Notes on Chapter 18: Techniques of Controlling

1. Financial Controls

1.1 Budgetary Control

●​ Definition: A system of controlling costs by establishing budgets for each section,

continuously comparing actual performance with the budget to find deviations, and
taking remedial measures to achieve desired results.
●​ Budget: A statement of expected results (sales, production, expenses, etc.) expressed
in numerical terms for a future period.
●​ Budget Summaries: A resume of all individual budgets that helps top management
visualize overall performance and identify major deviations for corrective action.

Kinds of Budgets:

1.​ Sales Budget: Forecast of total sales in quantity and value for a period, broken down by
product, area, or salesperson. It is the foundation for other budgets.
2.​ Production Budget: Forecast of the quantity of output to be manufactured, based on
the sales budget, production capacity, and inventory policy.
3.​ Materials Procurement Budget: Deals with direct materials required for budgeted
production, used for scheduling purchases.
4.​ Labour Budget: Estimates the direct labour required (grades, hours, and cost) for
carrying out the budgeted output.
5.​ Factory Overhead Budget: Details fixed and variable overhead costs for the budget
period.
6.​ Distribution Overhead Budget: Estimates all costs for promotion and distribution of
finished products (selling, transport, advertising, etc.).
7.​ Administrative Overhead Budget: Estimates expenses for office operations (salaries,
rent, etc.).
8.​ Cash Budget: Provides detailed estimates of cash receipts and disbursements to
ensure cash is available to meet commitments and is used efficiently.

Benefits of Budgetary Control:

●​ Provides standards for measuring performance.

●​ Aids in coordination of different departments.
●​ Helps in reducing waste by minimizing unproductive operations.
●​ Makes financial planning and control easier.
●​ Facilitates "control by exception" by focusing attention on important areas.
●​ Helps fix responsibility of positions.
●​ Acts as a sanction for incurring expenditure.

Limitations of Budgetary Control:

 ●​ Can bring about rigidity and reduce flexibility.
●​ Budgeted estimates may become useless due to changing conditions (inflation, etc.).
●​ Doesn't automatically prevent deviations or ensure results.
●​ Poor implementation can defeat its purpose.
●​ Budgets can be treated as an end in themselves, not a means.
●​ Liberal budgets may be used to hide inefficiencies.
●​ Can cause psychological resentment among employees due to perceived restrictions.

1.2 Profit and Loss Control

●​ The Profit and Loss statement is a widely used device that shows all revenue, expenses,
and income for a period.
●​ It helps management by highlighting increases or decreases in expenditures and
incomes from year to year, emphasizing revenue generation.

1.3 Return on Investment (ROI)

●​ Definition: A technique to evaluate the success of a business by measuring earnings in

relation to the capital invested.
●​ Formula: ROI = (Net Earnings / Investment).
●​ Advantages:
○​ Focuses attention on profits related to invested capital.
○​ Indicates how effectively resources are being employed.
○​ Helps in planning and locating areas for capital utilization.
○​ Useful for comparing performance over time and between companies or
divisions.
●​ Limitations:
○​ Difficult to compile information on sales, costs, and investment for individual
products.
○​ Excessive emphasis can lead to neglect of other important variables (e.g.,
morale, R&D).
○​ Inflation can make comparisons misleading due to appreciation in asset values.
○​ Can encourage conservatism and discourage long-run risk-taking.

1.4 Ratio Analysis

●​ Definition: The process of analyzing the relationship between two sets of figures
(financial or non-financial) from the firm's accounts.
●​ Key Financial Ratios:
○​ Liquidity Ratios: Measure ability to meet short-term obligations (e.g., Current
Ratio, Acid Test Ratio).
○​ Leverage Ratios: Measure the contribution to capital by owners vs. creditors
(e.g., Debt-Equity Ratio).
○​ Profitability Ratios: Measure relationship between profit and capital/sales (e.g.,
Return on Capital Employed, Return on Sales).
 ○​ Activity Ratios: Measure effectiveness of resource employment (e.g., Inventory
Turnover, Average Collection Period).
●​ Importance:
○​ Simplifies and summarizes complex accounting data.
○​ Trend Analysis helps present comparisons of financial performance over a
number of years.
○​ Facilitates inter-firm comparison with competitors.
○​ Helps management lay down targets and initiate corrective action.
○​ Aids external stakeholders (investors, banks) in financial decision-making.

2. Operational Controls

2.1 Quality Control

●​ Concept: Systematic control of factors affecting product quality (raw materials, tools,
skill, working conditions) to ensure the end product conforms to predetermined
standards.
●​ Steps: Establishing standards based on customer preferences, designing production to
conform to them, selecting processes, establishing inspection plans, and coordinating
activities to improve quality.
●​ Significance:
○​ Brings quality consciousness.
○​ Ensures better utilization of resources and less waste.
○​ Helps in providing greater customer satisfaction and increasing sales.
○​ Reduces production costs.
○​ Increases employee morale.
○​ Creates a good public image.
●​ Methods of Quality Control:
○​ 1. Inspection: An important part of production control. Can be Preventive
(finding causes before defects occur) or Remedial (separating defective items
after production). Can be done through Centralised/Floor inspection or
Patrolling inspection.
○​ 2. Statistical Quality Control (SQC): Applies statistical tools to inspection based
on the theory of probability. It involves Sampling where a small part of a lot is
inspected, and its quality is assumed for the whole lot.
■​ Control Chart: A graph presenting lines defining the range of expected
variability. It gives a running record of quality measurement to detect
assignable causes of variation.
■​ Acceptance Sampling: A method to control the quality of outgoing
products where a decision to accept or reject a lot is based on the number
of defectives found in a randomly picked sample.

2.2 Network Techniques (PERT & CPM)

 ●​ Used for planning, scheduling, and controlling projects, especially for time and cost
control.
●​ Steps in PERT/CPM:
○​ Identification of all key Activities (jobs consuming time/resources, denoted by
arrows) and Events (beginning/completion points, denoted by circles).
○​ Sequencing of Activities and Events to prepare a Network Diagram showing the
flow and dependencies.
●​ Programme Evaluation and Review Technique (PERT):
○​ Designed for planning and controlling complex, non-repetitive projects (e.g.,
R&D, construction of ships/highways).
○​ Uses three time estimates for each activity: Optimistic, Pessimistic, and
Normal. These are combined into a single weighted average "expected time".
○​ Focuses on evaluating and reviewing the programme.
○​ Applications: Scheduling, determining time/cost status, forecasting skill
requirements, predicting slippages, allocating resources.
●​ Critical Path Method (CPM):
○​ Most versatile technique, used for construction projects and plant maintenance
where activity timings are relatively well known.
○​ Based on one time estimate for each activity.
○​ Identify the Critical Path: The longest sequence of activities in the network,
which determines the total project duration. Any delay on this path delays the
entire project.
○​ Advantages: Provides an analytical approach, identifies critical elements, helps
in ascertaining time schedules, makes use of better planning, assists in avoiding
waste, and provides a standard method for communicating project plans.

3. Overall Performance Control

3.1 Management Audit

●​ Definition: A comprehensive and constructive review of the performance of the

management team of an organization. It evaluates the effectiveness and efficiency of
management formal and informal methods.
●​ **Scope:**Very wide, including organizational structure, planning, control systems,
communication, utilization of manpower and equipment, etc..
●​ Benefits:
○​ Locates present and potential danger spots.
○​ Highlights possible opportunities.
○​ Evaluates performance of control mechanics.
○​ Reduces costs by suggesting how to avoid waste.
○​ Reviews overall plans and policies.
3.2 Balanced Score Card (BSC)

●​ Concept: A balanced approach developed by Kaplan and Norton to evaluate firm

performance from four complementary perspectives, combining financial and
non-financial, qualitative and quantitative measures.
●​ Four Perspectives:
○​ Financial: How do we look to shareholders? (Assessed through ROI, Economic
Value Added, Profitability).
○​ Customers: How do customers see us? (Assessed through market share,
customer satisfaction, loyalty).
○​ Business and Production Process: What must we excel at? (Assessed
through process efficiency, unit costs, defect rates).
○​ Learning and Innovation: Can we continue to improve and create value?
(Assessed through employee skills, organizational learning, ability to change).
●​ Advantages:
○​ Evaluates strengths and weaknesses by providing balanced weight to different
factors.
○​ Reflects a hierarchy of intents with elements linked in a series of means-ends
relationships.
○​ States explicitly that the competitive advantage of the firm is the core element for
success.