Class 12 business studies Chapter 8 Controlling

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NCERT Notes for Class 12 business studies Chapter 8 Controlling

Class 12 business studies Chapter 8 Controlling

 

Controlling is one of the important functions of management. Managerial functions start with planning and ends with controlling. Controlling means ensuring that activities in an organization are performed as per plans. The controlling function finds out how far actual performance deviates from standards, analyses the causes of such deviations and attempts to take corrective actions based on the same. Without proper control even the best plan will not give the desired result. This process helps in formulation of future plans in the light of the problems that were identified and, thus, helps in better planning in the future periods.

Controlling ensures that an organisation’s resources are being used effectively and efficiently for the achievement of predetermined goals. Controlling function of a manager is a pervasive function. It is a primary function of every manager. Managers at all levels of management— top, middle and lower-need to perform controlling functions to keep a control over activities in their areas.

Features of controlling:

• Controlling is a goal-oriented process
• It is a pervasive function
• It is a backward-looking function. Controlling evaluates the past performance on the basis of pre-determined goals.
• Controlling is futuristic also. Controlling process helps in formulation of future plans in the light of the problems that were identified and, thus, helps in better planning in the future periods.

Importance of Controlling

A good control system helps an organisation in the following ways:

Accomplishing organisational goals:

Controlling measures, the actual performance with standards and make corrective action on deviations. Thus, controlling function guides the organization and keeps it on the right track so that the organizational goals might be achieved.

Judging accuracy of standards:

A good control system keeps a careful check on the changes taking place in the organization and in the business environment. This helps to review and revise the standards in the light of such changes.

Making efficient use of resources:

Controlling helps a manager to reduce wastage and spoilage of resources. Controlling ensures each activity is performed in accordance with predetermined standards and norms. This ensures that resources are used in the most effective and efficient manner.

Improving employee motivation:

A good control system ensures that employees know well in advance what they are expected to do and what are the standards of performance on the basis of which they will be evaluated. This will motivate them and helps them to give better performance.

Ensuring order and discipline:

Controlling creates an atmosphere of order and discipline in the organisation. It helps to minimise dishonest behaviour on the part of the employees by keeping a close check on their activities.

Facilitating coordination in action:

Each department and employee is governed by predetermined standards which are well coordinated with one another. This ensures that overall organisational objectives are accomplished.

Limitations of Controlling

Controlling function of management is suffers from the following limitations.

Difficulty in setting quantitative standards:

Controlling will be effective only when standards are fixed in quantitative terms. Control system loses some of its effectiveness when standards cannot be defined in quantitative terms. Employee morale, job satisfaction and human behaviour are such areas where standards can’t be fixed in quantitative terms.

Little control on external factors:

Generally, an enterprise cannot control external factors such as government policies, technological changes, competition etc.

Resistance from employees:

Control is often resisted by employees. They see it as a restriction on their freedom. For instance, employees might object when they are kept under a strict watch with the help of CC TV.

Costly affair:

Control is a costly affair as it involves a lot of expenditure, time and effort. A small enterprise cannot afford to install an expensive control system. It cannot justify the expenses involved. Managers must ensure that the costs of installing and operating a control system should not exceed the benefits derived from it.

Relationship between Planning and Controlling

Planning and controlling are inseparable twins of management. A system of control presupposes the existence of certain standards. These standards of performance which serve as the basis of controlling are provided by planning. Once a plan becomes operational, controlling is necessary to monitor the progress, measure it, discover deviations and initiate corrective actions. Thus, planning without controlling is meaningless. Similarly, controlling is blind without planning. If the standards are not set-in advance, managers have nothing to control. The relation between planning and controlling will be clear from the following points.

• When there is no plan, there is no basis of controlling.
• Future plans are made perfect by correcting the deviations, which are identified through controlling.
• Planning is clearly a prerequisite for controlling.
• Planning means deciding in advance what is to be done, how it is to be done, who should do it etc. Controlling ensures that things are done as per plan.
• It is utterly foolish to think that controlling could be accomplished without planning.
• Planning is basically an intellectual process involving thinking and analysis to discover an appropriate course of action for achieving objectives. Controlling, on the other hand, checks whether decisions have been translated into desired action.
• Planning is prescriptive whereas, controlling is evaluative.

The relationship between planning and controlling is that one helps the other.

1. Planning based on facts makes controlling easier and effective
2. Controlling improves future planning by providing information derived from past experience.

‘Planning is looking ahead while controlling is looking back’. Comment

Planning is looking ahead while controlling is looking back. However, the statement is only partially correct. Plans are prepared for future and are based on forecasts about future conditions. Therefore, planning involves looking ahead and is called a forward-looking function. On the contrary, controlling is like a postmortem of past activities to find out deviations from the standards. In that sense, controlling is a backward-looking function.

However, controlling is forward looking also because it does not end by comparing the past performance with the standards. It also involves finding the reason for deviation and suggest measures so that these deviations do not occur future. Planning is backward looking also in the sense that it is guided by the past experiences and the corrective actions initiated by the control functions. Thus, planning and controlling are both backward-looking as well as a forward-looking function.

Controlling Process

Controlling is a systematic process involving the following steps.

1. Setting performance standards
2. Measurement of actual performance
3. Comparison of actual performance with standards
4. Analysing deviations
5. Taking corrective action

Step 1: Setting Performance Standards:

The first step in the controlling process is setting up of performance standards. Standards are the criteria against which actual performance would be measured. Standards can be set in both quantitative as well as qualitative terms. For instance, standards set in terms of cost to be incurred, revenue to be earned, product units to be produced and sold, time to be spent in performing a task, all represents quantitative standards. Sometimes standards may also be set in qualitative terms. Improving goodwill and motivation level of employees are examples of qualitative standards.

Step 2: Measurement of Actual Performance:

Once performance standards are set, the next step is measurement of actual performance. Performance should be measured in an objective and reliable manner. There are several techniques for measurement of performance. These include personal observation, sample checking, performance reports, etc.

Measurement of performance of an employee may require preparation of performance report by his superior. Measurement of a company’s performance may involve calculation of certain ratios like gross profit ratio, net profit ratio, return on investment, etc., at periodic intervals.

Step 3: Comparing Actual Performance with Standards:

This step involves comparison of actual performance with the standard. Such comparison will reveal the deviation between actual and desired results. Comparison becomes easier when standards are set in quantitative terms. For instance, performance of a worker in terms of units produced in a week can be easily measured against the standard output for the week.

Step 4: Analysing Deviations:

Some deviation in performance can be expected in all activities. It is, therefore, important to determine the acceptable range of deviations. All deviations need not be brought to the notice of top management. In this regards, manager should use Critical Point Control(CPC) and Management by Exception (MBE).

Critical Point control (CPC)

It is neither economical nor easy to keep a check on each and every activity in an organization. Control should therefore focus on Key Result Areas (KRS’s). Key areas are those which have impact on whole organisation. For example, in a manufacturing organization, an increase in of 10% in the labour cost may be more worrying than a 20% increase in postal charges.

Management by Exception (MBE)/ Control by Exception

It is one of the important principles of control. This principle implies that only major exceptions (deviations) from the established standard should be reported to the top management. This idea is based on the concept “an attempt to control everything results controlling nothing”. Manager should not waste his time and energy in finding solutions for minor deviations rather he should concentrate on removing deviations of high degree. Deviations within the acceptable range (i.e,minor deviations) are ignored.

For Example, if a garment factory establishes that defects in 100 garments, i.e, 5% defects permissible. If the defect is between 1 to 5%, it need not be reported to the management. If the defects are 6% or more than that it must be reported.

Step 5: Taking Corrective Action:

The final step in the controlling process is taking corrective action. No corrective action is required when the deviations are within acceptable limits. However, when the deviations go beyond the acceptable range, especially in the important areas, it demands immediate managerial attention so that deviations do not occur again and standards are accomplished.

Corrective action might involve:

1. Training of employees if the production target could not be met.
2. If an important project is running behind schedule, corrective action might involve assigning of additional workers and equipment to the project and permission for overtime work.
3. In case the deviation cannot be corrected through managerial action, the standards may have to be revised.

Fig: Controlling process

Techniques of Managerial control

The various techniques of managerial control may be classified as into two broad categories:

1. Traditional Techniques
2. Modern Techniques
3. Traditional Techniques

Traditional techniques are those techniques which have been used by the companies for a long time now. However, these techniques have not become obsolete and re still being used by companies. These include:

1. Personal observation
2. Statistical reports
3. Breakeven analysis
4. Budgetary control

Modern Techniques

Modern techniques of controlling are those which are of recent origin and are comparatively new in management literature. These techniques provide a refreshingly new thinking on the

ways in which various aspects of an organisation can be controlled. These include:

1. Return on investment
2. Ratio analysis
3. Responsibility accounting
4. Management audit
5. PERT and CPM
6. Management information system

Traditional Techniques

Personal Observation

This is the most traditional method of control. Personal observation enables the manager to collect firsthand information. It also creates a psychological pressure on the employees to perform well as they are aware that they are being observed personally on their job. However, it is a very time-consuming exercise and cannot effectively be used in all kinds of jobs.

Statistical Reports

Statistical analysis in the form of averages, percentages, ratios, correlation, etc., present useful information to the managers regarding performance of the organisation in various areas. Such information when presented in the form of charts, graphs, tables, etc., enables the managers to read them more easily and allow a comparison to be made with performance in previous periods and also with the benchmarks.

Breakeven Analysis

Breakeven analysis is a technique used by managers to study the relationship between costs, volume and profits. Breakeven point is a point where there is no profit no loss. The sales volume at which there is no profit, no loss is known as breakeven point. With the help of breakeven analysis technique manager can estimate profits at different levels of cost and revenue. Breakeven point is determined by the intersection of Total Revenue and Total Cost curves.

The figure shows that the firm will break even at 500 units of output. At this point, there is no profit no loss. It is beyond this point that the firm will start earning profits.

Breakeven point can be calculated with the help of the following formula:

=Fixed Cost/ Selling price per unit — Variable cost per unit

Advantages of breakeven analysis:

1. Breakeven analysis helps a firm to ascertain profits at different levels of sales.
2. By separating fixed cost and variable cost it enables the management to exercise control over variable cost.
3. It helps to determine the minimum sales volume at which costa are fully recovered beyond which profit can be earned.

Budgetary Control

Budget is a statement of expected results and expected cost expressed in numerical terms. It helps to know the future results and to achieve these results how much we will have to spend. In budgetary control technique the estimated results are compared with the actual results. The variation between the two indicates inefficiency.

Advantages of budgetary control:

1. Budgeting focuses on specific and time-bound targets and thus, helps in attainment of organisational objectives.
2. Budgeting is a source of motivation to the employees who know the standards against which their performance will be appraised and thus, enables them to perform better.
3. Budgeting helps in optimum utilisation of resources by allocating them according to the requirements of different departments.
4. It is used for achieving co-ordination among the different departments.For instance, sales budget cannot be prepared without knowing production programmes and schedules.
5. It facilitates management by exception by stressing on those operations which deviate from budgeted standards in a significant way.

However, the effectiveness of budgeting depends on how accurately estimates have been made about future.

Modern Techniques

Return on Investment

Return on Investment (RoI) is a useful technique which provides the basic yardstick for measuring whether or not invested capital has been used effectively for generating reasonable amount of return. RoI can be used to measure overall performance of an organisation or of its individual departments or divisions. It can be calculated as under.

ROI =Net Income/Sales X Sales/Total Investment

Net Income before or after tax may be used for making comparisons. Total investment includes both working as well as fixed capital invested in business.

According to this technique, RoI can be increased either by increasing sales volume or by reducing total investment without having any reductions in sales volume.

Advantages of ROI to an organization:

1. It indicates how effectively resources are being used.
2. It focuses attention on profits and relates them to capital invested.

Ratio Analysis

Ratio Analysis refers to analysis of financial statements through computation of ratios. The most commonly used ratios used by organisations can be classified into the following categories:

1. Liquidity Ratios: Liquidity ratios are calculated to determine short-term solvency of business. Analysis of current position of liquid funds determines the ability of the business to pay the amount due to its stakeholders.
2. Solvency Ratios: Ratios which are calculated to determine the long-term solvency of business are known as solvency ratios. Thus, these ratios determine the ability of a business to service its obligation.
3. Profitability Ratios: These ratios are calculated to analyse the profitability position of a business. Such ratios involve analysis of profits in relation to sales or funds or capital employed.
4. Turnover Ratios: Turnover ratios are calculated to determine the efficiency of operations based on effective utilisation of resources. Higher turnover means better utilisation of resources.

Responsibility Accounting

Responsibility accounting is a system of accounting in which different sections, divisions and departments of an organisation are set up as ‘Responsibility Centres’. The head of the centre is responsible for achieving the target set for his centre. Responsibility centres may be of the following types:

Cost Centre

A cost center is a location or department within a company. The manager in charge of a cost cente is responsible for its costs but not directly responsible for revenues.

For example, in a manufacturing organisation, production department is classified as cost centre.

Revenue Centre:

A revenue centre is a segment of an organisation which is primarily responsible for generating revenue.

For example, marketing department of an organisation may be classified as a revenue center.

Profit Centre:

A profit centre is a segment of an organisation whose manager is responsible for both revenues and costs.

For example, repair and maintenance department of an organisation may be treated as a profit center if it is allowed to bill other production departments for the services provided to them.

Investment Centre:

An investment centre is responsible not only for profits but also for investments made in the centre in the form of assets. The investment made in each centre is separately ascertained and return on investment is used as a basis for judging the performance of the centre.

Management audit

This control technique helps to measure the efficiency levels of managers. Management audit refers to systematic appraisal of the overall performance of the management of an organisation. The purpose is to review the efficiency and effectiveness of management and to improve its performance in future periods.

The main advantages of management audit are as follows.

1. It helps to locate present and potential deficiencies in the performance of management functions.
2. It helps to improve the control system of an organisation by continuously monitoring the performance of management.
3. It improves coordination in the functioning of various departments so that they work together effectively towards the achievement of organisational objectives.
4. It ensures updating of existing managerial policies and strategies in the light of environmental changes.

Limitations of Management Audit

• There is no standard techniques of management audit.
• Management audit is not compulsory under any law

PERT and CPM

PERT (Programme Evaluation and Review Technique) and CPM (Critical Path Method) are important network techniques useful in planning and controlling. These techniques are especially useful for planning, scheduling and implementing time bound projects involving performance of a variety of complex, diverse and interrelated activities. The main aim of PERT and CPM is to control the time spent on the completion of a project and the optimum allocation of resources within the cost limit. These techniques deal with time scheduling and

resource allocation for these activities and aims at effective execution of projects within given time schedule and structure of costs.

The steps involved in using PERT/ CPM are as follows:

1. The total project is divided into a number of clearly identifiable activities which are then arranged in a logical sequence.
2. A network diagram is prepared to show the sequence of activities, the starting point and the termination point of the project.
3. Time estimates are prepared for each activity.
4. The longest path in the network is identified as the critical path. It represents the sequence of those activities which are important for timely completion of the project and where no delays can be allowed without delaying the entire project.
5. Modification of the plan, if necessary.

PERT and CPM are used extensively in areas like ship-building, construction projects, aircraft manu facture, etc.

Management Information System

Management Information System (MIS) is a computer-based information system that provides information and support for effective managerial decision-making. MIS also serves as an important control technique. It provides data and information to the managers at the right time so that appropriate corrective action may be taken in case of deviations from standards.

MIS offers the following advantages to the managers:

1. It facilitates collection, management and dissemination of information at different levels of management and across different departments of the organisation.
2. It supports planning, decision making and controlling at all levels.
3. It improves the quality of information with which a manager works.
4. It ensures cost effectiveness in managing information.
5. It reduces information overload on the managers as only relevant information is provided to them.