The essence of the management process is decision-making. Decision making is an unavoidable and continuous management activity. It may be directed towards some specific objectives, or it may result as a reaction of environmental factors as they occur. The decision-making process should be both efficient and effective. It would be effective when management’s objectives are achieved. It is said to be efficient when objectives are realized with the minimum use of resources. The process of decision-making involves two basic management functions of planning and control.
Planning Function of Management
The decision-making process starts with planning. Planning is a statement of what should be done, how it should be done and when it should be done. It is the design of a desired future state of an entity and of the effective ways of bringing it about. Its basic purpose is to provide guidelines for making decisions. Once a decision need has been recognized, planning provides for a method of scanning decision alternatives within the framework of the firm’s objectives and other constraints. Data are gathered about alternatives. After a proper analysis of collected data, a suitable alternative is selected. Action is initiated to commit to the decision. Planning is a feed forward process to reduce uncertainty about the future.
The task of planning the firm’s activities involves the identification of relevant controllable and non-controllable variable. Controllable variables subject to the influence of management, and can be controlled and manipulated to the best advantage of the enterprise. Controllable variables include employees’ quality and quantity, sources of capital, production techniques, cost and pricing, sales, research and development etc. Non controllable variables are not amenable to management control. The direction and magnitude of non controllable variable should be anticipated to maximize their favorable effects and/or to minimize their unfavorable effects. Examples are population changes, gross national product, competition, customers’ attitude, state of economic condition, government action etc. Business conditions do not remain static; they change rapidly and, therefore, plans should be revised and reformulated to adapt to the changed conditions.
Planning may be formal or informal. Formal planning is certainly better than informal planning. No-planning is, however, worse than informal planning. Too much formalization of plans is also dangerous since it tends to introduce rigidities. A reasonable balance should be struck between formal and informal planning.
The planning process in management involves four fundamental steps:
- Establishing enterprise objectives,
- Determining short-range objectives or operational goals,
- Developing strategies, and
- Formulating budgets or profit plans.
Objectives are statements of broad and long-range desired state of the enterprise in the future. They represent purposes to which efforts of the enterprise should be focused. They direct and motivate individuals for attaining the organizational goals. Long-range objectives are generally the qualitative expressions of the future intentions.
Goals represent the operational specifications of the broad objectives with time and quantity dimensions. Goals are the quantified targets to be attained within a specified period. Goals will specify when a new product should be introduced, when the firm should invest in the new plant, or what rate of return it should earn on its investment in the plant and so on. Strategies lay down the foundation for attaining the objectives and goals of the enterprise. Strategies specify the ways to achieve the goals operationally. Example being expanding sales through price reduction and/or aggressive advertisement.
Budgeting or profit planning is the formalization of objectives, goals and strategies for operational purposes. A budget or a profit plan is the formal expression of the firm’s targets, stated in financial terms, generally for one year. It is called the budget or the profit plan because it explicitly states the goals in terms of time expectation and expected financial results for each major segment of the entity. The budget permeates all levels of activities and unifies the diverse activities of the enterprise. Budgets are generally based on standards for costs and revenues. Budgets and standards are two strong arms of management accounting.
Control Function of Management
Control follows planning. It is the process to ensure that plans are being attained. It is a feedback system. It tells how effectively and efficiently objectives, goals and plans are accomplished, what went wrong and what can be done to assure adherence to planned activities in future. Control implies measurement and evaluation of performance.
The principal steps involved in the control function are:
- Comparison of actual performance against predetermined budgets and standards;
- Analysis of the variances from budgets and standards in order to determine the underlying causes;
- Initiating of an action that may correct the deficiencies indicated;
- Follow-up to appraise the effectiveness of the corrective action;
- The feed back of the information to the planning process to improve future planning and control activities.
Since control can be affected by individuals, the performance evaluation should be reported to the responsible managers. Performance report should clearly indicate to the manager what activities were controllable by him and what were not. Control is effective if it is exercised before an event occurs. What has happened in the past cannot be controlled now. For exercising control prior to the occurrence of an event, budgets and standards should be developed by seeking the participation of those who have to use them. The enterprise objectives should be communicated to managers and they should understand them.
Control would be effective only when performance is evaluated in an objective manner. Budgets and standards, against which performance is evaluated, should be realistic. Sometimes past performance is used as a benchmark to evaluate current performance. This is not a fair measurement of performance since last year’s performance may be out of line due to the changed conditions. Management accounting, with its emphasis on objectivity and fairness, provides a systematic way of developing budgets and standards and comparing performance only against the scientifically formulated budgets and standards.