(ii) Difficulty in Setting Rational Standards:
Usually, while devising a budgetary control system, it is difficult to set rational standards of performance. Despite the adoption of the best scientific approaches to setting rational standards; prejudices, bias and personal opinions of managers enter the budgetary-control system, through the back door.
(iii) Danger of Over-Budgeting:
Regulating the organizational operational life through the budgetary control system, might carry a danger of over-budgeting i.e. too much emphasis on details of minor items and light emphasis on major heads, requiring strict-control.
(iv) Lack of Departmental Cooperation and Co-ordination:
There might be a lack of departmental cooperation and co-ordination, while designing and implementing the budgetary control system. In fact, some managers might not be willing to cooperate with one another into the making of the system; due to personal differences and conflicting approaches.
As such, departmental co-ordination, which is the heart of the budgetary control system, might be unavailable or unobtainable, because of lack of cooperation among departmental managers. As a result, the budgetary control system becomes faulty or misleading, and a mere theoretical exercise in managing.
(v) Umbrella for Inefficiency:
Budgetary control system may become an umbrella for hiding organizational inefficiency; as many people might act within budgets – though remaining highly inefficient otherwise.
II. Non-Budgetary Control Techniques:
Some of the non-budgetary control techniques are described below:
(i) Direct Personal Observation and Supervision:
Direct personal observation and supervision by a manager is, perhaps, the oldest techniques of controlling. In this technique, control is exercised by a manager through a face-to-face contact with employees; by directly observing their performance e.g. by taking rounds in the plant where workers are performing or in any other manner.
This technique of controlling has the obvious advantage that corrective action by the manager could be taken on the spot. Moreover, this technique of direct observation has psychological impact on workers; as they are motivated to work as per standards of performance due to the fear of the manager.
However, direct personal observation and supervision technique of controlling has certain disadvantages, like the following:
(a) It is a time-consuming technique. The manager is left with little time for attending to his official duties.
(b) Direct personal supervision cannot be exercised all the time over all the employees.
(c) Due to this technique of controlling; there may be interference in the smooth flow of work of employees.
(d) This technique has a negative impact on self-motivated and enlightened workers; and they often resist to it.
(ii) Written Reports:
Under this technique of controlling; each manager prepares written reports on the performance of his subordinates; and submits these to higher authorities. Lower management submits reports to middle management to top management and the top management (i.e. Board of Directors) to the body of members.
The written report method of controlling has a psychological impact on workers. In fact, the fear of likely adverse remarks in the report makes workers discharge their duties efficiently.
However, this technique of controlling has certain limitations, as described below:
(a) This technique carries an element of subjectivity, in that a manager may deliberately favor or disfavor particular employees while ‘drafting reports.
(b) It is an imperfect technique of controlling, as the manager may not include all aspects of workers’ performance, in his reports.
(c) Drafting of written reports is a time-consuming process.
(d) Some managers may not to competent enough to draft reports.
(iii) Statistical Reports and Analysis:
Under this technique of controlling, a special staff of specialists prepares statistical reports and presents them in form of tables, ratios, percentages, correlation analysis, graphs, charts, etc. to higher management levels. Such reports are prepared in areas like production, sales, quality, inventory etc.; and these reports usually become the basis of managerial decision-making and action.
(iv) Break-Even Analysis:
Break-even analysis is a technique of Marginal costing. It is based on a classification of costs into fixed and variable categories.
The key-concept in break-even analysis is that of contribution, defined as:
Contribution = Selling price per unit – Variable cost per unit
With the help of this concept of contribution, the management is first interested in a full recovery of fixed costs. After recovering the fixed costs fully; the business enterprise reaches a point of break-even i.e. a point at which there is neither a profit nor losses.
Break-Even-Point (i.e. B.E.P.) is calculated as follows:
Suppose fixed costs = Rs. 1, 00,000
Selling price per unit = Rs. 20
Variable cost per unit = Rs. 12
Contribution per unit = Rs. 8 (i.e 20 – 12)
B.E.P = Fixed costs/Contributed per unit = 1, 00,000/8
= 12,500 units
A B.E.P. of 12,500 units indicates that if business produces and sells 12,500 units; it will recover fixed costs fully; and will have neither profits nor losses.
After reaching B.E.P., business can earn a profit of Rs.8 per unit (i.e. equal to contribution per unit); on selling each additional unit, (as fixed costs have already been recovered).
The technique of break-even analysis is helpful in profit planning and controlling – by predicting behavior of fixed and variable costs.
(v) Ratio Analysis:
Ratio-analysis is a tool of Financial Accounting and Management Accounting. Under this technique, the financial analyst analyses financial statements (i.e. the Income Statement and the Position Statement) by computing appropriate ratios.
In fact, figures do not speak. Ratios make them speak. The useful and meaningful accounting data give important clues to management for decision-making purposes – speaking through the media of accounting ratios.
Accounting ratios are usually divided into the following categories:
I. Liquidity ratios
II. Solvency ratios
III. Activity or performance ratios
IV. Profitability ratios
Modern Techniques of Controlling:
Some popular modern techniques of controlling are described below:
(I) Management Audit:
Management audit is a modern technique of controlling; in which the aim is to examine the efficiency of the management’s philosophies, policies, techniques etc. in successfully running an enterprise.
It may be defined as follows:
Management audit is an independent, overall and scientifically critical examination of the entire management process – with a view to discovering quality of management; and judging its success and failures in running and managing an enterprise.
Conducting Management Audit:
Management audit may be conducted either by an internal agency in the form of Management Audit Cell (MAC); or by an external agency such as management consultants. A growing tendency in the U.S.A. in regard to conducting management audit is to have certified management auditors for this purpose; so that a more objective view of management’s efficiency could be presented.
Point of Comment:
The scope of management audit is very wide. Management audit may cover areas like the following:
I. An appraisal of managers
II. Economic functioning of the enterprise
III. Fulfillment of major social responsibilities
IV. Functioning of the Board of Director
V. Soundness of organizational structure
VI. Intensity of sales promotion efforts
VII. Emphasis on research and development etc.
Evaluation of Management Audit:
Management audit, by identifying, deficiencies in management’s principles and practices helps in effecting structural improvements in the entire managerial system. Moreover, the fact of conducting management audit makes management more alert and progressive in its approach.
However, the scope of management audit is ill-defined. There is a lack of well-defined principles and procedures for conducting management audit.
(II) Internal Audit (or Operational Audit):
An effective modern technique of controlling is the internal audit, now coming to be called operational audit.
The scope of internal audit is wider that external audit. It not only concerns with ensuring a true and fair recording of the accounting information; but also offers comments on various operational aspects of enterprise-life. Hence it called operational audit.
Internal audit (or operational audit) may be defined as follows:
Internal audit is vouching and verification of accounting information by a staff of internal auditors; and is also concerned with examining the overall operational efficiency of the enterprise.
Point of Comment:
In a way, internal audit also encompasses elements of management audit.
Scope of Internal Audit:
Internal audit, besides, including financial audit as the core aspect of it; includes consideration of the following:
I. Appraisal of financial controls
II. Compliance with policies and procedures
III. Efficiency in utilizing resources
IV. Appraising quality of management performance etc.
Evaluation of Internal Audit:
Internal audit recommends improvements in the operational life of the enterprise, and provides managerial with a perennial supply of control information. It keeps a moral check on all the members of the organization.
However, installation and operation of internal audit system is much costly and time-consuming. Moreover, internal audit people have a lop-sided approach to their work; in that they have a tendency to look at every aspect of business operations from the accounting point of view.
(III) Social Audit:
Social audit may be defined as follows:
Social audit is concerned with the measurement of social performance of an organization in contrast to it economic performance.
The concept of social audit was first developed by Howard R. Bowen in the U.S.A. in the fifties. The application of the concept of social audit may be attributed to an increasing awareness of social responsibilities by business enterprises.
Some time back, the Tata Iron and Steel Company Limited conducted a social audit in its organization; though the audit report was not made available to the general public.
(IV) Responsibility Accounting:
Responsibility accounting is a technique of controlling borrowed from Management Accounting.
It is a system of controlling, whereby, the performance of managers is judged by assessing how far they have achieved the targets set for their departments or sections; for whose performance they are responsible.
Responsibility accounting may be defined as follows:
Responsibility accounting consists in dividing a business organization into responsibility centres, whereby, a distinct manager is assigned responsibility for achieving the predetermined target for his centre; and his success is judged by his ability in controlling the ‘controllable costs’ of his centre.
Points of Comment:
(i) Under responsibility accounting system, costs are assigned to responsibility centres; rather than to products.
(ii) Costs incurred by a responsibility centre are divided into two categories – controllable and uncontrollable. The head of the centre is directly responsible for the control label costs of his centre.
(V) Human Resource Accounting (HRA):
Rensis Likert and D.E. Bowers have undertaken experiments in human resource accounting.
HRA might be defined as follows:
HRA is accounting for people in an organization; which involves a measurement of costs incurred by an enterprise to recruit, select, hire and train human assets and a measurement of the economic value of people to the enterprise.
Point of comment:
Other techniques of controlling emphasize on profits, costs, performance etc.; but ignore the value of the human asset which makes for all the difference in organizational performance.
Approach to Measuring the Value of Human Assets:
There are two approaches to measuring the value of human assets:
I. Original costs of human assets i.e. costs incurred in acquiring, compensating and training people.
II. Replacement costs i.e. the costs required to replace a specific person.
An individual’s value to an organization is the present worth of the set of future services that he/she is expected to provide during the period of his/her stay in the organization.
Evaluation of HRA:
HRA helps management by providing valuable information for effective planning and managing human resources. With the help of measurement of costs of human assets, management can select persons with highest expected realizable value.
However, the biggest limitation of HRA is the basic problem involved in measuring the value of human assets – whether it should be based on original costs or replacement costs.
Many organizations, particularly, in the U.S.A. are following HRA.
(VI) Management Information System (MIS):
Management Information system (also known as MIS) is an integrated technique for gathering relevant information from whatever source it originates and transferring it into unusable form for the decision-makers in management. It is a system of communication primarily designed to keep all levels of organizational personnel abreast of the developments in the enterprise that affect them.
MIS provides working tools for all the management personnel in order to take the best possible action at the right time with respect to the operations and functions of the enterprise for which they are largely responsible.
The emphasis of MIS is on information for decision-making.
MIS facilitates control from several angles:
(a) MIS performs a useful triple service function to management. Actually MIS itself is a three stage process – data generation, data processing and information transmission.
MIS enhances the management’s ability to plan, measure and control performance, and taking necessary and corrective action.
(b) Facilitates total performance. MIS provides more specialized and technical kind of information for the concerned managers. MIS provides multiple types of information for all management levels on a baffling variety of organizational matters.
(c) Takes into account several critical dimensions. MIS takes into account – the real time requirements, frequency of requirement, accuracy requirement, data reduction requirement, storage requirement etc. MIS objectively determines what information is needed by whom, and with what frequency.
(d) MIS reduces overload of information. MIS stresses the information that is most useful to the decision-maker. Any firm, large or small, that uses a formalized approach or electronic data processing system for its daily business has foundation of MIS.
But normally, the larger the organization the more likely that MIS can be used by top management in establishing company policies and plans, monitoring the company performance and adapting the company strategies in response to changing circumstances.
(VII) Network Analysis Techniques – PERT/CPM:
PERT (Programme Evaluation and Review Technique) was developed by the special project office of the U.S. Navy in 1958. Almost at the same time engineers at the Du Pont Company U.S.A. developed CPM (Critical Path Method). Though there are some differences between PERT and CPM; yet both these techniques utilize the same principles.
Application in PERT/CPM:
Some of special areas for the application of PERT/CPM are given below:
(i) Building/construction projects
(ii) Ship building
(iii) Airport facilities building
(iv) Installation of computer systems
(v) Publication of books
Steps in PERT/CPM:
The application of PERT/CPM involve the following steps:
(i) Identification of Components:
The first step towards the application of PERT/CPM is an identification of all key activities or events necessary for the completion of the project.
The term activity may be defined as an operation or a job to be carried out; which consumes time and resources. It is denoted by an arrow, in the network diagram. The term event may be defined as the beginning or completion of an activity. It is denoted by a circle in the network diagram.
(ii) Sequencing of Activities and Events:
A network diagram is prepared to show the sequence of activities and events. It has a beginning and a terminal point for the project. It also depicts a number of paths of activities from the beginning to the completion of the project. For sake of convenience, each event is given a serial number.
(iii) Determination of Estimated Time:
For completion of the project during the contract period; it is essential to determine the expected time required to complete each activity.
Under PERT, three time estimates for the completion of each activity are made:
a. Optimistic or the shortest time
b. Pessimistic or the longest time
c. Normal or most likely time
(iv) Determination of the Critical Path:
At this stage, it is required to identify the sequence of those activities whose completion is critical for the timely completion of the project. Once the critical path is known; the management will be in a position to deploy resources more fruitfully; to spot troubles early and apply controls where these are most essential.
Point of Comment:
There must be no delay in the completion of activities which lie on the critical path; otherwise the entire project will be delayed.
(v) Modification in the Initial Plan:
The initial plan may be modified by re-sequencing some activities that lie along the critical path. When this is possible, it will result in a shorter time for the completion of the project.
(d) Distinction between PERT and CPM:
Though basic principles involved in PERT and CPM are the same; yet some differences between the two may be expressed as follows:
(i) PERT is event oriented; whereas CPM is activity oriented.
(ii) In CPM, it is assumed that the duration of every activity is constant; and hence only one time estimate is given for each set of activities. On the other hand, PERT allows for uncertainty in the duration of activities; and hence three time estimates optimistic (or the shortest time), pessimistic (or the longest time) and normal (or the most likely time) are given.
(iii) CPM requires some previous work experience for the completion of each activity; which is not necessary in PERT.
(iv) CPM is used where cost is the main consideration; while PERT is used where time is the main consideration.
Evaluation of PERT/CPM:
Merits following are the main advantages of PERT/ CPM:
(i) PERT/CPM provides an analytical approach to the achievement of project objectives which are defined clearly. It thus facilitates better utilization of time, efforts and capital.
(ii) It identifies most critical elements and pays more attention on these. It thus, facilitates ‘control by exception’ and increases effectiveness in handling projects.
(iii) PERT/CPM brings all the components of a project together in the flow chart and permits simultaneous performance of different parts of the project.
(iv) PERT/CPM forces managers to analyze all possibilities and uncertainties. It thus, helps to minimize time and cost overruns.
(v) It provides a kind of feed forward control; because delay in one activity affects all succeeding activities. Management can take action in advance, by effecting modifications of future activities.
Major limitations of PERT/CPM are as follows:
(i) It is not possible to accurately estimate time and cost involved in various activities of a project. Errors in estimation can make PERT/CPM erratic and unreliable.
(ii) PERT/CPM is time-consuming and expensive. As such, small firms cannot afford to take advantage of these techniques.
(iii) PERT/CPM cannot be applied with regard to assembly line operations, in which scheduling of operations is more guided by the speed of machines.
(iv) PERT/CPM lays stress on time and cost control; overlooking other aspects of the project like quality and design of the project.
People often resist to externally imposed control. The best controlling system is that in which people opportunity for exercising self-control has.
Situation is creating conditions for exercising self-control.
Some of the situations providing opportunities for self-control may be:
1. Management by Objectives (MBO):
Under MBO, there is a great possibility that people will exercise self-control; because they have their own hand in setting objectives for themselves; and are more likely to be committed to those objectives.
2. Delegation of Authority:
Successful delegation of authority requires attitudes of mutual trust and confidence between the superior and the subordinates. A superior may not like to impose controls on a responsible and competent subordinate; and may allow him to exercise self-control – as a measure to motivate him.
3. Assignment of Challenging Work:
When some challenging nature of work is assigned to an individual; the job itself creates situations in which only self-control could be exercised by the individual on himself.
4. Highly Dedicated Employees:
In case of highly dedicated employees, there is not much need to impose controls over them; as they could be assumed to be self-starters. They may be left to exercising self-control.
Points of Comment:
1. Even in situations of externally imposed controls; there is provision for exercising self-control. In fact, minute-to-minute control by a manager over subordinates’ performance is never possible.
2. People must not be left entirely to exercising self-control. There must be an ideal mix of externally imposed controls and self-controlling philosophy.