Unit – III

INVESTMENT DECISIONS & FUNDAMENTALS OF MANAGEMENT

Time value of money:

Definition: The idea that money available at the present time is worth more than the same
amount in the future due to its potential earning capacity. This core principle of finance holds
that, provided money can earn interest, any amount of money is worth more the sooner it is
received. It also referred to as "present discounted value".

If an investor invests a sum of ` 100 in a fixed deposit for five years with an interest rate of 15%
compounded annually, the accumulated amount at the end of every year will be as shown in table
– 1 below.

Table – 1 Compound amounts (amount of deposit = ` 100.00)

Year end Interest (`) Compound amount (`)

0 100.00
1 15.00 115.00
2 17.25 132.25
3 19.84 152.09
4 22.81 174.90
5 26.24 201.14

The formula to find the future worth in the third column is

F = PX(1+i)n

Where

P = Principle amount invested at time 0,

F = Future amount,

i = Interest rate compounded annually,

n = period of deposit.

The maturity value at the end of the fifth year is `201.14 this means that the amount ` 201.14 at
the end of the fifth year is equivalent to `100.00 at time 0 (i.e. at present). This is
diagrammatically shown in figure below. This explanation assumes that the inflation is at zero
percentage.
 201.14

0 1 2 3 4 5

100

Alternatively, the above concept may be discussed as follows:

If we want `100.00 at the end of the nth year, what is the amount that we should deposit now at a
given interest rate, say 15% A detailed working is shown in table – 2

Table – 2 Present worth amounts (rare of interest = 15%)

Year end Present worth (`) Compound amount after n

year(s)
0 100
1 86.96 100
2 75.61 100
3 65.75 100
4 57.18 100
5 49.72 100
6 43.29 100
7 37.59 100
8 32.69 100
9 28.43 100
10 24.72 100

The formula to find the present worth in the send column is

𝐹
P = (1+𝑖)𝑛

From table – 2 it is clear that if we want ` 100 at the end of the fifth year, we should now deposit
an amount of ` 49.72. Similarly, if we want ` 100.00 at the end of the 10th year. We should now
deposit an amount of ` 24.72.

Also, this concept can be stated as follows.

A person has received a prize from a finance company during the recent festival contest. But the
prize will be given in either of the following to modes:

1. Spot payment of ` 24.75 or

2. ` 100 after 10 years from now (this based on 15% interest rate compounded annually).
Capital: The order to start and run a business i.e., to produce and sell the goods or services,
money has to be invested. The money invested in the business in order to yield an income is
know as capital.

Need of Capital:

1. Purchasing Fixed Assets

2. Purchase of Raw Materials

3. To meet day-to-day expenditure

4. To promote a business

5. To conduct business operations smoothly

6. To wind up business

Function of Financing:

1) Investment Decision:

a) Capital Budgeting: Capital budgeting is long-term investment decision. It is most crucial

financial decision of firm. It relates to the selection of an asset or investment proposal or course
of action whose benefits are likely to be available in future over the lifetime of the project.

Ex: purchase of new Fixed Assets or Replacement of old assets

b) Working Capital Management: This short-term investment decision, working capital is

required for the day-to-day business activities of the enterprise. The important components of
working capital are inventories, receivables, and cash balances, which keep on circulating in
enterprises.

2) Financing Decision: Which is concerned with the financing-mix or capital structure or

leverage. The capital structure decides the blending of the owned and borrowed funds in the
total. Financial requirement it also implies determination of the sources, timing and procedure to
obtain funds which an enterprises needs for its long-term and short-term operation.

3) Dividend Policy Decision: The third major decision of finance manager is relating to
dividend policy. The firm has two alternatives with regard to management of profits of a firm.
Either they can be distributed to the shareholders in the form of dividends or they can be retained
in the business or even distributed some portion and retain the remaining the course of action to
be followed is a significant element in the dividend decision.

Need and Importance Of Capital Budgeting

Capital budgeting is the process of evaluating and selecting long-term investments that are
consistent with the goal of the firm. The need and importance of capital budgeting has been
explained as follows:

1. Long-term Implication

Capital expenditure decision affects the company's future cost structure over a long time span.
The investment in fixed assets increases the fixed cost of the firm which must be recovered from
the benefit of the same project. If the investment turns out to be unsuccessful in future or give
less profit than expected, the company will have to bear the extra burden of fixed cost. Such risk
can be minimized through the systematic analysis of projects which is the integral part of
investment decision.

2. Irreversible Decision

Capital investment decision are not easily reversible without much financial loss to the firm
because there may be no market for second-hand plant and equipment and their conversion to
other uses may not be financially viable. Hence, capital investment decisions are to be carried
out and performed carefully and effectively in order to save the company from such financial
loss. The investment decision which is undertaken carefully and effectively can save the firm
from huge financial loss aroused due to the selection of unfavorable projects.

3. Long-term Commitments of Funds

Capital budgeting decision involves the funds for the long-term. So, it is long-term investment
decision. The long-term commitment of funds leads to the financial risk. Hence, careful and
effective planning is must to reduce the financial risk as much as possible.

Classification Working Capital:

1) On the basis of concepts: on the basis of concept it is again classified into Gross Working
capital and Net Working Capital.

a) Gross Working Capital: In the broader sense the term working capital refers to the gross
working capital refers to the gross working capital. The notion of the gross working capital
refers to the capital invested in the total current assets of the enterprises.

b) Net Working Capital: In a narrow sense the term working capital refers to the net working
capital. Net working capital represents to excess of current assets and current liabilities.

2) On the basis of time: On the basis of time it is again classified in to Permanent working
capital and Temporary working capital.
a) Permanent or Fixed Working Capital: This is always a minimum level of current asset which
is continuously required by the enterprises to carry out its normal business operations and this
minimum is known as fixed working capital.

Ex: Every firm has to maintain a minimum level of raw material work-in-process, finished goods
and cash balance to the business operations smoothly and profitability.

b) Temporary or Variable Working Capital: This working capital, which is required to meet the
seasonal demands and some special exigencies.

Ex: Launching of extensive marketing campaigns and conducting research activities

Methods of Capital Budgeting: Method of capital budgeting are broadly classified into two
categories. There are further categorized into few types are shown below.

Capital budgeting

Traditional Methods Discount cash flow methods

1. Pay back period methods 1. Net present value (NPV) method

2. Accounting rate of return(ARR) 2. Internal rate of return method(IRR)

3. Profitability Index(PI)

Traditional Method:

1) Payback Period: Pay back period represent the number of years required to recover the
original investment. It also called as payoff period.

When project generates constant annual cash flows:

Original Cost of the project

Pay back period =
Annual cash inf lows

When project does generate constant annual cash flows

 Original Cost of the project − AACI for lower year
Pay back period = Lower year +
AACI for higher year − AACI for lower year

Note: Annual cash inflows is consider after tax and depreciation only

2) Accounting Rate of Return (ARR): The Average Rate of Return method of evaluating
proposed capital expenditure it is also known as the accounting rate of Return method. It is
based upon accounting information rather than cash flows.

This method based on accounting profit, takes into account the earnings expected from
investment over the entire lifetime of asset.

Average Annual Earning

ARR =  100
Average Investment

Total Annual Earnings After Tax and Depreciation

Average Annual Earning =
Expected Life of Asset

If there Scrap Value:

Net Investment
Average Investment =
2

If there is Scrap and Additional Capital:

Net Investment − Scrap Value

Average Investment = + Scrap Value + Additional Capital
2

Note : Project with highest ARR is preferred.

Discounted Cash Flow Method: This method is improved methods over the traditional
technique. Discounted cash flows are the future cash inflows reduced to their present value
based on a discounting factor. The process of reducing the future cash inflows to their present
value based on a discounting factor or cut-off returns is call discounting.

1) Net Present Method (NPV): Net present value refers to the excess of present value of future
cash inflows over and above the cost of original investment. It is takes into consideration the
time value of money.

NPV = Present Value of Cash inflows – Initial Investment

CF1 CF2 CFn

Pr esent Value Factor = + + .........
(1 + K ) (1 + k )2
(1 + k )n

Note: Which project gives highest value that project is accepted else rejected

2) Internal Rate of Return (IRR): This IRR for an investment proposal is that discount rate
which equates the present value of cash inflows with the present value of cash outflows of an
investment. In other wards IRR is rate at which sum of discounted cash inflows equal the sum of
discounted cash outflows. It can be also be defined as the rate which NPV equates to zero

P1 − Q
IRR = L + D
P1 − P2

L = Lower discount rate

P1= Present value of earning at lower rate

P2= Present value of earning at higher rate

Q = Annual Investment

D = Difference in rate of returns

Note: The project with greater or higher IRR is accepted.

3) Profitability Index (PI): Profitability Index is the ratio of present value of cash inflows to
the present value of cash outflows. It is also called benefit cost ratio.
 Pr esent value of cash inf lows
Pr ofitability Index =
Pr esent value of cash outflows

Note: When PI is greater than one, the proposal is accepted otherwise rejected.

Problems:

1) The proposals in respect of the following two projects are to be examined using a) Pay-back
method b) Accounting rate of return method

Initial investment of both projects = Rs.20,000

Estimated cash flows after tax are as follows.

Year Proposal -1 Proposal - 2

1 12,500 11,750

2 12,500 12,250

3 12,500 12,500

4 12,500 13,500

Solution:

Proposal – 1:

Pay-back period:

Since this proposal is generating constant annual cash inflows, pay-back period is given
by

Original Cost of the project

Pay back period =
Annual cash inf lows

20,000
Pay back period = = 1.6 years
12,500

ARR Method:

Average Annual Earning

ARR =  100
Average Investment
 50,000
Average Annual Earning = = 12,500
4

20,000 − 0
Average Investment = + 0 + 0 = 10,000
2

12,500
ARR =  100 = 125%
10,000

Proposal – 2:

Pay-back period:

Since this proposal has unequal cash inflows, pay-back period is given by

Original Cost of the project − AACI for lower year

Pay back period = Lower year +
AACI for higher year − AACI for lower year

Year Proposal - 2 AACI

1 11,750 11,750 AACI for Lower Year

2 12,250 24,000 AACI for Higher Year

3 12,500 36,500

4 13,500 50,000

Initial investment is lies between 1 year and 2 year

20,000 − 11,750
Pay back period = 1 + = 1.67 years
24,000 − 11,750

ARR Method:

Average Annual Earning

ARR =  100
Average Investment

50,000
Average Annual Earning = = 12,500
4

20,000 − 0
Average Investment = + 0 + 0 = 10,000
2
 12,500
ARR =  100 = 125%
10,000

2) Consider the case of the company with following two investment alternatives each costing
Rs.9 lakhs. The details of the cash inflows are as follows

Rs. In lakhs
Years
Project -1 Project - 2

1 3 6

2 5 4

3 6 3

The cost of capital is 10% per year. Which project will you choose under NPV and PI method?

Solution:

Project – 1:

NPV:

R 1
PV factor = = = 0.909 for first year like that for remaining years
(1+ R ) n
(1+ 0.1)1
Year Cash Inflows PV factor Present value of cash inflows

(1) (2) (3) (4 = 2x3)

1 300000 0.909 2,72,700

2 500000 0.825 4,13,000

3 600000 0.751 4,50,000

Present value of cash inflows 11,36,300

Present value of cash outflows 9,00,000

NPV 2,36,300
PI:

Pr esent value of cash inf lows

Pr ofitability Index =
Pr esent value of cash outflows

11,36,300
Pr ofitability Index = = 1.26
9,00,000

Project – 2:

NPV:

Year Cash Inflows PV factor Present value of cash inflows

(1) (2) (3) (4 = 2x3)

1 600000 0.909 5,45,400

2 400000 0.825 3,30,400

3 300000 0.751 2,25,300

Present value of cash inflows 11,01,100

Present value of cash outflows 9,00,000

NPV 2,01,100

PI:

Pr esent value of cash inf lows

Pr ofitability Index =
Pr esent value of cash outflows

11,01,100
Pr ofitability Index = = 1.22
9,00,000

NPV PI

Project – 1 2,36,300 1.26

Project – 2 2,01,100 1.22

According to NPV and PI shows highest value for project – 1 so project -1 is accepted.

3) A firm has an investment opportunity involving Rs.50,000. The cost of capital is 10%. From
the details given below find out the internal rate of returns and see whether the project is
acceptable.

Year Cash inflows

1 5,000
2 10,000
3 15,000
4 25,000
5 30,000
Solution:

P1 − Q
IRR = L + D
P1 − P2

PV @ Present value of PV @ Present value of

Year Cash Inflows
15% cash inflows 20% cash inflows

1 5000 0.870 4,350 0.833 4,165

2 10000 0.756 7,560 0.694 6,940

3 15000 0.658 9,870 0.579 8,685

4 25000 0.572 14,300 0.482 12,050

5 30000 0.497 14,910 0.402 12,060

Total 50,990 43,900

The present value of cash inflows at 15% is Rs.50,990 which is more than initial investment of
Rs.50,000 and at 20% Rs.43,900 which is less than the required one. Hence, the actual IRR lies
in between 15% and 20% and can be computed by way of interpolation as follows.

P1 − Q
IRR = L + D
P1 − P2

L = Lower discount rate - 15%

P1= Present value of earning at lower rate - Rs.50,990

P2= Present value of earning at higher rate - Rs.43,900

 Q = Annual Investment - Rs.50,000

D = Difference in rate of returns -5(20%-15%)

50,990 − 50,000
IRR = 15 + 5
50,990 − 43,900

990
IRR = 15 + D
7090

IRR = 15.7%

As the internal rate of return (IRR) is above the cost of capital (10%), the project is acceptable.

Introduction to Management: When human being started group activities for the attainment of
same common objectives whenever a group is formed and a group activity is organized to
achieve certain common objectives management is needed to direct, co-ordinate and integrate the
individual activities of a group and secure teams work to accomplish organizational objectives.
The objectives of all business are attained by utilizing the scare resources like men, materials,
machines, money etc.

In process of management, a manage uses human skills, material resources and scientific
methods to perform all the activities leading to the achievement of goods.

Definition: “Management is known exactly what you want men to do and then seeing that they
do it the best and cheapest ways”.

__F.W.Taylor

“Management is defined as the creation and maintenance of an internal environment in an

enterprise where individuals working together in groups, can perform efficiently and effectively
towards the attainment of group goals”.

__Koontz and O’Donell

Nature of Management: The study and application of management techniques in managing the
affairs of the organization have changed its nature over the period of time.
Multidisciplinary: Management is basically multidisciplinary. This implies that, although
management has been developed as a separate discipline, it draws knowledge and concepts from
various disciplines. It draws freely ideas and concepts from such disciplines as psychology,
sociology, anthropology, economics, ecology, statistics, operations research, etc. Management
integrates the ideas and concepts taken from these disciplines and present newer concepts which
can be put into practice for managing the organization.

Dynamic nature of principle: Based on integration and supported by practical evidences,

management has formed certain principles. However, these principles are flexible in nature and
change with the changes in the environment in which an organization exists.

Relative, not absolute principles:Management principle are relative, not absolute, and they
should be applied according to the need of the organization. Each organization may be different
from others. The difference may exist because of time, place, socio-cultural factors, etc.

Management Science or Art: There is a controversy whether management is science or art.

However, management is both a science and art.

Management as profession: Management has been regarded as profession by many while many
have suggested that it has not achieved the status of a profession.

Characteristics of Management:

Setting goals for organizations: Goals differ from organization to organization in business, the
basic economic goal is to earn maximum profit, while in service organization like hospital and
educational institution for the basic goal is to provide better service and better education.

Awareness of opportunities and resources: Management have awareness of opportunities and

resources like men, materials, money which assembles and integrates by management.

Management is transformation process: Management is a transformation process consisting of

planning, organizing, staffing, directing and controlling.

Management is universal: The principles and techniques of management are universally

applicable to all group activities performed at any level of organization.
System of authority: System of authority means a hierarchy of command and control. Managers
at different levels possess varying degrees of authority.

Co – Ordination: Various human beings organized in formal groups are endeavoring to achieve
the common organizational objectives, so various departments in the organization must work in
harmony with one another.

Management is Dynamic: The ever changing social environment directly and indirectly effect
the group activity thus changing environments provide a challenge to management. Efficient
management cannot remain static it must adopt itself to changing conditions.

Management is decision making: The managers are decision makers the marketing managers
decides about how to market, when to market, where to market how to collect funds for
organization.

Management is a profession: Management is not only a science but also an art. Art means
managers has to handle the person and things tactfully. Science means achieving objectives
through procedures.

Importance of Management: “No ideology, no ism, or political theory can win greater output
with less efforts from a given complex of human and materials resource only sound management
And it is on such greater output that a higher standard of life, more leisure, more amenities for all
must necessarily be found”.

Effective utilization of resources: Management tries to make effective utilization of various

resources. The resources are scarce in nature and to meet the demand of the society, their
contribution should be maximum for the general interests of the society. Management not only
decides in which particular alternative a particular resource be used but also takes actions to
utilize it in that particular alternative in the best way.

Development of resources: Management develops various resources. This is true with human as
well as non-human factors. Most of the researches for resource development are carried on in an
organization way and management is involved in those activities.
To incorporate innovations: Today changes are occurring at a very fast rate in both technology
and social process and structure these changes need to be incorporated to keep the organizations
alive and efficient. Therefore, they require high degree of specialization, high level of
competence, and complex technology. All these require efficient management so that
organizations work in the most efficient way.

Integrating various interest groups: In the organized efforts, there are various interest groups and
they put pressure over other groups for maximum share in the combined output. For example, in
the case of business organization, there are various pressure groups such as shareholders,
employees, government etc. These interest groups have pressure on an organization.

Stability in the society: Management provides stability in the society by changing and modifying
the resources in accordance with the changing environment of the society. In the modern age,
more emphasis is on new inventions for the betterment of human beings. These inventions make
old systems and factors mostly obsolete and inefficient. Management provides integration
between traditions and new inventions and safeguards, society from the unfavorable impact of
these inventions so that continuity in social process is maintained.

Levels of Management:

1. Top Management
2. Upper Middle management
3. Middle Management
4. Lower Management
5. Operating Force or Rank and file workmen
Top Management includes:

a) Board of directors

b) Managing directors

c) Chief executives

d) General Manager

e) Owners
 f) Share holders

Functions:

a) Setting basic goals and objectives

b) Expanding or contracting activities

c) Establishing policies

d) Monitoring performance

e) Designing/Redesigning organization system

f) Shouldering financial responsibilities etc.

upper Middle Management includes:

a) Sales executives
b) Production executives
c) Finance executives
d) Accounts executives
e) R & D executives
Functions:

a) establishment of the organization

b) Selection of staff for lower levels of management

c) Installing different departments

d) Designing operating policies and routines

e) Assigning duties to their subordinates

Middle Management includes:

a) Superintendent

b) Branch Managers
 c) General forcemeat etc.

Functions:

a) To cooperate to run organization smoothly

b) To understand inter locking of department in major policies
c) To achieve coordination between different parts of the organization
d) To conduct training for employee development
e) To build an efficient company team spirit
Lower Management includes:

a) Foremen
b) Supervisors or charge-hands
c) Office Superintendent
d) Inspectors etc.
Functions:

a) Direct supervision of workers and their work

b) Developing and improving work methods operations
c) Inspection function
d) Imparting instruction to workers
e) To give finishing touch to the plans and policies of top management
f) To act as link between top management and operating force
g) To communicate the feelings of workers to the top management.
Operating force includes:

a) Workers

b) Rank and file workman

c) Skilled and Semi-skilled workers

d) Unskilled workers

Function:
 a) To do work on machines or manually, using tools etc.

b) To work independently (incase of skilled workers) or under the

guidance of supervisor.

Functions of Management:

Planning: Involves selecting the objectives and actions to achieves them planning stage involves
decision making and choosing future courses of action from the various alternatives

Organizing: Role of each person in any organization is fixed. The concept of role is who will be
doing what should be known, to achieve organizational targets efficiently. It is intended that all
the tasks necessary to achieve targets are assigned to people who can do the best.

Staffing: Staffing function includes keeping the various organizational position fixed. This
activity is done by identifying work force requirements, keeping the records of the performance
of people working with the organization. So that suitable people can be prompted and at the
same time people performing not up to the mark could be send for training. If all the above
activities are taking place in nice way in any organization, it will give rise minimum work force
turnover.

Directing: Directing means influencing people, so that they will contribute to the organization
targets directing involves motivation, leadership styles and proper communication.

Controlling: It is the process of comparing the plans with the results. If there is deviation attain
taken to be bridge the gap between plan and actual results.

Coordinating: The essence of management is the achievement of coordination among people

coordination is a complex process following the principles by which organization activity can be
accomplished. Coordinative is possible oniy if all the personnel working in the organization
accept the target of the organization. This target must be clearly defined and ‘sold’ to everyone
concerned.
Evolution of Management Theory: Good management intends to achieve an objective with the
least use of man, machine, money and material and at the same time maximum satisfaction of the
participants.

Taylor’s Scientific Management: The utility of scientific methods to problems of management

was first introduced by F.W.Taylor

Definition: Scientific management may be defined as the “Art of knowing exactly what is to be
done and the best way of doing it”.

Scientific management is the result of applying scientific knowledge and scientific

methods to the various aspects of management and the problems that arise form them.

Principles of Scientific Management: Taylor through his principles of scientific management

initiated a system in which there would be an effective and fruitful coordination and cooperation
between the management and the workers.

Reject fast practices Replace Thumb rules by

guide lines

Taylor’s Scientific System improvement

Management

Collection data decision

making

Development of Science for each element of work: Analyze the work scientifically, rather than
using thumb rule. It means that an attempt is made to find out what is to be done by a particular
worker, how he is to do it, what equipment will be necessary to do it. This information is
provided to the worker, so as to reduce wastage of tie, material etc. and improve the quality work
Scientific selection, placement and training of workers: This principle states that select the
workers best suited to perform the specific task, and then train tem within the industry in order to
attain the objectives of the enterprise workers should also be trained from time to time to keep
them informed of latest development in the techniques of production.

Division of Labour: division of work in smaller tasks and separation of thinking element of job
from doing element of the job, this is the principle of specialization. It is essential for efficiency
in all sphere of activities as well as in supervision work

Standardization of methods, procedures, tools and equipment:

Standardization helps in reducing time, labour and cost of production. The success of scientific
management largely depends upon standardization of system, depends upon standardization of
system, tools, equipments and techniques of production

Use of time and motion study: Taylor’s introduced time and motion study to determine standard
work. Taylor’s undertook studies on fatigue, incurred by the workers and the time necessary to
complete task.

Differential wage system: Taylor’s differential piece rate scheme provides an incentive for a
worker to achieve high level of optimum output. It distinguishes the more productive workers
from less productive workers and motivates them to produce more.

Cooperation between labour and management: Mutual respect and cooperation between the
workers and management helps in providing proper and effective leadership. The labour starts
thinking that it is their work and they must put their heart in the work assigned to him.

Principle of Management by Exception: Taylor suggested that only major or significant

deviations between the actual performance and standard performance should be brought to the
notice of top management. Top management should pay more attention to those areas of work
where standards and procedures could not be established and where there is a significant
variation between standard performance and actual performance.

Administrative Management Theory (Henri Fayol and Others):

Henri Fayol is called as father of Modern Management

 He established the pattern of management and the pyramidal form of organization. He
pointed out that technical ability is more dominating on the lower level of management
managerial ability is more important on the higher level of management.

Henri Fayol analyzed the process of management and divided the activities of an
industrial undertaking into six groups

1. Technical activities

2. Commercial activities

3. Financial activities

4. Security activities

5. Accounting activities

6. Managerial activities

Henri Fayol’s Principles of Management:

Division of Work: This is the principles of specialization, division of work should be according
to work, department, job etc. Both technical and managerial activities can be performed in the
best manner only through division of labour and specialization. It can ensure maximum
productivity and efficiency in all sphere of activity.

Authority and Responsibility: The right to give order, the right to command, is called
authority. The obligation to accomplish objectives or expected results or performances is called
responsibility.

Discipline: No organization can work smoothly without discipline; it is the very core of
administration. The rules, regulations, policies and procedures must be honored by all the
members of organization. Discipline is imposed by administration. It requires good superiors at
all levels clear and fair agreement on rules, regulations, and procedures.

Unity of Command: In order to avoid confusion and conflict each individual should receive
orders and instructions only from one superior and should be accountable to one superior only.

Unity of Direction: All members of an organization must work together to accomplish common
or same objectives.

Emphasis on subordination of personal interest to common interest: It means that the

common interest of the organization must be given more importance that interest of the
individual. The organization will collapse when personal interest become supreme than the
general interest.

Adequate remuneration to personnel: The persons working in the organization should be paid
suitably and adequately. This will help to maintain their interest in the work and the enterprise.

Centralization: The decision for centralization would naturally vary from organization to
organization. However, there must be a good balance between centralization and
decentralization of authority and power.

Scalar chain or line of authority: An organization chart should be prepared form better
communication and effective co-ordination. It shows the flow of authority and responsibility
from top to bottom.

Order: right man for right job and right materials for the right thing would ensure systematic
utilization of resources and manpower employed in the undertaking without proper placement of
personnel. Workmanship will not be accurate and there would be wastage of materials and
equipment.

Equity: A group of people working together for some common objectives of the enterprise.
Hence there should be equity, justice and kindness on the part of managers to create loyalty and
devotion among subordinates.

Stability of workers: security of income and employment is a pre-requisite o sound

organization and management. This will reduce unnecessary labour turnover, and increase
efficiency by having stable working force.

Team spirit: According to the principle “Union is Strength” management should not adhere the
principle of divide and rule instead of it should try to achieve co-operation and team spirit in the
employees. Pride, loyalty, and sense of belonging is essential for efficient working and the
prosperity of the organization.

Initiative: Managers should encourage and develop the subordinates to take initiative. It is the
result of creative and imagination among employees.

Introduction:

Decision making is a daily activity for any human being. There is no exception about that. When
it comes to business organizations, decision making is a habit and a process as well.

Effective and successful decisions make profit to the company and unsuccessful ones make
losses. Therefore, corporate decision making process is the most critical process in any
organization.

In the decision making process, we choose one course of action from a few possible alternatives.
In the process of decision making, we may use many tools, techniques and perceptions.
In addition, we may make our own private decisions or may prefer a collective decision.

Usually, decision making is hard. Majority of corporate decisions involve some level of
dissatisfaction or conflict with another party.

Let's have a look at the decision making process in detail.

Steps of Decision Making Process:

Following are the important steps of the decision making process. Each step may be supported
by different tools and techniques.

Step 1: Identification of the purpose of the decision:

In this step, the problem is thoroughly analysed. There are a couple of questions one should ask
when it comes to identifying the purpose of the decision.

➢ What exactly is the problem?

➢ Why the problem should be solved?
➢ Who are the affected parties of the problem?
➢ Does the problem have a deadline or a specific time-line?

Step 2: Information gathering:

A problem of an organization will have many stakeholders. In addition, there can be dozens of
factors involved and affected by the problem.

In the process of solving the problem, you will have to gather as much as information related to
the factors and stakeholders involved in the problem. For the process of information gathering,
tools such as 'Check Sheets' can be effectively used.

Step 3: Principles for judging the alternatives:

In this step, the baseline criteria for judging the alternatives should be set up. When it comes to
defining the criteria, organizational goals as well as the corporate culture should be taken into
consideration.

As an example, profit is one of the main concerns in every decision making process. Companies
usually do not make decisions that reduce profits, unless it is an exceptional case. Likewise,
baseline principles should be identified related to the problem in hand.

Step 4: Brainstorm and analyse the different choices:

For this step, brainstorming to list down all the ideas is the best option. Before the idea
generation step, it is vital to understand the causes of the problem and prioritization of causes.

For this, you can make use of Cause-and-Effect diagrams and Pareto Chart tool. Cause-and-
Effect diagram helps you to identify all possible causes of the problem and Pareto chart helps
you to prioritize and identify the causes with highest effect.

Then, you can move on generating all possible solutions (alternatives) for the problem in hand.

Step 5: Evaluation of alternatives:

Use your judgement principles and decision-making criteria to evaluate each alternative. In this
step, experience and effectiveness of the judgement principles come into play. You need to
compare each alternative for their positives and negatives.

Step 6: Select the best alternative:

Once you go through from Step 1 to Step 5, this step is easy. In addition, the selection of the best
alternative is an informed decision since you have already followed a methodology to derive and
select the best alternative.

Step 7: Execute the decision:

Convert your decision into a plan or a sequence of activities. Execute your plan by yourself or
with the help of subordinates.

Step 8: Evaluate the results:

Evaluate the outcome of your decision. See whether there is anything you should learn and then
correct in future decision making. This is one of the best practices that will improve your
decision-making skills.

Method of Production:
Job production: In this system, goods are produced according to the orders with this method,
individual requirements of the consumers can be met. Each job order stands alone and is not
likely to be repeated. This type of production has a lot of flexibility of operation and hence
general purpose machines are required. Factories adopting this type of production, are generally
small in size.
Advantages:
1. It is the only method, which can meet the individual requirement.
2. There is no managerial problem, because of very less number of workers, and small size
of concern.
3. Such type of production requires less money and is easy to start.
Disadvantages:
1. There is no scope for continuous production and demand
2. As the purchase of raw materials is less, hence cost of raw materials per unit will be
slightly more.
3. For handling different type of jobs, only skilled and intelligent workers are needed, thus
labour cost increases.
Batch production: This type of production is generally adopted in medium size enterprise.
Batch production is in between job production and mass production. Batch production is bigger
in scale than the job production. While it is smaller than that of mass production, batch
production requires more machines than job production and fewer machines that the of mass
production.
Advantages:
1. While comparing with mass production it requires less capital
2. Comparing with job production, it is more advantageous commercially.
3. If demand for one product decrease then production, for another product may be
increased, thus the risk of loss is very less.
Disadvantages:
1. Comparing with mass production cost of scales and advertisement per unit is more
2. Raw materials to be purchased are in less quantity than that in mass production; therefore
it is slightly costlier than that of mass production because less quantity discount is
available.
Mass production: This method of production is used by concerns where manufacturing is
carried on continuously in anticipation of demand though demand of the product may not be
uniform through the year.
In mass production, simplification and standardization of products are made with the help
of specialized (one purpose) machine, articles of standardized nature can easily and
economically be produced on a large scale.
There is a small difference between mass production and continuous production. This is
mainly in the kind of product and its relation to the plant. In mass production plant and
equipment are flexible enough to deal with other products, involving same production process.
Where as in continuous or process production only standardized product in a sequence produced.
In this method layout and requirement of additional tools and equipment
Advantages:
1. A smooth flow of materials from one work station to the next in logical order.
2. Since the work from one process is fed directly into the next, small in process inventories
result
3. Total production time per unit short
4. Simple production planning control system are possible
5. Little skill is usually required by operations at the production line, hence training is
simple, short and inexpensive.
Disadvantages:
1. A breakdown of one machine may lead to a complete stoppage of the line that follows the
machine. Hence maintenance and repair is challenging job.
2. Since the product dictates the layout, changes in product design may require major
changes in the layout.
3. Generally high investment are required owing to the specialized nature of the machines
and their possible duplication in the line
Inventory: It defined as a comprehensive list of movable items which are required for
manufacturing the products and to maintain the plant facilities in working conditions.
Inventory Control: The systematic location, storage and recording of goods in such a way the
desired degree of service can be made to the operating shops at minimum ultimate cost.
Objectives of Inventory Control:
1. To support the production departments with materials of the right quality in the right
quantity, at the right time and the right price, and from the right supplier
2. To minimize investments in the materials by ensuring economies of storage and ordering
costs
3. To avoid accumulation of work in process
4. To ensure economy of costs by processing economic order quantities
5. To maintain adequate inventories at the required sales outlets to meet the market needs
promptly, thus avoiding both excessive stocks or shortages at any given time
6. To contribute directly to the overall profitability of the enterprise
Functions of inventory control:
✓ To develop policies, plans and standards essential to achieve the objectives
✓ To build up a logical and workable plan of organization for doing the job satisfactory
✓ To develop procedure and methods that will produce the desired results economically
✓ To provide the necessary physical facilities
✓ To maintain overall control by checking results and taking corrective actions.
Inventory Management System or Level:
The objects of inventory control is to establish level of inventory which will serve to
minimize the company’s costs and maximize its revenue.
It is determined by five basic variables
a) Minimum inventory b) Reorder point c) Recorder quantity d) Procurement lead time e)
Maximum inventory. Reorder Point Maximum Stock

Quantity

a) Minimum inventory: Minimum inventory or buffer stock is needed to take care of any
temporary unpredictable increase in the part usage or in the procurement lead time.
Time
b) Reorder point: Procurement
It is sufficiently above the minimum inventory to allow for issuing the
Time
purchase order and for delivery by a vendor. Reorder point stock level is equal to the minimum
stock plus the expected consumption during the procurement lead time.
c) Reorder Quantity: This is the fixed quantity of item for which order is placed every time the
stock drops to the reorder point. This quantity is fixed either on the basis of experience or
calculated.
d) Procurement lead time: This comprises the time required for preparing the purchase order, the
time gap between placing an order and receiving supplies and time required for inspection etc.
e) Maximum inventory: It is approximately the sum of the order quantity and minimum
inventory. It will exactly equal the sum of these two quantities if the ordered material is received
just when the minimum stock is reached.
Economic Order Quantity (EOQ): Economic order quantity is defined that quantity of
materials, which can be ordered at one time to minimize the cost of ordering and carrying the
stocks. In other words, it refers to size of each order that keeps the total cost low.
Inventory costs: The inventory costs can be classified into two categories,
1) Inventory ordering cost 2) Inventory carrying cost.

Carrying Cost
Annual Cost

Ordering Cost

Ordering Quantity
Inventory Ordering Costs (Co): The cost refer to the cost incurred to procure the materials
particularly in large organizations, these cost are significant. This is also called as procurement
cost.
Definition: It is the cost of placing an order from a vendor. This includes all costs incurred from
calling for quotation to the point at which the item is taken into stock.
Ex: Receiving quotations, Processing purchase requisition, Receiving materials and then
inspecting it , Follow up and expediting purchase order, Processing sellers invoice.

Ordering Cost

Ordering Cost

Ordering Quantity

Inventory Carrying cost: Carrying cost which are also known as holding costs are the costs
incurred in maintaining the stores in the firm. They are based on average inventory and consist
of:
Ex: Storage cost includes: Rent for storage facilities, Salary of person and related storage
expenses, Cost of insurance, Cost of capital.

Annual Cost
Carrying Cost

Ordering Quantity
Determine EOQ:
Step1:
Total Ordering cost per year = No. of orders placed per year x ordering cost per
Order
= (A/S) x O
A = Annual demand
S = Size of each order (units per order)
O = Ordering cost per order
Step2:
Total Carrying cost per year = Average inventory level x Carrying cost per year
= (S/2) x C
A = Annual demand
S = Size of each order (units per order)
C = Carrying cost per unit
Step3:
EOQ is one where the total ordering is equal to total carrying cost
A S
O= C
S 2
2AO = S2  C
2AO
S2 =
C
2AO
S=
C

Total Cost

Carrying Cost
Annual Cost

Ordering Cost
EOQ

Ordering Quantity
Where S is the Economic order quantity, A is the annual demand in units, O is the ordering cost
per order and C is the carrying cost per unit
Ex: A biscuit manufacturing company buys a lot bags of 10,000 bags wheat per annum. The
cost per bag is Rs.500 and ordering cost is Rs.400. The inventory carrying cost is estimated at
10% of the price of the wheat determine EOQ and number of orders required per year.
Solution:
Annual demand (A) = 10,000 bags
Ordering cost per order (O) = Rs.400
Carrying cost per unit (C) = 10% of Cost price
= 0.10 x 500 = Rs.50/-

2AO
EOQ =
C
2  10,000  400
=
50
= 1,60,000
EOQ = 400 bags
Annual demand (units)
The number of orders to be placed during the year =
EOQ
10,000
= 25 orders
400
In the above case, the company has to place 25 orders to optimize its ordering and carrying costs.
Self-Study Material:

Elton Mayo: Elton Mayo generally recognized as father of human relations approach Mayo led
the team which conducted the study psychological reaction of workers in on-the job situations
Mayo concluded that work arrangements in addition to meeting the objective requirements of
production must at the same time satisfy the employees subjective requirement of social
satisfaction at his work place.

Maslow’s Theory:

Maslow’s level of hierarchy about human relations and behavioral science approach, his
assumptions are based mainly on theory of ‘Human Needs’, he has defined five level of hierarchy
of needs starting from the biological need and then coming to more intangible ones .

1. Physical needs like food, clothes and shelter

2. Safety needs freedom from fear of insecurity
3. Social needs include a sense of being accepted in the society or environment one finds
himself in.
4. Ego needs include feeling of important and recognition
5. Self-actualization needs include need or desire for personal fulfillment of individual
potential and activity.

Self
Actualization
Needs

Ego Needs
Douglas McGregor Theory: He divides leadership is two styles labeled theory “X” and theory
“Y”. The traditional styles of leadership and controls stated in theory ‘X’ by McGregor, is
exercised to managers on the basis of his assumptions about human beings. These assumptions
as laid down or observed by McGregor for theory ‘X’ are

Theory “X”:

1. An average human being does not like to work and he tries to avoid it as far as
possible.
2. He avoids accepting responsible and challenging tasks, has no ambition but wants
security above all.
3. Because of this, the employees are to be forced, concerned and threatened with
punishments to make them put their best efforts. These people would not work
sincerely and honestly under democratic conditions.
However the above assumptions re not based on research finding. The autocratic style
basically presumes that workers are generally lazy, avoid work and shrink responsibilities. It is
believed that workers are more interested in money and security based on these assumptions the
leadership styles developed, insists on tighter control and supervision.

Theory of “Y”:
It focuses a totally different set of assumptions about the employees

1. Some employees consider work as natural as play or rest.

2. These employees are capable of directing and controlling performance on
their own
3. They are much committed to the objectives of the organization
 4. Higher rewards make these employees more committed to organization.
5. Given an opportunity they not only accept responsibility but also look for
opportunities to outperform others.
6. Most of them highly imaginative, creative and display ingenuity in handling
organizational issues.
ABC Analysis: ABC analysis is a technique of controlling inventories based on their value
and quantities. It is more remembered as an analysis for ‘Always Better Control’ of
inventory. Here all items of the inventory are listed in the order of descending values,
showing quantity held and their corresponding value. Then, the inventory is divided into
three categories A, B and C based on their respective values.

100

90

Volume of
inventory
(Rs.)
70
A B C

0 10 30 100

Volume of inventory (Units)

A – Refers to high value item

B – Refers to medium value item
C – Refers to low value item
A category comprises of inventory, which is very costly and valuable. Normally 70% of the
funds are tied up in such costly stocks, which would be around 10% of the total volume of
stocks. Because the stocks in this category are very costly, these require strict monitoring on
a day-to-day basis.
B category comprises of inventory, which is less costly. Twenty percent of the funds are tied
up in such stocks and these accounts for over 20% of the volume of stocks. These items
require monitoring on a weekly or fortnightly basis.
C category consists of such stocks, which are of least cost. Volume-wise, they form 70% of
the total stocks but value-wise, they do not cost more than 10% of the investment in the
stocks. This category of stocks can be monitored on a monthly or bi-monthly basis.
The following table summarizes the concept of ABC analysis;
Desired Degree of
Category Value (%) Volume (%)
Control
A 70 10 STRICT
B 20 20 MODERATE
C 10 70 LOW