MODULE 1 the resources of production remain mere resources and never become production”.

The importance of
management can be clearly understood in the following points:
Definition of management, science or art, manager vs. entrepreneur; Types of managers - managerial • It helps in achieving group goals.
roles and skills; Evolution of management-scientific human relations; System and contingency • Optimum utilization of resources
approaches • Minimization of cost
• Survival and growth
Definition of Management
• Generation of employment
Management is “the art of getting things done by a group of people with effective utilization of available • Prosperity of society
resources.”
Management --- Science or Art
Management can also be defined as “the process of coordinating and integrating work activities so that
they are completed efficiently and effectively with and through other people.” Management as Science

According to F. W. Taylor “Management is the art of knowing what you want to do and then seeing that The essential elements of Science:
it is done in the best and cheapest way.” · Systematic body of Knowledge
· Underlying principles and theories developed through continuous observation, enquiry,
According to Harold Koontz “Management is the process of designing and maintaining an environment in
experimentation and research.
which individuals, working together in groups efficiently to accomplish selected aims.”
· Universal truth and applicability.
According to George R. Terry “Management is a distinct process, consisting of planning, organizing, · The knowledge can be taught and learnt in class room and outside.
actuating and controlling, performed to determine and accomplish the objectives by the use of people and · Reliable basis for predicting future events.
resources.” Management as a discipline fulfills the science criterion. It contains all the essentials of science. However,
it is not as exact as that of other physical sciences like biology, physics, and chemistry because it deals
Economists consider management as a resource like land, labour, and capital for an organization. with human beings and it is very difficult to predict the human behavior accurately. The management
Management is required where a group of people are working to achieve any objective. theories and principles may produce different results at different times. Hence, a manager has to wisely
select the management theories and principles to achieve the desired goals. Since management is a social
Characteristics of Management process, therefore it falls in the area of social sciences.
· Management is a universal activity.
Management as Art
· Management is dynamic and not static.
· Management is a group of managers. Art implies application of practical knowledge & personal skill to trying about desired results. An art may
· Management is goal oriented. be defined as personalized application of general theoretical principles based on the current situation for
· Management draws ideas and concepts from various disciplines. achieving best possible results. Management is an art because of the following reasons –
· Management is integrative function. · Management process involves the use of practical knowledge and personal skills.
· Management is a social process. · Management seeks to achieve concrete practical results
· Management implies good leadership. · Management is creative. It brings out new situation and converts into output.
· Management is a continuous process. · Every artist becomes more and more proficient through constant practice. Similarly managers
· Management is a system of authority. learn through an art of trial and error initially but application of management principles over the
· Management is a resource. years makes them perfect in the job of managing.
· Management is intangible.
· Management is a profession, an art as well as a science. The above mentioned points clearly reveal that management combines features of both science as well
as art. Science provides the knowledge & art deals with the application of knowledge and skills. Thus, the
Need/Importance of Management theory (Science) and practice (art) of Management go side by side for the efficient functioning of an
organization. Hence, management is said to be both Science and Art.
Effective management is the most critical factor for the successful functioning of every organization.
According to Peter Drucker,“ Management is a dynamic life giving element in an organization, without it

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Administration Vs Management · To co-ordinate among themselves so as to integrate various activities of a department.

Administration Management Lower level management: Supervisors, General Foremen

1 Administration is concerned with decision Management is concerned with the execution · To assign jobs to workers.
making and policy formulation. of these policies into practice. · To give orders and instructions.
2 It is the higher level functions. It is the lower level functions. · To maintain discipline and good human relationship among workers.
3 Administration involves mainly legislative Management is responsible for effective · To train and develop the efficiency of the workers.
function & strategic determination. planning and guidance of the operations of an · To report feedback information about workers.
enterprise
4 It acts through the management. It acts through the organization. Managerial Roles
5 It refers to the Owners/Chairman/Board of It refers the employees such as MD, GM &
Mintzbers, a management thinker, has identified ten roles and classified them within three broad
Directors of the organization. Managers.
categories.
6 It requires more admin ability than technical It requires more technical ability than admin
1. Interpersonal Roles
ability. ability.
2. Informational Roles
3. Decisional Roles
Entrepreneur
1. Interpersonal Roles: Interacting with people inside and outside the organization
An entrepreneur is essentially a manager who brings resources, labour, materials and other assets into a) Figure head role:
combinations to develop a mechanism of wealth creation through some kind of innovative ideas. The As a symbolic head of an organization, the manager performs routine duties required by the status
wealth creation management may be either in the form of a product or service. The product or service of his office. E.g. to greet the visitors, to attend the employee family functions, etc.
may or may not be new or unique but value must be infused by the entrepreneur by receiving and b) Leader:
allocating the necessary skills and resources. Hiring, Training, motivating and guiding subordinates.
c) Liaison:
There are four basic qualities of a successful entrepreneur:
Interacting with other managers outside the organization to obtain favours and information e.g.
(i) initiative taking
PSUs or other industry groups etc.
(ii) organizing and reorganizing of social and economic mechanism
(iii) implementation of technological innovation or creative ideas 2. Informational Roles: Serving as a focal point for exchange of Information
(iv) acceptance of risk or failure a) Monitor:
A manager seeks and collects information concerning internal and external events of the
Types of Managers organization.
b) Disseminator:
· Top level management
A manager transmits the information to his subordinates peers and superiors within the
· Middle level management
organization.
· Lower level management
c) Spokes person:
Top level management: Board of Directors, MD, CEO, CFO Speaking on behalf of the organization and transmitting information on organizational plans,
· To establish overall long term goals and broad policies of the company. policies and actions to outsiders.
· To formulate budgets.
3. Decision Role: Making important decision
· To appoint top and key executives.
a) Entrepreneur:
· To represent the company to the outside world.
Initiating changes or improvements in the activities of the organization.
· To provide overall direction and leadership of company.
b) Disturbance handler:
Taking charge and corrective action when organization faces unexpected crises.
Middle level management: Sales executives, Planning executives, Production executives etc.
c) Resource allocation:
· To monitor and control the operating performance.
A manager is responsible for allocation of human, monetary and material resources.
· To train, motivate and develop supervisory level to achieve organization goals.
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d) Negotiator: Staffing Staffing is the function of employing suitable persons for the enterprise. It includes job
Representing the organization in bargaining with suppliers, dealers, trade union, agents, etc. analysis, manpower planning, recruitment, selection, training, placement,
compensation, promotion, appraisal, etc.
Managerial Skills Directing The function of guiding and supervising the activities of the subordinates is known as
directing. It involves four important elements; Supervision, Motivation, communication,
For analysis, skills required of any manager are classified under three different heads technical, human
and Leadership.
and conceptual skill.
Controlling The objective of controlling is to ensure that actions contribute to goal
1. Technical skill: accomplishment. It helps in keeping the organizational activities on the right path and
Technical skill is the skills about the tools, equipment, procedures and techniques. A manager aligned with plans and goals. Controlling includes four things:
should have a thorough knowledge of the principles, procedures and operations of a job. Technical skill (a) Setting standards of performance,
involves specialized knowledge, analytical skill and a facility in the use of the tools and techniques of a (b) Measuring actual performance,
specific discipline. (c) Comparing actual performance against the standard, and
(d) Taking corrective actions to ensure goal accomplishment.
2. Human skill:
Human skills are concerned with understanding of people. It refers to the ability to work with the Evolution of Management
people. It is the creation of an environment in which person feels secure and free to express their opinion.
The evolution of management principles can be better understood through the following four eras:
3. Conceptual skills: 1. Pre-Scientific Management Era (Before 1880)
This skill is the ability to recognize the various functions of an organization and to understand the 2. Classical Management Era (1880-1930)
relationship among them. The manager should have the ability for abstract thinking to run the 3. Neo-Classical Management Era (1930-1950)
organization with proper coordination among the different elements of the organization in such a way 4. Modern Management Era (1950 onwards)
that overall performance of the organization in the long run will be sound. The above periods are not exact and only signify the dominance of different schools of thought.

Pre-Scientific Management Era

During pre-scientific management era, valuable contributions were made by Churches, Military
Organizations and writers like Charles Babbage and Robert Oven. However, management principles
adopted by churches and military organizations were not much used in the conduct of business affair. In
the later period, Robert Owen and Charles Babbage made valuable contributions to the development of
management concepts though they were limited mostly to the field of developing the concept to make
resources more effective at the shop floor level as the structure of industry was simple in those eras.

Classical Management Era

Further study about managerial problems led the creation of various ideas by the management
thinkers. A number of management practitioners made tremendous contributions to the management
Functions of a Manager
theories. F.W. Taylor and Henry Fayol are the two management scholars whose contributions to the
management evolution characterize this era.
Functions Description
Planning Planning is the process of making decisions about future. It is the process of determining Neo-Classical Management Era
This is called neo-classical because they do not reject the classical concepts but only try to refine
enterprise objectives and selecting future courses of actions necessary for their
and improve them. This era is characterized by the contributions to the management concepts ased on
accomplishment. Planning is a fundamental function of management and all other the human relation and behavioral science.
functions of management are influenced by the planning process.
Organizing Organizing is concerned with the arrangement of an organization’s resources - people, Modern Management Era
materials, technology and finance in order to achieve enterprise objectives. It involves The evolution of this era can be seen after the Second World War when various concepts of
decisions about distribution of work, departmentalization, delegation, decentralization, science and art were implemented into management activities. It includes application of different
task allocation and the coordination of tasks.

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operation research tools for the purpose of optimization of resources. Also, many management theories System and Contingency Approach
hav been developed to counter various management issues in different perspectives.
System approach
Scientific Management
A system in simple terms is a set of interrelated parts. It is a group of interrelated but separate elements
Scientific management means application of scientific methods to the problems of management. Fredrick working towards a common purpose. The arrangement of elements must be orderly. There must be
Winslow Taylor is acknowledged as “father of scientific management.” He joined as a machinist at Midvale proper communication facilitating interaction between the elements and finally the interaction should
steel company in U.S.A at 1878 and became chief engineer in the year 1884 in the same company. Taylor lead to achieve a common goal.
conducted various experiments at the work place to find out how human beings could be made more
efficient. It was one of the earliest attempts to apply science to the management practice. An organization is also a system. It is constituted by different elements and proper co-ordination among
the elements is desirable for smooth functioning of the organization. The system approach provides a
Taylor sought to create a mental revolution among both workers and managers by defining clear unified focus to organizational efforts to achieve its objective. A major contribution of the system
guidelines for improving production efficiency. He was able to achieve consistent improvements in approach results from its strong emphasis on the interrelatedness or mutuality of the elements of an
productivity up to 200 percent. Taylor defined four principles to practice scientific management approach organization.
as following:
1. Study each part of the task scientifically, and develop a best method to perform it. An organization has three main elements; (i) Input, (ii) Output, and (iii) Process. The organization
2. Carefully select workers and train them to perform a task using the scientifically developed transforms a number of inputs into a variety of outputs through some transformation process and offers
method. the outputs to the external environment in the form of product goods and services. The system approach
3. Cooperate fully with workers to ensure they use the proper method. considers an organization as an open system that means the performance of an organization is dependent
4. Divide work and responsibility so management is responsible for planning work methods using upon the outside environment in forms of feedback, resources, etc.
scientific principles and workers are responsible for executing the work accordingly.
Weather, etc.
To put the philosophy of scientific management into practice, Taylor suggested the following techniques: Taxes
Consumers
1. Work study to simplify work and increase efficiency. This involves methods study, time study and
Human resources
motion study.
Technology
2. Scientific task setting to determine a fair day’s work.
3. A fair day's pay for a fair day's work. External Environment
4. Differential piece-wage plan to reward the highly efficient workers.
5. Standardization of materials, tools equipment, costing system, etc.
6. Scientific selection and training of workers. Transformation
INPUTS OUTPUTS
7. Specialization in planning and operations through ‘functional foremanship’. Taylor advocated the Process
appointment of eight foremen to guide workers, under planning and production departments. Money Goods
Foremen in the planning department include: route clerk, instruction card clear, time and cost Manpower Services
clerk and shop disciplinarian. Machine
The other four foremen in the production department include: gang boss, speed boss, repair boss Material
and inspector. Feedback

The system approach of management is characterized by the following:

• Open system
• Multidisciplinary
• Adaptive
• Dynamic
• Multilevel
• Multi dimensional

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 • Probabilistic MODULE 2

Contingency approach: A business is an organization that uses economic resources or inputs to provide goods or services to
customers in exchange for money or other goods and services. The prime objective of a business
The contingency approach is also called as situational approach. The management practice depends on organization is to earn profit which requires bringing together all the resources and put them into action
circumstances. in a systematic way, and coordinate and control these activities properly.

The contingency approach believes that no one approach is universally applicable and different problems These are the five basic forms of business ownership:
and situations require different approaches. This means that one management concept may be very (1) Sole proprietorship
effectively in one situation but it may fail in other situation. It is impossible to select one way of managing (2) Partnership
that works best in all situations. In such case, managers must identify the most suitable technique for a (3) Cooperative society
particular person, particular situation, and at a specific time. Thus, the contingency approach seeks to (4) Corporation
apply real life situations ideas drawn from various schools of management thought. (5) Joint stock company

Difference between System approach and Contingency approach 1. Sole Proprietorship

System approach Contingency approach • A type of business unit where one person is solely responsible for providing the capital and
1 It treats all organizations as same and has no It treats each organization as unique. bearing the risk of the enterprise, and for the management of the business.
unique nature. • A sole proprietorship is a business exclusively owned, managed and controlled by only one person.
2 System approach emphasizes interactions and Contingency approach emphasizes the It is easy to set-up and is the least costly among all forms of ownership.
interrelationships among systems and interdependencies of the subsystems and their
• The sole proprietorship form is usually adopted by small business entities.
subsystems. influence on the organizational performance.
3 The system approach provides a unified focus The contingency approach is situational.
Characteristics of sole proprietorship form of business organization
to the organizational efforts to achieve its
objective. • Single ownership: The sole proprietorship form of business organization has a single owner who
4 System approach is a generalized model for Contingency approach is pragmatic, specific and himself/herself starts the business by bringing together all the resources.
understanding and managing an organization. action oriented. • No separation of ownership and management: The owner himself/herself manages the business
5 The main concepts are input, output, process, There are no specific concepts. as per his/her own skill and intelligence. There is no separation of ownership and management as
limitations of the system, and interaction of is the case with company form of business organization.
the system with external environment. • Less legal formalities: The formation and operation of a sole proprietorship form of business
6 System approach is a theoretic model and The contingency approach believes that no one
organization does not involve any legal formalities. Thus, its formation is quite easy and simple.
believes the universalities of management approach is universally applicable and different
principles. problems and situations require different • No separate entity: The business unit does not have an entity separate from the owner. The
approaches. businessman and the business enterprise are one and the same, and the businessman is
responsible for everything that happens in his business unit.
• No sharing of profit and loss: The sole proprietor enjoys the profits alone. At the same time, the
Assignments: entire loss is also borne by him. He/she alone bears the risks and reaps the profits.
• What do you mean by an entrepreneur? Provide few examples of entrepreneurship. • Unlimited Liability: The sole proprietor owner is personally responsible for payment of debts and
liabilities of the business. If the business assets are not enough to pay the business liabilities, the
personal properties of the proprietor can also be utilized to pay off the liabilities of the business.
• One-man control: The controlling power of the sole proprietorship business always remains with
the owner. He/she runs the business as per his/her own will.

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Merits of Sole proprietorship • Contractual relationship: Partnership is created by an agreement among the persons who have
• Easy to form and wind up: It is very easy and simple to form and shut down a sole proprietorship agreed to join hands. Such persons must be competent to contract. Thus, minors, lunatics and
form of business organization as there is no requirement of no legal formalities to do so. insolvent persons are not eligible to become the partners.
• Quick decision and prompt action: As the business I run by a single person, the owner can take • Sharing business profits and losses: There must be an agreement among the partners to share
quick decisions on the various issues relating to business and accordingly prompt action can be the profits and losses of the business of the partnership firm. If two or more persons share the
taken. income of jointly owned property, it is not regarded as partnership.
• Direct motivation: Since, the entire profit of the business goes to the owner, it motivates the • Existence of lawful business: The business of which the persons have agreed to share the profit
proprietor to work hard and run the business efficiently. must be lawful. Any agreement to indulge in smuggling, black marketing etc. cannot be called
• Flexibility in operation: It is very easy to make changes in the business process as per the partnership business in the eyes of law.
requirements of the business. • Principal agent relationship: There must be an agency relationship between the partners. Every
• Maintenance of business secrets: The business secrets are known only to the proprietor. The partner is the principal as well as the agent of the firm. When a partner deals with other parties
proprietor is not bound to disclose any information to others and also not to publish his business he/she acts as an agent of other partners, and at the same time the other partners become the
accounts. principal.
• Personal touch: Since the proprietor himself handles everything relating to business, it is easy to • Unlimited liability: The partners of the firm have unlimited liability. They are jointly as well as
maintain a good personal contact with the customers and employees. individually liable for the debts and obligations of the firms. If the assets of the firm are insufficient
to meet the firm’s liabilities, the personal properties of the partners can also be utilized for this
Limitations of sole proprietorship purpose.
• Limited resources: The resources of a sole proprietor are always limited. Being the single owner • Voluntary registration: The registration of partnership firm is not compulsory. But an
it is not always possible to arrange sufficient funds from his own sources. Again borrowing funds unregistered firm suffers from some limitations (such as in case of any dispute among the
from friends and relatives or from banks has its own implications. So, the proprietor has a limited partners, it is not possible to settle the dispute through court of law) which makes it virtually
capacity to raise funds for his business. compulsory to be registered.
• Lack of continuity: The continuity of the business is linked with the life of the proprietor. Illness,
death or insolvency of the proprietor can lead to closure of the business. Thus, the continuity of Merits of partnership form of business organization
business is uncertain. • Easy to form: A partnership can be formed easily without many legal formalities. Since it is not
• Unlimited liability: In case of failure or loss of the business, if the business assets are not enough compulsory to get the firm registered, a simple agreement, either in oral, writing or implied is
to pay the business liabilities and debts, personal properties of the owner can also be used to pay sufficient to create a partnership firm.
the business obligations. • Availability of larger resources: Since two or more partners join hands to start partnership firm,
• Not suitable for large scale operations: Since the resources and the managerial ability are limited, it may be possible to pool more resources as compared to sole proprietorship business.
sole proprietorship form of business organization is not suitable for large-scale business. • Better decisions: In partnership firm each partner has a right to take part in the management of
• Limited managerial expertise: A sole proprietorship from of business organization always suffers the business. All major decisions are taken in consultation with and with the consent of all
from lack of managerial expertise. A single person may not be an expert in all fields like, partners. Thus, collective wisdom prevails and there is less scope for reckless and hasty decisions.
purchasing, selling, financing etc. Again, because of limited financial resources, and the size of the • Flexibility: The partnership firm is a flexible organization. At any time the partners can decide to
business it is also not possible to engage the professionals. change the size or nature of business or area of its operation after taking the necessary consent
of all the partners.
2. Partnership
• Sharing of risks: The losses of the firm are shared by all the partners equally or as per the agreed
A partnership is a business owned by two or more persons who contribute their resources into the entity ratio.
and share the profits of the business among themselves. • Keen interest: Since partners share the profit and bear the losses, they take keen interest in the
affairs of the business.
Characteristics of partnership form of business organization • Benefits of specialization: All partners actively participate in the business as per their
• Two or more persons: To form a partnership firm atleast two persons are required. The maximum specialization and knowledge.
limit on the number of persons is ten for banking business and 20 for other businesses. If the • Protection of interest: In partnership form of business organization, the rights of each partner
number exceeds the above limit, the partnership becomes illegal and the relationship among and his/her interests are fully protected. If a partner is dissatisfied with any decision, he can ask
them cannot be called partnership. for dissolution of the firm or can withdraw from the partnership.

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 • Secrecy: Business secrets of the firm are only known to the partners. It is not required to disclose • Based on Liability, the partners can be classified as ‘Limited Partners’ and ‘General Partners’. The
any information to the outsiders. It is also not mandatory to publish the annual accounts of the liability of limited partners is limited to the extent of their capital contribution. This type of
firm. partners is found in Limited Partnership firms in some European countries and USA. So far, it is
not allowed in India. However, the Limited liability Partnership Act is very much under
Limitations of partnership form of business organization consideration of the Parliament. The partners having unlimited liability are called as general
• Unlimited liability: The most important drawback of partnership firm is that the liability of the partners or Partners with unlimited liability. It may be noted that every partner who is not a
partners is unlimited i.e., the partners are personally liable for the debt and obligations of the limited partner is treated as a general partner.
firm. In other words, their personal property can also be utilized for payment of firm’s liabilities. • Based on the behaviour and conduct exhibited; there are two more types of partners besides the
• Instability: Every partnership firm has uncertain life. The death, insolvency, incapacity or the ones discussed above. These are
retirement of any partner brings the firm to an end. Also any unsatisfied partner can give notice o Partner by Estoppels; and
at any time to withdraw from the partnership. o Partner by Holding out.
• Non-transferability of share: The share of interest of any partner cannot be transferred to other A person, who behaves in the public in such a way as to give an impression that he/she is a partner
partners or to the outsiders. So it creates inconvenience for the partner who wants to transfer his of the firm, is called ‘partner by estoppels’. Such partners are not entitled to share the profits of
share to others fully and partly. The only alternative is dissolution of the firm. the firm, but are fully liable if somebody suffers because of his/her false representation. Similarly,
• Possibility of conflicts: In a partnership firm, every partner has an equal right to participate in the if a partner or partnership firm declares that a particular person is a partner of their firm, and such
management. Also every partner can place his/her opinion or viewpoint before other partners a person does not disclaim it, then he/she is known as ‘Partner by Holding out’. Such partners are
regarding any matter at any time. Difference of opinion may give rise to friction among the not entitled to profits but are fully liable as regards the firm’s debts.
partners and lead to dissolution of the firm.
3. Cooperative Society

Types of Partners • Cooperative society is defined as “a society, which has its objectives for the promotion of
economic interests of its members in accordance with cooperative principles.”
• Active Partners • A cooperative society is a business organization owned by a group of individuals and is operated
Based on extent of participation
• Sleeping Partners
for their mutual benefit. The persons making up the group are called members. Minimum number
of the members of a cooperative society is ten.
• Nominal Partners
Based on sharing of profit • Some examples of cooperatives are: water and electricity (utility) cooperatives, cooperative
• Partners in Profits
banking, credit unions, and housing cooperatives.
Partners
• Limited Partners
Based on liability Characteristics of a cooperative society
• General Partners
• Voluntary association: Members join the cooperative society voluntarily i.e., by their own choice.
• Partners by Estoppel Persons having common economic objective can join the society as and when they like, continue
Based on nature of behaviour
• Partners by Holding Out as long as they like and leave the society and when they want.
• Open membership: The membership is open to all those having a common economic interest.
• Based on the extent of participation in the day-to-day management of the firm partners can be Any person can become a member irrespective of his/her caste, creed, religion, colour, sex etc.
classified as ‘Active Partners’ and ‘Sleeping Partners’. The partners who actively participate in the • Number of members: A minimum of 10 members are required to form a cooperative society. In
day-to-day operations of the business are known as active partners or working partners. Those case of multi-state cooperative societies the minimum number of members should be 50 from
partners who do not participate in the day-to-day activities of the business are known as sleeping each state in case the members are individuals. The Cooperative Society Act does not specify the
or dormant partners. Such partners simply contribute capital and share the profits and losses. maximum number of members for any cooperative society. However, after the formation of the
• Based on sharing of profits, the partners may be classified as ‘Nominal Partners’ and ‘Partners in society, the member may specify the maximum member of members.
Profits’. Nominal partners allow the firm to use their name as partner. They neither invest any • Registration of the society: In India, cooperative societies are registered under the Cooperative
capital nor participate in the day-today operations. They are not entitled to share the profits of Societies Act 1912 or under the State Cooperative Societies Act. The Multi-state Cooperative
the firm. However, they are liable to third parties for all the acts of the firm. A person who shares Societies are registered under the Multi-state Cooperative Societies Act 2002. Once registered,
the profits of the business without being liable for the losses is known as partner in profits. This the society becomes a separate legal entity and attains certain characteristics.
is applicable only to the minors who are admitted to the benefits of the firm and their liability is • State control: Since registration of cooperative societies is compulsory, every cooperative society
limited to their capital contribution. comes under the control and supervision of the government. The cooperative department keeps
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a watch on the functioning of the societies. Every society has to get its accounts audited from the 4. Corporation
cooperative department of the government.
• Capital: The capital of the cooperative society is contributed by its members. Since, the member’s • A corporation is a business organization that has a separate legal personality from its owners.
contribution is very limited, it often depends on the loan from government and apex cooperative Ownership in a stock corporation is represented by shares of stock.
• The owners (stockholders) enjoy limited liability but have limited involvement in the company's
institutions or by way of grants and assistance from state and Central Government.
operations. The board of directors, an elected group from the stockholders, controls the activities
• Democratic set up: The cooperative societies are managed in a democratic manner. Every
of the corporation.
member has a right to take part in the management of the society. The society is managed by a
managing committee which is elected by the members of the cooperative society.
5. Joint stock company
Merits of cooperative society A company is an association of persons formed for carrying out business activities. A company has a legal
• Easy to form: Any ten adult members can voluntarily form an association and get it registered status independent of its members and has a common seal. A company is formed and registered under
with the Registrar of Cooperative Societies. The registration is very simple and it does not require The Companies Act.
much legal formalities.
• Limited liability: The liability of the members of the cooperative societies is limited upto their The capital of the company is divided into smaller parts called ‘shares of stock’. These ‘Shares’ represent
capital contribution. They are not personally liable for the debt of the society. the equity ownership of the issuing company. The shareholders are the owners of the company while the
• Open membership: Any competent like-minded person can join the cooperative society any time Board of Directors is the chief managing body elected by the shareholders. Usually, the owners exercise
he likes. There is no restriction on the grounds of caste, creed, gender, colour etc. The time of an indirect control over the business.
entry and exit is also generally kept open.
Features
• State assistance: The need for country’s growth has necessitated the growth of the economic
• Artificial person: A company is a creation of law and exists independent of its members. Like
status of the weaker sections. Therefore, cooperative societies always get assistance in the forms
natural persons, a company can own property, incur debts, borrow money, enter into contracts,
of loans, grants, subsidies etc. from the state as well as Central Government.
sue and be sued but unlike them it cannot breathe, eat, run, talk and so on. It is, therefore, called
• Stable life: The cooperative society enjoys the benefit of perpetual succession. The death,
an artificial person.
resignation, insolvency of any member does not affect the existence of the society because of its
• Separate legal entity: From the day of its incorporation, a company acquires an identity, distinct
separate legal entity.
from its members. Its assets and liabilities are separate from those of its owners. The law does
• Tax concession: To encourage people to form co-operative societies the government generally
not recognize the business and owners to be one and the same.
provides tax concessions and exemptions, which keep on changing from time to time.
• Formation: The formation of a company is a time consuming, expensive and complicated process.
• Democratic management: The cooperative societies are managed by the Managing Committee,
It involves the preparation of several documents and compliance with several legal requirements
which is elected by the members. The members decide their own rules and regulations within the
before it can start functioning. Incorporation of companies is compulsory under The Companies
limits set by the law.
Act or any of the previous company law, as state earlier.
Limitations of cooperative society • Perpetual succession: A company being a creation of the law, can be brought to an end only by
• Limited Capital: Most of the cooperative societies suffer from lack of capital. Since the members law. It will only cease to exist when a specific procedure for its closure, called winding up, is
of the society come from a limited area or class and usually have limited means, it is not possible completed. Members may come and members may go, but the company continues to exist.
to collect huge capital from them. Again, government’s assistance is often inadequate for them. • Control: The management and control of the affairs of the company is undertaken by the Board
• Lack of managerial expertise: The Managing Committee of a cooperative society is not always of Directors, which appoints the top management officials for running the business. The directors
able to manage the society in an effective and efficient way due to lack of managerial expertise. hold a position of immense significance as they are directly accountable to the shareholders for
Again due to lack of funds they are also not able to derive the benefits of professional the working of the company. The shareholders, however, do not have the right to be involved in
management. the day-to-day running of the business.
• Less motivation: Since the rate of return on capital investment is less, the members do not always • Liability: The liability of the members is limited to the extent of the capital contributed by them
feel involved in the affairs of the society. in a company. The creditors can use only the assets of the company to settle their claims since it
• Lack of interest: Once the first wave of enthusiasm to start and run the business is exhausted, is the company and not the members that owes the debt. The members can be asked to
intrigue and factionalism arise among members. This makes the cooperative lifeless and inactive. contribute to the loss only to the extent of the unpaid amount of share held by them.
• Corruption: In spite of government’s regulation and periodical audit of the accounts of the • Common seal: A company has a common seal. This seal is affixed to the company documents such
cooperative society, the corrupt practices in the management cannot be completely ignored. as agreements of a company, notices, circulars, etc.

15 16
 • Risk bearing: The risk of losses in a company is borne by all the share holders. This is unlike the • Delay in decision making: Companies are democratically managed through the Board of Directors
case of sole proprietorship or partnership firm where one or few persons respectively bear the which is followed by the top management, middle management and lower level management.
losses. In the face of financial difficulties, all shareholders in a company have to contribute to the Communication as well as approval of various proposals may cause delays not only in taking
debts to the extent of their shares in the company’s capital. The risk of loss thus gets spread over decisions but also in acting upon them.
a large number of shareholders. • Oligarchic management: In theory, a company is a democratic institution wherein the Board of
Directors are the representatives of the shareholders. Usually, the shareholders are spread all
Merits over the country and a very small percentage attends the general meetings. Hence, the
• Limited liability: The shareholders are liable to the extent of the amount unpaid on the shares shareholders have minimal influence in terms of controlling or running the business. The Board
held by them. Also, only the assets of the company can be used to settle the debts, leaving the of Directors as such enjoy considerable freedom in exercising their power which they sometimes
owner’s personal property free from any charge. This reduces the degree of risk borne by an use even contrary to the interests of the shareholders. Dissatisfied shareholders in such a
investor. situation have no option but to sell their shares and exit the company. As the directors virtually
• Transfer of interest: The ease of transfer of ownership adds to the advantage of investing in a enjoy the rights to take all major decisions, it leads to rule by a few.
company as the share of a public limited company can be sold in the market and as such can be • Conflict in interests: There may be conflict of interest amongst various stakeholders of a
easily converted into cash in case the need arises. This avoids blockage of investment and presents company. The employees, for example, may be interested in higher salaries, consumers desire
the company as a favorable avenue for investment purposes. high quality products at low prices and the shareholders want higher returns on their investments.
• Perpetual existence: Existence of a company is not affected by the death, retirement, resignation, These demands pose problems in managing the company as it often becomes difficult to satisfy
insolvency or insanity of its members as it is a separate entity from its members. A company will such diverse interests.
continue to exist even if all the members die. It can be liquidated only as per the provisions of The
Companies Act. Types of Companies
• Scope for expansion: As compared to the sole proprietorship and partnership forms of
A company can be categorized in two types: (i) private and (ii) public company.
organization, a company has large financial resources. Further, capital can be attracted from the
public as well as through loans from banks and financial institutions. Thus there is greater scope
Private Company
for expansion. The investors are inclined to invest in shares because of the limited liability,
• A private company is a company which is privately held. This means that, the company is owned
transferable ownership and possibility of high returns in a company.
by its founders, management, or a group of private investors.
• Professional management: A company can afford to pay higher salaries to specialists and
• A private company is a joint stock company, incorporated under The Indian Companies Act, 2013
professionals. Therefore, it can employ people who are experts in their area of specializations.
or any other previous act.
• A private company requires at least two or more persons for its formation and the maximum
Limitations:
numbers of a company can be up to 200 excluding the present and past employees.
• Complexity in formation: The formation of a company requires much time, effort and extensive
• A private company has a minimum paid-up capital of 1 lakh rupees.
knowledge of legal requirements and the procedures involved. As compared to sole
proprietorship and partnership form of organizations, formation of a company is more complex. • It is necessary for a private company to use the word private limited after its name.
• Lack of secrecy: The Companies Act requires each public company to provide from time-to-time • The main advantage of private companies is that management doesn't have to answer to
a lot of information to the office of the registrar of companies. Such information is available to stockholders and they don’t need to disclose any company information to general public.
the general public also. It is, therefore, difficult to maintain complete secrecy about the • Although private companies are not required to publicly disclose financial information, they are
operations of company. legally required to file certain documents with their state and follow required compliance laws for
• Impersonal work environment: Separation of ownership and management leads to situations in their shareholders.
which there is lack of effort as well as personal involvement on the part of the officers of a • The transferability of shares of a private company is completely restricted.
company. The large size of a company further makes it difficult for the owners and top • A private company has no right to invite public for trading shares of the company i.e. shares of
management to maintain personal contact with the employees, customers and creditors. the company are not publicly traded in the open market but the company can internally sell its
• Numerous regulations: The functioning of a company is subject to many legal provisions and share by a few willing investors. Hence, in most of the private companies, only a few individuals
compulsions. A company is burdened with numerous restrictions in respect of aspects including hold the company shares.
audit, voting, filing of reports and preparation of documents, and is required to obtain various • A private company can start its business just after receiving a certificate of incorporation.
certificates from different agencies, viz., registrar, SEBI, etc. This reduces the freedom of
Public Company
operations of a company and takes away a lot of time, effort and money.

17 18

• A public company is a company where the capital is raised from general public through shares MODULE 3
(equity) or bonds.
• A public company is a joint stock company formed and registered under The Indian Companies PLANNING
Act, 2013 or any other previous act.
Planning is defined as the process of deciding the future course of action in advance. It is the primary
• Minimum seven members are required to set up a public company but there is no defined limit
function of management.
on the number of members the company can have.
• A public company has a minimum paid-up capital of 5 lakh rupees. Planning is deciding in advance - what to do, how to do, when to do and who is to do it. It bridges the gap
• A public company generally uses suffix limited or public limited after its name. between where we are to where we want to go.
• Public companies are required by the Securities and Exchange Bureau of India (SEBI) to file an
annual report documenting their performance in detail. They must inform shareholders about the Planning is deciding the best alternatives among others to perform different activities in order to achieve
company’s operations, financial performance, management actions, and other decisions. A public pre-determined goals.
company has to adhere to the regulations and reporting standards as per SEBI.
• There is no restriction on the transferability of the shares of a public company. Characteristics of Planning
• The company can invite the public for the subscription of shares or debentures, and for this the • Planning is goal-oriented.
company is termed as public company. • Planning is looking ahead i.e. planning takes account of future’s possibilities.
• To start a business, the public company needs a certificate of commencement of business after it • Planning is an intellectual process. It involves tedious mental exercise such as creative thinking,
is incorporated. sound judgment and imagination.
• Planning involves choice among various alternatives and decision making about an alternative.
Private Vs Public Company • Planning is the primary function of management. Planning lays foundation for other functions of
management
Basis Public company Private company
• Planning is a continuous process. In other words, planning is a never ending function due to the
Members Minimum - 7 Minimum - 2 dynamic business environment.
Maximum - unlimited Maximum - 200
• Planning is all pervasive. It is required at all levels of management and in all departments of
Minimum paid-up capital Five lakh rupees One lakh rupees organization.
Minimum number of Three Two
• Planning is designed for efficiency. Planning leads to accomplishment of objectives at the
directors
minimum possible cost.
Transfer of shares No restriction Restriction on transfer
• Planning is flexible. Planning must provide enough room to cope with unpredictable
Invitation to public to Can invite the public to subscribe to Cannot invite the public to
circumstances.
subscribe to shares its shares or debentures subscribe to its securities
Funds Can accept funds from general Can accept fund only from Purpose /Importance of Planning
public members, directors or their · To focus attention on objectives & results
relatives
· To reduce uncertainties and risks
Stakeholders It is compulsory to call a statutory There is no such compulsion in the
general meeting of members. case of a private company. · To provide sense of direction
· To encourage innovation & creativity
· To help in better coordination
· To provide guidance in decision making
· To provide a basis for decentralization
· To improve efficiency in operation
· To facilitate better control of organizational activities

Features of a good plan

· It must be based on clearly defined objectives.
· It must be simple, easily understandable.
· It must be flexible or adaptable to changing conditions.

19 20
 · It must be balanced in all respects. Types of Planning
· It must provide standards for the evaluation of performance and actions.
· It should be economical. On the basis of nature
· It should be practicable. • Operational planning: Operational plans are concerned with day-to-day operations of the
· It has to be prepared with the consultation of concerned persons. organization. These plans are formulated by lower level management for short term period.
· It should be clear, specific and logical. Operational plans usually cover functional aspects such as production, finance, marketing etc.
· It should be capable of being controlled. • Strategic planning: Strategic planning is formulated by top level management for a long period of
time of five years or more. Strategic planning includes long-term decisions to achieve the
Steps in Planning Function organization mission and vision. Strategic planning is mainly concerned with the growth and
development of the organization. It is crucial to the ultimate success of the organization.
1. Establishment of objectives • Tactical planning: Tactical plans are those plans which are formulated for the successful
Planning starts with the setting up of goals and objectives. Objectives focus the attention of implementation of strategic plan. It is concerned with the integration of various organizational
managers on the end results to be achieved. Therefore, objectives should be stated in a clear, precise and units to achieve what’s outlined in the strategic plan. It involves how the resources of the
unambiguous language. organization should be used in order to achieve strategic goals. The tactical plan is also known as
coordinative or functional plan.
2. Establishment of Planning Premises • Contingency planning: Contingency plans are those which are made to address unexpected
Establishment of planning premises is concerned with finding out the obstacles in the way of happenings or when something needs to be changed on short call.
business during the course of operations and to take such steps that avoid these obstacles to a great
extent. On the basis of time
• Long term plan: Long term plan is the long term process that owners or top level management
3. Choice of alternative course of action use to achieve their business mission and vision. This includes strategic plans. It determines the
When objectives are set and premises are established, a number of alternative course of actions path and maneuvers for the organization to achieve its goal.
have to be considered. Each and every alternative has to be evaluated by considering its pros and cons. • Mid-term/Intermediate plan: Mid-term plan covers 6 months to 2 years. It outlines how the
The merits, demerits as well as the consequences of each alternative must be examined. After objective strategic plan will be pursued. Mid-term plan includes all of the individual departments and
and scientific evaluation, the best alternative is chosen. functions for the growth and development of the organization within the strategic plan.
• Short term plan: The time period for a short term plan is from one day to few weeks. It generally
4. Formulation of derivative plans allocates resources on temporary basis. These plans are generally problem specific and often
Derivative plans are the sub plans or secondary plans which help in the achievement of main plan. dissolved after the problem is solved.
Secondary plans will flow from the basic plan. These are meant to support and expedite the achievement
of basic plans. On the basis of use
• Single-use plans: These are used to plan a specific event. Single use plans are created for events
5. Securing Co-operation
and activities with a single occurrence. When the event is completed, the plan is dissolved. They
After the plans have been determined, it is advisable to take the subordinates into confidence to
are not used, once after their use. They are further recreated whenever required.
execute the plan effectively. The plan must be briefed to the subordinates and discussed for any
• Standing plans: This plan is designed for a situation that repeatedly occurs. These are
improvement in formulation as well as implementation of plans. Subordinates may feel motivated and
standardized approach to handle a situation; hence they are also referred to as standing guide to
more interested in the execution of these plans, since they are involved in decision making process.
managers for solving a problem.
6. Follow up/Appraisal of plans • Crisis plans: These plans are formulated to deal with specific crises that can occur in the future.
After choosing a particular course of action, it is put into action and the progress is continuously These plans are formulated randomly and based on the situation.
monitored to detect any deviation from the selected plan. This enables the management to take Policies, Procedures, and Regulations
corrective actions to minimize deviations from the actual plan. This step establishes a link between
planning and controlling function. • Policies provide broad guidelines for the smooth operation of the organization. They cover things
like hiring and firing, performance appraisals, promotions, and discipline. For example, a company
may have a policy to encourage recycling in the workplace or a policy that prohibits personal cell
phone use in manufacturing areas.
21 22

• Procedures are steps to be followed in established and repeated operations. Procedures should 2. Diagnose and state the problem
reflect the policies of the company and support the organization’s long-term goals. Procedures Once the problem is identified, the root cause of the problem is explored to recognize the real
may also detail steps that should be followed to ensure employees are disciplined in a fair and problem. This real problem must be stated in specific measurable terms.
unbiased manner. For example, if employees feel that other employees interacted with them in
an inappropriate manner, then they should follow the procedure for bringing this to 3. Developing alternatives
management’s attention. Or, the organization may establish procedures for what to do in cases Once the real problem is defined, potential solutions are investigated using different methods and
of emergencies, such as a fire or toxic spill. resources. These various alternative solutions guarantee adequate focus and realization on the problem.
• Regulations refer to what is allowable and what is strictly prohibited in an organization. In other
4. Evaluation of alternatives
words, a regulation is a kind of rule that addresses general situations. In many hospitals and
The alternatives are carefully examined for their feasibility and efficiency. The strengths,
laboratories, for example, there are safety regulations against wearing open-toed shoes or shoes
weaknesses and consequences of each alternative are considered as they are compared to solve the
with slippery soles. State and federal governments frequently issue regulations for industries that
problem adequately.
impact public safety.
5. Selection of the best alternative
Management By Objectives (MBO)
In this step, the best alternative is selected that will maximize the results in terms of defined
criteria. These criteria may include risk of loss, economy, timing, limitation of resources, etc.
Management by objectives (MBO) is a tool that can be used to improve the performance of an
organization by creating clearly defined objectives agreed upon by management and by the employees.
6. Implementation and Follow up
Peter Drucker, a prolific author and a leader in management theory, coined the phrase “management by
After making a decision, it is required to implement it successfully and the progress is continuously
objectives” in 1954. The intent of MBO is to improve employee motivation and organizational
monitored to ensure the effectiveness of the decision.
communication by focusing on aligning individual goals to corporate objectives. In MBO, a manager and
an employee do the following: Key to Success in Decision Making
• jointly set goals and objectives for a period. 1. Be problem oriented not just solution oriented
• together plan tasks that the employee performs with the support of management. 2. Set decision making goals
• agree on the standards for evaluating performance of the task. 3. Always check the accuracy of the information
• regularly meet to review progress. 4. Don’t be afraid to develop innovative alternatives
MBO must be a top-down management tool, because organizational goals are cascaded down to create 5. Be flexible
the various operational levels. Drucker showed that as long as employee goals support short-term and 6. Gain commitment for decision at an early stage
long-term organizational objectives, MBO will help move the company forward. Critics, however, charge 7. Evaluate and follow up the decision
that managers using the approach focus more on creating goals than on helping the employee achieve
them. Types of Decisions

Decision Making • Routine decision: Routine decisions are those that the manager makes in the daily functioning of
the organization, i.e. they are routine. Such decisions do not require much evaluation, analysis or in-
Decision making refers to determining the course of action to a specific problem from available depth study. Usually, routine decisions are taken by managers at the middle and lower level.
alternatives. It is the core of planning. • Tactical decision: Tactical decisions relate to the present issues or problems which cannot be
solved by the routine decision such as sudden failure of a machine.
Decision making is the cognitive process (documentation, brain storming, evaluation, etc.) of reaching a
decision. It is a position or opinion or judgment reached after intense consideration. • Strategic decision: Strategic decisions usually relate to the policies of the firm or the strategic plan
for the future. The strategic decisions have an impact on the organizational structure, objectives,
Decision Making is the process of mapping the likely consequences of decisions, working out the finances and the working conditions etc. Expanding the scale of operations, entering new markets,
importance of individual factors, and choosing the best course of action to take. changing the product mix, shifting the manufacturing facility, forming alliances with other
companies, etc. fall into this category. Strategic decisions are taken by top level managers.
Steps in Decision Making Process
• Operational decision: Operational decisions are taken by the the middle and the lower level
1. Awareness of a problem management in order to execute the planned activities.
The first step in the decision making process is to identify a problem. The manager must become
Organizing
aware that a problem exists and that it is important enough for managerial action.
23 24
Louis Allen defines Organizing as “the process of identifying and grouping of the work to be performed, work together in their individual capacities and not professional. The informal organization is featured by
defining and delegating responsibility and authority, and establishing relationships for the purpose of mutual aid, cooperation and companionship among members.
enabling people to work most effectively together in accomplishing their objectives.”
Difference between Formal organization and Informal organization
Organizing essentially implies a process which coordinates human efforts, assembles resources and
integrates both into a unified whole to be utilized for achieving specified objectives. Formal organization Informal organization
1 Formal organization is an organization in which Informal organization is formed as a
Organizing is establishing the internal organizational structure of the business. The focus is on division, job of each member is clearly defined, and their network of interpersonal relationship when
coordination, control of tasks and flow of information within the organization. authority, responsibility and accountability are people interact and associate with each
Organizing is the process of defining and grouping the activities of the enterprise and establishing fixed. other.
authority relationships among them. 2 Formal organization is created deliberately by Informal organization is formed
top management. spontaneously by its members.
Steps in the process of organizing 3 Formal organization is aimed at fulfilling An informal organization is created to
1. Identification and division of work organization’s objectives. satisfy social and psychological needs.
2. Identification of the necessary activities to accomplish 4 Formal organization is permanent in nature. It Informal organization is temporary in
3. Formation of groups of in the light of human resources to perform the activities continues for a long time. nature.
4. Assignment of duties 5 The formal organization follows official There are no defined channels of
5. Establishment of coordination and communication channel among the groups through authority communication, i.e. the channels of communication in informal organization
relationship and information flows communication are pre-defined. and so members can interact with other
members freely.
Formal and Informal Organization 6 In a formal organization, the rules and In an informal organization, there
regulations are supposed to be followed by every are values and beliefs that work as a
An organization is a collection of people who work together to attain specified objectives. There are two
member. control mechanism.
types of organization;
7 In formal organization, focus is on the In informal organization, interpersonal
(i) formal organization and
performance and efficiency of the members. relation is given more emphasis.
(ii) informal organization.
8 In a formal organization, all the members are All the members of an informal
Formal organization bound by the hierarchical structure. organization are equal.

An organization is said to be formal organization where there are certain policies, procedures and
regulations that establish work relationships among the members of the organization. These ensure the Assignments:
systematic and smooth functioning of the organization and help the organization to achieve its goal. There
• List out various planning tools and techniques. Explain any two of them.
exists a system of authority and a systematic flow of interactions among the employees which facilitates
coordination, interlinking and integration of the diverse departments within the organization. The job of each
employee is fixed, and roles, responsibilities, authority and accountability associated with the job is clearly
defined. For this purpose, the concept of division of labour and specialization of workers are applied and
so the work is assigned on the basis of their capabilities.

Informal organization

An informal organization is created when like-minded people meet, interact and associate with each other
to achieve a common goal. Such organization does not have a defined set of rules and regulations that
govern the relationship between its members. Instead, it is entirely based on the interpersonal
relationships between the individuals working in the organization. In an informal organization, there are
no defined channels of communication and so members can interact with other members freely. They

25 26

MODULE 4 Disadvantages:
• A functional structure places less emphasis on overall enterprise objectives than the objectives
Organization Structure pursued by a functional head. Such practices may lead to hinder the interaction between two or
more departments.
The organization structure can be defined as the framework which specifies the relationships between
• A conflict of interests may arise when the interests of two or more departments are not
people, work and resources within the organization, and within which the managerial and operating tasks
compatible.
are performed. It allows correlation and coordination among human, physical and financial resources and
• It may lead to inflexibility as people with same skills and knowledge base lack experience in diverse
this enables a business enterprise to accomplish desired goals.
areas.
As an organization grows, coordination becomes difficult due to the emergence of new business functions
and operations. Hence, for an organization to function smoothly, it becomes necessary to develop an Divisional Structure
organization structure and structural hierarchies within the organization.
In a divisional structure, the organization structure comprises of separate business units or divisions. Each
An organization structure provides the framework which enables the enterprise to function as an unit has a divisional manager responsible for performance and who has authority over the unit. Generally,
integrated unit by regulating and coordinating the responsibilities of individuals and departments. manpower is grouped on the basis of different products manufactured. Each division is multifunctional
because within each division functions like production, marketing, finance, purchase etc, are performed
Types of Organization Structures together to achieve a common goal. Each division is self-contained as it develops expertise in all functions
related to a product line.
The type of structure adopted by an organization will vary with the nature and types of activities
performed by the organization. The organizational structure can be classified under two categories which In order words, within each division, the functional structure tends to be adopted. However, functions
are as follows: may vary across divisions in accordance with a particular product line. Further, each division works as a
(i) Functional structure and profit center where the divisional head is responsible for the profit or loss of his division.
(ii) Divisional structure

Functional structure Managing Director

Grouping of related jobs or jobs of similar nature into a function and organizing the functions as separate
departments creates a functional structure. All departments report to a coordinating head.

Managing Director
Cosmetics Garment Footwear Skin care

Research & Human Research & Human

Production Accounts Purchasing Marketing Production Accounts Purchasing Marketing
Development Resources Development Resources

Advantages:
Advantages:
• It promotes efficiency in utilization of manpower as employees perform similar tasks within a
• It promotes flexibility because each division functions as an autonomous unit which leads to faster
department and are able to improve performance.
decision making.
• It helps in increasing managerial and operational efficiency because of similarity in the tasks being
• It facilitates expansion and growth as new divisions can be added without interrupting the existing
performed.
operations by merely adding another divisional head and staff for the new product line.
• It leads to minimal duplication of effort which results in economies of scale and this lowers cost.
• It makes training of employees easier as the focus is only on a limited range of skills.
Disadvantages:
• It ensures that different functions get due attention.

27 28
 • Conflict may arise among different divisions with reference to allocation of funds and further a Delegation of Authority
particular division may seek to maximize its profits at the cost of other divisions.
• It may lead to increase in costs since there may be a duplication of activities across different Delegation of authority means to the downward transfer of authority from a superior to a subordinate. A
products, providing each division with separate sets of similar functions. manager, no matter how capable he is, cannot manage to do every task on his own. The volume of work
makes it impractical for him to handle it all by himself. Hence, there is a practice to assign some part of
Authority the work to a subordinate and also give him the necessary authority to make decision within the area of
his assigned duties. It enables a manager to use his time on high priority activities but, the manager shall
Authority may be defined as the legitimate right to give orders and to get orders obeyed. It denotes the still be accountable for the performance of the assigned tasks.
power to take decision and get them executed by their subordinates.
Effective Delegation
Types of Authority: Line and Staff Authority 1. Define assignments and delegate authority in the light of results expected
2. Select the person in the light of the job
Line authority – Line authority is the direct authority which a superior exercises over his subordinates to
3. Maintain open lines communication
carry out orders and instructions.
4. Establish proper control
• The flow of line authority is always downward, that is from a superior to a subordinate
5. Reward effective and successful assumption of authority
• It creates a direct relationship between a superior and his subordinate.
• Line relationship behaves as a chain of command. Importance of Delegation
• It determines the accountability (subordinate is answerable to his superior). Effective delegation leads to the following benefits:
• These have direct impact on the accomplishment of the objectives of the enterprises. ▪ Effective management
• Employee development
Staff authority – Staff authority refers to those elements of the organization which help the line to work
• Benefits of specialized service
most effectively in accomplishing the primary objectives of the enterprises.
• Motivation of employees
• The flow of line authority is always horizontal.
• Facilitation of growth
Difference between Line and Staff Authority • Basis of management hierarchy
• Better coordination
Line Authority Staff Authority
1 Right to decide and command Right to provide advice, assistance and information Departmentalization
2 Contributes directly to the Assist line in the effective accomplishment of
Departmentalization is the process of grouping the activities of an enterprise into several units for the
accomplishment of organizational organization objectives
purpose of facilitating smooth administration at all levels. The administrative units so created may be
objectives
designated as departments, divisions, units, branches, sections, etc.
3 Relatively unlimited and general Relatively restricted to a particular function
4 Flow downward from a superior to May flow in any direction depending upon the need Need/Importance/Advantages of Departmentalization
subordinate of advice 1. Specialization
5 Creates superior and subordinate Extension of line and support line 2. Expansion
relation 3. Autonomy
6 Exercise control Investigates and reports 4. Fixation of responsibility
7 Makes operating decision Provides idea for decision 5. Appraisal
8 Bears final responsibility for results Does not bear final responsibility 6. Management development
9 Doing functions Thinking function 7. It facilitates better administrative control and better coordination.
10 Provides channel of communication No channel of communication is created
Choosing a basis for Departmentalization
1. Specialization
2. Coordination
3. Control
4. Economy
29 30

5. Attention different from those used by other products in the organization. E.g. HLL manufactures detergents, skin
6. Human Consideration care, soap and toothpaste.

Basis of Departmentalization HLL

1. Departmentalization by Functional Basis – Grouping of activities in accordance with the function of an
enterprise. Each major function of the enterprise is grouped into a department. It follows the principles
of specialization.
Manufacturing
Industry
Detergents Skin care Soap Toothpaste

5. Departmentalization by Customer basis – An enterprise may be divided into a number of departments

on the basis of the customers that it services. E.g. A banking institution may have separate departments
Research & Human for loans, transactions, credit cards and other banking services.
Production Accounts Purchasing Marketing
Development Resources
Bank
2. Departmentalization by Territorial basis – Departmentalization can be also done on the basis of
territory. A sales company may have separate departments to serve the southern region, northern region
etc. It has the advantage of the intimate knowledge of local conditions.

Global marketing
Cash Other banking
Loan Credit card
transaction services

Centralization and Decentralization

Those organizations in which decision making authority is retained by the top management are termed as
Asia - Pacific Africa Europe USA centralized organizations whereas those in which such authority is shared with lower levels are
decentralized organizations.
3. Departmentalization by Process basis – It is done on the basis of several discrete stages in the process
An organization can never be completely centralized or decentralized. As the company grows in size and
or technologies involved in the manufacture of a product. E.g. A production company may have separate
departments for casting, forging, machining, and heat treatment process. complexity, there is a tendency to move towards decentralized decision making. This is because in large
organizations those employees, who are directly and closely involved with certain operations, have more
Production knowledge about them than the top management which may only be indirectly associated with individual
operations. Hence, it can be said that every organization can be characterized by both centralization and
decentralization, and there is a need for a balance between these co-existing forces.

Human Resource Management

Machine Heat The success of an organization depends on the competence, motivation and performance of its human
Casting Forging
shop treatment resource to a great extent. The human resource management is concerned with functions of managing
the employees of an organization. The HRM functions include placing the right person on the right job,
4. Departmentalization by Product basis – It is suited for a large organization manufacturing a variety of introducing new employees to the organization, training and education to the employees for improving
products. For each major product a semi-autonomous department is created and it is put under the charge their performance and developing their abilities, maintaining their morale and protecting their health and
of a manager who is responsible for producing a profit for that product. Each product department is physical conditions.
entirely different from other product departments in the organization and they have their own setups for
raw material procurement, manufacturing, technology and marketing methods and that are markedly
31 32
Human Resource Management includes many specialized activities and duties which the human resource which remained unused during their course of action. Also, through job enrichment, the monotony breaks
personnel must perform. These duties are: and the employees get the opportunity to do something new, which ultimately results in the increased
• Recruitment i.e., search for qualified people satisfaction levels.
• Analyzing jobs, collecting information about jobs to prepare job descriptions.
• Developing compensation and incentive plans. Recruitment
• Training and development of employees for efficient performance and career growth.
Recruitment is the process of searching for prospective employees and stimulating them to apply for jobs
• Maintaining labour relations and union management relations.
in the organization. Goal of Recruitment is to create a large pool of persons available and willing to work.
• Handling grievances and complaints.
• Providing for social security and welfare of employees. The various activities involved with the process of recruitment includes
• Defending the company in law suits and avoiding legal complications. (a) identification of the different sources of labour supply,
(b) assessment of their validity,
(c) choosing the most suitable source or sources, and
Job Design
(d) inviting applications from the prospective candidates, for the vacancies.
Job design is defined as outlining the task, duties, responsibilities, qualifications, methods and
Methods or Techniques of Recruitment
relationships required to perform the given set of a job. The objective of a job design is to arrange the
1. Direct Method – Under the direct recruitment, a notice is placed on the notice-board of the enterprise
work in such a manner so as to reduce the boredom and dissatisfaction among the employees, arising due
to the repetitive nature of the task. specifying the details of the jobs available. Jobseekers assemble outside the premises of the
organization on the specified date and selection is done on the spot. Another popular well-established
There are four techniques of job design as below: practice of direct recruitment is campus recruitment wherein companies visit colleges and institutes
(1) Job simplification of management and technology to recruit candidates for technical, professional and managerial jobs.
(2) Job enlargement 2. Indirect Method – This method uses advertisements for recruitment in newspaper, journal, etc while
(3) Job rotation blind advertisement does not mention the company name on the advertisement.
(4) Job enrichment 3. Third Party method –
a. Employment agency
Job Simplification b. Professional recruiting agencies
Job simplification means breaking the job into relatively easier sub-parts with the intention to c. Employee referrals (Recommendations)
enhance the individual’s productivity by minimizing the physical and mental efforts required to perform d. Voluntary organization
a complex job.
Selection
Job enlargement
Job enlargement means increasing the scope of duties and responsibilities of an individual by Selection is the process of identifying and choosing the most suitable and promising candidates from
adding the related activities to his existing job profile without any change in his authority and his level in among the pool of the prospective job candidates developed at the stage of recruitment to fill up the
the hierarchy in the organization. The purpose behind the job enlargement is to increase the employee vacancies. The goal of selection is to sort out or to eliminate those judged unqualified to meet the job and
flexibility and reduce the monotony that occurs gradually over a period. organizational requirements. Recruitment is a method while selection is a procedure.

Steps in Selection
Job Rotation
• Screening of applications
Job rotation is the management technique wherein an employee is shifted from one job role to
• Selection test – written (Technical, aptitude etc.)
the other, with the purpose of familiarizing him with all the verticals of an organization. The purpose of
• Psychological test
job rotation is to reduce the monotony of work and letting an employee to acquire multi skills required
• Skill test
for performing different tasks in the organization.
• Document verification
Job Enrichment • Reference check
Job enrichment is the job design technique used to increase the satisfaction among the employees • Interview
by delegating higher authority and responsibility to them and thereby enabling them to use their abilities
to the fullest. The purpose behind the job enrichment is to motivate the employees to use their abilities Training and Development
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Training and Development is an attempt to improve the current or future employee performance by Performance management system is not a performance appraisal system, rather it is interactions with an
increasing an employee’s ability to perform through learning new skills and application of knowledge. It employee at every step of his work where each interaction provides the employee an opportunity for
is intended to improve the performance of the employees on the current job or prepare them for any learning the best way of doing the work.
future job.
Career Planning and Management
Benefits to the organization
The benefits of training and development to an organization are as follows: A career may be defined as ‘a sequence of jobs that constitute what a person does for improvise his living’.
▪ Training is a systematic learning, always better than hit and trial methods which lead to wastage of Career planning is a process by which one selects career goals and the path to those goals. It involves
efforts and money. setting up of career goals and determining appropriate educational and developmental programs to
▪ It enhances employee productivity both in terms of quantity and quality, leading to higher profits. improve the skills needed to achieve these goals. Career planning encourages individuals to explore and
▪ Training creates the future manager who can take over in case of emergency. gather information, which enables them to synthesize, gain competencies, make decisions, set goals, and
▪ Training increases employee morale and reduces absenteeism and employee turnover. take action. It is a crucial phase of human resource development that helps the employees in making a
▪ It helps in obtaining effective response to fast changing environment – technological and economic. strategy for work-life balance.

Benefits to the Employee Employees join an organization to fulfill their career goals and aspirations and organizations provide
The benefits of training and development activity to the employees are as follows: opportunities to fulfill them. Where there is a mismatch between the two, employees experience
▪ It improves skills and knowledge due to training lead to better career of the individual. dissatisfaction and withdraw from the organization to join another organization where such opportunity
▪ It increases performance by the individual help him to earn more. exists. It underlines the need for career planning. It helps the employees to achieve a better match
▪ Training makes the employee more efficient to handle machines. Thus, less prone to accidents. between their career goals and the opportunities available in the organization.
The career planning process involves the following steps:
Methods of Training
• Apprenticeship: Trainees are put under the guidance of a master worker. They spend a prescribed 1. Identifying individual needs and goals:
amount of time working with an experienced guide, or trainer to acquire a higher level of skill. Most individuals do not have a clear-cut idea about their career objectives and goals. Hence, the
• Coaching: In this method, the superior guides and instructs the trainee as a coach. The superior human resource professionals of organizations must help the employees by providing as much
educates the trainee and teach them the required skill. information as possible. The employees should be counseled on matters such as the kind of work that
• Job Rotation: This kind of training involves shifting the trainee from one department to another or suits them based on their skills, experience, and aptitude. Employees also must be well informed about
from one job to another. This enables the trainee to gain a broader understanding of all parts of the the specific career development activities being carried out within the organization. It guides the
business and how the organization as a whole functions. Job rotation allows trainees to interact with employees in determining career goals, identify career paths and advance their careers within the
other employees facilitating future cooperation among departments. organization.
• Class Room Programs: This is off the job method of training where specific/new information or
2. Analyzing career opportunities:
procedures are conveyed in a class. This method generally uses lectures, audio-visuals or case study
This step refers to the careful examination of career paths available to employees after identifying
to enhance the knowledge of the employees.
their career aspirations. Career paths show the possibilities of career progression and indicate the various
• Modeling and Simulation: It imitates the actual job and work environment by programming a
positions that employees can hold in the organization over a period of time, if they perform well. Career
computer and allows learning to take place without the risk or high costs that would be incurred if a
paths change over time in tune with employee’s needs and organizational requirements.
mistake were made in real life situation.
3. Aligning needs and opportunities:
Performance Management This refers to highlighting and aligning the gaps between the employee’s needs and the
opportunities provided by the organization. The alignment of needs and opportunities consists of two
Performance management is the process of creating a work environment or setting in which people are
steps, namely identifying the potential of employees and aligning employee needs with organizational
enabled to perform to the best of their abilities. In this process, the existing performance level of the
opportunities.
employees is assessed to improve the performance over time. It is a continuous process and by doing so,
the performance of the workforce is ensured to be connected with the overall mission and goals of the The potential of employees is accessed which reveals the need for further training or certain development
enterprise. activities to upgrade their knowledge and skills so that they can get benefits by the organizational
opportunities.

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4. Formulating action plans and performing periodic review: MODULE 5
This step refers to designing the actions plans and reviewing periodic performance for the career
development of an individual. After initiating the preceding steps, it is necessary to review the whole Directing
career plan and its implementation. It helps the employees in determining the direction of their career
Directing means giving instructions and guiding people in doing work in the best possible manner to
paths, the changes required in their careers and the skills needed to face new and emerging organizational
achieve the organizational objectives. It is one of the key managerial functions performed by every
challenges. It is also necessary from an organizational standpoint to find out how employees are doing,
manager. The directing function involves:
what are their goals and aspirations, and whether the career paths are in tune with individual needs and
• telling people what is to be done and explaining to them how to do it
serve the overall corporate objectives.
• issuing instructions and orders to subordinates to carry out their assignments as scheduled
• supervising their activities
• inspiring them to meet the mangers expectation and contribute towards the achievement of
organizational objectives
• providing leadership

The main characteristics of directing are below:

(i) Directing initiates action.
(ii) Directing takes place at every level of management.
(iii) Directing is a continuous process.
(iv) Directing flows from top to bottom.

Functions of Directing

As a function of management, directing is useful in many ways.

• It guides and helps the subordinates to complete the given task properly and as per schedule.
• It provides the necessary motivation to subordinates to complete the work satisfactorily and
strive to do them the best.
• It helps in maintaining discipline and rewarding those who do well.
• Directing involves supervision, which is essential to make sure that work is performed according
to the orders and instructions.
• Different people perform different activities in the organization. All the activities are interrelated.
In order to co-ordinate the activities carried out in different parts and to ensure that they are
performed well, directing is important. It thus, helps to integrate the various activities and so also
the individual goals with organizational goals.
• Directing involves leadership that essentially helps in creating appropriate work environment and
build up team spirit.

Elements in Directing

Communication, Supervision, Motivation and Leadership are the four essential elements of directing.

Motivation

Motivation means incitement or inducement to act or move. Motivation is the process of stimulating
people to action to accomplish desired goals. Motivation depends upon satisfying needs of people.
• Motivation is an internal feeling.
• Motivation produces goal directed behaviour.

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• Motivation can be either positive or negative. Positive motivation provides positive rewards like Financial and Non-Financial Incentives
increase in pay, promotion, recognition etc., Negative motivation uses negative means like
Incentive means all measures which are used to motivate people to improve performance. These
punishment, stopping increments, threatening etc. which also may induce a person to act in the
incentives may be broadly classified as financial and non financial.
desired way.
• Motivation helps to improve performance levels of employees as well as the organization.
Financial Incentives

Maslow’s Need Hierarchy Theory of Motivation: Financial incentives refer to incentives which are in direct monetary form or measurable in monetary term
and serve to motivate people for better performance. These incentives may be provided on individual or
Maslow’s need hierarchy theory is considered fundamental to understanding of motivation. This theory
group basis. The financial incentives generally used in organizations are listed below:
is based on human needs and focuses on the needs as the basis for motivation. Maslow proposed a
i. Pay and allowances: For every employee, salary is the basic monetary incentive. It includes basic
hierarchy of five needs. These are:
pay, dearness allowance and other allowances. Salary system consists of regular increments in the
i. Basic Physiological Needs: These needs are the most basic in the hierarchy and corresponds to
pay every year and enhancement of allowances from time-to-time. In some business organizations,
primary needs for human survival. Hunger, thirst, clothes, shelter and sleep are some examples of
pay hike and increments may be linked to performance.
these needs. In the organizational context, basic salary helps to satisfy these needs.
ii. Productivity linked wage incentives: Several wage incentive plans aims at linking payment of wages
ii. Safety Needs: These needs are concerned with sense of security and well being. Personal security,
to increase in productivity at individual or group level.
financial security, good health and protection from accidents, harm and their adverse effects are all
iii. Bonus: Bonus is an incentive offered over and above the wages/salary to the employees.
included in safety needs.
iv. Profit Sharing: Profit sharing is meant to provide a share to employees in the profits of the
iii. Social Needs: These needs refer to feel of affection and acceptance to the society so that a human
organization. This serves to motivate the employees to improve their performance and contribute
does not feel alone, isolated and depressed. Friendships, family and sense of belongingness all work
to increase in profits.
to fulfill social needs.
v. Co-partnership/Stock option: Under these incentive schemes, employees are offered company
iv. Esteem Needs: These include factors such as self-respect, autonomy status, recognition and
shares at a set price which is lower than market price. Sometimes, management may allot shares in
attention.
line of various incentives payable in cash. The allotment of shares creates a feeling of ownership to
v. Self Actualization Needs: It is the highest level of need in the hierarchy. It refers to the drive to
the employees and makes them to contribute for the growth of the organization.
become what one is capable of becoming. These needs include growth, self-fulfillment and
vi. Retirement Benefits: Several retirement benefits such as provident fund, pension, and gratuity
achievement of goals.
provide financial security to employees after their retirement. This acts as an incentive when they
are in service in the organization.
vii. Perquisites: In many companies perquisites and fringe benefits are offered such as car allowance,
housing, medical aid, and education to the children etc., over and above the salary. These measures
help to provide motivation to the employees/managers.

Non-Financial Incentives:

All the needs of individuals are not satisfied by money alone. Psychological, social and emotional factors
also play important role in providing motivation. Non-financial incentives mainly focus on these needs.
Some of the important non-financial incentives are discussed below:
i. Status: In the organizational context, status means ranking of positions in the organization. The
authority, responsibility, rewards, recognition, perquisites and prestige of job indicate the status
given to a person holding a managerial position. Psychological, social and esteem needs of an
Maslow’s theory is based on the following assumptions: individual are satisfied by status given to their job.
i. People’s behaviour is based on their needs. Satisfaction of such needs influences their behaviour. ii. Organizational Work Culture: Organizational work culture indicates the comfort and ease of doing
ii. People’s needs are in hierarchical order, starting from basic needs to other higher level needs. work. These influence the behaviour of employee in the organization. For example: ease of
iii. A satisfied need can no longer motivate a person; only next higher level need can motivate him. communication with top level management, leave policy, etc.
iv. A person moves to the next higher level of the hierarchy only when the lower need is satisfied. iii. Career Advancement Opportunity: Every individual wants to grow to the higher level in the
organization. Managers should provide opportunity to employees to improve their skills and be
promoted to the higher level jobs. Appropriate skill development programs, and sound promotion
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 policy will help employees to achieve promotions. Promotion works as a tonic and encourages • A good leader must be able to communicate his subordinates effectively. Human relation skills
employees to exhibit improved performance. are a must for any leader.
iv. Job Enrichment: Job enrichment is concerned with designing jobs that include greater variety of • Leaders must be influential so that they can build up team spirit and people will follow them
work content, require higher level of knowledge and skill; give workers more autonomy and voluntarily.
responsibility; and provide the opportunity for personal growth and a meaningful work experience.
If jobs are enriched and made interesting, the job itself becomes a source of motivation to the Leadership Style
individual.
There are many theories of leadership behaviour and styles. The most popular classification of leadership
v. Employee Recognition programs: Most people have a need for evaluation of their work and due
styles is based on the use of authority. Depending on the use of authority, there are three basic styles of
recognition. They feel that what they do should be recognized by others concerned. Recognition
leadership:
means acknowledgment with a show of appreciation. When such appreciation is given to the work
(i) Autocratic (ii) Democratic, and (iii) Laissez-faire
performed by employees, they feel motivated to perform/work at higher level.
vi. Job security: Employees want their job to be secure. They want certain stability about future income (i) Autocratic or Authoritarian leader
and work so that they do not feel worried on these aspects and work with greater zeal. This aspect
is more important as there are inadequate job opportunities and too many aspirants for these. An autocratic leader takes decision without consulting others. He gives orders and expects his
However, there is one negative aspect of job security. When people feel that they are not likely to subordinates to obey those orders. This type of leader does not change or wish to be contradicted. In this
lose their jobs, they may become complacent. type of leadership, there is only one-way communication with the subordinate in the form of command
vii. Employee participation: It means involving employees in decision making of the issues related to given by the manager.
them. In many companies, these programs are in practice in the form of joint management This type of leadership is useful when there is no need of input on the decision and the reward or
committees, work committees, canteen committees etc. punishment depends on the end result. This leadership style is effective in getting productivity in many
viii. Employee Empowerment: Empowerment means giving more autonomy and powers to situations like in a factory where the supervisor is responsible for production on time and has to ensure
subordinates. Empowerment makes people feel that their jobs are important. This feeling labour productivity.
contributes positively to the use of skills and talents in the job performance.
(ii) Democratic or Participative leader
Leadership
A democratic leader makes decisions in consultation with his subordinates although the final decision may
Leadership is the process of influencing the behaviour of people by making them strive voluntarily towards vary from their suggestions. Such leadership is generally appreciated by the people as persons involved in
achievement of organizational goals. Leadership indicates the ability of an individual to maintain good decision making have expertise in different domain of the decision making factors. This kind of leadership
interpersonal relations with followers and motivate them to contribute for achieving organizational style is more common now-a days, since leaders also recognize that people perform best if they have set
objectives. their own objectives. Such leaders respect the other’s opinion and support subordinates to perform their
duties and accomplish organizational objectives.
Features of Leadership
(iii) Laissez faire or Free-rein leader
▪ Leadership indicates ability of an individual to influence others.
▪ Leadership tries to bring change in the behaviour of others. In this type of leadership, the leader’s involvement in decision making is minimum and allowing the
▪ Leadership indicates interpersonal relations between leaders and followers. subordinates to formulate their own objectives and ways to achieve them. The group members work on
▪ Leadership is exercised to achieve common goals of the organization. their own tasks resolving issues themselves. The manager is there only to support them and supply them
▪ Leadership is a continuous process. the required information to complete the task assigned. At the same time, the subordinate assumes
responsibility for the work to be performed.
Leadership Qualities
Communication
In order to be successful, a leader must possess certain qualities. Few of the leadership qualities are
mentioned below: A general definition of communication is that it is the process of exchange of information between two or
• A good leader should be professionally competent, intelligent, analytical and he/she should have more persons to reach common understanding. The purpose of communication in organizations is to
a sense of fair play, including honesty, sincerity, integrity, and sense of responsibility. convey orders, instructions, or information so as to bring desired changes in the performance and or the
• A good leader must possess initiative, perseverance, be diligent and realistic in his outlook. attitude of employees. Communication plays key role in the success of a manager. How much professional

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knowledge and intelligence a manager possesses becomes immaterial if he is not able to communicate The paths of communication which are based on relationship establish formally by management
effectively with his subordinates and create understanding in them. are the formal channels. For example, top level (General Manager) communicates a decision to the middle
level (production manager) who may then issue orders or instructions to the lower level (foremen,
Process of Communication worker).

The process of communication between two individuals can be illustrated below: Communication, which takes place on the basis of social relations or friendly interaction among
staff, is called informal communication. For example, sharing of information between a production
Encoding Channel supervisor and an accountant, as they happen to be friends or so.
Sender Message Receiver
(b) Upward, Downward, Horizontal and Diagonal Communication
Feedback
On the basis of the flow or direction of communication in organizations, it can be classified as upward,
Communication is initiated by the sender who conceptualizes the information that is to be downward, horizontal or diagonal.
transmitted. This information is encoded with the help of language, symbols etc. into a message. The
message is transmitted from the sender to the receiver through an appropriate channel. Once the When employees make any request, appeal, report, suggest or communicate ideas to the
message is transmitted through the channel to the receiver, he decodes it back to the information and superior, the flow of communication is upward i.e., from bottom to top. For example, a foreman reports
assimilates it. The effectiveness of communication depends upon the extent to which the sender has breakdown of machinery to the factory manager, the flow of communication is upward. Upward
succeeded in making the receiver understand the information. This can be evaluated through feedback, communication encourages employees to participate actively in the operations of their department. They
where the receiver responds to the sender in the form of clarifications and doubts. Feedback, which makes get encouraged and their sense of responsibility increases when they are heard by their supervisors about
communication two way is important because it helps to evaluate the effectiveness of the problems affecting the jobs.
communication.
When communication is made from superiors down the hierarchy it is called a downward
Effective communication is defined as communication between two or more persons in which the communication. The flow of communication is downward i.e., from top to bottom. Communication of
intended message is properly encoded, delivered through appropriate channel, received, properly work assignments, notices, instructions, memos, reports, speeches, meetings, etc. are all forms of
decoded and understood by the recipient(s). In other words, communication is said to be effective when downward communication.
all the parties (sender and receiver) in the communication attain a common understanding of the
message. Communication among people of the same level and status is known as horizontal flow of
communication. Such communication facilitates coordination of activities that are interdependent.
Types of Communication
When communication is made between people who are neither in the same department nor at
In an organization communication can be made from supervisor to subordinate, from subordinate to the same level of organizational hierarchy, it is called diagonal communication. For example, cost
supervisor and also between two supervisors at the same level. Communication can be done orally or in accountant may request for reports from sales representatives not the sales manager for the purpose of
writing or even through gestures. Communication may be made through formal or informal channels. distribution cost analysis. This type of communication does take place under special circumstances.
Thus, the various types of communication are as follows:
(c) Verbal and Non-verbal Communication
On the basis of channel used On the basis of direction On the basis of mode used
(i) Formal (i) Upward (i) Verbal - (a) oral, (b) written On the basis of the mode used, communication may be verbal or non-verbal. While communicating,
(ii) Informal (ii) Downward (ii) Non-verbal managers may talk to their subordinates either face to face or on telephone or they may send letters,
(iii) Horizontal issue notices, or memos. These are all verbal communication. Thus, the verbal modes of communication
(iv) Diagonal may be oral and written. Face to face communication, as in interviews, meetings and seminars, are
examples of oral communication. Issuing orders and instructions on telephone or through an
(a) Formal and Informal Communication intercommunication system is also oral communication. The written modes of communication include
letters, circulars, notices, memos, etc.
The path through which information flows is called channel of communication. In every organization we
have both formal and informal channels. Non verbal communications are those which are not expressed orally or in writing and includes
body movements and facial expressions associated with communication. These form an important and
inevitable aspect of the total communication process because it compliments and substitutes verbal
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communication. A good communicator should have the right posture, facial expression and body language ➢ It starts with the work begins.
that are in tune with the words spoken. Lack of co-ordination between verbal and nonverbal contents of ➢ It monitors the ongoing activities to make ensure that the right things are being done.
communication would only confuse the receiver. So while communicating, care should be taken to ensure ➢ Problems are solved while they are occurring.
a proper blend between words and actions. • Feedback control:
➢ It takes place after the work is completed.
Effective Communication ➢ It ensures that the final results are as per planned.
➢ It focuses on quality of end results.
Effective Communication is defined as the ability to convey information to another effectively and
➢ Problems are solved after they occur.
efficiently. The characteristics of effective communication are:
1. Clarity of Purpose: The message to be delivered must be clear in the mind of sender. The person to
Controlling Process
whom it is targeted and the aim of the message should be clear.
2. Completeness: The message delivered should be complete. It should be supported by facts and Controlling is a systematic process involving the following steps.
observations. It should be well planned and organized. No assumptions should be made by the 1. Setting performance standards: The first step in the controlling process is setting up of performance
receiver. standards. Standards are the criteria against which actual performance would be measured. Thus,
3. Conciseness: The message should be concise. It should not include any unnecessary details. It should standards serve as benchmarks towards which an organization strives to work.
be short and complete. 2. Measurement of actual performance: Once performance standards are set, the next step is
4. Feedback: Whether the message sent by the sender is understood in same terms by the receiver or measurement of actual performance. Performance should be measured in an objective and
not can be judged by the feedback received. The feedback should be timely and in personal. It should reliable manner. Appropriate techniques must be employed for this purpose. As far as possible,
be specific rather than general. performance should be measured in the same units in which standards are set as this would make
5. Empathy: Empathy with the listeners is essential for effective verbal communication. The speaker their comparison easier.
should step into the shoes of the listener and be sensitive to their needs and emotions. This way he 3. Comparison of actual performance with standards: This step involves comparison of actual
can understand things from their perspective and make communication more effective. performance with the standard. Such comparison will reveal the deviation between actual and
6. Modify the message according to the recipient: The information requirement by different people in desired results.
the organization differs according to their needs. What is relevant to the middle level management 4. Analyzing deviations: If the deviations are beyond their acceptable range, these deviations need to be
might not be relevant to the top level of management. The content of the message should be modified analyzed for their causes. It is necessary to identify the exact cause(s) of deviations otherwise an
taking into account the attitude, knowledge, and position of the targeted recipient. appropriate corrective action might not be possible. The deviations and their causes are then
7. Multiple Channels of communication: For effective communication multiple channels should be used reported and corrective action taken at appropriate level.
as it increases the chances of clarity of message. The message is reinforced by using different channels 5. Taking corrective action: The final step in the controlling process is taking corrective action so that
and there are less chances of deformation of message. deviations do not occur again and standards are accomplished. In case the deviation cannot be
corrected through managerial action, the standards may have to be revised.
Controlling
Techniques of Managerial Control
Controlling is one of the important functions of a manager. Controlling means ensuring that the activities
in an organization are being performed as per the plans. Controlling also ensures that an organization’s The various techniques of managerial control may be classified into two broad categories: (i) Budgetary
resources are being used effectively and efficiently for the achievement of predetermined goals. The and (ii) Non-Budgetary control techniques.
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. Budgetary Control Techniques

Types of Control A budget refers to the plan of an enterprise expressed in financial terms. It lays down financial estimates
relating to various programs or activities for a defined period on the basis of given objectives. These
• Feedforward control: estimates are intended to serve as targets or standards for the purpose of controlling actual performance.
➢ It starts before a work begins.
Budgetary Control, as a technique of managerial control, refers to the policies, procedures and
➢ It ensures that the right directions are set and the right resource inputs are available.
practices of achieving given objectives through budgets. Thus, budgetary control involves preparation of
➢ It focuses on quality of resources.
budgets, relating the responsibilities of managers to budgeted activities, and the continuous comparison
➢ Problems are solved before they occur.
• Concurrent control:
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of actual with budgeted results. It aims at securing the objectives as per the budget and providing a basis It indicates the income or revenue expected to be earned from sale of goods produced or other
for its revision, if necessary. resources.

Classification of Budgets Production Budget

It shows the volume of production to be undertaken for a given period, together with the material,
Budgets may be classified on the following bases – labour and machinery requirements. Sometimes production budgets also show the anticipated cost of
• Based on Time Period production. Such budgets are better expressed in quantities rather than in monetary terms. E.g. direct-
• Based on Condition labor-hours, machine-hours, units of materials, square feet allocated, and units produced.
• Based on Capacity
• Based on Coverage Capital Expenditure Budgets
Capital expenditure budgets outline anticipated capital expenditures for plant, machinery,
Based on Time Period equipment, inventories, and other items a capital nature.

(i) Long Term Budget: Budgets which are prepared for periods longer than a year are called Long Cash Budgets
Term Budgets. E.g. Capital Expenditure budget, R&D budget. The cash budget is simply a forecast of cash receipts and disbursements against which actual cash
(ii) Short Term Budget: Budgets which are prepared for periods less than a year are known as Short surplus or deficit is measured.
Term Budgets. E.g. Cash budget.
Purchase Budget
Based on Condition It represents the quantities of raw materials and other consumable items to be purchased by a
manufacturing company.
(i) Basic Budget: A Budget, which remains unaltered over a long period of time, is called Basic
Budget. Labour Budget
(ii) Current Budget: A Budget, which is established for use over a short period of time and is related It indicates the types of skills of labourers and the numbers in each category estimated to be
to the current conditions, is called Current Budget. required in a given period alongwith the standard wages payable.

Based on Capacity Non-Budgetary Control Techniques

(i) Fixed Budget: It is a Budget designed to remain unchanged irrespective of the level of activity Non-Budgetary controlling techniques are those techniques which does not involve monetary aspects.
actually attained. They provide a refreshingly new thinking on the ways in which various aspects of an organization can be
(ii) Flexible Budget: It is a Budget, which by recognizing the difference between fixed, semi variable controlled. One or more of these techniques may be adopted along with budgetary control. These Non-
and variable costs is designed to change in relation to level of activity attained. Budgetary control techniques include:

Based on Coverage Personal Observation

This is the most traditional method of non-budgetary control. Personal observation enables the
(i) Functional Budget: Budgets, which relate to the individual functions in an organization, are known
manager to collect first hand information. It also creates a psychological pressure on the employees to
as Functional Budgets, e.g. Purchase budget, Sales budget, Production budget, Plant Utilization
perform well as they are aware that they are being observed personally on their job. However, it is a very
budget and Cash budget.
time-consuming exercise and cannot effectively be used in all kinds of jobs.
(ii) Master Budget: It is a consolidated summary of the various functional budgets. It serves as the
basis upon which budgeted Profit & Loss Account and forecasted Balance Sheet are built up. Break- Even Analysis
Break-even analysis is the analysis of costs in relation to volume of sales and impact of the same
Types of Budgets
on profits. It states the impact of changes in the volume of sales on profits. This analysis considers variable
The various types of budgets are as follows: costs (like direct materials cost, direct wages, etc.) and fixed costs (like factory and office rent, manager’s
salary, etc.), and determines the volume of sales at which costs will be fully covered and beyond which
Expense Budget profits will be earned.
This budget lays out the estimates of operating expenses of an enterprise for a given period. Fixed cost
BEP =
Selling price per unit − Variable cost per unit
Revenue Budget
47 48
PERT and CPM undertaken by management as self-audit, or may be carried out with the help of management
PERT (Programme Evaluation and Review Technique) and CPM (Critical Path Method) are the two consultants. Sometimes, the management audit is carried out to a specific section of the organization
important techniques used in both planning and controlling. instead of comprehensive audit to determine the efficiency of that particular section only.
In these techniques, a project is broken up into a set of independent and predictable activities.
The predecessor-successor relationships of the activities are established from start to completion thus Management Information System (MIS)
defining the complete project. The time needed to complete each activity is analyzed, and thus the MIS is a computer based information system which provides accurate, timely and up-to-date
completion time of the project is estimated. Bottleneck activities can also be identified that have a critical information to the managers for taking various managerial decisions. Thus, it is an important
impact on the project completion date. communication tool as ell as an important control tool.
These techniques are used to monitor and control the progress of the project activities while
ensuring that each activity is being completed in their stipulated time and hence ensuring the timely Assignment:
completion of the project. Such techniques are mainly used in areas like construction projects, ship • Compare the characteristics of individual and group behavior in the perspective of organization
building, aircraft manufacture, etc. culture.

Return on Investment (RoI)

Return on Investment is a useful technique which is used to determine whether invested capital
has been used effectively for generating reasonable amount of return or not. RoI can be used to measure
overall performance of an organization or of its individual departments or divisions. It can be calculated
as,
Net income from sales
RoI =
Total investment

As can be seen, RoI can be increased either by increasing sales volume proportionately more than
total investment or by reducing total investment without having any reductions in sales volume.
RoI provides top management an effective means of control for measuring and comparing
performance of different departments. It also permits departmental managers to find out the problem
which affects RoI in an adverse manner.

Statistical Quality Control (SQC)

Statistical quality control is concerned with ensuring whether the quality of a product or service
is being maintained or if there is any variation in the specified size, weight, finish, etc. The main objective
of SQC is to keep the variation in quality within the control limit. In the technique of SQC, control is
exercised on the statistical data with the help of control charts. The statistical data is created by the
samples drawn from the different batches of production. The SQC process involves specifying the norm
of quality level and limits, and then plotting the statistical data on the control chart. If all the points in the
chart lie within the upper control limit and the lower control limit, then the process is said to be in control.
If points are outside the control limits, the matter is investigated for assignable causes.

Management Audit
Management audit refers to the systematic and impartial examination, analysis and appraisal of
the overall performance of management. The purpose is to review the efficiency and effectiveness of
management and to improve its performance in future periods. It is helpful in identifying the deficiencies
in the performance of management functions such as methods of operation and control, and the use of
physical and human resources. Thus, it has a preventive effect on deviations and mistakes because the
audit aims on updating of existing managerial policies and strategies in the light of environmental changes.
In a sense, it acts as a sort of conscience keeper of the organization. Management audit may be

49 50

MODULE 6 Productivity

Use of Computers and IT in Management Control Productivity is the quantitative relation between what we produce and we spent to produce them i.e. it
is the arithmetic ratio of amount produced (output) to the amount of resources utilized (input).
Computers and various types of information technologies are widely employed in any organization in the Productivity can be expressed as:
modern days for the purpose of collecting, storing and disseminating data in the form of information Productivity = Output / Input
needed to carry out the functions of management and hence controlling the various components of the Productivity refers to the efficiency of the production system. It is an indicator to how well the factors of
organization. This information system is termed as management information system (MIS). Computers production (land, capital, labour and energy) are utilized. Productivity is the measure of reduction in
permit fast and economical processing of large data without confusions and make them readily available wastage of resources like men, material, machine, time, space, capital etc.
for decision making.
How to Measure Productivity?
• MIS is defined as a system based on the database of the organization evolved for the purpose of
providing information to the people in the organization. Productivity may be measured either on an aggregate basis or individual basis. On aggregate basis, output
• MIS is defined as a system which provides information support for decision making in the is compared with all inputs taken together. This is called as total productivity. On individual basis, output
organization and helps in efficient management of the organization. is compared with any one of the input factor and this is called as partial productivity or factor productivity.
• MIS is also considered as the back bone of an organization which integrates different components
Total Productivity Measure (TPM)
of the organization by means of computers and communication channels.
It is based on all the inputs. The model can be applied to any manufacturing organization or service
The various functions of the computers in an MIS are as follows:
company.
1. Data Input: Appropriate data are input to the computer terminals from various internal and external
Total productivity = Total tangible output / Total tangible input
sources of organization.
Total tangible output = Value of finished goods produced + Value of partial units produced + Dividends
2. Processing of Data: The input data is processed to convert into required information. Processing of data
from securities + Interest + Other income
is done by such activities as calculating, sorting, classifying, and summarizing.
Total tangible input = Value of (human + material + capital + energy + other inputs) used.
3. Storage of Information: Computers store the processed or unprocessed data for future use. If any
The word tangible here refers to measurable. The output of the firm as well as the inputs must be
information is not immediately required, it is saved for later use. A computer has large capabilities for
expressed in a common measurement unit. The best way is to express them in monetary terms.
data storage.
4. Retrieval of Information: Computer retrieves information from its data storage as and when required Partial Productivity Measures (PPM)
by various users.
5. Dissemination of Information: The processed information is disseminated to the users in the Depending upon the individual input partial productivity measures are expressed as:
organization through computer terminals and appropriate information technologies. Thus, they Partial productivity = Total output / Individual input
provide an information support for decision making in the organization. 1. Labour productivity = Total output / Labour input; Labour input is measured in terms of man-hours
2. Capital productivity = Total output / Capital input
3. Material productivity = Total output / Material input
4. Energy productivity = Total output / Energy input

Productivity Improvement Techniques

An improvement in the productivity would reflect when more output could be produced with a reduced
level of input. Rise in productivity results in higher production which has direct impact on the profit of the
organization and hence standard of living of the workers also gets better. Higher productivity also helps
to reduce cost per piece which make product available at cheaper rate. Thus, it is beneficial for consumers
as well. Higher productivity requires elimination of wastage in all forms such as wastage of raw materials,
wastage of time in case of men and machinery, wastage of space, etc. This could be achieved through
improved methods, investment in machinery and technology, improved quality, and improvement
techniques and manufacturing strategies.

51 52
o Improvement in Labour productivity: The labour productivity depends upon how the workers are • In-process inventories – These are the semi finished goods at various stages of manufacturing cycles.
utilized. Various techniques can be employed to improve labour productivity such as balancing of It is also called work-in-process (WIP).
work load, installation of efficient material handling system, formation of efficient workshop layout, • Indirect inventories – They include lubricants and spare parts needed for smooth operation, repair
motivation of the employees, training and education of the employees, enhancing the level of working and maintenance during manufacturing cycle.
condition, etc.
o Improvement in Material productivity: A manufacturing system converts raw material into finished
product with the help of mechanical or chemical processes. Material productivity depends upon how
material is effectively utilized in its conversion into finished product. Material productivity can be
improved by reducing the percentage of rejection, creation of scrap, level of spoilage, obsolescence
of materials, etc.
o Improvement in Machine Productivity: A manufacturing system converts raw material into finished
product through mechanical or chemical process with the help of machines and equipments. Machine
productivity can be increased by increasing the availability of the machines and minimizing the break
Importance of Inventory
down time of the machines, ensuring the availability of power, enhancing the skill of workers,
appropriate machine layout, etc. • To avoid the situation of stock out
• To prevent the loss of sales in high demand period
Direct and Preventive Control
• To take advantages of price discount
Controls are necessary to check whether the performance conforms to the plans prepared by the • To stabilize/smoothen the manufacturing operations
organization. In this context, two types of control approaches are exercised: direct control and preventive • To allow flexibility in production schedules
control.
Disadvantages of Inventory
Direct control
• Cost of inventory
Direct control is carried out once the deviations from the plans are observed and then corrective
• Inventory holding cost
steps are taken to rectify them. The procedure traces the causes of the deviations, determines the persons
• Ordering cost
responsible for the deviations, and gets them to correct their practices.
• No return from obsolete inventory
Preventive control
The basic philosophy of preventive control is that the best way to correct deviations is not to let Inventories are held at a specific location at a specific time to fulfill several important functions within or
these take place at all. Preventive control focuses on anticipating occurrence of possible deviations and outside the company but at the same time, inventory incurs a large amount working capital (as much as
preventing them. The principle of preventive control is to develop better managers who can manage 40%). It is, therefore, necessary to manage optimum level of inventories of various kinds for efficient
problems from a wider and intelligent perspective. In a preventive control system, it is assumed that highly operation of the system. Thus, an effective inventory management is a must for smooth and efficient
qualified managers make fewer mistakes and most of the deviations can be overcome by applying the running of an organization with least interruptions. Inventory management can be defined as “a planned
fundamentals of management. Hence, here manager’s management skill and knowledge is questioned if approach of determining what to order, when to order and how much to order and how much to stock so
any deviation is traced. that costs associated with buying and storing are optimal without interrupting production and sales”.

Inventory Management Importance of Inventory Management

Inventory generally refers to the materials in stock which are yet to be utilized. Inventory is the set of 1. To stabilize production: The demand for an item is not constant (sometimes high and sometimes low).
items that an organization holds for later use. It is also called the idle resource of an enterprise. Inventory Inventories of raw materials and components should be made available to the production as per the
may be classified as follows: demand failing which results in stock out and the production stoppage takes place due to lack of raw
materials. Hence, the inventory is kept to take care of this fluctuation so that the production is
• Raw inventories – These include raw materials and semi-finished products supplied by another firm smooth.
which are raw materials for the present industry. 2. To take advantage of price discounts: Usually the manufacturers offer discount for bulk buying and to
• Finished inventories – These are finished products lying in warehouse and waiting dispatch. gain this price advantage the materials are bought in bulk even though it is not required immediately.
Thus, inventory is maintained to gain economy in purchasing.

53 54

3. To meet the demand during the replenishment period: The lead time for procurement of different The classification of existing inventory is based on the consumption during the period and the value of the
materials often varies, so inventory is maintained to meet the demand to ensure the availability of items to be consumed in that period that is obtained by multiplying the item unit cost by the consumption
the materials on time. quantity in that period. The items are then arranged in the descending order of their inventories holding
4. To prevent loss of orders (sales): In this competitive scenario, a company cannot afford to miss the cost.
delivery schedule which may result in loss of sales. To avoid these losses, organizations have to
maintain inventory. Usually, the ABC analysis picks up 20% of the total inventory holding 70% of the total inventory investment
5. To keep pace with changing market conditions: The organizations have to anticipate the changing to A items, next about 35% of the inventory forms B category accounting for 20% of the total inventory
market sentiments and they have to stock materials in anticipation of non-availability of materials or cost while C items represent 45% of the total inventory contributes only 10% to the total inventory cost.
sudden increase in prices. Because A items are expensive and constitutes a major portion of the revenue, an optimal policy that
6. To fulfill miscellaneous criterion: Sometimes the organizations have to stock materials due to other minimize the investment in A items should be perused. These items should be monitored continually while
reasons like supplier’s minimum quantity condition or seasonal availability of materials. more sophisticated forecasting procedures are adopted. C items should be overstocked, if necessary,
while exercising a minimal degree of control on these items. Large lot sizes of C items could be also used
Objectives of Inventory Management to minimize the frequency of ordering. Judgment is exercised in handling B items. Usually, some of these
items are treated like A items while rest are treated like C items. B items could be reviewed periodically
• To ensure adequate supply of products to customer and avoid shortages as far as possible and these items could be ordered in small quantities or groups.
• To ensure no stock out of raw materials and hence smooth and uninterrupted production
• To minimize the financial investment in inventories Category Percentage of Percentage of
• To maintain timely record of inventories of all the items items inventory cost
• To maintain the stock within the desired limits and to take timely action for procurement A 20 70
• To provide a basis for both short-term and long-term planning of materials B 35 20
• To provide a reserve stock for variations in lead times of delivery of materials C 45 10

Benefits of Inventory Management

• Improvement in customer’s relationship because of the timely delivery of goods and service
• Smooth and uninterrupted production
• Efficient utilization of working capital
• Economy in purchasing
• Helps in minimizing loss due to deterioration, obsolescence damage and pilferage
• Eliminates the possibility of duplicate ordering

Inventory Management Techniques

The different techniques of inventory control are:

(1) ABC analysis, (2) HML analysis, (3) VED analysis, (4) FSN analysis, (5) GOLF analysis and (6) SOS analysis

1. ABC Analysis

The most widely used method of inventory control is known as ABC analysis. In this technique, the total 2. HML Analysis
inventory is categorized into three sub-heads A, B and C, hence named as ABC analysis. In this analysis, the classification of existing inventory is based on unit price of the items. They are
• A items: The items being of high value; expensive items require very tight control and need special classified as high price, medium price and low cost items.
care. The control need be exercised at higher level of authority.
• B items: The items being of moderate value; would require standard care. The control need be 3. VED Analysis
exercised at middle level of authority. In this analysis, the classification of existing inventory is based on criticality of the items. They are
• C items: The items being of low value; would be classified as the bulk of the firm’s inventory; relatively classified as vital, essential and desirable items. It is mainly used in spare parts inventory.
inexpensive require little care. The control can be exercised at the lower level of authority.
55 56
4. FSN Analysis
In this analysis, the classification of existing inventory is based consumption of the items. They are
classified as fast moving, slow moving and non-moving items.

5. GOLF Analysis
In this analysis, the classification of existing inventory is based sources of the items. They are classified
as Government supply, ordinarily available, local availability and foreign source of supply items.

6. SOS Analysis
In this analysis, the classification of existing inventory is based nature of supply of items. They are
classified as seasonal and off-seasonal items.

For effective inventory control, combination of the techniques of ABC with VED or ABC with HML or VED
with HML analysis is practically used. D = Annual demand of the inventory item (in units)
O = Ordering cost for a single order
Inventory Control Model H = Holding cost per unit inventory per year
Q = Number of units in each order
Economic Order Quantity (EOQ) Q = Economic Order Quantity (EOQ)
The EOQ model addresses “how much to order” and determine the optimal order size. Economic order
Under the above assumptions, the graph of inventory usage over time has a saw tooth shape as shown in
quantity is the order quantity that minimizes total holding and ordering costs.
the figure. Q represents the amount that is ordered. Because demand is constant over time, inventory
drops at a uniform rate over time. When the inventory level reaches 0, the new order is placed and
received, and the inventory level again jumps to Q. This process continues indefinitely over time. Hence,
the average inventory on hand can be suitably considered as Q/2.

The inventory costs can be calculated as follows:

Annual holding cost = Average inventory level  Holding cost per unit inventory per year
𝑄
𝐴𝑛𝑛𝑢𝑎𝑙 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 = × 𝐻
2

Annual ordering cost = Number of order placed in a year  Ordering cost per order
Annual demand
= × Ordering cost per order
Number of units in each order
Assumptions for calculating EOQ: 𝐷
𝐴𝑛𝑛𝑢𝑎𝑙 𝑜𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 = × 𝑂
• Demand is known and constant. 𝑄
Annual inventory cost (C) = Annual holding cost + Annual ordering cost
• Lead time is known and constant.
• Receipt of inventory is instantaneous and complete. 𝑸𝑯 𝑫𝑶
• Quantity discounts are not possible. 𝑪= +
𝟐 𝑸
• The inventory cost is composed of two variable costs; holding cost and ordering cost.
The inventory cost will be minimum, when Q = Q and dC/dQ = 0
• Stock-outs can be completely avoided.
𝒅𝑪 𝑯 𝑫𝑶
= −
𝒅𝑸 𝟐 (𝑸 )𝟐

𝑸 = √𝟐𝑫𝑶⁄𝑯

57 58

MODULE 7 Choice of factor will depend on relative merits and demerits of each source and period of financing.
However, if finance is needed for short term periods then banks, public deposits and financial
Financial Management
institutions may be the appropriate. On the other hand, if long term finance is required then share
Financial management is primarily concerned with maximize the organization’s wealth. It includes the capital and debentures may be the useful
optimal procurement of finance (revenue generation) as well as the usage of finance (allocation of fund).
4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so
For optimal procurement, different available sources of finance are identified and compared in terms of
that there is safety on investment and regular returns is possible. The funds will have to be spent first
their costs and associated risks. Similarly, the finance so procured needs to be invested in a manner that
on fixed assets and then an appropriate portion will be retained for working capital and for other
the returns from the investment exceed the cost at which procurement has taken place. Financial
requirements.
management aims at reducing the cost of funds procured, keeping the risk under control and achieving
effective deployment of such funds. It also aims at ensuring availability of enough funds whenever 5. Disposal of surplus: The utilization of profits or surpluses is also an important factor in financial
required as well as avoiding idle finance. It has a direct impact on the financial health of a business. management. A judicious use of surpluses is essential for expansion and diversification plans and also
in protecting the interests of share holders. This includes the following two decisions:
Financial management is concerned with the solution of three major issues relating to the financial
a. Dividend declaration - It includes deciding the rate of dividends and other benefits like bonus.
operations of a firm corresponding to the three questions of investment, financing and dividend decision.
b. Retained profits – This is the part of the profit to be retained to invest back in the expansional,
The investment decisions are concerned with the deployment of the firm’s funds or resource in different innovational, diversification plans of the company.
assets so that they are able to earn the highest possible return on their investments.
6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash
is required for many purposes like payment of wages and salaries, payment of electricity and water
Financing decision is concerned with the procurement of finance in the interest of the organization. It
bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw
involves the identification of various available sources and the decisions that how much fund to be raised
materials, etc.
from which source since each source of finance is associated with a financial risk.
7. Financial controls: The function of financial management is not only to plan, procure and utilize the
Dividend decision is the decision related to the distribution of dividend. Dividend is that portion of profit
funds but also to exercise control over finances. This can be done through many techniques like ratio
which is distributed to shareholders. The decision involved here is how much of the profit earned by
analysis, break even analysis, financial forecasting, cost and profit control, internal audit, rate of
company (after paying tax) is to be distributed to the shareholders and how much of it should be retained
return etc.
in the business. The extent of retained earnings also influences the financing decision of the firm.

Functions of Financial Management

1. Estimation of capital requirements: The first function of a finance manager is to make estimation short
term and long term financial requirements of the company. For that, he will prepare a financial plan
for present as well as for future. The amount required for purchasing fixed assets as well as needs for
working capital will have to be ascertained considering the policies of a concern. Estimations have to
be made in an adequate manner which increases earning capacity of enterprise.

2. Determination of capital composition: Once the estimations have been made, the capital structure
have to be decided. This involves short- term and long- term debt equity analysis. For example, may
it be wise to finance fixed assets through long term debts or to rent it? Long term funds should be
employed to finance working capital also, if not wholly then partially. The decision will depend upon
the proportion of equity capital a company is possessing and additional funds which have to be raised
from outside parties.

3. Choice of sources of funds: There are many choices a company has for procurement of funds such as:
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

59 60
Definition of Cost Direct expenses: These are the expenses which are attributed directly to a particular job. All direct cost
other than direct material and direct labour are termed as direct expenses. Some examples of the
Cost refers the monetary measure of the resources given up to achieve some objectives such as obtaining direct expenses are hire of special machinery, cost of special designs, moulds or patterns, fee paid to
a good or service. consultants, cost of patents and royalties, etc.

Elements of Cost Indirect expenses: These expenses cannot be attributed directly to a particular job. Indirect expenses are
also treated as overheads. Rent, rates and taxes of building, repair, insurance and depreciation on
The total cost of manufacturing a product is composed of:
fixed assets, etc, are some examples of indirect expenses.
a. Cost of material
b. Cost of labour Overheads
c. Expenses and Overheads
The term overhead has a wider meaning than the term indirect expenses. Overheads include the cost of
Cost of Material indirect material, indirect labour and indirect expenses. This is the aggregate sum of indirect material,
indirect labour and indirect expenses.
It is the cost of materials required for manufacturing a product. It consists of:
Overhead = Indirect material + Indirect labour + Indirect expenses
a. Cost of direct materials
b. Cost of indirect materials Overheads are classified into following three categories:
a. Factory overheads
Cost of direct materials: It is the cost of materials which are processed through various stages to obtain
b. Office and administrative overheads
the final product or a component of the product. These materials are termed as direct materials. It is
c. Selling overheads, and
also described as raw material, process material, prime material, production material, etc.
d. Distribution overheads
Cost of indirect materials: It is the cost of materials which are essentially needed to convert the direct
Factory overheads:
(raw) material into finished (final) product but not the integral part of finished product. Such materials
All indirect costs incurred in the factory for production of goods are termed as factory overheads.
cannot be related with a particular product, job, process, and activity e.g. cutting tools, lubricant,
Such costs are concerned with the running of the factory or plant. These include indirect material,
coolant, stationary, etc.
indirect labour and indirect expenses incurred in the factory. Some examples are as follows:
Cost of Labour • Expenses incurred on indirect materials like grease, oil, lubricants, cotton waste, small tools,
brushes for sweeping, polishing materials, etc.
For conversion of raw material into finished goods, human resource is needed, and such human resource • Expenses on indirect labour such as salaries of factory manager, foremen, supervisors, clerks,
is termed as labour. Labour cost can be classified into two categories: storekeeper, etc.
a. Cost of direct labour • Contribution to ESI, PF, leave pay of factory employee and other labour welfare activities
b. Cost of indirect labour • Indirect expenses such as rent of factory buildings and land, power and fuel used in factory, repair
and maintenance of plant and machinery
Cost of direct labour: Direct labour cost consists of wages paid to the workers directly engaged in the
• Depreciation of factory building, plant and machinery
manufacturing of the product such as wages paid to machine operator, welder, carpenter, etc. Direct
labour is also known as process labour, productive labour, operating labour. Office and Administrative overheads
These expenses are incurred for the management and administration of the business for efficient
Cost of indirect labour: The wages paid to the labour which are not directly engaged in converting raw
and proper functioning of the enterprise. For example:
material into finished product but they help the direct labour in performing their duties in efficient manner
• Office printing and stationery,
such as supervisor, store keeper, cleaner, helper, watchman, etc.
• Salary of administrative directors, office managers, clerks and other employees,
Expenses • Salary of legal adviser, consultants
• Salaries of cost accountants and financial accountants,
All cost incurred in the production of finished goods other than material cost and labour cost are termed • Rent, insurance, rates and taxes of office building,
as expenses. Expenses are classified into two categories: • Office lighting, heating and cleaning,
a. Direct expenses • Telephone charges, Audit fee etc.
b. Indirect expenses
61 62

Selling overheads Classification of Cost

Selling overheads are related with the marketing of the product. They include all such expenses which
are incurred for creating and enhancing the demand for the product. Followings are some examples: Costs can be classified in different ways.
• Salaries of sales managers, salesmen, technical representatives, clerks and other employees in
sales department 1. According to the nature of expenses
• Travelling expenses and commission of sales representatives
• Outlay costs: The actual expenses incurred in employing inputs are called outlay costs. These include
• Rent and insurance of showroom
costs on payment of wages, rent, electricity or fuel charges, raw materials, etc. These are treated as
• Expenses on market research and advertising
general expenses for the business.
Distribution overheads • Opportunity costs: Opportunity costs are the lost incomes that could have been earned from the
These overheads include al the expenses made on holding the finished goods and dispatching them next best alternative that is foregone. These costs calculate the income by the missed opportunity
to the customers. These expenses generally include: and calculate the losses that could be prevented by following the missed opportunity.
• Cost of packing material and packing expenses
2. According to the traceability to the product
• Godown rent, insurance, depreciation, and repair etc.
• Salaries of godown employees and logistic staffs • Direct/Traceable Cost: Direct costs are those which can be related to a specific process or product.
• Freight carriage outwards and other transport charges. They are also called traceable costs as we can directly trace them to a particular activity, product or
• Running expenses of delivery vans, repair, and depreciation. process. Examples of direct costs include cost of direct material, direct labour, direct charges
• Insurance in transit etc. (special tool used for product) etc.
• Indirect/Untraceable Cost: Indirect costs are those which do not directly relate to a specific activity
Ladder of cost
or component of the business. Examples of indirect costs include rent, taxes, electricity charges
etc. Although we cannot trace indirect costs as part of the cost of a given product, they are equally
important because they affect overall profitability and without which the product could not be
manufactured.

3. According to management function

• Manufacturing costs: These are incurred in the factory to convert raw materials into finished
goods. It includes cost of raw materials used (direct materials), direct labor, and factory overhead.
• Nonmanufacturing costs: These do not incur in transforming materials to finished goods. These
include selling expenses (such as advertising costs, delivery expense, salaries and commission of
salesmen) and administrative expenses (such as salaries of executives and legal expenses).

4. According to the variability

• Fixed cost: Fixed costs are those which do not change with the volume of output. Fixed costs will
remain broadly the same regardless of the level of production. For examples: Cost of the factory
building and production equipment, insurance, property taxes, etc.
Selling price = Total cost + Profit • Variable cost: A variable cost is one that varies in proportion to the production output, i.e. as the
output increases, variable cost also increases. For examples: direct labor, raw materials, and
electric power to operate the production equipment.
Variable cost α Output level
Total cost of production is calculated by adding both fixed cost and variable cost:
TC = FC + VC (Q)
Where, TC = total annual cost,
FC = fixed annual cost,
63 64
 VC = variable cost for Q units of production, and The intersection of total cost line and revenue line will be the break-even point. Break-Even point is the
Q = annual quantity produced no-profit no-loss point. The area between the two lines and below the break-even point is loss while the
Hence, production cost per unit = TC/Q area between these two lines and above the break-even point indicates the profit.

Break Even Analysis

Break-Even analysis is the study of relationship between the total cost and the output volume of a
company. It determines the level of the output at which all the expenses (both fixed and variable) done
by the company is recovered and the company starts making profit. It helps in profit forecasting and
planning for the company.

Calculation of Break-Even point

The Break-Even point (BEP) is the number of units of a product that should be produced to earn enough
revenue just to cover all the expenses (both fixed and variable) of production. This is also known as no-
profit no-loss point.

At Break-Even point,
Total revenue generated = Total cost of production
TR = FC + VC (Q)
SP (BEP) = FC + VC (BEP)
(SP - VC) BEP = FC
BEP = FC / (SP - VC)
Angle of incidence: It is the angle at which the revenue line intersects the total cost line. If this angle is
Problem: The fixed cost of a factory is Rs. 10,000, the selling price for one unit is Rs. 4 and the average
large, it will indicate that the profit is being made at high rate.
variable cost is Rs. 2 per unit, calculate the break-even point.
Margin of safety: It is the difference between the total volume of production/sales and the production at
Fixed costs = Rs. 10,000; Variable cost at Rs.2 per unit = 2Q
break-even point. The margin of safety must be kept high to earn high profit.
Total Cost = Rs. (10,000 + 2Q)
Total revenue at Rs. 4 per unit = 4Q Financial Statement
For BEP, Total revenue generated = Total cost of production
Hence, 4Q = (10,000 + 2Q); Q = 10,000 / (4-2) = 5,000 units. Financial statements are the reports prepared by a company’s management to ascertain the profits
Problem: A company is planning to manufacture a product. It’s estimated cost per year as follows: earned or losses incurred by the company during a specified period and also to ascertain its financial
Fixed cost / year = INR 1,00,000; Variable cost / unit = INR 100; Selling price /unit = INR 300 position at the end of that specified period. These reports are prepared to provide information on financial
(a) Calculate the BEP. performance of the company to its various stakeholders which include investors, tax authorities,
(b) Calculate the volume of output needed to be produced to get a profit of INR 50,000. government, employees, etc.

Break-Even Chart Financial statements serve the following important functions:

• They provide information on how the firm has performed in the past and what is the current
It is the graphical representation of the relationship between the cost and the output/sale volume. The financial position of the firm.
volume of production/sale is plotted along the X axis and the cost and revenue is plotted along the Y axis. • They provide necessary aid for planning the financial activities of the business and making proper
As the fixed cost is constant for any level of production, it is represented by a straight line parallel to the utilization of the funds.
X axis. The variable cost starts above the fixed cost line and it moves upward from left to right as the • They provide the basis for long term strategic decisions.
variable cost increases with the volume of production. Adding the variable cost to the fixed cost will state
the total cost of the production. The revenue line will start from the origin and move upward from left to
right as it also increases with the sale volume.

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Equity Shares: Equity shares are shares which do not enjoy any preferential right in the matter of payment
Financial statement of dividend or repayment of capital. The equity shareholder gets dividend only after the payment of
dividends to the preference shares. There is no fixed rate of dividend for equity shareholders. The rate of
dividend depends upon the surplus profits. In case of winding up of a company, the equity share capital is
refunded only after refunding the preference share capital Equity shareholders have the right to take part
in the management of the company. However, equity shares also carry more risk.
Profit loss Cash flow
Balance sheet 2. Debentures:
account statement

Whenever a company wants to borrow a large amount of fund for a long but fixed period, it can borrow
Balance Sheet
from the general public by issuing loan certificates called Debentures. The total amount to be borrowed
Balance sheet shows the financial position of the firm at a given point of time. The balance sheet lists the is divided into units of fixed amount. These units are called Debentures. These are offered to the public in
assets, liabilities and capital (or net worth) on a specific date. It may be regarded as a static picture of the the same manner as is done in the case of shares. The holders of debentures are the creditors of the
company on that date. company. A debenture is issued under the common seal of the company. It is a written acknowledgement
Balance sheets are prepared at least annually but may be done so more often and on specific occasions of money borrowed. It specifies the terms and conditions, such as rate of interest, time repayment,
when the need exists in the connection with making decisions concerning large project investment, security offered, etc.
dividend distribution, etc.
3. Public Deposits:
Profit and Loss Account General public also like to deposit their savings with a popular and well established company which can
The account, through which annual net profit or loss of a business is ascertained, is called profit and loss pay interest periodically and pay-back the deposit when due. The period for which a company may accept
account. Once the gross profit or loss of a business is ascertained through trading account, the net profit public deposits ranges between six months to three years.
is determined by deducting all indirect expenses (business operating expenses) from the gross profit
4. Retained earnings:
through profit and loss account.
Profit and loss account is prepared for a period of time and on the last day of an accounting period. The company usually does not distribute the whole of its profits among its shareholders. The portion of
Gross profits or losses are recorded on its credit side. In case of loss, it is presented by minus (-). All the the profits which is not distributed among the shareholders but is retained is called retained earnings.
indirect expenses are recorded on its debit side. Difference between the credit and debit indicates the net These retained earnings may be used to meet long term financial requirements.
profit or net loss. If the difference is positive, there is profit and if it is negative it shows the loss.
5. Loans from banks:
Cash Flow Statement
There are many commercial banks established by the governments which give long term loans at
The cash flow statement displays the sources and uses of cash during the period. reasonable rate of interest. It is a flexible source of finance as loans can be repaid when the need is met.
Also, the period of repayment of term loan can be extended up to certain periods. The loan process
Sources of Long Term Finance consumes less time and less cost compared to other sources such as shares, debentures etc.
The main sources of long term finance are as follows: Capital Budgeting

1. Shares: The word Capital refers to the total investment of a company in tangible and intangible assets, whereas
budgeting is the art of building budgets. Budgets are a blue print of a plan and action expressed in
Issue of shares is the main source of long term finance. A company divides its capital into units of a definite
quantities and manners. Hence, capital budgeting is also called “Investment decision”. Capital budgeting
face value. Each unit is called a share. A person holding shares is called a shareholder. The holders of
is the process of making investment decisions in various capital expenditures such as:
shares are the owners of the business. Shares may be of two types: (i) Preference shares and (ii) Equity
• Purchase of fixed assets such as land and building, plant and machinery, good will, etc.
shares.
• The expenditure relating to addition, expansion, improvement and alteration to the fixed assets.
Preference Shares: Preference shares are the shares which carry preferential rights. These rights are (a) • The replacement of fixed assets.
receiving dividends at a fixed rate, (b) getting back the capital in case the company is wound-up. • Research and development project.
Investments in these shares are safe and a preference shareholder also gets dividend regularly.
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Capital budgeting decisions are very crucial for any business since they affect its earning capacity in the Capital Budgeting Techniques (or) Project Evaluation Techniques
long run. These decisions normally involve huge amounts of investment and it is often almost impossible
At each point of time a business firm has a number of proposals regarding various projects in which it can
for a business to wriggle out of such decisions except at a huge cost. Therefore, they need to be taken
with utmost care. invest funds. But the funds available with the firm are always limited and it is not possible to invest funds
in all the proposals at a time. Hence, it is very essential to select from amongst the various competing
Need and Importance of Capital Budgeting proposals, those which give the highest benefits. There are many methods of evaluating profitability of
capital investment proposals. The various commonly used methods are as follows:
1. Huge investments: Capital budgeting requires huge investments of funds. Hence, the firm must prepare
(A) Traditional methods: These methods do not take into consideration the time value of money.
a control plan for its capital expenditure before investing.
(1) Pay-back period method
2. Long-term: Capital expenditure is long-term in nature or permanent in nature. Therefore financial risks (2) Post pay-back method
involved in the investment decision are more. Hence, it needs careful planning of capital budgeting. (3) Accounting or Average rate of return method
(B) Time-adjusted method or Modern methods: These methods do not take into consideration the time
3. Irreversible: The capital investment decisions are irreversible and are not changed back. Once the value of money considering the fact that a rupee earned today has more value than a rupee earned
decision is taken, it is very difficult to come out without involving huge losses. after five years.
(4) Net present value method
4. Long-term effect: Capital budgeting not only reduces the cost but also increases the revenue in long- (5) Profitability index method
term. It brings significant changes in the profit of the company by avoiding over or more investment (6) Internal rate of return method
or under investment. Over investments refers to be less utilization of the assets and vice-versa.
Therefore before making the investment, it is required carefully planning and analysis of the project 1. Pay-Back Period Method
thoroughly.
The ‘pay-back’ sometimes called as pay-out or pay-off period method represents the period in which the
Capital Budgeting Process total investment in permanent assets pays back itself. This method is based on the principle that every
capital expenditure pays itself back within a certain period out of the additional earnings generated from
1. Project generation the capital assets.
2. Project evaluation Under this method, various investments are ranked according to the length of their payback period in
3. Project selection such a manner that the investment within a shorter payback period is preferred to the one which has
4. Project execution longer pay back period. It is one of the non- discounted cash flow methods of capital budgeting.

1. Project generation Initial investment

Payback period =
• Identification of Investment Proposals Annual cash inflow
• Screening the Proposals
2. Project evaluation Merits
• Evaluation of various proposals in terms of their profitability (Various methods such as payback • It is easy to calculate and simple to understand.
period method, rate of return method, net present value method, internal rate of return method • Pay-back method provides further improvement over the accounting rate return.
are used for this purpose) • Pay-back method reduces the possibility of loss on account of obsolescence.
3. Project selection
• Prioritize the accepted proposals after considering their urgency, risk and profitability Demerits
• Approval and preparation of capital expenditure budget to procure the assets required for the • It ignores the time value of money.
accepted proposals during the budget period • It ignores all cash inflows after the pay-back period.
4. Project execution • It is one of the misleading evaluations of capital budgeting.
• Procurement of fund and procurement of assets for implementation of the proposal
• Performance review of the proposal through post completion audit such as comparing the actual Accept /Reject Criteria
return from the investment with the anticipated return or any unfavorable variances that should If the actual pay-back period is less than the predetermined pay-back period, the project would be
be looked into and the causes of the same are identified so that corrective action may be taken accepted. If not, it would be rejected.
in future
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2. Post Pay-Back Profitability Method Net present value method is one of the modern methods for evaluating the project proposals. In this
method cash inflows are considered with the time value of the money. The future value of the cash inflow
This method is the improvement of traditional pay-back period method. One of the serious limitations of is converted into present value of cash inflow. Net present value is the difference between the total
pay-back period method is that it does not take into account the cash inflows earned after pay-back period present values of future cash inflows and the total present value of the investment.
and hence the true profitability of the project cannot be assessed. Hence, an improvement over this
method is made by taking into account the return receivable beyond the pay-back period. Thus, this NPV = Total present value of cash inflows − Net investment
method takes into account the earnings expected from the investment over their estimated life.
Merits
Post payback profitability = Cash inflow during estimated life − Original investment • It recognizes the time value of money.
• It considers the total benefits arising out of the proposal.
Post payback profitability
Post payback profitability index = • It is the best method for the selection of mutually exclusive projects.
Original investment
• It helps to achieve the maximization of shareholders’ wealth.
3. Average Rate of Return (ARR) Method
Demerits
This method also takes into account the revenue expected from the investment over their whole life but • It is difficult to understand and calculate.
the revenue is calculated using the accounting concept of profit (net profit after tax and depreciation) • It needs the discount factors for calculation of present values.
rather than cash inflows. According to this method, various projects are ranked in order of the rate of • It is not suitable for the projects having different effective lives.
earnings or rate of return. The project with the higher rate of return is ranked higher than the one with
lower rate of return. Accept/Reject criteria
In this method, average profit after tax and depreciation is calculated and then it is divided by the total If the present value of cash inflows is more than the present value of cash outflows, it would be accepted.
investment in the project. If not, it would be rejected.

Average annual profit 5. Profitability Index (PI) Method

ARR = × 100
Net investment in the project
The Profitability Index (PI) is the ratio of the present value of change in operating cash inflows to the
Average annual profit = Total annual profit − tax & 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 present value of investment cash outflows instead of the difference between the two present values as
used in NPV. Hence, PI is a variation of NPV. By construction, if the NPV is zero, PI is one.
Merits
• It is easy to calculate and simple to understand. Total Present value of cash inflows
PI =
• It is based on the accounting information rather than cash inflow. Net Investment
• It is not based on the time value of money.
• It considers the total benefits associated with the project.
6. Internal Rate of Return (IRR) Method
Demerits
This method is popularly known as time adjusted rate of return method/discounted rate of return method
• It ignores the time value of money.
also. The internal rate of return is defined as the interest rate that equates the present value of expected
• It ignores the reinvestment potential of a project.
future receipts to the cost of the investment outlay. This internal rate of return is found by trial and error.
• Different methods are used for accounting profit. So, it leads to some difficulties in the calculation
First we compute the present value of the cash-flows from an investment, using an arbitrarily elected
of the project.
interest rate. Then we compare the present value so obtained with the investment cost. If the present
value is higher than the cost figure, we try a higher rate of interest and go through the procedure again.
Accept/Reject criteria
Conversely, if the present value is lower than the cost, lower the interest rate and repeat the process. The
If the actual accounting rate of return is more than the pre-determined required rate of return, the project
interest rate that brings about this equality is defined as the internal rate of return. This rate of return is
would be accepted. If not, it would be rejected.
compared to the cost of capital and the project having higher difference, if they are mutually exclusive, is
adopted and other one is rejected. As the determination of internal rate of return involves a number of
4. Net Present Value (NPV) Method
attempts to make the present value of earnings equal to the investment, this approach is also called the
Trial and Error Method. Internal rate of return is time adjusted technique and covers the disadvantages
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of the Traditional techniques. In other words it is a rate at which discount cash flows to zero. It is expected Capital and Revenue Expenditure
by the following ratio
Capital Expenditure refers to the expenditure incurred for acquiring fixed assets or assets which increase
Steps to be followed: the earning capacity of the business. The benefits of capital expenditure to the firm extend to number of
years. Examples of capital expenditure are expenditure incurred for acquiring a fixed asset such as
Step 1: Find out factor F calculated as follows: building, plant and machinery etc.

Initial investment Revenue expenditure, on the other hand, is an expenditure incurred in the course of normal business
F=
Cash inflow transactions of a concern and its benefits are availed of during the same accounting year. Salaries, carriage
Step 2: Find out positive net present value etc. are examples of revenue expenditure.
Step 3: Find out negative net present value Difference between capital expenditure and revenue expenditure
Step 4: Find out formula net present value
Basis of Capital expenditure Revenue expenditure
Positive net present value
IRR = Bse factor + × DP Difference
Difference in positive and negative net present value
Purpose It is incurred for acquiring of fixed It is incurred for the maintenance of fixed
Base factor = Positive discount rate assets. assets.
DP = Difference in percentage Earning It increases the earning capacity of It helps in maintaining the earning capacity
capacity the business. of the business intact.
Merits Periodicity of Its benefits are spread over a number Its benefits accrue only in one accounting
• It considers the time value of money. benefit of years. year.
• It takes into account the total cash inflow and outflow. Placement in It is an item of Balance Sheet and is It is an item of Trading and Profit and Loss
• It does not use the concept of the required rate of return. financial shown as an item of asset. Account and is shown on the debit side of
• It gives the approximate/nearest rate of return. statements either of the two.
Occurrence of It is non-recurring in nature. It is usually a recurring expenditure.
Demerits expenditure
• It involves complicated computational method.
• It produces multiple rates which may be confusing for taking decisions. Capital and Revenue Receipts
• It is assume that all intermediate cash flows are reinvested at the internal rate of return.
Capital receipts are receipts which do not arise out of normal course of business. Examples of such receipts
Accept/Reject criteria are sale of fixed assets, and raising of loans etc. Such receipts are not treated as income of the enterprise.
If the present value of the sum total of the compounded reinvested cash flows is greater than the present
Revenue receipts are receipts which arise during the normal course of business, Sale of goods, rent from
value of the outflows, the proposed project is accepted. If not, it would be rejected.
tenants, dividend received, etc. are some of the examples of revenue receipts. They are the items of
incomes of the business entity.

Investment decision can be long-term or short-term. A long-term investment decision is called a Capital
budgeting decision while short-term investment decisions are called Working capital decisions.

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Capital budgeting decisions are very crucial for any business since they affect its earning capacity in the
long run. For example: making investment in a new machine to replace an existing one or acquiring a new
fixed asset or opening a new branch, etc. These decisions normally involve huge amounts of investment
and it is often almost impossible for a business to wriggle out of such decisions except at a huge cost.
Therefore, they need to be taken with utmost care.

Short-term investment decisions (Working capital decisions) are concerned with the decisions about the
levels of cash, inventory and receivables. These decisions affect the day-to-day working of a business.
These affect the liquidity as well as profitability of a business. Efficient cash management, inventory
management and receivables management are essential ingredients of sound working capital
management.

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