Question

Explain why the four steps involved in the control function are important. How are the various ratios used by accountants and managers differently in the control function?

Answer 1

Answer-

The 4 steps and their importance in the controlling function are:

(1) establishing standards - standards are the benchmarks. Managers aims to achieve or better the set standards. For eg. in a manufacturing process, the standard is 200 hours of overtime in a month. The managers will look at this standard and try to achieve overtime hours of 200 hours or less in a particular month. Benchmarking is important as it helps the management evaluate their performance against a standard.

(2) Measuring performance - This step involves the measurement of actual perfromance. How much was the actual overtime hours in a month has to be determined in order to analyse the firm's efficiency.

(3) Comparing the actual performance with expected perfromance - this step is the analysis of the deviation of the actual results from the standard. If the actual overtime was 250 hours, the management has to ask why there was the extra 50 hours of overtime. This step is important is it gives the management a picture of the firm's efficiency.

(4) Correcting the differences - in the last step, the management will look at ways as to how to reduce the gap between the benchmark and the actual results. This step is very important to improve a firm's efficiency by taking actions to reduce wastes, bottlenecks, errors etc.

Ratios like current ratio, debt to equity ratio, profitability margins etc are very important to the controlling function.

Take the example of operating profit margin. It is sales - COGS - sg&a expenses. In the steel manufactring industry, the standard operating profit margin is 25%. So, any steel making firm will use this benchmark to guage their margins. If their operating profit margin is greater than 25%, the company has done good by achieving a higher margin than the benchmark.

Hence, it is imperative that there should be a good understanding of these ratios in order to assess the actual performance vis a vis the standard and then improve the actual performance.

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