Chapter 8: Managerial Control

Management and Control

Controlling is one of the important function of the management. Managers have to control people and other sources of organizations in order to survive. But control should be at the right amount and type. Lack of control can lead to financial losses, reputation damages, market share losses, even for bankruptcy. Too much control can result in unhappiness and reduced motivation in the organizations.

Controlling is the process of ensuring that actual activities in the organization go according to the planned activities.

To control an organization effectively managers will need information about performance standards and also actual performance. Managers decide which standards, measurements, and metrics are needed to effectively monitor and control the organization. The progress towards the organizational goals will be monitored, measured, assessed, and if necessary, modified through the controlling function.

Companies face a wide range of uncertain internal and external factors that may affect achievement of their strategic, operational, or financial objectives. Internal control is a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance.

Management is a process through which required resources are utilized by a sequence of functions starting with Planning, followed by Organizing, Leading, and Controlling (P-O-L-C framework) for achieving organizational goals. Each function contributes to the management process from a different perspective, but they are interconnected and complement each other. Controlling helps managers monitor how well planning, organizing, and leading have been performed. As you can see, management control is continuous process; as a last function in the management process it provides a critical backward link to planning function.

Steps in The Control Process

The steps in the basic control process follow the logic of planning:

• establish standards and methods to measure performance,
• measure performance,
• compare the actual performance with the established standards, whether performance matches the standard and then
• take corrective action as needed.

A standard is a unit of measurement used to evaluate results and simply the criteria of performance. In the planning process goals and objectives will be determined and they will eventually become the foundations for controls. Goals and objectives will become performance standards.

Performance standards should be realistic and acceptable to the people involved, otherwise controlling might become very hard and subjective.

Standards and controls usually deal with time, cost, quality, productivity, or behavior. Once set, standards must be continually reevaluated to ensure that they are still necessary and valid.

The second step in the basic control process is the measurement of performance. Managers must measure actual performance to determine any variations from standard.

Four approaches used by managers to measure and report actual performance:

• “personal observations”,
• “statistical reports”,
• “oral reports”, and
• “written reports

Organizations prepare different types of formal reports of quantitative performance measurements, such as sales volume, profit, cost of the goods sold. Managers will review those reports daily, weekly, or monthly. These performance measurements should be related to the standards set in the first step of the control process.

The third step in the control process is comparing actual performance to performance standards. There will be a comparison between the “what is” and the “what should be.” Managers must measure actual performance to determine any variations from standard. The difference between “what is” and “what should be” is known as the deviation.

The fourth and final step in the controlling process is evaluating results and taking action. Managers can choose among three possible courses of action:

• do nothing
• solve the problem (correct the actual situation)
• revise the standards

If performance falls short of standards corrective action becomes essential. Corrective action can include changes in the original performance standards if standards too high or too low instead of a change in performance.

Types of Control

Managers can implement controls before an activity begins (feedforward control), during the time the activity is going on (concurrent control), and after the activity has been completed (feedback control).

Feedforward controls or pre controls are designed to detect and anticipate deviations from standards at various points before work is performed. Feedforward controls prevents problems before the operation takes place. This form of operational control focuses on the quality, quantity, and characteristics of the inputs into the production process. The key to feedforward controls is taking managerial action before a problem occurs.

Concurrent controls apply to processes as they happen and it is the process of monitoring and adjusting ongoing activities and processes. Such controls are not necessarily proactive, but they can prevent problems from becoming worse, therefore this type of controls are designed to provide immediate feedback so that operations can be changed rapidly to decrease errors or increase quality.

Feedback controls are post-performance controls because the control takes place after the activity is done. The information obtained by feedback controls will be mostly used for corrective purposes.

Feedback controls have two advantages:

• First, feedback gives managers meaningful information on how effective their planning efforts were. Feedback that shows little variance between standard and actual performance indicates that the planning was generally on target. If the deviation is significant, a manager can use that information to formulate new plans.
• Second, feedback can enhance motivation. People want to know how well they are doing and feedback gives this information.

Scope of Control

Managers should control both the overall organization and departments, teams, and individuals. Some control strategies apply to the whole organization or major divisions. Control is also an issue at the lower, operational level, where department managers and supervisors focus on the performance of teams and individual employees.

Three major categories of control scope: “strategic”, “operational”, and “tactical”.

Strategic control is a specialized form of management control. It is assessment and regulation of how the organization as a whole fits its external environment and meets its long-term objectives and goals.

Tactical control focuses on implementing strategy. Tactical control is assessment and regulation of the day- to-day functions of the organization and its major units in the implementation of its strategy.

Operational control regulates the activities or methods an organization uses to produce the goods and services it supplies to customers. Operational control, in contrast to strategic control, is concerned with executing the strategy.

The Level and Focus of Control Systems

The decision about where to focus to control in an organization involves critical choices based on which actions and outcomes should receive the greatest attention.

In other words, the focus of control refers not only to what is to be controlled but also to where control should be located in the organizational structure. When we explain the scope of control we mentioned that managers will consider both control of the overall organization and control of departments, teams, and individuals. Therefore, some control strategies apply to the top levels of an organization or major divisions or teams and individual employees.

• Organization Level: The Balanced Scorecard
• Department Level: Behavior versus Outcome Control

Balanced Scorecard is a comprehensive approach has become popular in recent years by combining several indicators of effectiveness into a single framework and this new approach balances various parts of the organization rather than focusing on one aspect.

Managers using the balanced scorecard do not rely only on the short-term financial measures, the balanced scorecard helps an organization set goals and measure performance from four perspectives which are financial performance, customer service, internal business processes, and the organization’s capacity for learning and growth.

The balanced scorecard will help managers assess the organization from many perspectives so they have a better understanding of total effectiveness.

There are two different approaches to evaluating and controlling team or individual performance and allocating rewards.

One approach focuses primarily on “how people do their jobs”, whereas the other focuses primarily on the outcomes people produce. Behavioral controls involve the direct evaluation of managerial and employee decision making, not of the results of managerial decisions. Behavior control is based on manager observation of employee actions to see whether the individual follows desired procedures and performs tasks as structured.

A second approach to control is to pay “ less attention” to “what people do than to what they accomplish”. Outcome control is based on monitoring and rewarding results, and managers might pay little attention to how those results are obtained.

Most Common Tools and Techniques for Controlling

Managers use a large number of tools and techniques for effective controlling. Therefore, we need to know specific techniques for managing the control process.

• budgetary control
• financial controls
• other control tools and techniques such as break- even analysis, activity-based costing, just-in-time inventory control and total quality management.

Budgetary Controls: Budgetary control is one of the most commonly used methods of managerial control. A budgetary control is the process of setting targets for an organization’s expenditures, monitoring results and comparing them to the budget, and making changes as needed.

A budget is a detailed plan that covers a specified length of time to allocate resources. Budgets are a natural part of controlling. Managers will develop the company’s strategies. After that they will make a plan and budget for specific actions to achieve the goals.

After preparation of plans and budgets, the next step is executing the plans. And then managers can compare actual results with the budgeted amounts and they can use the information to make control decisions. Thus, budgets can help managers determine what, if any, corrective action to take by providing with feedback about the likely effects of their strategies and plans. Budges will also help to evaluate the strategic risks and opportunities. Because of the feedback signals, managers might need to revise their plans and possibly their strategies.

There are different purposes for budgeting; therefore, there can be different types of budgets.

Budgets can be classified as strategic and operational budgets under the time basis. When strategic budgets are long term financial plans to coordinate the activities needed to achieve the long term goals of the company, operational budgets are short term financial plans to coordinate the activities needed to achieve the short term goals of the company.

Budgets can be classified as static and flexible budgets . When static budgets are prepared for only one level of sales volume flexible budgets are prepared for various levels of sales volume.

The master budget is the set of budgeted financial statements and supporting schedules for the entire organization. The master budget includes 3 separate but interdependent budgets that formally present the company’s sales, production, and financial goals:

• The operating budget
• The capital expenditures budget
• The financial budget

The operating budget is the set of budgets that forecast of the revenues and expenses such as sales revenue, cost of goods sold, and operating expenses.

The second type of master budget is the capital expenditures budget . This budget presents the company’s plan for projects and longıterm assets such as purchases of property, plant, equipment, and other long-term assets.

The third type is the financial budget. The financial budget lay out how an organization will acquire its cash and how it intends to use the cash. First element of the financial budget is the cash budget. The cash budget will help to projects cash inflows and outflows.

Financial Controls: Financial controls tell whether the organization is successful financially and also they can be useful indicators of other kinds of performance problems. Financial controls related to financial analysis.

A manager needs to be able to evaluate financial reports that compare the organization’s performance with earlier data or industry norms. These comparisons enable the manager to see whether the organization is improving and whether it is competitive with others in the industry.

The most common financial analysis focuses on ratios. Ratio analysis expresses the relationship among selected items of financial statement data by calculating the ratios.

The ratios available to managers for controlling organizations can be divided into four categories:

• Liquidity ratios
• Activity ratios
• Profitability ratios
• Leverage ratios (Solvency ratios)

Liquidity ratios measure an organization’s ability to meet its current debt obligations.

Activity ratios measure internal performance with respect to key activities defined by management. Activity ratios use turnover measures to show how efficiently a company operates and uses its assets.

Profitability ratios measure the income or operating success of a company for a given period of time.

Leverage refers to funding activities with borrowed money. A company can use leverage to make its assets produce more than they could on their own.

Other control tools and techniques: Cost-Volume- Profit (CPV) analysis is a planning tool for the management so it can be used for control purposes in business organizations. CPV analysis will assist to estimate the amount of sales needed to achieve a target profit.

The breakeven point (BEP) can be used to determine the target profit. The breakeven point (BEP) is the sales level at which the company does not earn a profit or a loss. Total cost will be equal to the total revenues at the BEP.

The cost of produced goods and services must be measured so managers can be sure they are selling those products for more than the cost to produce them. Companies with various products, can get better costing information by using Activity Based Costing (ABC) and Activity Based Management (ABM).

A Just-in-Time (JIT) system is an inventory management and control system that ensures the timely delivery of a product or service and related inputs. The objective is to produce the product or service only as needed with only the necessary materials, equipment, and employee time that will add value to the product or service.

Another popular approach based on a decentralized control philosophy is Total Quality Management (TQM). TQM an organization-wide effort to integrate quality into every activity in a company through continuous improvement of products and processes. The implementation of total quality management involves the use of many techniques, such as quality circles, benchmarking, Six Sigma principles, reduced cycle time, and continuous improvement.