32 Introduction to Financial Management

33 Time Value of money

34 Costing
35 Break-even Analysis
36 Basics of Accounting
37 Basics of Marketing
38 Project Management

EE 14 601 / EC 14 802–
ENGINEERING ECONOMICS
&
PRINCIPLES OF
MANAGEMENT
(As per University of Calicut
Syllabus)

1 3

TEXT BOOKS AND REFERENCE BOOKS

Part A - Engineering Economics

Text Books
1. Panneer Selvam, R, ―Engineering Economics‖, Prentice Hall of India Ltd, New Delhi, PART A
2001.
2. Dwivedi, D.N., ―Managerial Economics, 7/E”, Vikas Publishing House, 2009.
Reference Books
1. Sullivan, W.G, Wicks, M.W., and Koelling. C.P., ―Engineering Economy 15/E‖,
Prentice Hall, New York, 2011. ENGINEERING ECONOMICS
2. Chan S. Park, ―Contemporary Engineering Economics‖, Prentice Hall of India, 2002.
3. Prasanna Chandra, ―Financial Management: Theory & Practice, 8/E”, Tata-McGraw
Hill, 2011.

Part B – Principles of Management

Reference Books
1. F. Mazda, Engineering management, Addison Wesley, Longman Ltd., 1998
2. Lucy C Morse and Daniel L Babcock, Managing engineering and technology, Pearson,
Prentice Hall
3. O. P. Khanna, Industrial Engineering and Management, Dhanpat Rai and Sons, Delhi,
2003.
4. P. Kotler, Marketing Management: Analysis, Planning, Implementation and Control,
Prentice Hall, New Jersey, 2001
5. Venkata Ratnam C.S & Srivastva B.K, Personnel Management and Human Resources,
Tata McGraw Hill.
6. Prasanna Chandra, Financial Management: Theory and Practice, Tata McGraw Hill.
7. Bhattacharya A.K., Principles and Practice of Cost Accounting, Wheeler Publishing
8. Weist and Levy, A Management guide to PERT and CPM, Prantice Hall of India
9. Koontz H, O‘Donnel C & Weihrich H, Essentials of Management, McGraw Hill.
10. Ramaswamy V.S & Namakumari S, Marketing Management : Planning,Implementation

5 7
 SYLLABUS
MODULE DETAILS INDEX
I Introduction to Engineering Economics – Technical efficiency, Economic
efficiency – Cost
concepts: Elements of costs, Opportunity cost, Sunk cost, Private and Social
cost, Marginal cost, Marginal revenue, Profit maximisation, Break-even Sr No Contents Pg No
analysis. 1 Syllabus
Supply and Demand: Determinants of demand, Law of demand, 2 Text Books and Reference Books
Determinants of supply, Law of supply, Market equilibrium. Elasticity of 3 Question paper pattern
demand – Types of elasticity, Factors affecting the price elasticity of 4 Introduction to the subject
demand.
Module 1
National Income Concepts: GDP and GNP, Per capita income, Methods of 5 Introduction to Engineering Economics
measuring national 6 Technical efficiency, Economic efficiency
income.
7 Concept of costs
Inflation and Deflation: Concepts and regulatory measures – Monetary 8 Profit maximisation
policy and Fiscal policy. 9 Break-even analysis
10 Demand and supply analysis
II Value Analysis - Time value of money - Interest formulae and their
applications: Single-payment compound amount factor, Single-payment 11 National Income Concepts
present worth factor, Equal-payment series compound amount factor, Equal- 12 Inflation and deflation
payment series sinking fund factor, Equal-payment series present worth 13 Monetary and Fiscal Policies
factor, Equal-payment series capital recovery factor, Effective interest rate.
Module 2
Investment criteria: Pay Back Period, Net Present Value, Internal Rate of 14 Value Analysis
Return, Benefit-cost 15 Time Value of Money
ratio.
Principles of management – Evolution of management theory and functions
16 Investment criteria
III
of management Module 3
Organizational structure – Principle and types. 17 Introduction to management
18 Evolution of management theory
Decision making – Strategic, tactical & operational decisions, decision
making under certainty, risk & uncertainty and multistage decisions & 19 Functions of management
decision tree 20 Organisation structure
21 Decision making
Human resource management – Basic concepts of job analysis, job
evaluation, merit rating, wages, incentives, recruitment, training and 22 Introduction to Human Resource Management
industrial relations 23 Human Resource Planning
24 Job Analysis
IV Financial management – Time value of money and comparison of alternative
methods. Costing – Elements & components of cost, allocation of overheads,
25 Recruitment and selection
preparation of cost sheet, break even analysis. 26 Performance Appraisal
27 Job Evaluation and Merit rating
Basics of accounting – Principles of accounting, basic concepts of journal,
ledger, trade, profit &loss account and balance sheet.
28 Training and Development
Marketing management – Basic concepts of marketing environment, 29 Wage and Salary administration
marketing mix, advertising and sales promotion. 30 Compensation and incentives
31 Industrial relations
Project management – Phases, organisation, planning, estimating, planning
using PERT & CPM Module 4

4 2

MODULE 1

Chapter 1 – Introduction to engineering

economics
What economics is about?
EE14 601 Engineering Economics and Principles of Management
Economics is a social science that deals with human wants and their
satisfaction. People have unlimited wants. But the resources to satisfy these wants
are limited.

The action of earning and spending is called economic activity.

The starting point of all economic activity is the existence of human wants.
QUESTION PAPER PATTERN
Wants give rise to efforts and efforts secure satisfaction. The things which directly
satisfy human wants are called consumption goods. A few consumption goods like
air, sunshine, etc. are abundant. They are available at free cost. But most of goods
are scarce. They are available only by paying a price. And, therefore, they are called University Examination Pattern for Section 1
economic goods. They do not exist in sufficient quantity to satisfy all wants.
PART A: Analytical/problem solving SHORT questions 4x 5 marks=20 marks
Candidates have to answer FOUR questions out of FIVE. There shall be minimum of ONE
Limited means (resources ) and unlimited ends (Needs) and maximum of TWO questions from each module with total FIVE questions.

Choosing between ends-. Economics is a science of choice when faced with PART B: DESCRIPTIVE questions 2 x 15 marks=30 marks
Two questions from each module with choice to answer one question.
scarce means and unlimited ends. Maximum Total Marks: 50

Deriving maximum satisfaction – Economics teaches us to make the best use of Note: Section 1 and Section 2 are to be answered in separate answer books
our limited resources.
Maximum 50 marks each for Section 1 and Section 2
Income and employment –Economics is also concerned with the levels of income
and employment in the country as well as the causes of their fluctuation.

Economic development – Economics concerns itself with the study of economic University Examination Pattern for Section 2
growth.
PART A: Analytical/problem solving SHORT questions 4x 5 marks=20 marks
Candidates have to answer FOUR questions out of FIVE. There shall be minimum of ONE
Various definitions and maximum of TWO questions from each module with total FIVE questions.

Adam Smith’s definition: A science of wealth
Adam Smith in his book “Wealth of Nations” defined economics as “An enquiry
into the Nature and causes of the Wealth of Nations”. Adam Smith was known as
the Father of Economics.
PART B: Analytical/ DESCRIPTIVE questions 2 x 15 marks=30 marks
Two questions from each module with choice to answer one question.
Maximum Total Marks: 50
Note: Section 1 and Section 2 are to be answered in separate answer books

Marshall’s Definition: Science of material welfare

Maximum 50 marks each for Section 1 and Section 2

8 6
“Economics is a study of man’s actions in the ordinary business of life; it enquires
how he gets his income and how he uses it. Thus it is on one side the study of
wealth and on the other, and on the other and more important side, a part of the
study of man.”
Robbins’ Definition: Science of Scarcity or Science of choice
Economics studies human behaviour as a relationship between ends and scarce
means which have alternate uses.
Features of scarcity definition:
1. Human wants are unlimited- If one want is satisfied another want crops up.
2. Limited means to satisfy human wants – Though the wants are unlimited, yet the
means for satisfying these wants are limited.
3. Alternative uses of scarce resources – Same resources can be devoted for
alternative lines of production
4. Efficient use of scarce resources – Since wants are unlimited, so these wants are
to be ranked in order of priorities.
5. Need for choice and optimisation – Since human wants are unlimited, so one has
to choose between the most urgent and less urgent wants. Hence economics is
called a science of choice.
(2) How to produce?
Having decided the quantity and the type of goods to be produced, we must next
determine the techniques of production to be used. Example: labour intensive or
capital intensive.
(3) For whom to produce?
This problem refers who will consume the goods and services produced: A few
rich and many poor or vice-versa. The goods and services are produced for the
people who can purchase them. And the purchasing power of the people depends
on how the produced goods and services are distributed among the people who are
helped to produce them. i.e., how is the product distributed among the four factors of
production-land, labour, capital and enterprise. It shows how the national product is
to be distributed ie who should get how much.
(4) Are resources economically used?
This is the problem of economic efficiency or welfare maximisation. There is to be
no waste or misuse of resources since they are limited.
(5) The problem of full employment of resources.

Samuelson’s definition: Growth definition
Economics is the study of how men and society choose, with or without the use of
money, to employ the scarce productive resource which have alternative uses, to
produce various commodities over time and distribute them for consumption, now
and in future among various people and groups of society.
The problem of full employment of resources implies that existing resources, scarce
as they are, should not remain unutilized or under-utilized.
(6) The problem of growth of resources.
Another problem for an economy is to make sure that it keeps expanding or
developing so that it maintains conditions of stability.

Nature of Economics: Is economics a science or an art?
Economics is both a science and an art. Economics is considered as a science
because it is a systematic knowledge derived from observation, study and
experimentation. However, the degree of perfection of economics laws is less
compared with the laws of pure sciences.
An art is the practical application of knowledge for achieving definite ends. A
science teaches us to know a phenomenon and an art teaches us to do a thing. For
example, there is inflation in a country. This information is derived from positive
science. The government takes certain fiscal and monetary measures to bring down
the general level of prices in the country. The study of these fiscal and monetary
measures to bring down inflation makes the subject of economics as an art.
Subject matter (scope) of economics – Traditional view
The subject matter of economics is generally divided into four parts. They are
Production, Consumption, Exchange and Distribution.
Production means producing things or creation or addition of utilities to the goods
and services to make them capable of satisfying various wants.
Consumption deals with human wants and their satisfaction. This tells how people
behave in consumption of goods and services in order to maximise their satisfaction.
Exchange refers to transfer of goods and services through the medium of money
and various credit instruments.

Nature of Economics: Is economics a positive science or normative
science?
A positive science explains the why of things ie their causes and effects. A
normative science explains the rightness or wrongness of things.
Finally, distribution refers to the sharing of income from production by four factors
of production namely, land, labour, capital and organization. Here, we study how
wage, rent, interest and profit is determined.

9 11

5. Engineering economics helps understand the market condition, general economic

environment in which the firm is working
6. Engineering economics provides the basis for resource allocation problem.
7. Engineering economics deals with the identification of economic choices, and is
concerned with the decision making of engineering problems of economic choice.

Economic Reasoning
Economic reasoning means how to think like a modern economist, making decisions on the
basis of costs and benefits. Economic reasoning provides a framework within which to
approach a question. In the economic way of thinking, every choice has its costs and
benefits, and decisions are made by comparing them.

WHY DO ENGINEERS NEED TO LEARN ABOUT ECONOMICS?

Engineers must decide if the benefits of a project exceed its costs, and must make
this comparison in a unified framework. The framework within which to make this
comparison is the field of engineering economics, which strives to answer exactly
these questions, and perhaps more.

Consideration of economic factors is as important as regard for the physical laws

and science that determine what can be accomplished with engineering. The
following figure shows how engineering is composed of physical and economic
components

Engineering

Physical environment Economic environment

The above figure shows how engineering is composed of physical and economic
components.

1. Physical Environment : Engineers produce products and services

depending on physical laws (e.g. Ohm's law; Newton's law).

Physical efficiency takes the form:

system output(s)
Physical (efficiency ) = -------------------
system input(s)

2. Economic Environment : Much less of a quantitative nature is known about

economic environments -- this is due to economics being involved with the
actions of people, and the structure of organizations.

Satisfaction of the physical and economic environments is linked through

production and construction processes. Engineers need to manipulate
systems to achieve a balance in attributes in both the physical and economic

13 15
In addition, we also study, Public Finance and Planning. Public finance studies the
financial operations of the governments and other public bodies. Here we study, how
the government collects money, how it spends and how it frames its fiscal policy.
Planning is also included in the subject matter of economics which refers to the
systematic, efficient and full utilization of available limited resources for the
maximum public welfare.
Subject matter: Micro and Macro Economics – Modern View
Micro Economics
The term ‘micro‘ is derived from the Greek word ‘mikros‘ which means ‘small‘.
Therefore micro economics studies the economic behaviour of individual units of
an economy and not an economy as a whole. It concerns itself with the detailed
study of individual decision-makers like a household, a firm or individual consumers
and producers. How a consumer maximizes his satisfaction with his limited income
or how a firm maximizes its profits or how the wage of a worker is determined are
all instances of micro analytical approach.
According to Prof. Boulding ―Micro economics is the study of particular firms,
particular households, individual prices, wage incomes, individual industries, and
particular commodities. Since the subject matter of micro economics deals with the
determination of factor prices and product prices micro economics is called as ‘price
theory‘.
Macro Economics
The word ‘macro‘is derived from the Greek word ‘makros‘which means ‘large‘.
Therefore macro economics is the study of economy in its totality or as a whole. It
is concerned with the study of national income and not individual income, national
saving and not individual saving, aggregate consumption expenditure and not
individual consumption expenditure, total production and not production of
individual firm, price level and not individual price etc. In short it deals with the
economy as a whole. The problem of full employment, aggregate consumption,
aggregate investment, total savings, general level of prices and variations in them
are all the subject matter of macro economics. It is also known as income and
employment theory.
The following comparison further clarifies the distinction.
12
CHAPTER 2 – EFFICIENCY
From the organization’s point of view, efficient and effective functioning of the
organization would certainly help it to provide goods/services at a lower cost which in
turn will enable it to fix a lower price for its goods or services.
Types of Efficiency
Efficiency of a system is generally defined as the ratio of its output to input. The
efficiency can be classified into technical efficiency and economic efficiency.
Technical efficiency
It is the ratio of the output to input of a physical system. The physical system may be a
diesel engine, a machine working in a shop floor, a furnace, etc.
Technical efficiency (%) = Output * 100
Input
The technical efficiency of a diesel engine is as follows:
Technical efficiency (%) = Heat equivalent of mechanical energy produced * 100
Heat equivalent of fuel used
In practice, technical efficiency can never be more than 100%. This is mainly due to
frictional loss and incomplete combustion of fuel, which are considered to be
unavoidable phenomena in the working of a diesel engine.
Economic efficiency
Economic efficiency is the ratio of output to input of a business system.
Economic efficiency (%) = Output *100
Input
= Worth * 100
Cost
‘Worth’ is the annual revenue generated by way of operating the business and ‘cost’ is
the total annual expenses incurred in carrying out the business. For the survival and
growth of any business, the economic efficiency should be more than 100%.
Economic efficiency is also called ‘productivity’. There are several ways of improving
productivity.
1. Increased output for the same input
2. Decreased input for the same output
3. By a proportionate increase in the output which is more than the proportionate
increase in the input
4. By a proportionate decrease in the input which is more than the proportionate
decrease in the output
5. Through simultaneous increase in the output with decrease in the input.
Increased output for the same input. In this strategy, the output is increased while
keeping the input constant. Let us assume that in a steel plant, the layout of the existing
facilities is not proper. By slightly altering the location of the billet-making section, and
bringing it closer to the furnace which produces hot metal, the scale formation at the top
16
Economics is both a positive and normative science. It not only tells us why certain
things happen, it also tells us whether it is right to happen. For example we know
that few people in the world are very rich while the masses are very poor. Economic
should explain not only the causes of this unequal distribution of wealth but also it
should say whether this is good or bad. It might well say that wealth ought to be
fairly distributed.
Reason for Economic Problems
Economic problem arises because of scarcity of resources in relation to demand for
them. The following are the reasons for emergence of economic problems:
1. Human wants (or ends) are unlimited
There is no end to human wants. As one want is satisfied, many others crop up and
this goes on endlessly.
2. Resources (means) to satisfy wants are limited (scarce)
Goods and services are produced by an economy with its resources namely-land,
labour, capital and enterprise. Unfortunately, such resources are limited in relation to
its demand. Due to scarcity of resources, we cannot produce all the goods and
services that the various sections of the society need.
3. Resources have alternative uses
The resources of an economy are not only scarce but also have alternative uses and
therefore choice has to be made in their use. For example, a plot of land can be used
to produce wheat or for construction of a factory or for a school building. If the plot
is used for the cultivation of wheat, it cannot be used for other purposes. In other
words, production of one commodity has to be sacrificed for production of other.
Thus, the economy constantly faced with choosing better alternative uses to which
its resources should be put.
In short, the problem of making a choice among alternative uses of resources is
called the basic or central problem of an economy. Such problems are common to all
economies.
Fundamental Economic Problems
The central problems relate to different aspects of resources are cited below:
(1) What to produce and in what quantities?
The first major decision relates to the quantity and the range of goods to be
produced. Since resources are limited, we must choose between different alternative
collection of goods and services that may be produced. It also implies the allocation
of resources between different types of goods. Eg consumer goods or capital goods,
necessaries or luxurious goods etc.
After deciding which goods should be produced society has to decide the quantity of
each good has to be produces.
10
environments, and within the bounds of limited resources. Following are
some examples where engineering economy plays a crucial role:
1. Choosing the best design for a high-efficiency gas furnace
2. Selecting the most suitable robot for a welding operation on an
automotive assembly line
3. Making a recommendation about whether jet airplanes for an
overnight delivery service should be purchased or leased
4. Considering the choice between reusable and disposable bottles for
high-demand beverages
system worth
Economic (efficiency ) = -----------------
system cost
Engineering Economics
Engineering economics is the application of economic principles and calculations to
engineering projects. It deals with the concepts and techniques of analysis useful in
evaluating the worth of systems, products and services in relation to their costs.
Definition
Engineering economics deals with the methods that enable one to take economic
decisions towards minimizing costs and/or maximizing benefits to business
organization.
Engineering economics is used to answer many different questions:
1. Which engineering projects are worthwhile?
Eg Has the mining or petroleum engineer shown that the mineral or oil
deposits are worth developing?
2. Which engineering projects should have higher priority?
Eg. Has the industrial engineer shown which factory improvement projects
should be funded with the available money?
3. How should the engineering project be designed?
Eg. Has the civil or mechanical engineer chosen the best thickness for
insulation?
Scope of engineering economics
1. Engineering economics is concerned with the monetary consequences or financial
analysis of the projects, products and processes that engineers design.
2. Engineers are required to use economic concepts in the major fields such as
increasing production, improving productivity, reducing human efforts, increasing
wealth by maximising profit, controlling and reducing cost
3. Engineering economics has a very important role to play in all engineering
decisions
4. Engineering economics provides a number of tools and techniques to solve
engineering problems related to product mix, output level, pricing the product,
investment, quantum of advertisement etc
14
of ladles will be considerably reduced. The molten metal is usually carried in ladles to
the billet-making section. In the long run, this would give more yield in terms of tonnes
of billet produced. In this exercise, there is no extra cost involved. The only task is the
relocation of the billet-making facility which involves an insignificant cost.
Decreased input for the same output. In this strategy, the input is decreased to produce
the same output. Let us assume that there exists a substitute raw material to manufacture
a product and it is available at a lower price. If we can identify such a material and use it
for manufacturing the product, then certainly it will reduce the input. In this exercise,
the job of the purchase department is to identify an alternate substitute material. The
process of identification does not involve any extra cost. So, the productivity ratio will
increase because of the decreased input by way of using cheaper raw materials to
produce the same output.
Less proportionate increase in output is more than that of the input. Consider the
example of introducing a new product into the existing product mix of an organization.
Let us assume that the existing facilities are not fully utilized and the R&D wing of the
company has identified a new product which has a very good market and which can be
manufactured with the surplus facilities of the organization. If the new product is taken
up for production, it will lead to—
_ an increase in the revenue of the organization by way of selling the new product in
addition to the existing product mix and
_ an increase in the material cost and operation and maintenance cost of machineries
because of producing the new product.
When proportionate decrease in input is more than that of the output. Let us consider
the converse of the previous example, i.e. dropping an uneconomical product from the
existing product mix. This will result in the following:
_ A decrease in the revenue of the organization
_ A decrease in the material cost, and operation and maintenance cost of Machinery
Simultaneous increase in output and decrease in input. Let us assume that there are
advanced automated technologies like robots and automated guided vehicle system
(AGVS), available in the market which can be employed in the organization we are
interested in. If we employ these modern tools, then:
_ There will be a drastic reduction in the operation cost. Initially, the cost on equipment
would be very high. But, in the long run, the reduction in the operation cost would
break-even the high initial investment and offer more savings on the input.
_ These advanced facilities would help in producing more products because they do not
experience fatigue. The increased production will yield more
general manager salary and canteen and welfare expenses, power and fuel, cost of training
new employee lighting and heating, telephone expenses, etc.
Administration overhead includes all the costs that are incurred in administering the
business.
Selling overhead is the total expense that is incurred in the promotional activities and
the expenses relating to sales force.
Distribution overhead is the total cost of shipping the items from the factory site to the
customer sites.
The selling price of a product is derived as shown below:
(a) Direct material costs + Direct labour costs + Direct expenses = Prime cost
(b) Prime cost + Factory overhead = Factory cost
(c) Factory cost + Office and administrative overhead = Costs of production
(d) Cost of production + Opening finished stock – Closing finished stock = Cost of
goods sold
(e) Cost of goods sold + Selling and distribution overhead = Cost of sales
(f) Cost of sales + Profit = Sales
(g) Sales/Quantity sold = Selling price per unit
OTHER COSTS/REVENUES
The following are the costs/revenues other than the costs which are presented in the
previous section:
x Marginal cost
x Marginal revenue
x Sunk cost
x Opportunity cost
x Private and social cost
Marginal Cost
Marginal cost of a product is the cost of producing an additional unit of that product. Let
the cost of producing 20 units of a product be Rs. 10,000, and the cost of producing 21
units of the same product be Rs. 10,045. Then the marginal cost of producing the 21st
unit is Rs. 45.

Marginal Revenue

Marginal revenue of a product is the incremental revenue of selling an additional unit of

that product. Let, the revenue of selling 20 units of a product be Rs. 15,000 and the
revenue of selling 21 units of the same product be
Rs. 15,085. Then, the marginal revenue of selling the 21st unit is Rs. 85.

Sunk Cost

17 19

CHAPTER 4 – PROFIT MAXIMISATION 4. The analysis also helps to formulate price policies by showing the effect of
different price structures on costs and profits. We are aware that pricing
Profit maximization refers to the sales level where profits are highest. In economics plays an important part in stabilising and fixing up volumes especially in
depression periods.
profit maximisation is the process by which a firm determines the price and output level
5. The analysis helps to know the amount of overhead costs to be charged to
that returns the greatest profit.
the product cost at various levels of operation as we know that pre
determined overhead rates are related to a selected volume of production.
All firms seek to maximize profit - that is, the difference between total revenue and total
cost. To find the profit maximizing point, firms look at marginal revenue (MR) - the
Break even chart
total additional revenue from selling one additional unit of output - and the marginal
cost (MC) - the total additional cost of producing one additional unit of output. When
the marginal revenue of selling a good is greater than the marginal cost of producing it,
firms are making a profit on that product. This leads directly into the marginal decision
rule: additional units of a good should be produced as long as the marginal revenue of
an additional unit exceeds the marginal cost. It follows that the maximizing solution
occurs where marginal revenue equals marginal cost.

The break-even analysis can be shown graphically which is known as the break-
even chart. A break-even chart is the graphic approach to the study of the
relationship of cost, revenue and profit. Costs are fixed costs and variable costs.
Fixed costs are the costs which remain fixed for all practical purposes to a certain
level of activity. Eg cost of plant and machinery, salaries, rent etc. Variable costs
vary in proportion to output. Cost of material, wages etc are examples of variable
costs.

If the firm produces less than Q1, MR is greater than MC. Therefore, for this extra The main objective of break-even analysis is to find the cut-off production volume
output, the firm is gaining more revenue than it is paying in costs. Total revenue will from where a firm will make profit. Let
increase. Close to Q1, MR is only just greater than MC, therefore, there is only a small s = selling price per unit
increase in profit. But, profit is still rising. v = variable cost per unit
However, after Q1, the marginal cost of the output is greater than the marginal revenue. FC = fixed cost per period
Q = volume of production
This means the firm will see a fall in its profit level.
The total sales revenue (S) of the firm is given by the following formula:
S=s x Q

Total Marginal Total Marginal The total cost of the firm for a given production volume is given as
Output Price revenue revenue cost cost Profit TC = Total variable cost + Fixed cost
0 14 0 0 2 0 -2 = (v x Q) + FC
1 12 12 12 6 4 6
2 10 20 8 8 2 12 The linear plots of the above two equations are shown in the figure above.
3 8 24 4 12 4 12 The intersection point of the total sales revenue line and the total cost line is
4 6 24 0 20 8 4 called the break-even point.
5 4 20 -4 35 15 -15

21 23
This is known as the past cost of an equipment/asset. Let us assume that an equipment
has been purchased for Rs. 1,00,000 about three years back. If it is considered for
replacement, then its present value is not Rs. 1,00,000. Instead, its present market value
should be taken as the present value of the equipment for further analysis. So, the
purchase value of the equipment in the past is known as its sunk cost. The sunk cost
should not be considered for any analysis done from now onwards.
Opportunity Cost
In practice, if an alternative (X) is selected from a set of competing alternatives (X,Y),
then the corresponding investment in the selected alternative is not available for any
other purpose. If the same money is invested in some other alternative (Y), it may fetch
some return. Since the money is invested in the selected alternative (X), one has to
forego the return from the other alternative (Y). The amount that is foregone by not
investing in the other alternative (Y) is known as the opportunity cost of the selected
alternative (X). So the opportunity cost of an alternative is the return that will be
foregone by not investing the same money in another alternative.
Consider that a person has invested a sum of Rs. 50,000 in shares. Let the expected
annual return by this alternative be Rs. 7,500. If the same amount is invested in a fixed
deposit, a bank will pay a return of 18%. Then, the corresponding total return per year
for the investment in the bank is Rs. 9,000. This return is greater than the return from
shares. The foregone excess return of Rs. 1,500 by way of not investing in the bank is
the opportunity cost of investing in shares.
Private cost and social cost
Private cost is the cost incurred by a firm producing a commodity or service. However,
the production activities of a firm may lead to economic benefit or harm for others. If
we add together the private cost of production and economic damage upon others, that is
known as social cost.
20
The corresponding volume of production on the X-axis is known as the break-
even sales quantity.
At the intersection point, the total cost is equal to the total revenue. This point is
also called the no-loss or no-gain situation. For any production quantity which is
less than the break-even quantity, the total cost is more than the total revenue.
Hence, the firm will be making loss.
For any production quantity which is more than the break-even quantity, the total
revenue will be more than the total cost. Hence, the firm will be making profit.
Profit = Sales – (Fixed cost + Variable costs)
= s x Q – (FC + v x Q)
Mathematical approach to cost volume profit analysis
In order to understand the relationship between Cost, volume and profit, it is
necessary to understand the following terms:
1. Contribution
2. Contribution/sales or Profit/volume ratio
3. Break even Point
1. Contribution
Contribution is the difference between the sales and the marginal cost of sales
(variable cost) and it contributes towards the fixed expenses and profit.
Contribution = Selling price – Marginal/variable cost
Or Contribution = Fixed expenses + Profit
Or Contribution – Fixed expenses = Profit
In marginal costing contribution is very important as it helps us to find out the
profitability of a product, department or division, to have better product mix, for
profit planning and to maximise the profits of a concern.
2. Contribution/Sales or Profit volume (P/V) ratio:
This ratio is calculated as under:
P/V ratio = Contribution
Sales
= Fixed expenses + Profit
Sales
= Sales – Variable costs
Sales
= Changes in profits or contributions
Changes in sales
24
CHAPTER 3 – ELEMENTS OF COST
Cost can be broadly classified into variable cost and overhead cost. Variable cost varies
with the volume of production while overhead cost is fixed, irrespective of the
production volume.
Variable cost can be further classified into direct material cost, direct labour cost, and
direct expenses.
The overhead cost can be classified into factory overhead, administration overhead,
selling overhead, and distribution overhead.
Direct material costs are those costs of materials that are used to produce the product.
Direct materials are those materials which can be identified in the product and can be
conveniently measured and directly charged to the product. Thus, these materials directly
enter the product and form a part of the finished product. For example, timber in furniture
making, cloth in dress making, bricks in building a house.
Direct labour cost is the amount of wages paid to the direct labour involved in the
production activities. It is that labour which can be conveniently identified or attributed
wholly to a particular job, product or process or expended in converting raw materials into
finished goods. Wages of such labour are known as direct wages.
Direct expenses are those expenses that vary in relation to the production volume, other
than the direct material costs and direct labour costs. Direct expenses are expenses
relating to manufacture of a product or rendering a service which can be identified or
linked with the cost object other than direct material cost and direct employee cost. Such
expenses are charged directly to the particular cost account concerned as part of the prime
cost. Examples of direct expenses are: (i) Excise duty; (ii) Royalty; (iii) Architect or
Supervisor’s fees; (iv) Travelling expenses to the city; (v) Repairs and maintenance of plant
obtained on hire
Overhead cost is the aggregate of indirect material costs, indirect labour costs and
indirect expenses.
Indirect Materials are the costs of which cannot be directly attributed to a particular cost
object. Indirect materials are those materials which do not normally form a part of the
finished product. Eg.
Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton waste,
bricks and cements.
Indirect labour is that which cannot be directly attributed to a particular cost object. In
other words paid to labour which are employed other than on production constitute
indirect labour costs. Example of such labour are: supervisors; maintenance workers; men
employed in service departments, material handling and internal transport; apprentices,
trainees and instructors; clerical staff and labour employed in time office and security
office.
Indirect expenses are expenses which cannot be allocated but which can be apportioned
to or absorbed by cost centres or cost units such as rent, insurance, municipal taxes,
18
CHAPTER 5 - BREAK-EVEN ANALYSIS
Break even analysis is an important part of marginal costing. Marginal costing is
based on the principle of classifying the operating expenses into fixed and variable
costs.
There may be a change in the level of production due to many reasons, such as
competition, introduction of a new product, trade depression or boom, increased
demand for the products, scarce resources, change in the selling prices of products
etc. In such cases management must study the effect on profit on account of the
changing levels of production. A number of techniques can be used an aid to
management in this respect. One such technique is break even analysis.
The term break even analysis is interpreted in the narrower as well broader sense.
Used in its narrower sense, it is concerned with finding out the breakeven point, ie
level of activity where the total cost equals the total selling price.
Used in its broader sense, it means that system of analysis which determines the
probable profit at any level of production. The break even analysis establishes the
relationship of costs, volume and profit; so this analysis is also known as “Cost
Volume Profit Analysis”.
Assumptions of break even analysis
1. All costs can be separated into fixed and variable costs
2. Fixed costs will remain constant and will not change with the change in the
level of output.
3. There will be no change in the operating efficiency
4. Variable costs will fluctuate in the same production in which the volume of
output
5. Selling price remains constant even though there may be competition or
change in the volume of production
6. The number of units produced and sold will be the same as there is no
opening stock
7. There is only one product or in the case of many products, product mix will
remain unchanged
Objectives of Break even analysis
1. This analysis helps to forecast profit fairly accurately as it is essential to
know the relationship between profits and costs on one hand and the
volume on the other
2. The analysis is useful in setting up flexible budgets which indicate costs at
various levels of activity. Sales and variable costs tend to vary with the
volume of output. It is necessary to budget the volume first for establishing
budgets for sales and variable costs.
3. The analysis assists in evaluation of performance for the purpose of control.
In order to review profits achieved and costs incurred, it is necessary to
evaluate the effects on cost of changes in volume
22
This ratio can also be shown in the form of a percentage if the formula is multiplied S 15
by 100. Thus if the selling price is Rs 15 and the marginal/variable cost is Rs 10 then iii) Break-even point in units = ____Fixed cost_____
P/V ratio is Contribution per unit
= 15-10 = 5 = 1 = 33% = 150000 = 30,000 units
15 15 3 5
The P/V ratio is one of the most important ratios for studying the profitability of iv) Break-even point in rupees = Fixed cost____ x Selling price per unit
operations of a business and establishes the relationship between contribution and Contribution per unit
sales. = 30000 x 15 = Rs 4,50,000
v) Break-even point in units = Fixed cost_____
In the above example, for every Rs 100 of the sales, contribution is 33%. A sale of Contribution per unit
every Rs 100 will bring a profit of Rs 33 after fixed expenses are met. Or Contribution per unit = Fixed cost _____
Break-even point in units
Comparison of P/V ratios for different products can be made to find out which
product is more profitable. Higher the P/V ratio, more will be the profit and lower = 150000 = Rs 6
the P/V ratio, lesser will be the profit. Hence, it should be the goal of every concern 25000
to increase or improve the P/V ratio. It can be done by: Selling price = VC + Contribution
a) Increasing the selling price per unit = Rs 10 + Rs 6
b) Reducing the direct and variable costs by effectively utilising men, machines and = Rs 16
materials
c) Switching the production to more profitable products showing a higher P/V ratio Calculation of output or sales value at which a profit can be earned
Output to earn sales value (in units) =
The P/V ratio is very useful and is used for the calculation of: Fixed costs + Desired Profit__________
1. Break – even point = Fixed costs Selling price per unit – variable cost per unit
P/V ratio
2. Value of sales to earn a desired amount of profit OR Fixed costs + Desired Profit
= Fixed costs + Desired Profit Contribution per unit
P/V Ratio
3. Margin of safety = Profit Output to earn sales value (in rupees) =
P/V Ratio Fixed costs + Desired Profit x selling price
per unit
Example: Calculate P/V ratio from the following information: Selling price per unit – variable cost per unit
i) Given: Selling price Rs 10 per unit, Variable cost per unit Rs 6
ii) Given the profits and sales of two periods as under OR Fixed costs + Desired profit
Sales (Rs) Profit (Rs) P/V ratio
2013 1,50,000 20,000
2014 1,70,000 25,000
Example :
Solution: From the following data, calculate:
i) P/V ratio = Contribution x 100 = 4_ x 100 = 40 % i) Break-even point expressed in amount of sales in rupees.
Sales 10 ii) Number of units that must be sold to earn a profit of Rs 1,20,000 per year.
Where contribution = SP-VC = 10-6 = 4 iii) How many units are to be sold to earn a net income of 15% of sales ?
ii) P/V ratio = Change in profit x 100 Selling price per unit Rs 40
Change in sales Variable manufacturing cost per unit Rs 22
= 5000_ x 100 = 25 % Variable selling cost per unit Rs 3
20000 Fixed factory overheads Rs 1,60,000
Fixed selling cost Rs 20,000
3. Break- even point

25 27

CHAPTER 6 – LAW OF SUPPLY AND DEMAND

The Concept of Utility
The term utility refers to the want satisfying power of a commodity or service. It is
the power of a commodity or service to satisfy a want.

Total Utility and Marginal Utility

Total Utility (TU) is the total amount of satisfaction obtained from the consumption
of all the units of the commodity. It is the utility derived from all units of the
commodity consumed within a specified time period.

Marginal Utility (MU) is the additional utility obtained from the consumption of an
additional unit of the commodity. We can express marginal utility as
MU = ΔTU/ΔQ

The Law of Diminishing Marginal Utility

The earliest formulation of law of diminishing marginal utility was by Hermann

Heinrich Gossen in 1854. But it was Alfred Marshall popularized it and gave the name
law of diminishing marginal utility. The law states that marginal utility of a
commodity diminishes as an individual consume more and more of the commodity.
That is, as we consume more and more of commodity the utility derived from the
addition unit diminishes. The law of diminishing marginal utility means that the total
utility increases at a decreasing rate.

As an individual consumes more and more of a commodity within a limited time period,
the marginal utility of the additional unit decreases, becomes zero and if consumption is
continued becomes negative.

Eg. Consider the following data of a company for the year 2014: The Nature of Demand
Sales = Rs. 1,20,000 In economics, demand refers to the various quantities of a good or service that people
Fixed cost = Rs. 25,000 will be and able to purchase at various prices during a period of time. It is
Variable cost = Rs. 45,000 important to note that a mere desire for a good or service does not constitute demand.
Find the following: Unless demand is backed by purchasing power, it does not constitute demand.
(a) Contribution
(b) Profit Demand Function
(c) BEP Short Run demand Function:
Short run is a very short period of time. For many purposes in economics, it is useful to
(d) M.S.
focus on the relationship between quantity demanded of a good and its own price, while
keeping other determining factors constant. Thus, we can write the demand function as
Solution
Qxd = f (Px)
(a) Contribution = Sales – Variable costs This implies that the quantity demanded of the commodity x is a function of its own
= Rs. 1,20,000 – Rs. 45,000 price, other determinants remaining constant.
= Rs. 75,000 Long run demand function:
(b) Profit = Contribution – Fixed cost Long run is a long period of time. Demand for a commodity is determined by several
= Rs. 75,000 – Rs. 25,000 factors. An individual‘s demand for a commodity depends on the own price of the
= Rs. 50,000 commodity, his income, prices of related commodities, his tastes and preferences,

29 31
Solution:
i) Break-even point (in rupees)
= Fixed cost_______________
per unit
Selling price/unit -Variable cost/unit
= 160000+20000 x 40
40 – 25
= 30000 x 40 = Rs 4,80,000
15
Marginal/variable cost = Variable manufacturing cost + Variable selling cost
= 22+3 = 25
ii) Output to earn a profit of Rs 1,20,000
Fixed costs + Desired Profit_
Selling price per unit – variable cost per unit
A business is said to break even when its total sales are equal to its total costs. It is
a point of no profit or no loss. At this point, contribution is equal to fixed cost. A
x selling price concern which attains break-even point at less number of units will definitely be
better from another concern where break-even point is achieved at more units of
production.
The formulae to find the break-even quantity and break-even sales
1. Break-even quantity (in units)
= Fixed cost__________
Selling price/unit -Variable cost/unit
OR ______Fixed cost__________
Contribution per unit

= 180000+120000 = 20,000 units The answer we get will be in units.

40-25
iii) Suppose number of units to be sold = N 2. Break-even sales (in Rs. ) =
then, N= Fixed costs + Desired Profit_ Fixed cost__________ x Selling price per unit
Contribution per unit Selling price/unit -Variable cost/unit
= 180000 + (15/100)(Nx40)
15 OR Fixed cost____ x Selling price per unit
15 N = 180000 + 6 N Contribution per unit
N = 20,000 units

Margin of safety OR Fixed cost

Margin of safety is the difference between the actual sales and break even sales. P/V Ratio
If the distance is relatively short, it indicates that a small drop in the production or
sales will reduce the profit considerably. The answer we get will be in rupees.
If the distance is long it means that the business can still make profits even after a
serious drop in production. In case the selling price per unit and variable for per unit is not available we can
Margin of safety is the range of sales over and above the Break even sales. use the formula:
Margin of safety= Present sales – Breakeven sales
OR Profit
P/V Ratio Fixed cost x Sales (Rs)
Sales – variable cost
Eg . Alpha Associates has the following details:
Fixed cost = Rs. 20,00,000 Example: From the following particulars calculate i) Contribution ii) P/V Ratio ii)
Variable cost per unit = Rs. 100 Break-even point in units and in rupees iv) What will be the selling price per unit if
Selling price per unit = Rs. 200 the break-even point is brought down to 25,000 units?
Find Fixed expenses Rs 1,50,000
(a) The break-even sales quantity, (b) The break-even sales Variable cost per unit Rs 10
(c) If the actual production quantity is 60,000, Selling price per unit Rs 15
find (i) contribution; and (ii) margin of safety by all methods
Solution:
Solution i) Contribution = SP – VC = 15-10 = Rs 5
ii) P/V Ratio = C x 100 = 5 x 100 = 33.33%

28 26

advertisement expenditure made by the producers of the commodity, expectations etc. (c) BEP
Thus, individual‘s demand for a commodity can be expressed in the following general
functional form, P/V ratio = Contribution
Qxd = f (Px, I, Pr, T, A, E) Sales
= 75,000 x 100
Where, 1,20,000
Qxd = Quantity demanded of commodity ―x
Px = Price of commodity x = 62.50%
I = Income of the individual consumer BEP = Fixed cost
Pr = Price of related commodities P/V ratio
T = Tastes and preferences of individual consumer = 25000 x 100
A = Advertisement expenditure 62. 50
E = Expectations = Rs. 40,000

(d) M.S. = Profit

P/V ratio
Law of Demand
= 50 000 x 100
62 50
Law of demand expresses the functional relationship between price and quantity
= Rs. 80,000
demanded. According to the law of demand, other things being equal, if the price of
the commodity falls the quantity demanded of it will rise and if the price of the
commodity rises, its quantity demanded will decline. Thus, according to law of
demand, there is an inverse relationship between price and quantity demanded, other
things remaining the same. The other things which are assumed to be constant are tastes
and preferences of the consumer, the income of the consumer, prices of related
commodities etc. Thus, the law of demand assumes that all things other than price
remain constant.

The law of demand can be illustrated through a demand schedule and through demand
curve. Demand schedule shows various quantities of good or service that people
will buy at various possible prices during some specified period, while holding
constant all other relevant economic variables on which demand depends. A
demand schedule is presented below:

Price Quantity demanded

10 20

8 40

6 60

4 80

2 100

We can convert the demand schedule into demand curve by graphically plotting the
various price-quantity combinations, as shown below.

32 30

It is common practice in economics to measure price on vertical axis and quantity
demanded per unit of time on the horizontal axis. Thus, the demand curve is a graph
showing the various quantities of a good or service that the people will be willing and
able to buy at various possible prices. Demand curve slopes downwards from left to the
right. The downward sloping demand curve is in accordance with the law of demand,
which describes inverse price-quantity demanded relationship. The various points on the
demand curve represents alternative price -quantity combinations.
Assumptions of Law of Demand
1. Income of the buyer remains constant
2. Tastes and preferences of the consumers remain the same
3. Price of related goods (substitutes and complementary goods) remain the same
4. Consumers do not know about any new substitute product
5. There is no expectation of change in the price of commodity in the near future
6. The size of population remains constant
Factors affecting demand (Determinants of demand)
The following are the factors that determine the demand of a commodity:
1. Price of commodity – Price is the basic factor that determines demand. When
price changes demand also changes. When price decreases, demand falls and
vice versa.
2. Nature of the commodity- Demand depends on whether the commodity is a
necessity or a luxury. Demand of necessary goods generally remains constant.
Demands of comforts and luxuries change with the change in their prices.
Demand of prestige goods generally remains constant. Demand of durable goods
changes with the change in their price. Thus the nature of the commodity
determines the demand.
3. Income and wealth of consumers – Change in income can bring about a
change in demand. If the income of consumer increases, the demand for normal
goods will also increase because with the increase in income, he can spend more
amounts on the purchase of such goods. If the income decreases the demand for
normal goods also decreases.
33
(2) Perfectly Elastic demand
If a small change in price leads to an infinitely large change in quantity demanded, we
can say that demand is perfectly elastic. At the going price, consumers will buy an
infinite amount (if available). Above this price, they will buy nothing. The coefficient of
elasticity will be infinity when demand will be infinite when demand is perfectly elastic
(E =∞). This is also an imaginary concept
(3) Elastic Demand
When the percentage change in quantity demanded exceeds the percentage change in
price, the demand is said to be elastic. That is, a certain percentage change in price leads
to a greater percentage change in quantity demanded. The value of coefficient of
elasticity will be greater than one when demand is elastic. E>1
(4) Inelastic Demand
When percentage change in quantity demanded is less than percentage change in
price, demand is said to be inelastic. That is, a certain percentage change in price leads
to a smaller percentage in quantity demanded. The coefficient of elasticity will be less
than one but greater than zero ( E <1) when demand is inelastic.
37
4. Price effect – When there is a fall in the price of any commodity, the consumers
who were not purchasing that commodity earlier will now purchase some units
of the commodity. In addition to this, existing consumers will buy more quantity
because the price has fallen.
5. Different uses of commodity – If a commodity can be used for several
purposes, its demand will be affected by a change in its price. For example,
electricity can be used for several uses. If the price of electricity increases, it
will be used only for limited or more important purposes (eg for lighting only).
If the price falls, it will be used freely for lighting, heating, cooking etc.
Exceptions to the Law of Demand
1. Veblen goods - Some consumers measure the utility of a commodity entirely by
its price. That is, for them, the greater the price of the commodity, the greater
it‘s utility. E.g. Diamonds. This form of conspicuous consumption is called
―Veblen effect. When the price of such commodities goes up, their prestige
value also goes up.
2. Giffen goods - If the price of an inferior good falls, consumer‘s real income
increases. So, instead of buying more inferior goods, consumers substitute other
superior goods. In such case, quantity demanded of inferior goods falls as price
falls. Such goods are called Giffen Goods. Thus law of demand does not apply
to inferior goods such as second hand appliances, coarse cloth, jowar, bajra, low
quality ball pens,etc.
3. Demand for necessaries – The law of demand does not apply to necessary
goods. Whatever be the prices, we buy certain quantity of necessary goods like
salt, kerosene, matches, medicines etc
4. Fear of shortage – In case a serious shortage is feared, eg in times of wars,
people may buy more even though the price is rising due to the fear of further
price rise.
5. Festival, marriage etc – In the season of festival, marriage etc, people may buy
more even though the prices are high.
Elasticity of Demand
The law of demand states that the demand of a commodity increases on a fall in its price
and decreases on an increase in its price. Thus law of demand tells us only the direction
of change. It does not tell the rate at which the changes take place. The concept of
elasticity of demand has been introduced to measure the change in demand. Elasticity of
demand refers to the sensitiveness or responsiveness of quantity demanded of a good to
a change in its own price, income and prices of related goods.
35
While fixing the price of this product, a businessman has to consider the elasticity of
demand for the product. He should consider whether a lowering of price will stimulate
demand for his product, and if so to what extent and whether his profits will also increase
a result thereof. If the increase in his sales is more than proportionate, to the reduction in
price his total revenue will increase and his profits might be larger. On the other hand, if
increase in demand is less than proportionate to fall in price, his total revenue we will fall
and his profits would be certainly less.
In general, for items having inelastic demand, the producer will fix a higher price and items
whose demand is elastic the businessman will fix a lower price.
2. International trade:
In order to fix prices of the goods to be exported, it is important to have knowledge about
the elasticity’s of demand for such goods. A country may fix higher prices for the products
with inelastic demand. However, if demand for such goods in the importing country is
elastic, then the exporting country will have to fix lower prices.
3. Formulation of Government Policies:
The concept of price elasticity of demand is important for formulating government policies,
especially the taxation policy. Government can impose higher taxes on goods with inelastic
demand, whereas, low rates of taxes are imposed on commodities with elastic demand.
4. Factor Pricing:
Price elasticity of demand helps in determining price to be paid to the factors of
production. Share of each factor in the national product is determined in proportion to its
demand in the productive activity. If demand for a particular factor is inelastic as compared
to the other factors, then it will attract more rewards.
5. Decisions of Monopolist:
A monopolist considers the nature of demand while fixing price of his product. If demand
for the product is elastic, then he will fix low price. However, if demand is inelastic, then he
is in a position to fix a high price.
Theory of Supply
Nature of Supply
Supply refers to the various quantities of a good or service that sellers will be able to
offer for sale at various prices during a period of time. It shows how price of a good or
service is related to the quantity which the sellers are willing and able to make
available in the market.
Supply Function
Like demand, supply also depends on many things. In general, quantity supplied of a
product is expected to depend on own price, prices of related products, prices of inputs,
39
Accordingly, there are three kinds of elasticity of demand. They are:
1. Price elasticity of demand - Price elasticity of demand measures the sensitivity of
quantity demanded to change in own price of good
= Proportionate change in quantity demanded
Proportionate change in price
2. Income elasticity of demand - Income elasticity of demand measures the sensitivity of
quantity demanded to change in income of the consumer.
= Proportionate change in quantity demanded
Proportionate change in income
3. Cross elasticity of demand - Cross elasticity of demand analyses the responsiveness
of quantity demanded of one good to changes in the price of another good.
= Proportionate change in quantity demanded of Commodity A
Proportionate change in price of commodity B
Degrees of Elasticity of Demand (Types of price elasticity)
The value of price elasticity of demand ranges from zero to infinity. That is, 0< Ep<∞.
Based on the value of elasticity or degree of responsiveness of quantity demanded, price
elasticity of demand is classified into five categories. They are
1) Perfectly inelastic demand
2) Perfectly elastic demand
3) Elastic demand
4) Inelastic demand
5) Unitary elastic demand
(1) Perfectly inelastic demand
When quantity demanded does not change as a result of change in price, demand is said
to be perfectly inelastic. In other words, same quantity will be bought whatever the price
may be. Numerical value of elasticity will be zero (E = 0) when there is perfectly or
completely inelastic demand. This is an imaginary situation
36
state of technology, expectations, number of producers (sellers) in the market etc. This
list can be summarised in a supply function
QXS = f (Px, Pr, Pi, T, E, N)
Where,
QXS = Quantity supplied of commodity x
Px = Price of the commodity x
Pr = Prices of related products
Pi = Prices of inputs
T = State of technology
E = Expectations
N = Number of producers in the market
For a simple theory of price, we need to know how quantity supplied varies with the
product‘s own price, all other things being held constant. Thus we can write the supply
function as;
QXS = f (Px)
That is, quantity supplied of commodity x is a function of its own price, other
determinants are assumed to remain constant.
Law of Supply
The functional relationship between price and quantity supplied is called the law of
supply. According to the law of supply, as the price of the commodity falls, the quantity
supplied decreases or alternatively, as the price of the commodity rises the quantity
supplied increases, other things being equal. Therefore, there is a direct relationship
between of the commodity and quantity supplied.
The law of supply can be illustrated through a supply schedule and supply curve. Supply
schedule is a table that shows various quantities of a good or service that sellers are
willing and able to offer for sale at various possible prices during some specified period.
A supply schedule is presented below
Supply schedule shows that as price rises, a greater quantity is offered for sale. By
plotting the information contained in the supply schedule on a graph we can derive the
supply curve as shown below
40
4. Tastes and preferences of consumers – Any change in fashion, taste and
preferences of consumers brings about changes in demand. Eg particular styles
of clothes, food items etc
5. Price of related goods – The demand for a commodity is affected by not only
its own price but also by the price of related goods. These related goods fall into
two categories: substitutes and complements.
Substitute goods – Two goods are said to be substitutes of each other when one
can be used in place of another. For example, tea and coffee are substitute
goods. If the price of substitute commodity increases, the demand for the
original commodity will increase and vice versa.
Complementary goods – Two goods are said to be complementary to each other
when they are used together. In the case of complementary goods, if the demand
of original commodity increases, the demand of complementary goods will also
increase and vice versa.
Reasons for law of Demand / Why the demand curve slopes
downwards?
1. The Law of Diminishing Marginal Utility – Law of demand is derived from
the Law of Diminishing Marginal Utility. Law of Diminishing marginal utility
states that when a consumer consumes more of a commodity, every additional
unit of that commodity will give him less satisfaction. Therefore the consumer
will buy more only at a lower price. If the price is higher, he will restrict its
consumption. For this reason, the demand of a commodity increases at a lower
price and decreases at a higher price and thus the demand curve slopes
downwards. In other words, the demand curve slopes downwards because the
marginal utility curve also slopes downwards.
2. Income effect - When the price of the commodity falls, the consumer can buy
more quantity of the commodity with his given income. If he chooses to buy the
same amount of the commodity as before, some money will be left with him.
That is, consumer‘s real income or purchasing power increases. This increase in
real income induces the consumer to buy more of the commodity. This is
called the income effect of the change in price of the commodity. This is the
reason why a consumer buys more of a commodity whose price falls. Similarly,
an increase in the price of the commodity results in the reduction of real income
of the consumer. Hence, the consumer buys less of a commodity whose price
rises.
3. Substitution effect - Again, when price of the commodity falls, it becomes
relatively cheaper than other commodities. This induces the consumer to
substitute the commodity whose price has fallen for other commodities which
have now become relatively dearer. This change in quantity demanded
resulting from substituting one commodity for another is referred to as
substitution effect of the price change.
34
(5) Unitary Elastic Demand
If a certain percentage change in price leads to an equal percentage change in quantity
demanded, then demand said to have unitary elasticity. Unitary elasticity is the
boundary between elastic and inelastic demand. The coefficient of elasticity will be
equal to one when demand is unitary elastic (E =1)
Determinants or factors affecting elasticity
1. Necessaries – Demand is inelastic. Whatever the price we must buy them.
2. Luxuries and comforts- Demand is more elastic. A little fall in their price stimulates
demand and vice versa.
3. Existence of substitutes – For commodities having substitutes, the demand is elastic. Eg
tea and coffee. If the price of any one of them falls, it will be purchased in larger
quantities.
4. Several uses – When a commodity has several uses, demand for it is elastic. With a fall
in price such a commodity tends to be put to less urgent uses. Thus its demand extends
and vice versa. If a commodity has only one use, a change in price of the commodity will
influence its one use only.
5. Possibility of postponements – When we can postpone buying a commodity, the
demand is elastic. More is purchased when price falls, and less when it rises. Eg if the price
of warm suiting goes up its demand will considerably contract because its purchase can be
conveniently postponed.
Significance of elasticity of demand
The concept of elasticity is very useful to producers and policy makers. It is a valuable tool
to decide increase or decrease in price to effect a change in quantity demanded. The
following are its application:
1. Price fixation
38
The supply curve is a graph showing various quantities of a good or service that sellers (5)Unitary Elastic Supply
are willing and able to offer for sale at various possible prices. The supply curve slopes If the percentage change in quantity supplied is equal to percentage change in price,
upwards because of the direct relationship between price and quantity supplied. supply is said to be unitary elastic. The value of coefficient of elasticity will be equal to
one (E =1) when supply is unitary elastic.
Why there is a direct relationship between price and quantity supplied? The main reason
is that higher prices serve as an incentive for sellers to offer greater quantity for sale.
The sellers or producers can be induced to produce and offer a greater quantity for sale
by higher prices.

Elasticity of Supply
Price elasticity of supply measures the responsiveness or sensitiveness of quantity
supplied of a commodity to a change in its price. It is given by the percentage change in
the quantity supplied of a commodity divided by the percentage change in price. Market Equilibrium
E= percentage change in quantity supplied
The market equilibrium occurs when the prevailing price equates quantity demanded to
percentage change in price
quantity supplied. Consumers bring demand to the market for buying goods to satisfy
their wants. Producers or sellers bring supply of their goods to the market to sell them
and earn profit. The market demand and supply determine prices of goods and services
Types of Supply Elasticity exchanged between buyers and sellers. Thus, market equilibrium is reached when
market demand for and market supply of a good are equal and as a result, equilibrium
When the supply curve is upward sloping, the elasticity of supply will be anything prices and equilibrium quantities are determined. At such equilibrium, buyers find that
between zero and infinity. On the basis of the value of the coefficient of elasticity of they are able to buy exactly the same amount that they are demanding at the prevailing
supply we can classify it into the following five categories price and sellers are able to sell exactly the amount they are willing to supply at the
(1) Perfectly inelastic supply prevailing price.
(2) Inelastic supply
(3) Unitary elastic supply
(4) Elastic supply
(5) Perfectly elastic supply

(1) Perfectly Inelastic Supply

When the quantity supplied of a commodity does not change at all in response to the
change in price, elasticity of supply is said to be perfectly inelastic. This is the case of
zero elasticity (E = o) and the supply curve will be vertical straight line

When the price of commodity X is Rs.1, buyers are willing and able to purchase 100
units but sellers are willing and able to offer only 20 units for sale. Therefore, there is a

41 43

CHAPTER 7 – NATIONAL INCOME 3) Gross National Product

GNP is defined as the money value of all goods and services produced by the
Introduction nationals of a country within the country and outside the country during a year.
Economic growth of a country measured with the help of change in its national
GNP at market price = GDP at market price + NFIA
income. The rate of growth of national income of an economy is indicative of the
pace at which the economy has been growing. The rate of growth of national income
when compared with the rate of growth of population indicates whether the GNP at factor cost = GNP at market price – NIT
economy is declining, stagnant or developing.
GDP and GNP comparison
Concepts: In order to distinguish between GDP and GNP we have to consider two terms; (a)
domestic territory of a country and (b) nationality of citizens.
1) National Income: GDP is a territorial of geographical concept. It includes only those goods and
services which are produced within the domestic territory of a country, during a
The money value of all final goods and services produced in a country during a
year. However it does not include income generated by the home nationals in
financial year.
foreign countries. GNP, on the other hand, is a measure of the value of goods and
services that the nationals or residents of the country produce regardless of where
Sources of Income they are located.
Following are the different sources of income
a) Income from work: People earn income mainly from work. The standard of
living of the people depends on quantity and quality of goods and services
4) Net Domestic Product (NDP)
Net Domestic Product is Gross Domestic Product minus depreciation or
consumed by them. It in turn depends on the money income of the people.
consumption of fixed capital.
b) Income from property: Properties like land, building, factories, machinery etc.
Depreciation or consumption of fixed capital refers to the loss of value of fixed
can be lent out to others to earn income. The income so earned is called rental
capital due to wear and tear in the process of production.
income.
c) Royalties:-Income earned by those who own mineral wealth like iron ore, coals,
natural gases etc. and by those who possess copy rights, patents etc. (intellectual NDP at market price and factor cost
property). The various types of properties mentioned above are called fixed assets or NDP at market prices is the market value of all final goods and services produced
fixed capital. within the domestic territory of a country less depreciation during a year.
d) Dividends:-People can earn dividends by investing the surplus income in stocks NDP at market prices includes the contribution of foreigners residing the domestic
and shares. territory of a country. However, which excludes the contribution of the citizens of
the country residing abroad.
e) Interest:-The surplus income used for purchasing bonds or debentures or lending
to banks or other agencies may yield interest income .These incomes (d) & (e) are
NDP at market price = GDP at market price – depreciation.
called liquid assets. The fixed assets and liquid assets together represent capital.
NDP at factor cost is the total payments made by all the producers to all factors of
production within the domestic territory of a country. In another word NDP at factor
cost is the sum total of the earnings of all factors of production in the form of wages
2) Gross Domestic Product (GDP) and salaries, rent, interest and profit.
The money value of all final goods and services produced in the domestic territory
of a country during a year is called GDP. NDP at factor cost = NDP at market price – net indirect taxes
Domestic territory of a country includes the following :
x Political boundary including territorial waters
x Ships and aircrafts operated by the residents of a country between
5) Net National Product (NNP) at market prices
It can be defined as the total value of final goods and services produced in an
two or more countries.
economy after allowing depreciation
x Fishing vessels, oil and natural gas rigs operated by the residents of a
country in the international waters or where the country has exclusive
NNP at market price = GNP at market price – depreciation
rights to operate.
x Embassies, consulates and military establishments of the country
located in other countries.
6) Net National Product at factor cost or National Income
NNP at factor cost is defined as the volume of goods and services turned out in
country during an accounting year or it is the net value added at factor cost in

45 47
shortage of 80 units. At price of Rs.5, buyers are willing and able to purchase only 20
units while sellers are willing to offer 140 units. Therefore, there will be a surplus of
120 units in the market. Let us now consider a price of Rs.3. At this price, buyers are
willing to purchase 60 units and sellers are willing to offer 60 units for sale. That is, at
this price, there is neither a surplus nor a shortage. Quantity supplied of commodity is
equal to the quantity supplied. Thus PX = Rs.3 is the equilibrium price and QXS = QXD
=6o is the equilibrium quantity.
The determination of equilibrium price and quantity can also be shown graphically by
bringing together the market demand and market supply curve on the same graph, as
shown below.
The intersection of market demand curve DD and market supply curve SS at point E
defines the equilibrium price P* and the equilibrium quantity Q*. At the equilibrium
price, quantity demanded is equal to the quantity supplied. Because there is no excess
demand or excess supply there is no pressure for the price to change further.
44
country during a year. Or it is the sum total of domestic factor incomes and net
factor incomes from abroad. Thus,
NNP at factor cost or National Income = NNP at market prices -
NIT
Note
1. The difference between GDP and GNP is the value of NFIA
2. The difference between Gross and Net aggregates is the value of consumption of
fixed capital or depreciation.
3. The difference between market prices and factor costs is the value of net indirect
taxes.
7) Personal Income
Personal income is the income received by the households and non corporate
business in a country during a year.
Personal income = National Income – corporate profits –corporate income taxes -
social security Contributions + transfers from Government to individuals
8) Disposable income
Disposable income is the income actually available to the households and to the non
corporate business after they have fulfilled their tax obligation to the government.
That is, it is the income actually available to the individuals for saving and
consumption.
Disposable Personal Income = personal income – personal tax .
9) Per capita Income
It is the average per person national income.
Per capita Income = National income / Population
METHODS OF MEASURING NATIONAL INCOME
There are the three methods of calculating national income. The choice of a method
depends upon the availability of data. GDP is the measure of an economy’s total output.
It is also used as a measure of total income and total expenditure in that economy.
Incomes received by individuals is being spent to buy the output of goods and services
produced. Hence the income is equal to expenditure and expenditure is equal to the
value of output produced in the economy.
Income = Expenditure = Output
I. Product Method
This is also called the output method, the inventory method or the census method. It
consists of finding out the market value of all the goods and services produced during a
year.
According to this method the economy is classified into different sectors. The various
sectors are Primary sector consisting of agriculture, fishing and mining; Secondary
48
(2) Perfectly Elastic Supply
At any given price infinite quantity is supplied, supply is said to be perfectly elastic. The
coefficient of elasticity will be infinity (E = ∞ ) when supply is perfectly elastic.
Perfectly elastic supply curve is depicted by a horizontal supply curve parallel to
quantity axis.
(3)Elastic Supply
If the percentage change in quantity supplied is greater than percentage change in price,
supply is said to be elastic. The value of the coefficient of elasticity will be greater than
unity (E>1) when the supply is elastic.
(4)Inelastic Supply
If the percentage change in quantity supplied is smaller than the percentage change in
price, supply is said to be inelastic. The value of the coefficient of supply will be greater
than zero but less than unity (E<1).
42
Normal residents of a country: All persons who ordinarily live in a country at least
for one year and whose economic interest belongs to that country are called the
normal residents of a country.
GDP includes the following components:
a) Value of goods and services used for ultimate consumption (C)
b) Value of capital goods used for investment purposes (I)
c) Government expenditure – refers to value of goods produced and services offered
by government (G)
d) Net receipts from abroad in terms of excess of value of exports (E) and imports
(I) . Net receipts (E-I)
GDP can be estimated both at market prices and at factor costs.
Market price is the price at which a commodity is sold and purchased in the
market. It is the price what the buyers pay actually, not what the producers actually
get. The point to be noted is that when a product goes to the market for sale,
government levies indirect taxes (like sales tax, excise duty, etc.) which is added to
the factor cost of the commodity.
Consequently market price becomes higher than factor cost. Similarly, sometimes
government gives subsidy on sale of certain goods (like sugar, rice, LPG cylinder)
which is subtracted from factor cost. As a result, MP becomes lower than Factor
Cost (FC).
Factor cost refers to all factor payments made by the producing unit (firm) to the
factors of production for rendering productive services in the production of goods
and services. It is called factor cost because it is cost to the producer (firm) who
pays to factors in the form of rent, wages, interest, etc. and profit to himself.
MP includes net indirect tax whereas FC does not. Thus, FC becomes MP when net
indirect taxes are added to FC. In the absence of indirect taxes and subsidies, MP
and FC are the same.
GDP at market price
GDP at market price is defined as the money value of all final goods and services
produced in the domestic territory of a country during an accounting year estimated
at the prices prevailing in the markets.
GDP at market price = C + I + G + (E-I)
GDP at factor cost
It is the estimation of GDP in terms of the earnings of factors of production. GDP at
factor cost is the sum total of the earnings received by the factors of production in
terms of wages, rent, interest and profit.
GDP at factor cost = (GDP at market price) – (Net Indirect Taxes)
Where , Net Indirect Taxes = Indirect Taxes – Subsidies
46
sector consisting of industrial sectors and Tertiary sector consisting of service sector. In
each sector we make an inventory of goods produced and find out the end product
making an addition to the value of goods. The value added method can be followed in
order to avoid double counting. The value added of a firm is its output less whatever it
purchases from other firms such as raw materials, and other inputs
II. Income Method
It measures GDP as the sum of incomes earned by factors of production like land,
labour, capital and enterprise in the form of rent, wages, interest and profits. To arrive at
the totality of income of nation, the following procedure will be adopted:
a) Net rents include the rental value of owner occupied houses.
b) Wages, salaries and all such earnings of person employed, pensions are excluded.
c) Earnings by way of interest.
d) Income of joint stock companies.
e) Income from overseas investment.
This method gives national income at factor cost.
III. Expenditure Method
This method is also called the flow of product approach or the outlay method.
Here we take into account the expenditure on finished products-
x Expenditure by consumers on goods and services.
x Expenditure by producers on investment of goods.
x Expenditure by government on consumption as well as capital goods.
x Net exports ie exports minus imports
demand pull inflation. Excess demand may result due to increase in money
supply. This is also known as demand pull inflation
2. Cost push inflation - When inputs such as wages, raw materials and
overheads costs more, the prices of finished products are also pushed up.
When final prices rise as a result of increase in input costs, it is called cost-
push inflation
3. Creeping inflation – This is slow moving and a very mild inflation. When
general price level rises mildly say to 2% annually, it can be called creeping
inflation.
4. Deficit induced inflation – When the Government adopts deficit budget, and
when deficit increases, this leads to inflation
5. Ratchet inflation – In some sectors, the demand for the goods is excessively
high and supply is lagging behind the excessive demand and as a result the
prices of the commodity shoots up.
6. Running inflation – The rate of increase in the general price level reached
double digit in the case of running inflation.
7. Galloping inflation – In the case of galloping inflation, the general price
level reaches double digits or even triple digits. The rate of increase in
inflation may be 50%
8. Hyper inflation – Money becomes worthless and it is better to hold stocks
of goods and assets rather than money. Every minute, the value of money
changes so much so that people may have to carry bags of currency with
them to purchase daily use goods.

Difficulties in measurement of National Income
1. Non monetized sector – In India the bulk of goods and services produced do not come
to market for sale; these are either consumed by the producers themselves or exchanged
through barter system of exchange. So it becomes difficult to find out the market value
of production
2. Lack of distinct differentiation – In India large number of workers are engaged in
many activities simultaneously. Thus it becomes difficult to estimate the National
income in different economic activities.
3. Black money – A significant part of the economy operates through black money.
Economic activities are not reported or are under- reported. This is done in order to
evade taxes. So estimates of National income becomes wrong
4. Non – availability of data about certain incomes – data about incomes of small
producers and household enterprises is not available. Hence estimates may go wrong
5. Fluctuation in price levels – Fluctuations make the measurement of national income
unstable.
Causes of inflation
I] Factors affecting demand
a) Increase in money supply – Inflation is caused by an increase in money
supply which leads to an increase in aggregate demand. The higher the
growth rate of money supply, the higher is the rate of inflation
b) Increase in disposable income – When the disposable income of people
increases, it raises their demand for goods
c) Increase in consumer spending – The demand for goods and services
increases when consumer expenditure increases when consumer expenditure
increases. They may also spend more when they are given credit facilities to
buy goods on hire purchase and installment basis
d) Cheap monetary policy – Cheap monetary policy leads to an increase in the
money supply which raises the demand for goods and services. It raises the
money income of the borrowers which in turn raises the demand. [ Cheap
monetary policy refers to a situation where interest rates on loans are
decreased so that money is available to the public at cheap rates.]
e) Black Money – People have a general tendency to spend unearned money
extravagantly. This leads to unnecessary demand for commodities. This
leads to a rise in price level
f) Increase in exports – When the demand for domestically produced goods
increases in foreign countries, this raises the earnings of industries producing
export commodities which in turn creates more demand for goods and
services

II] Factors affecting supply

49 51

3. Higher reserve requirements – An increase in the CRR and SLR will reduce the a) Policy of export promotion and import reduction – To control deflation, the
ability of the member banks to create credit and thus the step will result in decrease Government should adopt export promotion, this will solve the problem of over
in supply of money and credit. production. Further it may be necessary to reduce imports
4. Curbs on unproductive lending – The Central Bank may dissuade the member b) Control on production – To increase the price level, it may be necessary to
banks from giving loans for unproductive purposes and impose restrictions on regulate production in the various industries
consumer loans.
5. Higher margin requirements - The Central Banks may ask member banks to have
higher margin requirements so that the borrower can obtain lower amount of loan
and this will reduce the supply of money.

B. Fiscal Measures
Fiscal policy is the use of Government revenue collection (taxation) and expenditure
(spending) to influence the economy, or else it involves the Government changing
the levels of taxation and Government spending in order o influence the aggregate
demand and level of economic activity.
The fiscal measures include:
1. Taxation – Government may increase the tax rates to curb excessive spending on
goods and services
2. Public borrowing – Government borrows from the public on voluntary basis or
compulsory basis through deposit schemes.
3. Deficit spending – The Government by reducing its deficit spending, can control
inflation. Deficit financing is the practice in which Government spends more money
than it receives as revenue, the difference being made up by borrowing or minting
new funds.

C. Price Control
1. Increase in supply of goods – By increasing supply of goods. Government can
arrest price rise by encouraging investments
2. Price control and rationing – rationing of essential commodities and proper
implementation of public distribution system.

DEFLATION
Deflation is a condition of falling prices. It is just the opposite of inflation. In
deflation, the value of money goes up and prices fall down. Deflation brings a
depression phase of business in the economy. Here output of goods and services
increases more rapidly than the volume of money income in the economy.

Causes of deflation
1. Decrease in the quantity of money – If the supply of money is less than the
demand, then the purchasing power of money will increase and consequently
the price level will decrease. Therefore deflationary situation will rise in the
country
2. Increasing taxation – If the Government imposes high rate of taxes, the
purchasing power of the public will be adversely affected and it will give rise
to a deflationary situation
3. Open Market Operations – When RBI sells government securities in the
open market, public money goes in the hand of the RBI adversely affecting

53 55
 g) Shortage of factors of production – One of the important factors affecting the
supply of goods is the shortage of factors such as labour, raw materials, etc.
CHAPTER 8 – INFLATION, DEFLATION –
They lead to excess capacity and reduction in industrial production CONCEPTS AND REGULATORY MEASURES
h) Industrial dispute – In countries where trade unions are powerful, they can
also restrict production
i) Natural calamities – Natural calamities likes droughts, floods etc affects the Inflation
supply of agricultural products Inflation simply means a continuous increase in general price level. It can be
j) Artificial scarcities – It is created by speculators who indulge in black described as a decline in the real value of money or a loss of purchasing power in
marketing. They reduce the supply and raise the prices the medium of exchange. When the general price level rises, each unit of currency
k) Increase in exports – When the country produces more goods for export than buys fewer goods and services. Inflation has been defined in several ways by
for domestic consumption, this creates shortages of goods in domestic different economists. Inflation is too much of money chasing too few goods.
market. This leads to inflation in the economy
The rate of inflation is measured through Wholesale Price Index (WPI) or Consumer
Price Index (CPI) or GDP Deflator.
Effects of inflation
a. Inflation reduces the standard of living of people who live on fixed income such
Features of inflation:
as pensioners and landlords
1. It is the situation of rising prices
b. Interest rates rise due to two reasons. First lenders, require higher rewards, as
2. It is the situation where supply of money is rising. Situation of more money
there is a fall in the value of money. Hence they charge a higher interest rate as a
chasing less number of goods
compensatory measure. Second, the government may increase the bank rate through
3. Money buys less when price levels rises, Purchasing power decreases
the central bank in order to control inflation. As a result commercial banks are also
4. The value of money decreases
compelled to increase their lending rates.
c. People will not feel like saving as they expect further erosion in the value of
Shifts in demand and supply curve leading to Inflation
money and hence they feel like saving by postponing consumption.
d. They also feel it is safer to invest in goods rather than saving money
e. Social and political effects – Inflation disrupts social life by favouring rich and
black markets. People lose faith in democratic government due to inflation

Measures to control inflation

Measures are of three types:
a. Monetary Measures
b. Fiscal measures
c. Price control

A. Monetary measures
The best remedy for fighting inflation is to reduce the aggregate spending. Monetary
policy can help in reducing the pressure of demand. Monetary policy works by
controlling the cost and availability of credit. During inflation, the Central bank can
raise the cost of borrowing and reduce the credit-creating capacity of the commercial
banks. This will make borrowing more costly than before and thereby the demand
for funds will be reduced. Similarly with a reduction in their credit-creating
capacity, the banks will be more cautious in their lending policies. The result will be
fall in the volume of spending.
The main methods of controlling the credit-creating capacity of banks are:
1. The Bank rate – The Central Bank of the country increases the bank rate in order
to make borrowing a costly affair so that there would be less incentive for borrowing Types of inflation
and as consequence, the supply of money and credit will decrease in the economy. 1. Demand pull inflation – When there is excess demand beyond the output
2. Open Market Operations – The Central bank will sell Government bonds and capacity of the economy to supply goods and services, it contributes to the
securities to the public or to the banks in order to reduce the supply of money. rise in inflation. When excess demand is responsible for inflation, it is called

52 50

CHAPTER 9 –MONETARY & FISCAL POLICY
Monetary Policy of RBI or Credit control Measure of RBI
Monetary policy refers to the credit control measures adopted by the Central bank of
country. It is a policy employing the central bank’s control of supply of money as an
instrument for achieving the objectives of general economic policy.
Objectives
The important objectives of the monetary policy are:
1. Price Stability – Fluctuations in prices create different problems of
production, distribution besides uncertainty and instability for the economy.
Stability of price level is the chief ain of Monetary policy. It will keep value
of money stable, eliminate cyclical fluctuations, bring economic stability,
secures social justice and promotes economic welfare.
2. Full employment- It is a situation in which those who are willing to work at
the prevailing wage rate are able to find jobs. The problem of full
employment is one of maintaining adequate effective demand. In a
developing economy unemployment will have to be removed. So monetary
policy should be designed to increase investment. Such a policy is the cheap
money policy (low interest rate). Borrowing for investment will increase and
through operation of multiplier and accelerator, the level of employment can
be raised.
3. Balance of payments equilibrium – The achievement of this goal has been
necessitated by the tremendous growth in international trade. A deficit in
BOP will retard attainment of other objectives. This is because a deficit in
BOP leads to sizeable outflow of money.
4. Reduction in inequalities of income and wealth – Inflation causes a large
scale redistribution of income and wealth. The losers are people with fixed
income. To avoid inequality, monetary policy should be so designed to
control changes in price level.
5. Economic growth – It implies an increase in the real per capita income or
output of a country over a long period of time. Monetary policy helps in
achieving continuous economic growth by maintaining equilibrium between
the total demand for money and total output produced in the economy and
creating favourable conditions for saving and investment.
Instruments of monetary policy
a) Quantitative instruments
1. Bank rate policy:
2. Open Market Operations:
3. Variable Cash reserve ratio:
4. Variable Statutory Liquidity Ratio
5. Repo Rate and Reverse Repo Rate
b) Qualitative measures
1. Moral suasion
2. Publicity
the deposits of commercial banks. Thus to some extent credit creation
powers of the commercial banks are restricted which gives rise to deflation
4. Inflation ultimately leads to deflation – Inflation gives an incentive to
production and employment which raise income. High profits encourage
investments, consequently production goes up so much that effective demand
for goods fall short of it and the situation of deflation crops up
5. Increased productivity – Innovative solutions and new processes help
increase efficiency which ultimately leads to lower prices.
Effects of deflation
1. Effects on debtors and creditors – When prices fall, debtors lose and
creditors gain. The creditors gain because whatever the amount they receive
as interest etc carries now a higher purchasing power than before. The
producers are worst hit by the falling prices
2. Effects on consumers – During periods of falling prices consumers gain
because of the fall in price. The cost of the living falls rapidly. The
consumers can purchase more amounts of goods with falling prices
3. Effects on salaried classes and fixed income earners – They tend to gain
when the prices decrease. With increase in purchasing power of money, their
standard of living tends to increase
4. Effects on producers – producers tends to lose during the period of deflation.
The prices they pay for inputs are high and when they complete production,
prices fall. Profit margin decreases
5. Adverse effects on banking – During deflation, the number of borrowers
goes down on account of general recession in the economy
Measures to control deflation
The following measures will be taken up to control deflation:
1. Monetary measures –
a) Cheap money policy – Under this policy the rate of interest should be deliberately
cut down to encourage new business enterprises
b) Deficit financing – To check deflationary situations, the monetary authority
should resort to a policy of monetary expansion to push up the declining price.
c) Expansion of credit – Businessmen and industrialists should be encouraged to
borrow funds
2. Fiscal measures –
a) Reduction in taxation – The Government should follow the reduced tax policy. If
it is so, the purchasing power of the people will increase and demand for
commodities will go up
b) Repayment of public debt – The Government should repay the past debt taken
from the public. This will increase the purchasing power of the public
c) Increase in public expenditure – Government should increase the expenditure in
different development programmes. This will increase the volume of employment
and also the purchasing power of people
d) Grant subsidies - The Governmet should give subsidies to encourage setting up
of new industries which will increase the volume of employment in the economy
3. Other measures -

56 54
3. Direct action
The credit control measures of RBI are classified into quantitative and qualitative
measures.
(a)Quantitative weapons
1. Bank rate policy:
Bank rate is the lending rate of central bank. It is the official minimum rate at which
central bank of a country rediscounts the eligible bills of exchange of the
commercial banks and other financial institutions or grants short term loans to them.
By increasing bank rate, RBI can make bank credit costlier. Bank rate is the
minimum rate at which central bank of a country will lend to other banks. If bank rate
goes up, the rates charged by banks goes up. If interest rates go up, businessmen will be
discouraged to borrow more money.
2. Open Market Operations:
RBI Act authorizes the RBI to engage in the purchase of securities of central and
State Government and such other securities as specified by Central Govt. When
there is an excessive supply of money, RBI sells the securities in the open market. In
that way RBI is able to withdraw the excess money from circulation. But when there
is shortage of money supply in the market, it purchases securities from the open
market and as a result, more money is arrived at for circulation
3. Variable Cash reserve ratio:
Under the RBI Act of 1934, every scheduled and non- scheduled bank is required to
maintain a fixed percentage of total time and demand liabilities as cash reserve with
RBI. It is called statutory Cash Reserve Ratio (CRR). An increase in CRR reduces
lending capacity of the bank and a decrease in CRR increases the lending capacity.
RBI can prescribe a CRR ranging up to 15%.
MODULE 2
CHAPTER 1 - VALUE ANALYSIS/VALUE
ENGINEERING
1 INTRODUCTION
Value analysis is one of the major techniques of cost reduction and cost prevention. It
is a disciplined approach that ensures necessary functions for minimum cost without
sacrificing quality, reliability, performance, and appearance. According to the Society of
American Value Engineers (SAVE), Value Analysis is the systematic application of recognized
techniques which identify the function of a product or service, establish a monetary value for the
function and provide the necessary function reliably at the lowest overall cost. It is an organized
approach to identify unnecessary costs associated with any product, material part,
component, system or service by analysing the function and eliminating such costs without
impairing the quality, functional reliability, or the capacity of the product to give service.
2 WHEN TO APPLY VALUE ANALYSIS
One can definitely expect very good results by initiating a VA programme if one or more of
the following symptoms are present:
1. Company’s products show decline in sales.
2. Company’s prices are higher than those of its competitors.
3. Raw materials cost has grown disproportionate to the volume of production.
4. New designs are being introduced.
5. The cost of manufacture is rising disproportionate to the volume of production.
6. Rate of return on investment has a falling trend.
7. Inability of the firm to meet its delivery commitments.

4. Variable Statutory Liquidity Ratio
According to sec 24 of Banking Regulation Act 1949, every commercial bank is
required to maintain a certain percentage of its total deposits in liquid assets such as
cash in hand, excess reserve with RBI, balances with other banks, gold and approved
Government and other securities. This proportion of liquid assets to total deposits is
called SLR. Banking Regulation Act empowers RBI to fix the SLR up to 40%. The
variation of the SLR is intended to reduce the lendable funds in the hands of the
commercial banks and to check the expansion of bank credit. An increase in SLR
will decrease the lendable funds in the hands of commercial banks and vice versa.
2.1 Value Analysis vs. Value Engineering
Often the terms value analysis and value engineering are used synonymously. Though the
philosophy underlying the two is same, i.e. identification of unnecessary cost, yet they are
different. The difference lies in the time and the stage at which the techniques are applied.
Value analysis is the application of a set of techniques to an existing product with a
view to improve its value. It is thus a remedial process. Value engineering is the
application of exactly the same set of techniques to a new product at the design stage,
project concept or preliminary design when no hardware exists to ensure that bad
features are not added. Value engineering, therefore, is a preventive process.

5. Repo Rate and Reverse Repo Rate Value

Repo rate is the rate at which RBI lends to commercial banks generally against
government securities. Reduction in Repo rate helps the commercial banks to get
money at a cheaper rate and increase in Repo rate discourages the commercial banks
to get money as the rate increases and becomes expensive. Reverse Repo rate is the
rate at which RBI borrows money from the commercial banks. The increase in the
Repo rate will increase the cost of borrowing and lending of the banks which will
discourage the public to borrow money and will encourage them to deposit.
b) Qualitative measures
The term ‘value’ is used in different ways and, consequently, has different meanings. The
designer equates the value with reliability; a purchase person with price paid for the item; a
production person with what it costs to manufacture, and a sales person with what the
customer is willing to pay. Value, in value investigation, refers to “economic value”, which
itself can be divided into four types: cost value, exchange value, use value, and esteem
value. These are now briefly described.
Cost value. It is the summation of the labour, material, overhead and all other elements of
cost required to produce an item or provide a service compared to a base.
Exchange value. It is the measure of all the properties, qualities and features of the product,
which make the product possible of being traded for another product or for money. In a

57 59

Secondary functions are usually related to convenience. The product can still work and 6 ADVANTAGES AND APPLICATION AREAS
fulfill its intended objective even if these functions are not in-built and yet they may be
Advantages
necessary to sell the product.
The advantages of value engineering are as follows:
Tertiary functions are usually related to esteem appearance. For example, Sunmica top of
1. It is a much faster cost reduction technique.
a table gives esteem appearance for the table. Let us consider a single example of painting a
2. It is a less expensive technique.
company bus to explain all the above three functions. Here, the primary function of painting
3. It reduces production costs and adds value to sales income of the product.
is to avoid corrosion. The secondary function is to identify the company to which the bus
Applications
belongs by the colour of the paint (e.g. blue colour for Ashok Leyland Ltd.). The tertiary
The various application areas of value engineering are machine tool industries, industries
function is to impart a very good appearance to the bus by using brilliant colours.
making accessories for machine tools, auto industries, import substitutes, etc.

4 AIMS
The aims of value engineering are as follows:
1. Simplify the product.
2. Use (new) cheaper and better materials.
3. Modify and improve product design.
4. Use efficient processes.
5. Reduce the product cost.
6. Increase the utility of the product by economical means.
7. Save money or increase the profits.
The value content of each piece of a product is assessed using the following questions:
1. Does its use contribute to value?
2. Is its cost proportionate to its usefulness?
3. Does it need all its features?
These three questions pertain to the function of the part which may decide the elimination of
parts.
_ Is there anything better for the intended use?
_ Can company or vendor standard be used?
_ Can a usable part be made by a lower-cost method?
_ Is it made with the proper tooling, considering volume?
_ Does the part yield suitable profit?
_ Can another vendor furnish the same at a lower cost?

5 VALUE ENGINEERING PROCEDURE

The basic steps of value engineering are as follows:
(a) Blast
(i) Identify the product.
(ii) Collect relevant information.
(iii) Define different functions.
(b) Create
(iv) Different alternatives.
(v) Critically evaluate the alternatives.
(c) Refine
(vi) Develop the best alternative.
(vii) Implement the alternative.

Step 1: Identify the product. First, identify the component for study. In future, any design
change should add value and it should not make the product as obsolete one. Value
engineering can be applied to a product as a whole or to sub-units.
Step 2: Collect relevant information. Information relevant to the following must be
collected:
_ Technical specifications with drawings
_ Production processes, machine layout and instruction sheet
_ Time study details and manufacturing capacity

61 63
conventional sense, exchange value refers to the price that a purchaser will offer for the
product, the price being dependent upon satisfaction (value) which he derives from the
product. Value derived from the product consists of two parts “use value” and “esteem
value”, which are now described.
Use value. It is known as the function value. The use value is equal to the value of the
functions performed. Therefore, it is the price paid by the buyer (buyer’s view), or the cost
incurred by the manufacturer (manufacturer’s view) in order to ensure that the product
performs its intended functions efficiently. The use value is the fundamental form of
economic value. An item without “use value” can have neither “exchange value” nor
“esteem value”.
Esteem value. It involves the qualities and appearance of a product (like a TV set), which
attract persons and create in them a desire to possess the product. Therefore, esteem value is
the price paid by the buyer or the cost incurred by the manufacturer beyond the use value.
Performance
The performance of a product is the measure of functional features and properties that make
it suitable for a specific purpose. Appropriate performance requires that (a) the product
reliably accomplish the intended use of work or service requirement (functional
requirements), (b) the product provide protection against accident, harmful effects on body
and danger to human life (safety requirements), (c) the product give trouble-free service
cover during its specified life span (reliability requirements), (d) service and maintenance
work can be carried out on the product with ease and with simple tools (maintainability
requirements), and (e) appearance of the product creates an impression on the buyer and
induces in him or her the desire to own the product (appearance requirements).
Performance and cost must be interwoven. Desired performance at the least cost should be
achieved by selecting appropriate materials and manufacturing operations, which is the
measure of value. Therefore, the value of the product is the ratio of performance (utility) to
cost. Thus,
Value = Performance (utility)/Cost
Value can be increased by increasing the utility for the same cost or by decreasing the cost
for the same utility. Satisfactory performance at lesser cost through identification and
development of low cost alternatives is the philosophy of Value analysis.
3 FUNCTION
Function is the purpose for which the product is made. Identification of the basic
functions and determination of the cost currently being spent on them are the two major
considerations of value analysis. Function identifies the characteristics which make the
product/component/ part/item/device to work or sell. “Work functions” lend performance
value while “sell functions” provide esteem value. Verbs like “support”, “hold”, “transmit”,
“prevent”, “protect”, “exhibits”, “control”, etc., are used to describe work functions, while
“attract”, enhance”, “improve”, “create”, etc., are used to describe “sell” functions.
Classification of the functions
Rarely do all functions assume equal importance. Usually, some functions are more
important than others. Functions can be classified into the following three categories:
1. Primary function
2. Secondary function
3. Tertiary function
Primary functions are the basic functions for which the product is specially designed to
achieve. Primary functions, therefore, are the most essential functions whose non-
performance would make the product worthless, e.g. a photo frame exhibits photographs,
a chair supports weight, a fluorescent tube gives light.
Secondary functions are those which, if not in-built, would not prevent the device from
performing its primary functions, e.g., arms of a chair provide support for hands.
60
CHAPTER 2 – TIME VALUE OF MONEY
Time value of money can be explained by taking a very simple scenario. If you are offered
the choice between having Rs 10,000 today and having Rs 10,000 at a future date, you will
usually prefer to have Rs 10,000 now. Similarly if the choice is between paying Rs 10,000
now or paying the same Rs 10,000 at a future date, you will prefer to pay the Rs 10,000
later. It is simple common sense. In the first case by accepting Rs 10,000 early, you can
simply put the money in the bank and earn an interest. Similarly in the second case by
deferring the payment, you can earn interest by keeping money in the bank.
Therefore the time gap allowed us to make some money. This incremental gain is the time
vale of money.
If the bank interest was zero, what would be the time value of money? It would also be zero.
So interest plays a very important role in determining the time value of money. Interest rate
is the cost of borrowing money as a yearly percentage. For investors interest rate is the rate
earned on an investment in yearly percentage.
Most financial decisions, such as the purchase of assets or procurement of funds, affect the
firm’s cash flows in different time periods. For example, if fixed asset are purchased it will
require immediate cash outlays and will generate cash flows during many future periods.
Similarly, if firm borrows funds from the bank it receives cash now and commits an
obligation to pay interest and repay principal in future periods. Cash flows become logically
comparable when they are appropriately adjusted for their differences in time and risk.
Reasons for individual’s Time Preference for Money:
a) Uncertainty: An individual is not certain about future cash receipts, he prefers receiving
cash now.
b) Preference for Consumption: Individuals have a preference for current consumption in
comparison to future consumption. In order to forego the present consumption for a future
one, they need a strong incentive. Say for example if the individual’s present preference is
very strong then he has to be offered a very high incentive to forego it like a higher rate of
interest.
c) Inflation – Inflation means that the prices of things are rising faster than they actually
should. When there is inflation, the value of currency decreases over time. If the inflation is
more, then the gap between the values of money today to the value of money in the future is
more. So greater the inflation, the greater is the gap and vice versa.
d) Investment Opportunities: Most individuals prefer present cash to future cash because
of the available opportunities to which they can put present cash to earn additional cash. For
e.g., an individual who is offered Rs. 100 now or Rs 100 one year from now would prefer
Rs100 now if he could earn interest of Rs 5 by putting in the saving account in the bank for
one year. His total cash in one year from now will be Rs.105.
1. Single-Payment Compound Amount (future value of a single amount)
Here, the objective is to find the single future sum (F) of the initial payment (P)
made at time 0 after n periods at an interest rate i compounded every period.
The cash flow diagram of this situation is shown
64
1. Moral suasion – It implies friendly persuasion. Central Bank morally request the
commercial banks to please adjust their lending policies according to the present
economic conditions.
2. Publicity – It makes know the view of the central bank regarding monetary
policy. It regularly publishes statement of assets and liabilities of commercial banks
for information to the public. It publishes reports of general money, markets and
banking trends
3. Direct action – It refers to all those directives and restrictive measures the
Central Bank may enforce on all commercial banks. It may reject loan facilities
altogether. It may refuse to sanction further accommodation to a bank. It may charge
penal rate of interest on advances made to offending banks.
Fiscal Policy
Fiscal policy is the use of government spending, taxes and debt management to
adjust employment, prices and aggregate demand. The level of aggregate spending
is influenced by the changes in government expenditures and taxes.
Objectives
1. Full employment – The level of employment can raised by increasing the
propensity of the community to consume through progressive taxation.
Public investment is another measure suggested to raise the level of
employment.
2. Optimum allocation of resources – Fiscal policy aims at the diversion of
existing resources from unproductive to productive and socially desirable
uses.
3. Equitable distribution of income and wealth – This is attained by
transferring wealth from rich to poor by taxation and promoting savings.
4. Economic growth – This is attained through increasing rate of capital
formation through public investment.
5. Price stability – This is done for protecting the economy from inflation
Instruments of Fiscal policy
1. Government spending – public expenditure stimulates employment, output,
income and aggregate demand in the economy. The important items of
government expenditures are expenditures on public works, relief
expenditures, subsidies, transfer payments and social security benefits.
2. Taxes – Taxes determine the size of disposable income in the hands of
people. A change in tax structure will influence the level of aggregate
demand and employment.
3. Savings – Savings determine the level of private spending in the economy.
The government adopts compulsory saving schemes to counteract inflation.
4. Debt management – when government spends more than it collects in taxes,
it has to borrow money in order to finance its deficits. Public debt may be
managed in such a way as to influence the supply of money in the economy.
58
_ Complete cost data and marketing details
_ Latest development in related products
Step 3: Define different functions. Identify and define the primary, secondary and tertiary
functions of the product or parts of interest. Also, specify the value content of each function
and identify the high cost areas.
Step 4: Different alternatives. Knowing the functions of each component part and its
manufacturing details, generate the ideas and create different alternatives so as to increase
the value of the product. Value engineering should be done after a brain storming session.
All feasible or non-feasible suggestions are recorded without any criticism; rather, persons
are encouraged to express their views freely.
Basic principles of brain storming
Some of the important principles of brain storming which are useful in value analysis are
now listed.
(i) A quality idea comes from quantity of ideas. If the number of ideas generated is more, the
more good solutions do turn up.
(ii) Creative ideas emerge from unconventional thinking. This is possible when members of
the group “talk off the top of their heads” and voice weird ideas as they flash through their
minds, regardless of how stupid or impractical they may appear. Often, non-technical
personnel can prove to be the greatest innovators in technical areas since their viewpoints
are objective and they do not know that some of their ideas are technically not feasible at all.
So it is preferable to include one or two non-technical persons in the study team. Members
are to be told by the team leader in the beginning of the session itself, not to breathe a word
of criticism of even the most weirdest idea.
(iii) Spontaneous evaluation of ideas curbs imaginative thinking and retards the flow of
creative ideas. The group should not evaluate the alternatives suggested by its member
immediately since immediate evaluation may curb imaginative thinking and slow down the
flow of creative ideas.
(iv) Hitch-hiking on the ideas often lead to better ideas. Participants have to improve upon
ideas of other members either directly or by combining more ideas in addition to
contributing ideas of their own. A brilliant idea may not be a practical one initially, or it
may look to be silly or useless but discussions can convert it into a valuable one.
(v) Creativity is a regenerative process and the recording of ideas as they emerge helps
serve as a catalyst to generate more ideas. Memory may not retain all ideas or recall them
when they are needed. So, a stenographer may be asked to record ideas simultaneously. A
tape recorder can also be used for this purpose or even ideas can be written on a blackboard.
These recorded ideas can be reviewed at some later date.
(vi) When ideas cease to flow, short diversions enable the mind to rebound with new ideas
after recuperation. Members of the syndicate may reach a stage where new ideas do not
come. At such a stage, short diversions—rest, favourite sport, hobby, lunch or tea break,
etc.—may be taken during which members are advised to sleep over the ideas and report
fresh after the break. Such short diversions enable mind to recoup and rebound with new
ideas.
Step 5: Critically evaluate the alternatives. Different ideas recorded under step 4 are
compared, evaluated and critically assessed for their virtues, validity and feasibility as
regards their financial and technical requirements. The ideas technically found and
involving lower costs are further developed.
Step 6: Develop the best alternative. Detailed development plans are made for those ideas
which emerged during step 5 and appear most suitable and promising. Development plans
comprise drawing the sketches, building of models, conducting discussions with the
purchase section, finance section, marketing division, etc.
Step 7: Implement the alternative. The best alternative is converted into a proto-type
manufacturing model which ultimately goes into operation and its results are recorded.
62
 Cash flow diagram for single payment compound amount
The formula to get F is

The formula to obtain the single-payment compound amount is

F = P(1 + i)n
Where:
Where A = equal amount to be deposited at the end of each interest period
P = principal amount n = No. of interest periods
n = No. of interest periods i = rate of interest
i = interest rate (It may be compounded monthly, quarterly, semiannually or F = single future amount at the end of the nth period
annually)
F = future amount at the end of year n Eg. A company has to replace a present facility after 15 years at an outlay of
Rs. 5,00,000. It plans to deposit an equal amount at the end of every year for
the next 15 years at an interest rate of 18% compounded annually. Find the
equivalent amount that must be deposited at the end of every year for the next
15 years.
Eg A person deposits a sum of Rs. 20,000 at the interest rate of 18%
compounded annually for 10 years. Find the maturity value after 10 years.

F = P(1 + i)n
= 20,000 x 5.234 = Rs. 1,04,680

2. Single-Payment Present Worth Amount (Present value of a single amount)

Here, the objective is to find the present worth amount (P) of a single future sum
(F) which will be received after n periods at an interest rate of i compounded at the
end of every interest period.
The cash low diagram is shown below

= 5,00,000 x 0.0164
= Rs. 8,200

5. Equal-Payment Series Present Worth Amount (Present value of an annuity)

The formula to obtain the present worth is The objective of this mode of investment is to find the present worth of an equal
P= F____ payment made at the end of every interest period for n interest periods at an interest rate
(1 + i)n of i compounded at the end of every interest period.

Eg. A person wishes to have a future sum of Rs. 1,00,000 for his son’s
education after 10 years from now. What is the single-payment that he should
deposit now so that he gets the desired amount after 10 years? The bank gives
15% interest rate compounded annually.
P = F / (1 + i)n
= 1,00,000 x 0.2472
= Rs. 24,720

3. Equal-Payment Series Compound Amount (Future value of an annuity)

65 67

P = present worth (loan amount) Let i be the nominal interest rate compounded annually. But, in practice, the
A = annual equivalent payment (recovery amount) compounding may occur less than a year. For example, compounding may be monthly,
i = interest rate quarterly, or semi-annually. Compounding monthly means that the interest is computed
n = No. of interest periods at the end of every month. There are 12 interest periods in a year if the interest is
compounded monthly. Under such situations, the formula to compute the effective
Eg. A bank gives a loan to a company to purchase an equipment worth Rs. interest rate, which is compounded annually, is
10,00,000 at an interest rate of 18% compounded annually. This amount Effective interest rate, R = (1 + i/C)C – 1
should be repaid in 15 yearly equal installments. Find the instalment amount where,
that the company has to pay to the bank. i = the nominal interest rate
C = the number of interest periods in a year.

Eg. A person invests a sum of Rs. 5,000 in a bank at a nominal interest rate of 12% for
10 years. The compounding is quarterly. Find the maturity amount of the deposit after
10 years.

No. of interest periods per year, C = 4

Effective interest rate, R = (1 + i/C)C – 1
= (1 + 12%/4)4 – 1
= 12.55%, compounded annually.

F = P(1 + R)n = 5,000(1 + 0.1255)10

= Rs. 16,308.91
= 10,00,000 x (0.1964)
= Rs. 1,96,400

BASES FOR COMPARISON OF ALTERNATIVES

7. Uniform Gradient Series Annual Equivalent Amount
The objective of this mode of investment is to find the annual equivalent amount of
a series with an amount A1 at the end of the first year and with an equal increment
(G) at the end of each of the following n – 1 years with an interest rate i
compounded annually.
In most of the practical decision environments, executives will be forced to select the best
alternative from a set of competing alternatives. Let us assume that an organization has a
huge sum of money for potential investment and there are three different projects whose
initial outlay and annual revenues during their lives are known. The executive has to select
the best alternative among these three competing projects.
There are several bases for comparing the worthiness of the projects. These bases are:
1. Present worth method
2. Future worth method
3. Annual equivalent method
4. Rate of return method

PRESENT WORTH METHOD OF COMPARISON

Eg. Alpha Industry is planning to expand its production operation. It has identified
three different technologies for meeting the goal. The initial outlay and annual
revenues with respect to each of the technologies are summarized below. Suggest the
best technology which is to be implemented based on the present worth method of
comparison assuming 20% interest rate, compounded annually
Eg. A person is planning for his retired life. He has 10 more years of service. He would
like to deposit 20% of his salary, which is Rs. 4,000, at the end of the first year, and
thereafter he wishes to deposit the amount with an annual increase of Rs. 500 for the
next 9 years with an interest rate of 15%. Find the total amount at the end of the 10th
year of the above series.

69 71
 In this type of investment mode, the objective is to find the future worth of n equal
payments which are made at the end of every interest period till the end of the nth
interest period at an interest rate of i compounded at the end of each interest period.
The cash low diagram is shown below
Where:
P = present worth
A = annual equivalent payment
i = interest rate
n = No. of interest periods

Eg. A company wants to set up a reserve which will help the company to have an
annual equivalent amount of Rs. 10,00,000 for the next 20 years towards its employees
welfare measures. The reserve is assumed to grow at the rate of 15% annually. Find
the single-payment that must be made now as the reserve amount.
The formula to get F is

Where,
A = equal amount deposited at the end of each interest period
n = No. of interest periods
i = rate of interest
F = single future amount

Eg A person who is now 35 years old is planning for his retired life. He plans to
invest an equal sum of Rs. 10,000 at the end of every year for the next 25 years
starting from the end of the next year. The bank gives 20% interest rate,
compounded annually. Find the maturity value of his account when he is 60
years old.
= 10,00,000 x 6.2593
= Rs. 62,59,300

6. Equal-Payment Series Capital Recovery Amount

The objective of this mode of investment is to find the annual equivalent amount (A)
which is to be recovered at the end of every interest period for n interest periods for
a loan (P) which is sanctioned now at an interest rate of i compounded at the end of
every interest period.

= 10,000 x 471.981
= Rs. 47,19,810

4. Equal-Payment Series Sinking Fund

In this type of investment mode, the objective is to find the equivalent amount (A)
that should be deposited at the end of every interest period for n interest periods to
realize a future sum (F) at the end of the nth interest period at an interest rate of i.

Where:

68 66

Solution In all the technologies, the initial outlay is assigned a negative sign and the annual
revenues are assigned a positive sign.

TECHNOLOGY 1
Initial outlay, P = Rs. 12,00,000
Annual revenue, A = Rs. 4,00,000
Interest rate, i = 20%, compounded annually
Life of this technology, n = 10 years

The cash flow diagram of this technology

= 4,000 + 500 _ 3.3832

= Rs. 5,691.60
This is equivalent to paying an equivalent amount of Rs. 5,691.60 at the end of every year
for the next 10 years. The future worth sum of this revised series at the end of the 10th year
The present worth expression for this technology is is obtained as follows:
PW(20%)1 = –12,00,000 + 4,00,000 _ (P/A, 20%, 10)
= –12,00,000 + 4,00,000 _ (4.1925)
= –12,00,000 + 16,77,000
= Rs. 4,77,000 = 5,691.60(20.304)
= Rs. 1,15,562.25

Where P/A =
Eg. A person is planning for his retired life. He has 10 more years of service. He would
TECHNOLOGY 2 like to deposit Rs. 8,500 at the end of the first year and thereafter he wishes to deposit
Initial outlay, P = Rs. 20,00,000 the amount with an annual decrease of Rs. 500 for the next 9 years with an interest
Annual revenue, A = Rs. 6,00,000 rate of 15%. Find the total amount at the end of the 10th year of the above series.
Interest rate, i = 20%, compounded annually
Life of this technology, n = 10 years
The cash flow diagram of this technology is shown

The present worth expression for this technology is

PW(20%)2 = – 20,00,000 + 6,00,000 _ (P/A, 20%, 10)
= – 20,00,000 + 6,00,000 _ (4.1925) = Rs 6808.40
= – 20,00,000 + 25,15,500
= Rs. 5,15,500

TECHNOLOGY 3
Initial outlay, P = Rs. 18,00,000 = Rs. 138237.50
Annual revenue, A = Rs. 5,00,000
Interest rate, i = 20%, compounded annually
Life of this technology, n = 10 years 8. Effective Interest Rate

72 70
The cash flow diagram of this technology is shown
The annual equivalent cost expression of the above cash flow diagram is
AE1(20%) = 5,00,000(A/P, 20%, 15) + 2,00,000
= 5,00,000(0.2139) + 2,00,000
= 3,06,950

Where A/P =
The present worth expression for this technology is
PW(20%)3 = –18,00,000 + 5,00,000 _ (P/A, 20%, 10) Alternative 2
= –18,00,000 + 5,00,000 _ (4.1925) Down payment, P = Rs. 4,00,000
= –18,00,000 + 20,96,250 Yearly equal installment, A = Rs. 3,00,000 n = 15 years
= Rs. 2,96,250 i = 20%, compounded annually

From the above calculations, it is clear that the present worth of technology 2 is the highest The cash flow diagram for the manufacturer 2 is shown
among all the technologies. Therefore, technology 2 is suggested for implementation to
expand the production.
0 1 2 3 4 15
. .

FUTURE WORTH METHOD 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000

4,00,000
Consider the following two mutually exclusive alternatives: Cash flow diagram for manufacturer 2.

The annual equivalent cost expression of the above cash flow diagram is
AE2(20%) = 4,00,000(A/P, 20%, 15) + 3,00,000
= 4,00,000(0.2139) + 3,00,000
= Rs. 3,85,560.

Alternative 3
At i = 18%, select the best alternative based on future worth method of comparison.
Down payment, P = Rs. 6,00,000
Solution Alternative A Yearly equal installment, A = Rs. 1,50,000 n = 15 years
Initial investment, P = Rs. 50,00,000 i = 20%, compounded annually
Annual equivalent revenue, A = Rs. 20,00,000 The cash flow diagram for manufacturer 3 is shown.
Interest rate, i = 18%, compounded annually
Life of alternative A = 4 years 0 1 2 3 4 15
The cash flow diagram of alternative A .
.

1,50,000 1,50,000 1,50,000 1,50,000 1,50,000

6,00,000
Cash flow diagram for manufacturer 3.

The future worth amount of alternative B is computed as
FWA(18%) = –50,00,000(F/P, 18%, 4) + 20,00,000(F/A, 18%, 4)
= –50,00,000(1.939) + 20,00,000(5.215)
= Rs. 7,35,000
The annual equivalent cost expression of the above cash flow diagram is
AE3(20%) = 6,00,000(A/P, 20%, 15) + 1,50,000
= 6,00,000(0.2139) + 1,50,000
= Rs. 2,78,340.
The annual equivalent cost of manufacturer 3 is less than that of manufacturer 1 and manufacturer 2.
Therefore, the company should buy the advanced machine centre from manufacturer 3

73 75

CHAPTER 3 - METHODS OF PROJECT

1 2,00,000 1,00,000
2 1,75,000 2,00,000
ANALYSIS 3
4
25,000
2,00,000
3,00,000
4,00,000
5 1,50,000 2,00,000

Firms need to invest their capital or funds in assets or projects. These assets or Compute payback period of A & B.
projects involve large sums of money and considerable risk. Usually for assets or
Solution:
projects many alternatives are available. Such investments are known as capital
Year Project A Cumulative Project B Cumulative
budgeting. Cash flows Cash flows Cash flows Cash flows
1 2,00,000 200000 1,00000 100000
Capital Budgeting / Project planing is the process of making investment decision in 2 1,75,000 375000 2,00,000 300000
capital expenditure. It involves the planning and control of capital expenditure. It is 3 25,000 400000 3,00,000 600000
4 2,00,000 600000 4,00,000 1000000
the process of deciding whether or not to commit resources to particular long-term
5 1,50,000 750000 2,00,000 1200000
projects whose benefits are to be realized over a period of time.
PBP of A = 3 years
Features of Capital Budgeting PBP of B = 2+ 200000
300000
1. Exchange of funds for future benefits:
= 2.67 years
2. The future benefits are expected to be realized over a period of time. Project B is better.
3. The funds are invested vested in long-term activities.
4. They have a long term and significant effect on the profitability of the concern, Evaluation criteria
5. They involve huge funds. According to Payback criterion, the shorter the PBP, more desirable the project.

Advantages of PBP method

1. Simple to understand and easy to apply
Importance of Capital Budgeting 2. Rough and ready method for dealing with risk.
1. Large Investment: Capital budgeting decision involves large investment of Disadvantages
funds. But the funds available with the firm are always limited and the demand for 1. Ignores time vale of money
funds far exceeds the resources. Hence it is very important for a firm to plan and 2. Ignores cash flows beyond pay back period.
control its capital expenditure. 3. Does not measure profitability of the project
2. Long Term Commitment of Funds: capital expenditures involves not only large
amount of funds but also funds for long term or permanent basis. The long tern 2. AVERAGE RATE OF RETURN
commitments of funds increases, the financial risk involved in the investment This method take into account the earnings expected from the investment over their
decision. Greater the risk involved, greater is need for careful planning of capital whole life. It is known as accounting rate if Return method for the reasons that under
expenditure i.e. Capital Budgeting. this method, the accounting Concept of profit is used rather than cash inflows.
3. Irreversible Nature: The Capital expenditure decision is of irreversible nature. According to this method, various projects are ranked in order of the rate of earnings
Once the decision for acquiring a permanent asset is taken, it becomes very difficult or rate of return. The project with the higher rate of return is selected as compared to
to dispose of these assets without incurring heavy losses. the one with the lower rate of return. This method can be used to make decisions as
4. Long term Effect on profitability: Capital budgeting decisions have a long term to accepting or rejecting a proposal. The expected return is determined and the
and significant effect on the profitability of a concern. Not only the present earnings project with a higher rate of return than the minimum rate specified by the firm
of the firm are effected by the investments in capital asserts but also the future
called cut-off rate, is accepted and the one which gives a lower expected rate of
growth and profitability of the firm depends upon the investment decision taken return than the minimum rate is rejected.
today. An unwise decision may prove disastrous and fatal to the very existence of
the concern. ARR = Average income x 100
5. Difficulties of investment Decisions: The long tern investment decision are Average investment
difficult to be taken because decision extends to a series of years beyond the current Average investment = Opening investment + Closing investment
accounting period, uncertainties of future, higher degree of risk. 2
Example. Find out ARR
6. National Importance: Investment decision though taken by individual concern is
Cost of project Rs 2,00,000
of national importance because it determines employment, economic activities and Estimated life in years 5
growth. Returns Rs 60000, Rs 50000, Rs 40000, Rs 30000 and Rs 20000

Average income = 60000+50000+40000+30000+20000

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RATE OF RETURN METHOD
Where F/A =
Eg. A person is planning a new business. The initial outlay and cash flow pattern for the new
business are as listed below. The expected life of the business is five years. Find the rate of return for
the new business
Alternative B
Period 0 1 2 3 4 5 Initial investment, P = Rs. 45,00,000
Annual equivalent revenue, A = Rs. 18,00,000
Cash flow –1,00,000 30,000 30,000 30,000 30,000 30,000 Interest rate, i = 18%, compounded annually
(Rs.) Life of alternative B = 4 years
The cash flow diagram of alternative B is illustrated
Solution
Initial investment = Rs. 1,00,000 Annual equal revenue =
Rs. 30,000 Life = 5 years
The cash flow diagram for this situation is shown

The future worth amount of alternative B is computed as

30,000 30,000 30,000 30,000 30,000 FWB(18%) = – 45,00,000(F/P, 18%, 4) + 18,00,000 (F/A, 18%, 4)
= –45,00,000(1.939) + 18,00,000(5.215)
0 1 2 3 4 5 = Rs. 6,61,500

1,00,000 The future worth of alternative A is greater than that of alternative B. Thus, alternative A
Cash flow diagram. should be selected.
The present worth function for the business is
PW(i) = –1,00,000 + 30,000(P/A, i, 5)
ANNUAL EQUIVALENT METHOD
When i = 10%,
PW(10%) = –1,00,000 + 30,000(P/A, 10%, 5) Eg. A company is planning to purchase an advanced machine centre. Three original manufacturers
have responded to its tender whose particulars are tabulated as follows:
= –1,00,000 + 30,000(3.7908)
= Rs. 13,724. Manufacturer Down payment Yearly equal No. of
When i = 15%, installment installments
(Rs.) (Rs.)
PW(15%) = –1,00,000 + 30,000(P/A, 15%, 5)
1 5,00,000 2,00,000 15
= –1,00,000 + 30,000(3.3522)
2 4,00,000 3,00,000 15
= Rs. 566. 3 6,00,000 1,50,000 15
When i = 18%,
PW(18%) = –1,00,000 + 30,000(P/A, 18%, 5)
Determine the best alternative based on the annual equivalent method by assuming i = 20%,
= –1,00,000 + 30,000(3.1272) compounded annually.
= Rs. – 6,184
Solution Alternative 1
i = LR + P1 - Q x (HR-LR) Down payment, P = Rs. 5,00,000
P1 – P2 Yearly equal installment, A = Rs. 2,00,000 n = 15 years
i = 20%, compounded annually
= 15% + 0.252% The cash flow diagram for manufacturer 1 is shown .
= 15.252%
0 1 2 3 4 15
.
Therefore, the rate of return for the new business is 15.252%. .

2,00,000 2,00,000 2,00,000 2,00,000 2,00,000

5,00,000
Cash flow diagram for manufacturer 1.

76 74

5
= 40000
Average investment = 200000/2 =100000
Investment evaluation techniques:
ARR = 40000/100000 = 0.4 = 40%
A. Traditional or non discounting techniques:
Evaluation criteria:
Higher the ARR better the project
1. PAY BACK PERIOD
The payback method is the simplest way of looking at one or more major project ideas.
Advantages of Rate of Return Method
It tells you how long it will take to earn back the money you'll spend on the project.
1. It is very simple to understand and easy to operate.
2. This method is based upon the accounting concept of profits; it can be readily
calculated from the financial data.
3. It uses the entire earnings of the projects in calculating rate of return. The formula is:
Disadvantages of Rate of Return Method In case of equal cash inflows,
1. It does not take into consideration the cash flows, which are more important than
the accounting profits.
2. It ignores the time value of money as the profits earned at different points of time Cost of Project
= Payback Period
are given the equal weighs Annual Cash Inflow

B. Discounted cash flow techniques Example: A project requires an outlay of Rs 50,000 and yields an annual cash flow of Rs
12,500 for 7 years. Calculate Payback period.

The traditional methods of capital budgeting suffer from serious limitations that give Solution: Payback period = Cost of project
the equal weights to present and future flow of income. These do not take into Annual cash inflow
accounts the time value of money. Following are the discounted cash flow methods:
= 50000/12500 = 4 years
3. NET PRESENT VALUE
In case of unequal cash inflows:
This method is the modern method of evaluating the investment proposals. This E+B
method takes into consideration the time value of money and attempts to calculate C
the return in investments by introducing the factor of time element. It recognizes the Where ,
fact that a rupee earned today is more valuable earned tomorrow. The net present E = Year preceding the last year of recover
value of all inflows and outflows of cash occurring during the entire life of the B = Balance to be recovered
C = cash flow in the last year of recovery
project is determined separately for each year by discounting these flows by the
firm’s cost of capital. Example: Calculate payback period for a project which requires a cash outlay of Rs 20,000 and
Following are the necessary steps for adopting the net present value method of generates cash inflows of Rs 8,000, Rs 7000, Rs 4000 and Rs 3000.
evaluating investment proposals.
1. Determine appropriate rate of interest that should be selected as the minimum Solution.
required rate of return called discount rate. Year Cash Flow Cumulative cash flow
2. Compute the present value of total investment outlay. 1 8000 8000
3. Compute the present value of total investment proceeds. 2 7000 15000
4. Calculate the net present value of each project by subtracting the present value of 3 4000 19000
cash inflows from the present value of cash outflows for each project. 4 3000 22000
5. If the net present value is positive or zero, the proposal may be accepted PBP = E + B
otherwise rejected. C
= 3 + 1000
NPV = Present value of inflows – Present value of outflows 3000
= 3 1/3 years
Advantages of Net Present Value
1. It recognizes the time value of money and is suitable to be applied in situations Example: The following details are available in respect of the cash flows of two projects A & B:
Year Project A Project B
with uniform cash outflows and cash flows at different period of time. Cash flows Cash flows
0 (4,00,000) (5,00,000)

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2. It takes into account the earnings over the entire life of the projects and the true internal rate of return method. It can be defined as the rate of discount at which the
profitability of the investment proposal can be evaluated. present value of cash inflows is equal to the present value of cash outflows.
3. It takes into consideration the objective of maximum profitability.
Steps required for calculating the internal rate of return.
Disadvantages of Net Present Value 1. Determine the future net cash flows during the entire economic life of the
1. This method is more difficult to understand and operate. project.
2. It is not easy to determine an appropriate discount rate. The cash inflows are estimated for future profits before depreciation and
3. It may not give good results while comparing projects with unequal lives and after taxes.
investment of funds. 2. Determine the rate of discount at which the value of cash inflows is equal
to the
Example present value of cash outflows.
Consider a project which has the following cash flows:
Year Cash flows
3. Accept the proposal if the internal rate of return is higher than or equal to
the minimum required rate of return.
0 (10,00,000) 4. In case of alternative proposals select the proposals with the highest rate of
1 2,00,000 return as long as the rates are higher than the cost of capital.
2 2,00,000
3 3,00,000
4 3,00,000
The Internal Rate of Return (IRR) of a Capital Budgeting project is the discount rate
5 3,50,000 at which the Net Present Value (NPV) of a project equals zero
Rate of interest is 10%. Calculate NPV.
Intrapolation formula
Solution:
Year Cash flows NPV IRR = LR + P1 - Q x (HR-LR)
P1 – P2
0 (10,00,000) 1000000 10,00,000
( 1+ 0.10)0 where,
1 2,00,000 200000 181818 LR = Lower discount rate
( 1+ 0.10)1 HR = Higher discount rate
P1 = Present value at lower rate
P2 = Present value at higher rate
2 2,00,000 200000 165289 Q = Initial investment
( 1+ 0.10)2
Advantages of Internal Rate of Return Method
1. It takes into account the time value of money and can be usefully applied in
3 3,00,000 300000 225394
( 1+ 0.10)3
situations with even as well as uneven cash flows at different periods of time.
2. It considers the profitability of the project for its entire economic life.
3. It provides for uniform ranking of various proposals due to the % rate of return.
4 3,00,000 300000 204904 Disadvantages of Internal Rate of Return Method
( 1+ 0.10)4 1. It is difficult to understand.
2. This method is based upon the assumption that the earnings are reinvested at the
5 3,50,000 350000 217322 internal rate of return for the remaining life of the project, which is not a justified
( 1+ 0.10)5 assumption particularly when the rate of return earned by the firm is not close to the
internal rate of return.
NPV = 1000000- 994728 = -5273 3. The result of NPV and IRR method may differ when the project under evaluation
differ their size.
Evaluation criteria
Reject the project if NPV is negative and accept if NPV is positive Accept or reject criterion:
If the project’s IRR is greater than the firm’s cost of capital, accept the proposal.
4. BENEFIT COST RATIO Otherwise reject the proposal. A project with highest IRR is considered best.

This is also known as Profitability Index. This is similar to NPV method. The major Example.
drawback of NPV method that not does not give satisfactory results while evaluating Year Cash flow
0 (1,00,000)
1 30,000

81 83

MODULE III
Managing like all other practices- whether medicine, music composition, engineering, accountancy-
is an art. It is a know-how. It is doing things in the light of realities of a situation. Yet managers can
work better by using the organised knowledge of management. It is this knowledge that constitutes a
CHAPTER 1- INTRODUCTION TO science. Thus managing as practice is an art; the organised knowledge underlying the practice may
be referred to as science.
MANAGEMENT LEVELS OF MANAGEMENT

One of the most important human activities is managing. Ever since people began forming groups to
accomplish aims they could not achieve as individuals, managing has been essential to ensure the
coordination of individual efforts. As society has come to rely increasingly on group effort, and as
many organised groups have become large, the tasks of managers are gaining importance.
DEFINITION OF MANAGEMENT
Considering the hierarchy of authority and responsibility, one can identify three levels of
management namely:
(i) Top management of a company consists of owners/shareholders, Board of Directors, its
Chairman, Managing Director, or the Chief Executive, or the General Manager or Executive
Committee having key officers.

Management is the process of designing and maintaining an environment in which individuals,
working together in groups, efficiently accomplish selected aims.
CHARACTERISTICS OF MANAGEMENT
1. As managers, people carry out the managerial functions of planning, organising, staffing,
directing and controlling. Though managers tasks pertain to designing an internal
environment for performance within the organisation, managers must also operate in the
external environment of an enterprise as well. External elements that effect operation are
economic, technological, social, ecological, political and ethical factors. Moreover many
organisations now operate in different countries.
2. Management applies to any kind of organisation. Management applies to small and large
organisations, to profit and not-for-profit organisations, to manufacturing as well as service
industries.
3. It applies to managers at all organisational levels. Only the time spent for each function
may differ. Top level managers spend more time on planning and organising than lower
level managers.
4. The aim of all managers is the same: to create a surplus. In business organisations this
surplus is profit. In nonprofit organisations, such as charitable organisations, it may be
satisfaction of needs. Universities create a surplus through generation and dissemination of
knowledge as well as providing service to the community or society.
5. Managing is concerned with productivity, which implies effectiveness and efficiency.
Effectiveness means achievement of objectives. Efficiency is the achievement of ends with
the least of resources.
Efficiency means doing things right, effectiveness means doing the right things.
6. Management is both an art and a science
Top management is the ultimate source of authority and it lays down goals, policies and plans for the
enterprise. It devotes more time on planning and coordinating functions. It is accountable to the
owners of the business of the overall management. It is also described as the policy making group
responsible for the overall direction and success of all company activities
(ii) Middle management of a company consists of heads of functional departments viz. Purchase
Manager, Production Manager, Marketing Manager, Financial controller, etc. and Divisional and
Sectional Officers working under these Functional Heads.
The job of middle management is to implement the policies and plans framed by the top
management. It serves as an essential link between the top management and the lower level or
operative management. They are responsible to the top management for the functioning of their
departments.
(iii) Lower level or operative management of a company consists of Superintendents, Foremen,
Supervisors, etc.
It is placed at the bottom of the hierarchy of management, and actual operations are the responsibility
of this level of management. It consists of foreman, supervisors, sales officers, accounts officers and
so on. They are in direct touch with the rank and file or workers. Their authority and responsibility is
limited. They pass on the instructions of the middle management to workers.
MANAGERIAL SKILLS
A skill is an individual's ability to translate knowledge into action. In order to be able to successfully
discharge his roles, a manager should possess four major skills. These are conceptual skill, human
relations skill, technical skill and design skill.

Management is the "art of getting things done through people".
SCOPE OF MANAGEMENT
1. Production management – Production management involves designing the product, location
and layout of plant and building, planning and control of factory operations, operation of
purchase and storage of materials, inventory cost quality control etc
2. Marketing management- It involves marketing research to determine the needs and
expectations of consumers, planning and developing suitable products, setting appropriate
prices, selecting right channel of distribution, promotional activities.
3. Financial management – selecting appropriate sources of funds, raising funds at the right
time, administration of earnings etc.
Conceptual skill deals with ideas. The conceptual skill refers to the ability of a manager to take a
broad and farsighted view of the organization and its future, his ability to think in abstract, his ability
to analyze the forces working in a situation, his creative and innovative ability and his ability to
assess the environment and the changes taking place in it.
The technical skill is the manager's understanding of the nature of job that people under him have to
perform. It refers to a person's knowledge and proficiency in any type of process or technique. In a
production department this would mean an understanding of the technicalities of the process of
production.
Human relations skill is the ability to interact effectively with people at all levels. This skill
develops in the manager sufficient ability (a) to recognize the feelings and sentiments of others; (b)
to judge the possible actions to, and outcomes of various courses of action he may undertake; and (c)

85 87
2 30,000 the projects requiring different initial investments. PI method provides solution to
3 40,000 this.
4 45,000
BCR = Present value of inflows
Solution: Present value of outflows
Assume i = 15% Evaluation criteria:
PV of cash outflows = 30000 + 30000 + 40000 + 45000 BCR > 1 accept
( 1+ 0.15)1 ( 1+ 0.15)2 ( 1+ 0.15)3 ( 1+ 0.15)4 BCR< 1 reject
= RS 1,00,800.811
Advantages of PI method
Assume i = 16% 1. It considers Time value of money
2. It considers all cash flow during life time of project.
PV of cash outflows = 30000 + 30000 + 40000 + 45000 3. More reliable than NPV method when evaluating the projects requiring different
( 1+ 0.16)1 ( 1+ 0.16)2 ( 1+ 0.16)3 ( 1+ 0.16)4 initial investments.
= RS 98,636.36
Disadvantages of PI method
1. This method is difficult to understand.
IRR = LR + P1 - Q x (HR-LR) 2. Calculations under this method arte complex
P1 – P2
Example :
= 15 + 100800 – 100000 x (16-15) Consider the following investments and find out the BCR. Initial investment = Rs 1,00,000. Cost
100800- 98636 of capital = 12%. Benefits are as follows:
Year Benefit
1 25,000
= 15 + 800 x1 2 40,000
2164 3 40,000
4 50,000
= 15+0.37 = 15.37%
Solution:

Year Benefit NPV

1 25,000 25000 22321

( 1+ 0.12)1

2 40,000 40000 31887

( 1+ 0.12)2

3 40,000 40000 28471

( 1+ 0.12)3

4 50,000 50000 31775

( 1+ 0.12)4

BCR = 114456 = 1.144

100000

5. Internal rate of return

It is a modern technique of capital budgeting that takes into account the time value
of money. It is also known as “time adjusted rate of return discounted cash flows”
“yield method” “trial and error yield method” Under this method, the cash flows of
the project are discounted at a suitable rate by hit and trial method, which equates
the net present value so calculated to the amount of the investment. Under this
method, since the discount rate is determined internally, this method is called as the

84 82

to examine his own concepts and values which may enable him to develop more useful attitudes 4. Personnel management – it includes manpower planning, recruitment, selection, training,
about himself. appraisal, promotion & transfers, compensation, employee welfare services.

Design Skill involves the ability to solve problems of the organisation. Top and middle level MANAGEMENT FUNCTIONS /PROCESS OF MANAGEMENT
managements must have the ability to see more than a problem. They must have in addition the skill
of a good design engineering working out a practical solution to the problem. Managers must be able The following six are the functions of a manager: planning, organizing, staffing, directing,
to develop a workable solution to the problem. coordinating and controlling.

As we go through a hierarchy from bottom to top levels, the technical skills lose their importance.
As we go from the bottom of managerial hierarchy to the top, the importance of these skills will rise.
SIGNIFICANCE OF MANAGEMENT
1. Achievements of group goals : Management creates team work and team spirit in an organization
by developing a sound organization structure. It brings the human and material resources together
and motivates the people for the achievement of the goals of the organization.
2. Optimum utilization of resources : Management always concentrates on achieving the objectives
of the enterprise. The available resources of production are put to use in such a way that all sort of
wastage and inefficiencies are reduced to a minimum. Workers are motivated to put in their best
performance by the inspiring leadership.
3. Minimisation of cost : In the modern era of intense competition, every business enterprise must
minimise the cost of production and distribution. Only those concerns can survive in the market,
which can produce goods of better quality at the minimum cost.
4. Change and growth : A business enterprise operates in a constantly changing environment.
Changes in business environment create uncertainties and risk and also produce opportunities for
growth. An enterprise has to change and adjust itself in the ever changing environment.
5. Efficient and smooth running of business : Management ensures efficient and smooth running
of business, through better planning, sound organization and effective control of the various factors
of production.
6. Higher profits : Profits can be enhanced in any enterprise either by increasing the sales revenue
or reducing costs. To increase the sales revenue is beyond the control of an enterprise. Management
by decreasing costs increases its profits and thus provides opportunities for future growth and
development.
7. Provide innovation : Management gives new ideas, imagination and visions to an enterprise.
1. Planning : Planning involves selecting missions and objectives as well as the actions to achieve
them; it requires decision making, that is choosing future courses of action from among alternatives.
There are various types of plans, ranging from overall purposes and objectives to the most detailed
actions to be taken.
2. Organizing : People working in groups to achieve some goal must have roles to play, much like
the parts actors fill in a drama, whether these roles are the ones they develop themselves, are
accidental or haphazard, or are defined and structured by someone who wants to make sure that they
contribute in a specific way to group effort. The concept of a role implies that what people do has
definite purpose or objective; they know how their job objective fits into the group effort, and they
have the necessary authority, tools and information to accomplish the tasks.
Organising is that part of managing which involves establishing an intentional structure of roles for
people to fill in an organisation. It is intentional in the sense that all the tasks necessary to accomplish
goals are assigned and , it is hoped, assigned to people who can do them best.
The purpose of an organisation structure is to help create an environment for human performance.
Although the structure must define the tasks to be done, the roles so established must also be
designed in the light of the abilities and motivations of the people available.
3. Staffing : staffing involves filling, and keeping filled, the positions in the organisation structure.
This is done by identifying work force requirements; inventorying the people available; recruiting;
selecting; placing; promoting; appraising; planning the careers of; compensating, and training or
otherwise developing both candidates and current job holders so that tasks are accomplished
effectively and efficiently.
4. Directing : Directing is the function of leading the employees to perform efficiently, and
contribute their optimum to the achievement of organizational objectives. Jobs assigned to
subordinates have to be explained and clarified, they have to be provided guidance in job
performance and they are to be motivated to contribute their optimum performance with zeal and
enthusiasm. The function of directing thus involves the following sub-functions :
(a) Communication

(b) Motivation

(c) Leadership

5. Controlling : Controlling involves the following process :

(a) Measurement of performance against predetermined goals.

(b) Identification of deviations from these goals.
(c) Corrective action to rectify deviations.

NATURE OF MANAGEMENT

Science or an art?

88 86
 CHAPTER 2 -EVOLUTION OF MANAGEMENT
THOUGHTS
I) SCIENTIFIC MANAGEMENT ERA
Adam Smith’s contribution in Wealth of Nations outlined the economic advantage that organization
and society can gain from the division of labour. He used the pin-manufacturing industry for his
example. Smith noted that 10 individuals, each doing a specialized task, could produce about 4800
pins a day. However, if each worked separately and had to perform each task, it would be quite an
accomplishment to produce even 10 pins a day. Smith concluded that division of labour increased
productivity by increasing each worker’s skill and dexterity, by saving time lost in changing tasks,
and by creating labour-saving inventions and machinery
Charles Babbage suggested the use of proper management in the management of an organisation.
II) SCIENTIFIC MANAGEMENT ERA
FREDERICK W. TAYLOR :
He is known as ‘father of scientific management’.
Four basic parts of a series of ideas developed by Taylor are as follows:
i) Each person’s job should be broken down into elements and a scientific way to perform each
clement should be determined.
ii) Workers should be scientifically selected and trained to do the work in the designed and trained
manner.
iii) There should be good cooperation between management and workers so that tasks are performed
in the designed manner.
iv) There should be a division of labour between managers and workers. Managers should take over
the work of supervising and setting up instructions and designing the work, and the workers should
be free to perform the work himself.
Taylor based his management system on production-line time studies. Instead of relying on
traditional work methods, he analyzed and timed steel workers' movements on a series of jobs. Using
time study as his base, he broke each job down into its components and designed the quickest and
best methods of performing each component. In this way he established how much workers should be
able to do with the equipment and materials at hand. He also encouraged employers to pay more
productive workers at a higher rate than others, using a "scientifically correct" rate that would benefit
both company and worker. Thus, workers were urged to surpass their previous performance standards
to earn more pay Taylor called his plan the differential rate system.
HENRY L. GANTT
Abandoning the differential rate system as having too little motivational impact, Gantt came up with
a new idea. Every worker who finished a day's assigned work load would win a 50-cent bonus.
Then he added a second motivation. The supervisor would earn a bonus for each worker who
reached the daily standard, plus an extra bonus if all the workers reached it. This, Gantt reasoned,
would spur supervisors to train their workers to do a better job.
Every worker's progress was rated publicly and recorded on individual bar charts,--in black on days
the worker made the standard, in red when he or she fell below it. Going beyond this, Gantt
originated a charting system for production scheduling; the "Gantt chart" is still in use today.
THE GILBRETHS
Frank B. and Lillian M. Gilbreth made their contribution to the scientific management movement as a
husband-and-wife team. Lillian and Frank collaborated on fatigue and motion studies and focused
on ways of promoting the individual worker's welfare. To them, the ultimate aim of scientific
management was to help workers reach their full potential as human beings.
89
CHAPTER 3 – FUNCTIONS OF MANAGEMENT
Planning Function of Management
Planning is deciding in advance what to do and how to do. It is one of the basic managerial functions.
Planning involves selecting missions and objectives and deciding on the actions to achieve them; it
requires decision making, that is, choosing a course of action from among alternatives
Planning bridges the gap from where we are to where we want to go.
Importance of Planning
1. Planning increases the organization's ability to adapt to future eventualities: The future is
generally uncertain and things are likely to change with the passage of time. The uncertainty is
augmented with an increase in the time dimension. With such a rise in uncertainty there is
generally a corresponding increase in the alternative courses of action from which a selection
must be made. The planning activity provides a systematic approach to the consideration of
such future uncertainties and eventualities and the planning of activities in terms of what is
likely to happen.
2. Planning helps crystallize objectives: The first step in planning is to fix objectives which will
give direction to the activities to be performed. This step focuses attention on the results
desired. A proper definition and integration of overall and departmental objectives would result
in more co-ordinated inter-departmental activities and a greater chance of attaining the overall
objectives.
3. Planning ensures a relatedness among decisions: A crystallization of objectives as mentioned
above would lead to a relatedness among the decisions which would otherwise have been
random. Decisions of the managers are related to each other and ultimately towards the goals or
objectives of the enterprise. Creativity and innovation of individuals is thus harnessed towards
a more effective management of the company.
4. Planning helps the company to remain more competitive in its industry:Planning may suggest
the addition of a new line of products, changes in the methods of operation, a better
identification of customer needs and segmentation and timely expansion of plant capacity all of
which render the company better fitted to meet the inroads of competition.
5. Adequate planning reduces unnecessary pressures of immediacy: If activities are not properly
planned in anticipation of what is likely to happen, pressures will be exerted to achieve certain
results immediately or a in a hurry. Thus adequate planning supplies orderliness and avoids
unnecessary pressures.
Planning Process
1. Being aware of opportunities – All managers should take a preliminary look at possible
future opportunities and see them clearly and completely, know where their company
stands in light of its strengths and weaknesses, understand what problems it has to
solve and why and know what it can expect to gain. Awareness of opportunities should
be made in light of the market, competition, what customers want, our strengths and
our weaknesses.
2. Setting objectives: Objectives may be set for the entire organisation and each department or
unit within the organisation. Objectives specify the end results and indicate the end points of
what is to to be done, where primary emphasis is to be placed, and what is to be
accomplished by network of strategies, policies, procedures, rules, budgets and programs.
3. Developing premises: Premises means the assumptions about the environment in which the
plan is to be carried out. It is important for all managers involved in the planning process to
93
organization to be a bureaucracy whose activities and objectives were rationally thought out and
whose divisions of labour were explicitly spelled out. Weber also believed that technical competence
should be emphasized and that performance evaluations should be made entirely on the basis of
merit.
MARY PARKER FOLLETT
Follett was convinced that no one could become a whole person except as a member of a group;
human beings grew through their relationships with others in organizations. In fact, she called
management "the art of getting things done through people." She was a great believer in the power of
the group, where individuals could combine their diverse talents into something bigger.
Follett’s model was an important forerunner of the idea that management meant more than just
what was happening inside a particular organization. By explicitly adding the organizational
environment to her theory, Follett paved the way for management theory to include a broader set of
relationships, some inside the organization and some across the organization's borders.
IV) THE BEHAVIORAL SCHOOL
There was increased interest in helping managers deal more effectively with the "people side" of
their organizations.
THE HUMAN RELATIONS MOVEMENT
Human relations is frequently used as a general term to describe the ways in which managers interact
with their employees. When "employee management" stimulates more and better work, the
organization has effective human relations; when morale and efficiency deteriorate, its human
relations are said to be ineffective. The human relations movement arose from early attempts to
systematically discover the social and psychological factors that would create effective human
relations.
THE HAWTHORNE EXPERIMENTS.
The human relations movement grew out of the famous "Hawthorne Studies" because many of them
were performed at Western Electric's Hawthorne plant near Chicago. The Hawthorne Studies began
as an attempt to investigate the relationship between the level of lighting in the workplace and worker
productivity.
In some of the early studies, the Western Electric researchers divided the employees into test groups,
who were subjected to deliberate changes in lighting, and control groups, whose lighting remained
constant throughout the experiments. The results of the experiments were ambiguous. When the test
group's lighting was improved, productivity tended to increase. But when lighting conditions were
made worse, there was also a tendency for productivity to increase in the test group. To compound
the mystery, the control group's output also rose over the course of the studies, even though it
experienced no changes in illumination. Obviously, something besides lighting was influencing the
workers' performance.
Mayo and his associates decided that a complex chain of attitudes had touched off the productivity
increases. Because they had been singled out for special attention, both the test and the control groups
had developed a group pride that motivated them to improve their work performance.
The researchers concluded that employees would work harder if they believed management was
concerned about their welfare and supervisors paid special attention to them. This phenomenon as
subsequently labelled the Hawthorne Effect
V) THE BEHAVIORAL SCIENCE APPROACH
Maslow’s Need Hierarchy Theory
According to Maslow, the needs that people are motivated to satisfy fall into a hierarchy. The five
stage model can be divided into basic (or deficiency) needs (e.g. physiological, safety, love, and
esteem) and growth needs (self-actualization). Physiological and safety needs are at the bottom of the
hierarchy, and at the top are ego needs (the need for respect, for example) and self actualizing needs
(such as the need for meaning and personal growth). In general, Maslow said lower level needs must
be satisfied before higher level needs can be met. People are motivated to achieve certain needs.
Mc Gregor’s Theory X and Theory Y
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Specialization: The work of an organization is separated into units and departments through an
organizational network of associations. This helps in getting specialization in different areas of work
in an organization.
Well-defined jobs: Organizational structure aids in getting the right people to do the job by choosing
people in accordance with their skills, knowledge and qualifications for working in different
departments of the organization. This aids in properly defining the work of an organization which
further aids in explaining the responsibilities of each person.
Clarifies authority: Organizational structure aids in helping the manager to understand each
person’s role. This can be achieved in the manager being able to understand clearly how he has to use
his powers. This aids in an increase in production as jobs and responsibilities that are well defined
make the manager’s jobs much more efficient.
Co-ordination: Organization is a process of establishing co-ordination amongst various departments
and it also aids in defining relations amongst various positions and individuals assisting each other. If
the managers at a higher level implement their power over the network of activities of managers at
lower levels, it can bring about efficiency in work.
Effective administration: The organizational structure aids in clarifying the positions of the jobs.
The roles and responsibilities of different managers are well-defined and by dividing the work it is
easy to achieve specialization. This further aids in an organization that is well-organized and
efficient.
Organising Process
Division of work: The first process of Organising includes identification and division of work which
shall be done in accordance with the plans that are determined previously.
Departmentation: once the work of identifying and dividing the work has been done those that are
similar are to be grouped together.
Linking departments: When the process of departmentation was completed, linking of departments
has to be done so that those departments operate in a co-ordinated manner which gives a shape to
overall organisation structure.
Assigning Duties: On completion of departmentation process assigning duties i.e. defining authority
and responsibilty to the employees on the basis of their skills and capabilities has to be done, which
in consequence magnifies efficiency with regard to their work.
Defining hierarchal structure: Each employee should also know from whom he has to take orders
and to whom he is accountable/responsible.
Staffing Function of Management
Staffing is that part of the process of management which is concerned with acquiring, developing,
employing, appraising, remunerating and retaining people so that right type of people are available at
right positions and at right time in the organisation. In the simplest terms, staffing is ‘putting people
to jobs’.
Importance of Staffing
x Filling the Organisational positions
x Developing competencies to challenges
x Retaining personnel - professionalism
x Optimum utilisation of the human resources
Staffing Process
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McGregor distinguished two alternative basic assumptions about people and their approach to work.
These two assumptions, which he called Theory X and Theory Y, take opposite views of people's
commitment to work in organizations. Theory X managers, McGregor proposed, assume that people
must be constantly coaxed into putting forth effort in their jobs. Theory Y managers, on the other
hand, assume that people relish work and eagerly approach their work as an opportunity to develop
their creative capacities.
VI) RECENT DEVELOPMENTS IN MANAGEMENT THEORY
THE SYSTEMS APPROACH
Rather than dealing separately with the various segments of an organization, the systems approach to
management views the organization as a unified, purposeful system composed of interrelated parts.
This approach gives managers a way of looking at the organization as a whole and as a part of the
larger, external environment. Systems theory tells us that the activity of any segment of an
organization affects, in varying degrees, the activity of every other segment.
THE CONTINGENCY APPR0ACH
The contingency approach (sometimes called the situational approach) was developed by managers,
consultants, and researchers who tried to apply the concepts of the major schools to real-life
situations. When methods highly effective in one situation failed to work in other situations, they
sought an explanation. Why, for example, did an organizational development program work
brilliantly in one situation and fail miserably in another. Advocates of the contingency approach had
a logical answer to all such questions: Results differ because situations differ; a technique that works
in one case will not necessarily work in all cases.
According to the contingency approach the manager's task is to Identify which technique will, in a
particular situation, under particular circumstances, and at particular time, best contribute to the
attainment of management goals.
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1. Analyzing Manpower requirements: It is making an analysis of work and estimating the
manpower requirement to accomplish the same.
2. Recruitment: It is identifying and attracting capable applicants for employment. it ends with
the submission of applications by the aspirants.
3. Selection: It is choosing the fit candidates from the applications received in the process of
recruitment.
4. Placement: This may be on probation and on successfully completion of the same the
candidate may be offered permanent employment.
5. Training and Development: It is concerned with imparting and developing specific skills for a
particular purpose.
6. Performance Appraisal: Systematic evaluation of personnel by superiors or others familiar
with their performance so as to rank employees to ascertain their eligibility for promotions.
Directing Function of Management
Directing means giving instructions, guiding, counselling, motivating and leading the staff in an
organisation in doing work to achieve Organisational goals. From top executive to supervisor
performs the function of directing and it takes place accordingly wherever superior –
subordinate relations exist. Directing is a continuous process initiated at top level and flows to
the bottom through organisational hierarchy.
Importance of Directing
Directing initiates actions: Directions is the beginning of the subordinate’s execution of their work.
Actions begin right from this function onward as the employees learn their jobs and carry out the
proper instructions that are given to them.
Directing integrates efforts: Every department’s efforts can be easily connected and included along
with the other departments through proper direction. This can also be achieved through influential
leadership and efficient communication.
Directing is a means of motivation: A manager uses this motivation factor effectively in order to
enhance the employee’s performance in the organization.
Directing will enable to cope with the changes: It is normal for humans to resist any new changes
that are brought in an organization. The function of direction is necessary for meeting the new
challenges in a fast-changing environment, both internally and externally.
Coordination function of management
Coordination is considered as the essence of management because:
1. Different functions of management when effectively carried out to lead to
better co-ordination.
2. Coordination is involved in every function of management and hence should
not be regarded as one of its functions
3. Planning, organising, staffing, directing and controlling all involve
coordination
Importance of coordination
1. Team work or unity of direction – The efforts of various persons should be integrated
as group efforts to achieve the objectives of the organisation.
2. Functional differentiation – The organisations functions are divided into departments
and each department works in isolation. Hence coordination is necessary
3. Reconciliation of goals – each department has its own goals. Individuals within
departments may give importance to department goals rather than organisation goals.
Coordination helps to reconcile this.
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In their conception, motion and fatigue were intertwined—every motion that was eliminated reduced
fatigue. Using motion picture cameras, they tried to find the most economical motions for each task
in order to upgrade performance and reduce fatigue. The Gilbreths argued that motion study would
raise worker morale because of its obvious physical benefits and because it demonstrated
management's concern for the worker.
III) CLASSICAL ORGANIZATION THEORY SCHOOL
Scientific management was concerned with increasing the productivity of the shop and the individual
worker. Classical organization theory grew out of the need to find guidelines for managing such
complex organizations as factories.
HENRI FAYOL
Henri Fayol referred to as father of modern management school.
FAYOL’S 14 PRINCIPLES OF MANAGEMENT
1.
1 Division
Di i i off Labor.
L b Work
W k should
h ld beb divided
di id d among individuals and groups to ensure that
effort and attention are focused on special portions of the task. Fayol presented work
specialization as the best way to use the human resources of the organization.
2. Authority and responsibility- The concepts of Authority and responsibility are closely
related. Authority was defined by Fayol as the right to give orders and the power to exact
obedience. Responsibility involves being accountable, and is therefore naturally associated
with authority. Whoever assumes authority also assumes responsibility.
3. Discipline. Members in an organization need to respect the rules and agreements that govern
the organization. To Fayol, discipline results from good leadership at all levels of the
organization, fair agreements (such as provisions for rewarding superior performance), and
judiciously enforced penalties for violations.
4. Unity of Command. Each employee must receive instructions from only one person. Fayol
believed that when an employee reported to more than one manager, conflicts in instructions
and confusion of authority would result.
5. Unity of Direction. Those operations within the organization that have the same objective
should be directed by only one manager using one plan. For example, the personnel
department in a company should not have two directors, each with a different hiring policy.
6. Subordination of Individual Interest to the Common Good. In any undertaking, the
interests of employees should not take precedence over the interests of the organization as a
whole.
7. Remuneration. Compensation for work done should be fair to both employees and
employers.
8. Centralization. Decreasing the role of subordinates in decision making is centralization;
increasing their role in decentralization. Fayol believed that managers should retain final
responsibility, but should at the same time give their subordinates enough authority to do
their jobs properly. The problem is to find the proper degree of centralization in each case.
9. Scalar chain or the Hierarchy. The line of authority in an organization—often represented
today by the neat boxes and lines of the organization chart—runs in order of rank from top
management to the lowest level of the enterprise. Lower level managers should always keep
upper level managers informed of their work activities. The existence of a scalar chain and
adherence to it are necessary if the organization is to be successful
10. Order. Materials and people should be in the right place at the right time. People, in
particular, should be in the jobs or positions they are most suited to.
11. Equity. Managers should be both friendly and fair to subordinates.
12. Stability of tenure of personnel. A high employee turnover rate undermines the efficient
functioning of an organization. Retaining productive employees should always be a high
priority of management
13. Initiative. Subordinates should be given the freedom to conceive and carry out their plans,
even though some mistakes may result.
14. Espirit de Corps. Promoting team spirit will give the organization a sense of unity. To
Fayol, even small factors should help to develop the spirit. He suggested, for example, the
use of verbal communications instead of formal, written communication whenever possible.
MAX WEBER
Developed a theory of bureaucratic management that stressed the need for a strictly defined
hierarchy governed by clearly defined regulations and lines of authority. He considered the ideal
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agree on the premises. The more thoroughly individuals charged with planning understand
and agree to utilise consistent planning premises, the more coordinated the enterprise
planning will be.
4. Determining alternative courses: Search for and examine alternative courses of action.
5. Evaluating alternative courses: The next step is to weigh the pros and cons of each
alternative.
6. Selecting an alternative: This is the real point of decision making. The best plan has to be
adopted and implemented.
7. Implement the plan: This is concerned with putting the plan into action.
8. Follow-up action: Monitoring the plans are equally important to ensure that objectives are
achieved.
Types of Plans
Purposes or missions: It identifies the basic functions or task of an enterprise. The purpose of a
business is generally of production and distribution of goods and services. The purpose of a
state highway department is designing, building, and operating a system of state highways.
Objectives: Objectives are ends towards which the management seeks to achieve by its operations.
They serve as a guide for overall business planning. The objective of a firm might be to make a
certain profit.
Strategy: A strategy is the determination of the basic long term objectives of an enterprise and
adoption of courses of action and allocation of resources necessary to achieve these goals
A strategy may include such major policies as marketing directly rather than distribution.
Policy: They are general statements meant to bring out a consistency in decision making. For
example company policy may grant annual vacations to employees
Procedure: They are plans that establish a required method of handling future activities.
Procedures are routine steps on how to carry out activities. Procedures are specified steps to be
followed in particular circumstances. For example in a manufacturing company, the procedure for
handling orders may involve the sales department (for the original order), the finance department (for
acknowledgement of receipt of funds and for customer credit approval), the accounting department
(for recording the transaction), the production department (for the order to produce the goods or the
authority to release from stock), and the shipping department (for determination of shipping means
and routes)
Rule: Rules are specific statements that spell out required actions or non actions, allowing no
discretion. Eg No smoking
Programme: Programmes are detailed statements about a project which outlines the objectives,
policies, procedures, rules, tasks, human and physical resources required and the budget to implement
any course of action. Eg An airline’s programme to acquire a $400 million fleet of jets.
Budget: It is a plan which quantifies future facts and figures.
Organizing Function of Management
Organising is the process of defining and grouping activities and establishing authority relationships
among them to attain organizational objectives.
Importance of Organizing
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Controlling Function of Management
The managerial function controlling always maximise the use of scarce resources to achieve the
purposeful behaviour of employees in an organisation. In planning stage, it is decided that how
the resources would be utilised but where as in the controlling stage it is observed that whether
the resources are being utilised in the same way as planned or not. Thus, control completes the
whole sequence of management process.
Importance of Controlling
x Control system acts as an adjustment in organisational operations. It mainly checks whether
plans are being observed and suitable progress towards the objectives is being made or not, and
if necessary any action to control the deviations.
x Policies and other planning elements set by the managers become the basis and reason for
control. Through control it is monitored whether the individuals adhere to those frameworks or
not so that organisation and management can verify the quality of various policies.
x Exercising some authority and forming superior-subordinate relationship throughout the
organisation can be established through controlling.
x With the presence of authority or control the individuals will work properly and exhibit better
performance to reach the targets set for them.
x Control system ensures the organisational efficiency and effectiveness. When Proper system
exists the organisation effectively achieves its objectives.
Policy Vs Strategy
1. A policy is a dependent decision while strategy is a rule for making decisions
2. Policy is a guideline to the thinking and action of those who make decisions. Strategy is
concerned with the direction in which human and physical resources are deployed in order to
maximise the chances of achieving the organisation objectives
3. A policy can be delegated downwards but strategy cannot
4. Policy formulation is the responsibility of top level management while strategy formulation
is usually done by middle level.
5. Policy deals with routine activities essential for effective and efficient running of an
organisation while strategy deals with strategic decisions.
Strategy vs tactics
Tactics are the doing aspects that follow the planning. Tactics refer specifically to the actions.
Strategies outline what we are going to do. Tactics are the specific actions that are required to bring
the strategy to life. Tactics support strategies just as strategies support goals.
The tactics themselves are the things that get the job done. Strategies can comprise numerous tactics,
with many people involved in attempting to reach an overall goal. While strategy tends to involve the
higher ups of an organisation, tactics tend to involve all members of the organisation.
A system based on tactics without strategy leads to shooting in the dark – you might get something
done, but it doesn’t become sustainable or provide you with a path to continue on. A system based on
strategy without tactics means the strategy has no means of being carried out. The principle is that
tactics are defined by strategy, and that neither can exist effectively without the other.
Motivating
Motivation is an important function of management. Motivation means a process of stimulating
people to action to accomplish desired goals.
CHAPTER 4- ORGANISATION STRUCTURE
An organizational structure defines how activities such as task allocation, coordination and
supervision are directed towards the achievement of organizational aims.
An organization can be structured in many different ways, depending on their objectives. The
structure of an organization will determine the modes in which it operates and performs.
Organisational structure is defined as the pattern of relationships among the component parts of an
organisation.
Span of control refers to the number of subordinates a supervisor has. It is the number of people who
report to one manager in a hierarchy. The more people under the control of one manager - the wider
the span of control. Less means a narrower span of control.
The principle of span of management states that there is a limit to the number of subordinates a
manager can effectively supervise, but the exact number will depend on the impact of underlying
factors.
Why should you develop a structure for your organisation?
x Structure gives members clear guidelines for how to proceed. A clearly-established structure
gives the group a means to maintain order and resolve disagreements.
x Structure binds members together. It gives meaning and identity to the people who join the
group, as well as to the group itself.
x Structure in any organization is inevitable -- an organization, by definition, implies a
structure. Your group is going to have some structure whether it chooses to or not. It might
as well be the structure which best matches up with what kind of organization you have,
what kind of people are in it, and what you see yourself doing.
Principles of organization
1. Principle of unity of objectives: Organizational goals, departmental goals, and individual goals
must be clearly defined. All goals and objectives must have uniformity. When there is contradiction
among different level of goals desired goals can’t be achieved. Therefore, unity of objectives is
necessary
2. Principle of specialization: When an employee takes special type of knowledge and skill in any
area, it is known as specialization. Modern business organization needs the specialization, skill and
knowledge by this desired sector of economy and thus, efficiency would be established.
3. Principle of coordination: In an organization many equipment, tools are used. Coordination can
be obtained by group effort that emphasize on unity of action. Therefore, coordination facilitates in
several management concepts
4. Principle of authority: Authority is the kind of right and power through which it guides and
directs the actions of others so that the organizational goals can be achieved. It is also related with
decision making. It is vested in particular position, not to the person because authority is given by an
institution and therefore it is legal. It generally flows from higher level to lowest level of
management. There should be unbroken line of authority.
5. Principle of responsibility: Authority is necessary to perform the work .Not only authority is not
provided to the people but obligation is also provided. So the obligation to perform the duties and
task is known as responsibility. Responsibility can’t be delegated. It can’t be avoided.

Importance of motivation Types of Organisation Structure

1. Effective utilisation of human resources- Motivation induces every individual to perform
well. It results into enhanced productivity and production.

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organisation has grouping of activities in accordance with the functions of an organisation such as
production, marketing, finance, human resource and so on.
The specialist in charge of a functional department has the authority over all other employees for his
function.
x Project teams are created whenever specific projects require a high degree of technical skill and other
resources for a temporary period.
x Project team form the horizontal chain and functional departments create a vertical chain of
command.
x Members of a particular team are drawn from the functional departments and are placed under the
direction of a project manager who has the overall responsibility of a particular project.

Advantages
x Is logical and reflection of functions
x Follows principle of occupation specialisation
x Simplifies training
x Better control as the manger in charge of each functional department is usually an specialist.
Disadvantages
x Reduced coordination between functions.
x Conflicts between different functions could be detrimental for the organisation as a whole.
x Difficult for general managers to coordinate different departments.
However, it is much suitable for large organisations where there is ample scope for specialisation.
Once harmony and proper coordination among different functions is achieved, it could lead to sure
success for an organisation.
c. Line and Staff Organisation
It is a combination of line and functional structures. Under this organisation the “line” is supported by
the “staff”. Staff personnel acts as an advisory group adjacent to the line. In this organisation
structure, the authority flows in a vertical line and gets the help of staff specialist who are in
advisory. When the line executives need advice, information about any specific area, these staff
specialists are consulted.
For example Chief accountant has command authority over accountants and clerks in the accounts
departments
but he has only advisory relationship with other departments like production or sales.

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 There are two types of organisation structure – Formal organisation structure and Informal 2. Makes employees quality oriented – A clear understanding of the way motivation works
Organisation structure helps a manager make his employees quality oriented
3. Maintains good human relations – It results in harmonious relation between employer and
Formal organisation means an intentional structure of roles in a formally organised enterprise. It employees.
refers to the structure of jobs and positions with defined functions and relationships. This type of 4. Basis of good cooperation – Motivated employees work together to enhance production.
organisation is built by the management to realise its objectives. 5. Better image about organisation to the public
Informal organisation is a network of interpersonal relationships that arise when people interact with
Motivation process
each other. It refers to the relationships between people based not on procedures but on personal
Stage 1 – Need deficiency – It is the deficiency of something within the individual and provides the
attitudes, prejudices, likes and dislikes.
spark, and which is the starting point of motivation. Eg desire to get promotion
TYPES OF FORMAL ORGANISATIONAL STRUCTURE Stage 2- Selection of a course of action – the employee is seeking strategies to satisfy his need. He
selects the best strategy
a. Line Organisation Stage 3 – Assessment of employee’s performance – The supervisor assesses the performance of the
It is perhaps the oldest and the simplest organisational structure. Line functions are those which have employee
direct responsibility for accomplishing the objective of the enterprise. In this kind of structure every Stage 4 – Reward or punishment – In the light of the employee’s performance, he is rewarded or
manager exercise a direct authority over his subordinate who in turn directly reports to their punished. Give reward means he is able to satisfy his needs.
superiors.
x There is a hierarchical arrangement of authority.
x Each department is self contained and works independently of other departments.
x Lines of authority are vertical i.e. from top to bottom.
x There are no staff specialists.

Advantages
x Simple to establish and operate
x Promotes prompt decision making.
x Easy to control as the managers have direct control over their subordinates.
x Communication is fast and easy as there is only vertical flow of communication.
Disadvantages
x Lack of specialisation
x Managers might get overloaded with too many things to do.
x Failure of one manager to take proper decisions might affect the whole organisation.
However, line structures are suitable for
x small businesses where there are few subordinates
x organisations where there is largely of routine nature and methods of operations are simple.

b. Functional Organisation
Under this system, the whole task of management and direction of subordinates is divided according
to the type of work involved. The organisation is divided into a number of functional areas. This

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CHAPTER 5 – DECISION MAKING Advantages

Decision making is an essential part of planning. Decision making and problem solving are used in
all management functions, although usually they are considered a part of the planning phase.
Decision making signifies the actual selection of the course of action from among a number of
alternatives.
Few management applications of decision theory
1. Select the best from among several job offers
2. Select the most important investment portfolio
3. Determine whether a large, small or no plant should be built
CHARACTERISTICS OF DECISION MAKING
The essential characteristics of decision making are given below:
1. It is a process of choosing a course of action from among the alternative courses of action.
2. It is a human process involving to a great extent the application of intellectual abilities.
3. It is the end process preceded by deliberation and reasoning.
4. It is always related to the environment. A manager may take one decision in a particular set of
circumstances and another in a different set of circumstances.
5. It involves a time dimension and a time lag.
6. It always has a purpose. Keeping this in view, there may just be a decision not to decide.
x Line managers are provided expert advice by these specialists.
x Staff managers provide specialist advice which can improve quality of decisions in various
departments.
Disadvantages
x Line managers and staff managers might have conflicts on particular issues.
x Line and staff managers might not be clear as to what the actual area of operations is and
what is expected of them. Co-ordination may be a problem.
d. Project Organisation
Project organisation is not a separate type of organisation like the line, functional or line and staff
organisation; rather it is set up within an organisation for the purpose of completing a project or
accomplishing assigned objectives in time and within cost and profit goals laid down by the
management. The project structure consists of a number of horizontal organisational units to
complete projects of a long duration. A team of specialists from different areas is created for each
project. Usually this team is managed by the project manager. The project staff is separate from and
independent of the functional departments.

DECISION MAKING PROCESS

1. Setting objectives
2. Defining the Problem
3. Analyzing the problem
4. Developing Alternatives
5. Selecting the Best Alternative
6. Implementing the Decision

TYPES OF DECISIONS

There are three types of decision in business:

x Strategic decisions
x Tactical decisions
x Operational decisions

Strategic decisions are long term, complex decisions made by senior management. These decisions
will affect the entire direction of the firm. An example may be to become the market leader in their
field. Top managers are often responsible for making strategic decisions or decisions that concern the
long-term goals of the company. For example, a company might decide to develop new products or
focus its efforts on increasing the volume of an existing product. Top managers are often responsible
for making strategic decisions or decisions that concern the long-term goals of the company. For
example, a company might decide to develop new products or focus its efforts on increasing the
volume of an existing product.
Advantages
x Special attention can be provided to meet the complex demand of the project.
x It allows maximum use of specialist knowledge thus chances of failure are very less.
x Project staff works as a team towards common goal which results in high motivation level for its
members.
Disadvantages
As the project staff consists of personnel from diverse fields, it might be quite challenging for the
project manager to coordinate among them.
e. Matrix Organisation
x Matrix organisation combines two structures – functional departmentation and project structure.
x Functional department is a permanent feature of the matrix structure and retains authority for overall
operation of the functional units.

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Tactical decisions are medium term, less complex decisions made by middle managers. They follow
on from strategic decisions and aim to meet the objectives stated in any strategic decision. For
example in order to become the market leader, a firm may have to launch new products/services or
open new branches. Once a company's goals and policies are established by senior management,
tactical decisions aimed at achieving a company's goals and implementing company policy need to be
made. Such decisions are usually made by middle managers and require managers to focus on
specific actions that will bring about the company's objectives. For example, a mid-level manager
might devise a plan to provide employees with incentives in order to increase production. This
requires mangers to have accurate information so that their decisions are based on facts
Operational decisions are day to day decisions made by junior managers that are simple and routine.
This could involve the regular ordering of supplies or the creation of a staff rota. They are decisions
regarding the day-to-day functions of a business. These decisions are considered operational
decisions and they are subordinate to strategic and tactical decisions. While these decisions are the
responsibility of low-level managers, good decision making is crucial here since such decisions focus
on productivity, quality control and employee performance. Moreover, operational decisions can be
broken down into:
x Short term planning needs like ordering supplies, establishing work priorities and enlisting
temporary help
x Medium term planning like hiring and firing personnel, purchasing equipment, training
individuals and modifying procedures
x Long term planning like replacing subcontractors, redesigning production facilities and
modifying capacity
Decision Making under Certainty
In this environment, the decision maker knows with certainty the consequences of selecting every
course of action or decision choice. In this type of decision problems the decision maker presumes
that only one state of nature is relevant for his purposes. He identifies this state of nature, takes it for
granted and presumes complete knowledge as to its occurrence. For example, suppose a person has
Rs 5,00,000 to invest for a one year period. One alternate is to open a savings account paying 4%
interest and another is to invest in a government treasury paying 9% interest. If both investments are
secure and guaranteed, then there is a certainty that the treasury note will be the better investment.
The various techniques for solving problems under certainty are i) System of equations ii) Linear
programming iii) Inventory models iv) Break even analysis
Decision Making under Risk
The future conditions are not always made in advance. In real life most managerial decisions are
made under risk decisions, that is, some information is available but it is insufficient to answer all the
questions about the outcome. So a decision maker has to make probability estimates of these
outcomes. In decision making under risk one assumes that there exist a number of possible future
states of nature. Each has a known (or assumed) probability of occurring, and there may not be one
future state that results in the best outcome for all alternatives
Examples of future states and their probabilities are as follows:
• Alternative weather (weather) will affect the profitability of alternative construction schedules; here,
the probabilities of rain and of good weather can be estimated from historical data.
Decision Making under Uncertainty
At times a decision maker cannot assess the probability of occurrence for the various states of nature.
Uncertainty occurs when there exist several (i.e., more than one) future states of nature but the
probabilities of each of these states occurring are not known. In such situations the decision maker
can choose among several possible approaches for making the decision. A different kind of logic is
used here, based on attitudes toward risk. Such situations arise when a new product is introduced in
the market or a new plant is set up.
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(i) Human Resource Planning, i.e., determining the number and kinds of personnel required to fill
various positions in the organisation.
(ii) Recruitment, selection and placement of personnel, i.e., employment function.
(iii) Training and development of employees for their efficient performance and growth.
(iv) Appraisal of performance of employees and taking corrective steps such as transfer from one job
to another.
(v) Motivation of workforce by providing financial incentives and avenues of promotion
(vi) Remuneration of employees. The employees must be given sufficient wages and fringe benefits
to achieve higher standard of living and to motivate them to show higher productivity.
(vii) Social security and welfare of employees.
FUNCTIONS OF HUMAN RESOURCE MANAGEMENT
The main functions of human resource management are classified into two categories:
(a) Managerial Functions and (b) Operative Functions
(a) Managerial Functions
Following are the managerial functions of Human Resources Management.
1. Planning: The planning function of human resource department pertains to the steps taken in
determining in advance personnel requirements, personnel programmes, policies etc.
2. Organisation: Under organisation, the human resource manager has to organise the operative
functions by designing structure of relationship among jobs, personnel and physical factors in such a
way so as to have maximum contribution towards organisational objectives. In this way a personnel
manager performs following functions :
(a) preparation of task force;
(b) allocation of work to individuals;
(c) integration of the efforts of the task force;
(d) coordination of work of individual with that of the department.
3. Directing: Directing is concerned with initiation of organised action and stimulating the people to
work. The personnel manager directs the activities of people of the organisation to get its function
performed properly. A personnel manager guides and motivates the staff of the organisation to follow
the path laid down in advance.
4. Controlling: It provides basic data for establishing standards, makes job analysis and performance
appraisal, etc. All these techniques assist in effective control of the qualities, time and efforts of
workers.
(b) Operative Functions: The following are the Operative Functions of Human Resource
Management
1. Procurement of Personnel: It is concerned with the obtaining of the proper kind and number of
personnel necessary to accomplish organisation goals. It deals specifically with such subjects as the
determination of manpower requirements, their recruitment, selecting, placement and orientation, etc.
2. Development of Personnel: Development has to do with the increase through training, skill that is
necessary for proper job performance. In this process various techniques of training are used to
develop the employees.
3. Compensation to Personnel: Compensation means determination of adequate and equitable
remuneration of personnel for their contribution to organisation objectives.
4. Maintaining Good Industrial Relation: Human Resource Management covers a wide field. It is
intended to reduce strifes, promote industrial peace, provide fair deal to workers and establish
industrial democracy.
5. Record Keeping: In record-keeping the personnel manager collects and maintains information
concerned with the staff of the organisation. It is essential for every organisation because it assists the
management in decision making such as in promotions.
6. Personnel Planning and Evaluation: Under this system different type of activities are evaluated
such as evaluation of performance, personnel policy of an organisation and its practices, personnel
audit, morale, survey and performance appraisal, etc.
IMPORTANCE OF HUMAN RESOURCE MANAGEMENT
1. It helps management in the preparation adoption and continuing evolution of personnel
programmes and policies.
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Models of decision making
The Rational Model
The Rational model proposes that managers use a rational, four stage sequence when making
decisions. According to this model, managers are completely objective and possess complete
information to make a decision. Despite criticism for being unrealistic, the rational model is
instructive because it analytically breaks down the decision-making process and serves as a
conceptual anchor for newer models. The four stages are:
1. Identify the problems or opportunities
2. Generate alternative solutions
3. Evaluate alternatives and select a solution
4. Implement and evaluate the chosen solution
Non rational models of decision making
In contrast to the rational model’s focus on how decisions should be made, Non rational models
attempt to explain how decisions actually are made. They are based on the assumption that decision
making is uncertain, that decision makers do not possess complete information, and that it is difficult
for managers to make optimal decisions. Two non rational models are Herbert
Simon’s normative model and the garbage can model.
Simon’s Normative Model
Herbert Simon proposed this model to describe the process that managers actually use when making
decisions. The process is guided by a decision maker’s bounded rationality. Bounded rationality
represents the notion that decision makers are “bounded” or restricted by a variety of constraints
when making decisions. These constraints include any personal characteristics or internal and
external resources that reduce rational decision making. Personal characteristics include the limited
capacity of the human mind, personality (a meta-analysis of 150 studies showed that males displayed
more risk taking than females), and time constraints. Examples of internal resources are the
organization’s human and social capital, financial resources, technology, plant and equipment, and
internal processes and systems. External resources include things the organization cannot directly
control such as employment levels in the community, capital availability, and government policies.
The Garbage Can Model
As is true of Simon’s normative model, this approach grew from the rational model’s inability to
explain how decisions are actually made. It assumes that organizational decision making is a sloppy
and haphazard process. This contrasts sharply with the rational model, which proposed that decision
makers follow a sequential series of steps beginning with a problem and ending with a solution.
According to the garbage can model, decisions result from a complex interaction between four
independent streams of events: problems, solutions, participants, and choice opportunities. The
interaction of these events creates “a collection of choices looking for problems, issues and feelings
looking for decision situations in which they might be aired, solutions looking for issues to which
they might be the answer, and decision makers looking for work.” A similar type of process occurs in
your kitchen garbage basket. We randomly discard our trash and it gets mashed together based on
chance interactions. Consider, for instance, going to your kitchen trash container and noticing that the
used coffee grounds are stuck to a banana peel. Can you explain how this might occur? The answer is
simple: because they both got thrown in around the same time. Just like the process of mixing
garbage in a trash container, the garbage can model of decision making assumes that decision making
does not follow an orderly series of steps. Rather, attractive solutions can get matched up with
whatever handy problems exist at a given point in time or people get assigned to projects because
their workload is low at that moment. This model of decision making thus attempts to explain how
problems, solutions, participants, and choice opportunities interact and lead to a decision
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CHAPTER 7 – HUMAN RESOURCE PLANNING
HUMAN RESOURCE PLANNING
Human resource planning is the systematic and continuing process of analysing an organisation’s
workforce requirements under changing conditions and developing personnel policies appropriate to
the long term effectiveness of the organisation.
Human Resource planning is the process by which a management determines how an organisation
should move from its current manpower position to its desired manpower position. Through planning
a management strives to have the right number and the right kinds of people at the right places, at the
right time, to do things which result in both the organisation and the individual receiving the
maximum long-range benefit.
Definition of Human Resource Planning :
Coleman has defined Human Resource Planning as ―the process of determining manpower
requirements and the means for meeting those requirements in order to carry out the integrated plan
of the organisation.
NEED AND IMPORTANCE OF HUMAN RESOURCE PLANNING
1. Despite growing unemployment, there has been shortage of human resources with required skills,
qualification and capabilities to carry on works. Hence the need for human resource planning.
2 Large numbers of employees, who retire, die, leave organisations, or become incapacitated because
of physical or mental ailments, need to be replaced by the new employees. Human resource planning
ensures smooth supply of workers without interruption.
3. Human resource planning is also essential in the face of marked rise in workforce turnover
(employee turnover refers to the number of employees who leave an organisation and are replaced by
new employees) which is unavoidable and even beneficial. Voluntary quits, discharges, marriages,
promotions and seasonal fluctuations in business are the examples of factors leading to workforce
turnover in organisations.
4. Technological changes and globalisation usher in change in the method of products and
distribution of production and services and in management techniques. These changes may also
require a change in the skills of employees, as well as change in the number of employees required. It
is human resource planning that enables organisations to cope with such changes.
5. Human resource planning is also needed in order to meet the needs of expansion and
diversification programmes of an organisation.
OBJECTIVES OF HUMAN RESOURCE PLANNING
The major objectives of Human Resource Planning in an organisation are to :
(i) ensure optimum use of human resources currently employed;
(ii) avoid balances in the distribution and allocation of human resources;
(iii) assess or forecast future skill requirements of the organisation‘s overall objectives;
(iv) provide control measure to ensure availability of necessary resources when required;
(v) control the cost aspect of human resources;
(vi) formulate transfer and promotion policies
STEPS IN HUMAN RESOURCE PLANNING
HRP involves the following steps:
1. Analysis of Organisational Plans and Objectives:
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 Multi-stage Decision making

CHAPTER 6 – HUMAN RESOURCE MANAGEMENT
Human Resource Management is a process, which consists of four main activities, namely,
acquisition, development, motivation, as well as maintenance of human resources.
Human Resource Management is responsible for maintaining good human relations in the
organisation. It is also concerned with development of individuals and achieving integration of goals
of the organisation and those of the individuals.
NATURE OF HUMAN RESOURCE MANAGEMENT
1. Inherent Part of Management: Human resource management is inherent in the process of
management. This function is performed by all the managers throughout the organisation rather that
by the personnel department only.
2. Pervasive Function: It is performed by all managers at various levels in the organisation.
3. Basic to all Functional Areas: Human Resource Management permeates all the functional area of
management such as production management, financial management, and marketing management.
4. People centered: Human Resource Management is people centered and is relevant in all types of
organisations.
5. Personnel Activities or Functions: Human Resource Management includes manpower planning,
employment, placement, training, appraisal and compensation of employees.
6. Continuous Process: Human Resource Management is not a ‘one shot’ function. It must be
performed continuously if the organisational objectives are to be achieved smoothly.
Multiple-stage decisions refer to decision tasks that consist of a series of interdependent stages
leading towards a final resolution. The decision-maker must decide at each stage what action to take
next in order to optimize performance (usually utility). One can think of many examples of this sort:
working towards a degree, troubleshooting, medical treatment, scheduling, budgeting, etc.
Decision trees
Some decisions involve a series of steps, the second step depending on the outcome of the first, the
third depending on the outcome of the second and so on. Often uncertainty surrounds each step, so
the decision maker faces uncertainty piled on uncertainty. Decision trees are a model for solving such
a problem.
Decision tree is a graphical method for identifying alternate actions, estimating probabilities, and
indicating the resulting expected payoff. This graphical form visually helps the decision maker view
his alternatives and outcomes. Instead of compressing all the information regarding a complex
decision into a table, decision maker can draw a schematic representation of the problem that displays
the information in more easily understandable fashion.
Example of the problems which can be solved through decision tree may be when a new product is to
be introduced, whether to tool up for tool up for it in a major way as to assure production at the
lowest possible cost or to undertake cheaper temporary tooling involving a higher manufacturing cost
but lower capital losses if the product does not sell well as estimated etc.
Here the second step of decision, that is, going for major or minor tooling, depends on the outcome of
the first decision, that is, whether to go for new product or not. Similarly within the major tooling,
there may be alternatives which can be considered in the light of decision made of tooling.

PERSONNEL MANAGEMENT VS HUMAN RESOURCE MANAGEMENT

1. Human resource management emerged in late 70’s. But personnel management precedes HRM
2. HRM gives emphasis not only to employee development but also development of management
team. PM is a management activity which is largely aimed at non-manager.
3. Personnel management is a routine function. Human resource management is a strategic function
4. The speed of decision taking is low in PM compared with HRM
5. Under personnel management, employees are provided with less training and development
opportunities. Under human resource management, employees are provided with more training and
development opportunities

OBJECTIVES OF HUMAN RESOURCE MANAGEMENT

(i) To ensure effective utilisation of human resources, all other organisational resources will be
efficiently utilised by the human resources.
(ii) To establish and maintain an adequate organisational structure of relationship among all the
members of an organisation by dividing of organisation tasks into functions, positions and jobs, and
by defining clearly the responsibility, accountability, authority for each job and its relation with other
jobs in the organisation.
(iii) To generate maximum development of human resources within the organisation by offering
opportunities for advancement to employees through training and education.
(iv) To ensure respect for human beings by providing various services and welfare facilities to the
personnel.
(v) To ensure reconciliation of individual/group goals with those of the organisation in such a
manner that the personnel feel a sense of commitment and loyalty towards it.
(vi) To identify and satisfy the needs of individuals by offering various monetary and non- Squares represent decisions you can make. The lines that come out of each square on its right show
monetary rewards. all the available distinct options that can be selected at that decision analysis point. Circles show
various circumstances that have uncertain outcomes (For example, some types of events that may
SCOPE OF HRM : affect you on a given path). The lines that come out of each circle denote possible outcomes of that
uncontrollable circumstance.

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Human resource planning is a part of overall plan of organisation. Plans concerning technology, 2. It supplies skilled workers through scientific selection process.
production, marketing, finance, expansion and diversification give an idea about the volume of future 3. It ensures maximum benefit out of the expenditure on training and development and appreciates
work activity. the human assets.
2. Forecasting Demand for Human Resources: Human resource planning starts with the estimation 4. It prepares workers according to the changing needs of industry and environment.
of the number and type of personnel required at different levels and in different departments. 5. It motivates workers and upgrades them so as to enable them to accomplish the organisation goals.
3. Forecasting Supply of Human Resources: One of the important areas of human resources 6. Through innovation and experimentation in the fields of personnel, it helps in reducing casts and
planning is to deal with allocation of persons to different departments depending upon the work-load helps in increasing productivity.
and requirements of the departments. While allocating manpower to different departments, care has 7. It contributes a lot in restoring the industrial harmony and healthy employer-employee relations.
to be taken to consider appointments based on promotions and transfers. 8. It establishes mechanism for the administration of personnel services that are delegated to the
4. Estimating Manpower Gaps: Net human resource requirements or manpower gaps can be personnel department.
identified by comparing demand and supply forecasts. Such comparison will reveal either deficit or
surplus of human resources in future. Deficits suggest the number of persons to be recruited from
outside whereas surplus implies redundant to be redeployed or terminated. Similarly, gaps may occur
in terms of knowledge, skills and aptitudes. Employees deficient in qualifications can be trained
whereas employees with higher skills may be given more enriched jobs.
5. Matching Demand and Supply : It is one of the objectives of human resource planning to assess
the demand for and supply of human resources and match both to know shortages and surpluses on
both the side in kind and in number. This will enable the human resource department to know
overstaffing or understaffing. Once the manpower gaps are identified, plans are prepared to bridge
these gaps. Plans to meet the surplus manpower may be redeployment in other departments and
retrenchment in consultation, with the trade unions. People may be persuaded to quit through
voluntarily retirement. Deficit can be met through recruitment, selection, transfer, promotion, and
training plans. Realistic plans for the procurement and development of manpower should be made
after considering the macro and micro environment which affect the manpower objectives of the
organisation.

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 CHAPTER 8 – JOB ANALYSIS
JOB ANALYSIS
Job analysis is an intensive and direct technique for identifying the essential information regarding
the job. It is the process of determining the tasks involved in the job and the personnel qualities of the
individuals required to perform the job.
Job analysis provides information both for the job and job holder. It involves the breaking up of a job
into its basic elements and studying them in detail to obtain all relevant facts about the job. It
provides information about the job contents, job duties and personnel qualities required for the job.
Job analysis is the process of evaluation of the operations, duties, responsibilities, work conditions,
nature of work, qualities of personnel etc.
It is written record of the physical, mental, social, psychological and behavioural characteristics
which a person should possess in order to perform the job effectively.
CONTENTS OF JOB SPECIFICATION:
1. Physical characteristics – Job specification tells what should be the height, weight, sight, physical
structure, health etc of the personnel who are required to perform the job in question.
2. Psychological features – It includes the decision making ability, mental ability, analytical ability
etc of the personnel.
3. Personal characteristics – Behaviour, attitude, leadership quality etc of the personnel must be
included.
4. Responsibility – A person’s sense of responsibility towards a particular job should be clearly
indicated. Eg responsibility for equipment, office records etc
5. Qualification – Educational qualification, experience, training etc should be included.

Job analysis is ―the process of determining, by observation and study, and reporting pertinent
information relating to the nature of a specific job. It is the determination of the tasks which comprise
the job and of the skills, knowledge, abilities and responsibilities required of the worker for a
successful performance and which differentiate one job from all others.

INFORMATION PROVIDED BY JOB ANALYSIS

Job analysis provides the following information:

1. Job Identification : Its title, including its code number;

2. Significant Characteristics of a Job : It location, physical setting, supervision, union jurisdiction,
hazards and discomforts;
3. What the Typical Worker Does : Specific operation and tasks that make up an assignment, their
relative timing and importance, their simplicity, routine or complexity, the responsibility or safety of
others for property, funds, confidence and trust;
4. Which Materials and Equipment a Worker Uses : Metals, plastics, grains, yarns, milling
machines, punch presses and micrometers;
5. How a Job is Performed : Nature of operation - lifting, handling, cleaning, washing, feeding,
removing, drilling, driving, setting-up and many others;
6. Required Personal Attributes : Experience, training, apprenticeship, physical strength, co-
ordination or dexterity, physical demands, mental capabilities, aptitudes, social skills;
7. Job Relationship : Experience required, opportunities for advancement, patterns of promotions,
essential co-operation, direction, or leadership from and for a job.

SOURCES OF INFORMATION FOR JOB ANALYSIS

Information on a job may be obtained from three principal sources :

(a) From the employees who actually perform a job;
(b) From other employees such as supervisors and foremen who watch the workers doing a job and
thereby acquire knowledge about it; and
(c) From outside observers specially appointed to watch employees performing a job. Such outside
persons are called the trade job analysts. Sometimes, special job reviewing committees are also
established.

METHODS OF JOB ANALYSIS

Four methods or approaches are utilised in analysing jobs.

1. Personal Observation : The materials and equipment used, the working conditions and probable
hazards, and an understanding of what the work involves are the facts which should be known by an
analyst.
2. Sending out of Questionnaires : This method is usually employed by engineering consultants.
Properly drafted questionnaires are sent out to job-holders for completion and are returned to
supervisors.

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1. Qualified Personnel: By using external sources of recruitment the management can make
qualified and trained people to apply for vacant Jobs in the organisation.
2. Wider choice : When vacancies are advertised widely a large number of applicants from outside
the organisation apply. The management has a wider choice while selecting the people for
employment.
3. Fresh Talent: The insiders may have limited talents. External sources facilitate infusion of fresh
blood with new ideas into the enterprise. This will improve the overall working of the enterprise.
4. Competitive Spirit: If a company can tap external sources, the existing staff will have to compete
with the outsiders. They will work harder to show better performance.
CHAPTER 10 – PERFORMANCE APPRAISAL
Performance appraisal or Performance evaluation is a method of evaluating the behaviour of
employees in a work place, normally including both the quantitative and qualitative aspect of job
performance. Performance here refers to the degree of accomplishment of the tasks that makeup an
individual job. It indicates how well an individual fulfilling the job demands. Performance is
measured in terms of results.
USES OF PERFORMANCE APPRAISAL

SELECTION: 1. Help in Deciding Promotion : A well-organised, development and administered performance

To select means to choose. Selection is a part of the recruitment function. It is the process of
choosing people by obtaining and assessing information about the applicants (age, qualification,
experience and qualities) with a view of matching these with the job requirements and picking up the
most suitable candidates. The choices are made by elimination of the unsuitable at successive stages
of the selection process.
SELECTION PROCESS
The selection process begins with the job specification. The more dearly and precisely it is done the
less would be the number of qualified applicants. Suppose the purpose is to select management
trainees. If the qualification prescribed is MBA, the number of applicants may be in hundred. If the
qualification is graduation in any discipline, the number of applicants may be in thousand.
1. Initial Screening: The initial screening and/or preliminary interview is done to limit the costs of
selection by letting only suitable candidates go through the further stages in selection. At this stage,
usually a junior executive either screens all enquiries for positions against specified norms (in terms
of age, qualifications and experience) through preliminary interview where information is exchanged
about the job, the applicant and the, mutual expectations of the individual and the organization. If the
organization finds the candidate suitable, an application form, prescribed for the purpose, is given to
these candidates to fill in and submit.
2. Application Form : The application form is usually designed to obtain information on various
aspects, of the applicant‘s social, demographic, academic and work-related background and
references. The forms may vary for different positions some organizations may not have any form
specially designed instead, ask the candidates to write applications on a plain sheet.
3. Tests: A test is a sample of an aspect of an individual‘s behaviour, performance or attitude. It also
provides a systematic basis for comparing the behaviour, performance or attitude of two or more
persons. Tests serve as a screening device and provide supplementary inputs in selection decisions.
Their value lies in the fact that they serve additional predictors intended to make selection decision
more apt and accurate.
Intelligence Tests: These are tests to measure one‘s intellect or qualities of understanding.
They are also referred to as tests of mental ability. The traits of intelligence measured include:
reasoning, verbal and non-verbal fluency, comprehension, numerical, memory and spatial relations
ability.
Aptitude Tests: Aptitude refers to one‘s natural propensity or talent or ability to acquire a
particular skill. While intelligence is a general trait, aptitude refers to a more specific capacity or
potential. It could relate to mechanical dexterity, clerical, linguistic, musical academic etc.
Achievement Tests: These are proficiency tests to measure one‘s skill or acquired
knowledge. The paper and pencil tests may seek to test a person‘s knowledge about a particular
subject.
PIP Tests : PIP tests are those which seek to measure one‘s personality, interest and
preferences. These tests are designed to understand the relationship between any one of these and
certain types of jobs.
Projective Tests : These tests expect the candidates to interpret problems or situations.
Responses to stimuli will be based on the individual‘s values, beliefs and motives.
appraisal programme may help the management in determining whether an individual should be
considered for promotion because the system not only appraises the worth of the employee on the
present job but also evaluates his potentialities for higher job.
2. Help in Personnel Actions : Personnel actions such as lay-offs, demotions, transfers and
discharges etc. may be justified only if they are based on performance appraisal.
3. Help in Wage and Salary Administration : The wage increase given to some employees on the
basis of their performance may be justified by the performance appraisal results.
4. Help in Training and Development : An appropriate system of performance appraisal helps the
management in devising training and development programmes and in identifying the areas of skill or
knowledge in which several employees are not at par with the job requirements.
5. Aid to Personnel Research : Performance appraisal helps in conducting research in the field of
personnel management. Theories in personnel field are the outcome of efforts to find out the cause
and effect relationship between personnel and their performance. By studying the various problems
which are faced by the performance appraiser, new areas of research may be developed in personnel
field.
STEPS IN APPRAISING PERFORMANCE :
1. Establishing Performance Standard: The process of evaluation begins with the establishment of
Performance Standards. While designing a job and formulating a job description, performance
standards are usually developed for the position.
2. Communicating Performance Expectations to Employees: The next important step is to
communicate the aforesaid standards to the concerned employees. Their jobs and jobs-related
behaviour should be clearly explained to them.
3. Measuring Actual Performance: The third step is the measurement of actual performance. To
determine what actual performance is, it is necessary to acquire information about it we should be
concerned with how we measure and what we measure.
4. Comparing Actual Performance with Standards: The next step is comparison of actual
performance with the standards. By doing so the potentiality for growth and advancement of an
employee can be appraised and judged. Efforts are made to find out deviations between standard
performance and actual performance.
5. Discussing the Appraisal with the Employee: After comparing actual performance with
standards, the next step is to discuss periodically the appraisal with the employee. Under this
discussion good points, weak points, and difficulties are indicated and discussed so that performance
is improved. The information that the subordinate receives about his performance assessment has a
great impact of his self-esteem and on his subsequent performance.
6. Initiating Corrective Action: The final step is the initiation of corrective action whenever
necessary. Immediate corrective action can be of two types. One is immediate and deals
predominantly with symptoms. The other is basic and delves into causes. Immediate corrective action
is often described as putting out fires whereas basic corrective action gets to the source of deviation
and seeks to adjust the difference permanently. Coaching and counseling may be done or special
assignments and projects may be set. Persons may be deputed for formal training courses, and
decision making responsibilities and authority may be delegated to the subordinates. Attempts may
also be made to recommend for salary increases or promotions, if these decisions become plausible in
the light of appraisals.

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 CHAPTER 9 – RECRUITMENT AND SELECTION
Recruitment means search of the prospective employee to suit the job requirements as represented
by job specification–a technique of job analysis. It is the first stage in selection which makes the
vacancies known to a large number of people and the opportunities that the organisation offers. In
response to this knowledge, potential applicants would write to the organisation. The process of
attracting people to apply in called recruitment.
SOURCES OF RECRUITMENT :
The various sources of recruitment are generally classified as internal source and external source.
(a) Internal Sources : This refers to the recruitment from within the company. The
various internal sources are promotion, transfer, past employees and internal
advertisements.
(b) External Sources : External sources refers to the practice of getting suitable
persons from outside.
EXTERNAL SOURCES OF RECRUITMENT
1. Direct Recruitment: An important source of recruitment is direct recruitment by placing a notice
on the notice board of the enterprise specifying the details of the jobs available. It is also known as
recruitment at factory gate. The practice of· direct recruitment is generally followed for filling casual
vacancies requiring unskilled workers.
2. Casual Callers or Unsolicited Applications: The organisations which are regarded as good
employers draw a steady stream of unsolicited applications in their offices. This serves as a valuable
source of manpower
3. Media Advertisement: Advertisement in newspapers or trade and professional journals is
generally used when qualified and experienced personnel are not available from other sources. Most
of the senior positions in industry as well as commerce are filled by this method.
4. Employment Agencies: Employment exchanges run by the Government are regarded as a good
source of recruitment for unskilled, semi-skilled and skilled operative jobs. Employment exchanges
and selected private agencies provide a nation-wide service in attempting to match personnel demand
and supply.
5. Management Consultants: Management consultancy firms help the organisations to recruit
technical, professional and managerial personnel. They maintain data bank of persons with different
qualifications and skills and even advertise the jobs on behalf their clients to recruit right type of
personnel.
6. Educational Institutions or Campus Recruitment: Big organisations maintain a close liaison
with the universities, vocational institutes and management institutes for recruitment to various jobs.
7. Recommendation: Applicants introduced by friends and relatives may prove to be a good source
of recruitment.
9. Telecasting: The practice of telecasting of vacant posts over T.V. is gaining importance these
days. The detailed requirements of the job and the qualities required to do it are publicized along with
the profile of the organisation where vacancy exists. The use of T.V. as a source of recruitment is less
as compared to other sources.
10. Raiding : Raiding is a technical term used when employees working elsewhere are attracted to
join organisations. The organisations are always on the lookout for qualified professionals, and are
willing to offer them a better deal if they make the switch.
MERITS OF EXTERNAL SOURCES
The merits of external sources of recruitment are as under:
3. Maintenance of Log Records : The employee maintains a daily record of duties he performs,
marking the time at which each task is started and finished.
4. Personal Interviews may be held by the analyst with the employees, and answers to relevant
questions may be recorded.
PURPOSES AND USES OF JOB ANALYSIS
1. Organisation and Manpower Planning : It is helpful in organisational planning for it defines
labour needs in concrete terms and coordinates the activities of the work force, and clearly divides
duties and responsibilities.
2. Recruitment and Selection : By indicating the specific requirements of each job (i.e., the skills
and knowledge), it provides a realistic basis for hiring, training, placement, transfer and promotion of
personnel.
3. Wage and Salary Administration : By indicating the qualifications required for doing specified
jobs and the risks and hazards involved in its performance, it helps in salary and wage administration.
Job analysis is used as a foundation for job evaluation.
4. Job Re-engineering : Job analysis provides information which enables us to change jobs in order
to permit their being manned by personnel with specific characteristics and qualifications.
5. Employee Training and Management Development : Job analysis provides the necessary
information to the management of training and development programmes. It helps it to determine the
content and subject-matter of in-training courses. It also helps in checking application information,
interviewing, weighing test results, and in checking references.
6. Performance Appraisal : It helps in establishing clear-cut standards which may be compared with
the actual contribution of each individual.
7. Health and Safety : It provides an opportunity for indentifying hazardous conditions and
unhealthy environmental factors so that corrective measures may be taken to minimise and avoid the
possibility of accidents.
JOB DESCRIPTION
The results of the job analysis are written in a statement known as job description. In other words job
description is a descriptive statement of the organisational relationship, responsibilities and duties on
a given job. It tells us what is to be done and how it is to be done and why.
CONTENTS OF JOB DESCRIPTION
1. Job location – Job description should mention the location of the job. That is in which department
it is located
2. Name of the job – Appropriate name should be given to each job so that it can be easily identified.
3. Summary of the job – Description about the job such as the primary, secondary and other duties
to be performed.
4. Duties and responsibilities – The duties and responsibilities concerned with each job should be
specifically mentioned. Time taken to perform the job is also to be indicated.
5. Degree of supervision – The degree of supervision required for each job should be mentioned
clearly.
6. Details of equipment, material and tools used – Machine, tools and equipments needed to
perform the job should be included.
7. Relation with other jobs – The relation of the job with other jobs should be clearly stated in the
job description.
8. A brief description of the overall purpose of the job – A brief description of the overall purpose
of the job should be indicated.
9. Special qualification of the job, mental, physical experiences – Qualifications, mental and
physical experience required for the job
10. Physical conditions- The physical environment of the job is described in terms of heat, light,
noise level etc.
JOB SPECIFICATION
The job description helps in preparing the specification for each job. So it is a product of job analysis.
It is a statement of maximum acceptable human qualities necessary to perform the job satisfactorily.

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CHAPTER 11- JOB EVALUATION 4. Interview: Interview is an oral examination of candidates for employment. No selection process is
complete without one or more interviews. Interview is the most common and core method of both
Job Evaluation is a system wherein a particular job of an enterprise is compared with its other jobs. In obtaining information from job-seekers, and decision-making on their suitability or otherwise.
the present industrial era, there are different types of jobs which are performed in every business and
industrial enterprise. Comparative study of these jobs is very essential because on the basis of such
study the structure of wages for different types of jobs is prepared. The comparison of jobs may be
made on the basis of different factors such as duties, responsibilities, working conditions, efforts, etc.
In nut shell, it may be said that job evaluation is a process in which a particular job of a business and
industrial enterprise is compared with other jobs of the enterprise.

OBJECTIVES OF JOB EVALUATION

The following are the objectives of job evaluation :

(i) To secure and maintain complete, accurate and impersonal

descriptions of each distinct job or occupation in the entire plant
(ii) To provide a standard procedure for determining the relative worth of
each job in a plant;
(iii) To determine the rate of pay for each job which is fair and equitable
with relation to other jobs in the plant, community or industry;
(iv) To ensure that like wages are paid to all qualified employees for like
work;
(v) To promote a fair and accurate consideration of all employees for
advancement and transfer;
(vi) To provide a factual basis for the consideration of wage rates for
similar jobs in a community and industry; and
(vii) To provide information for work organisation, employees selection,
placement, training and numerous other similar problems.

JOB EVALUATION VS JOB ANALYSIS

Job analysis is a systematic way of gathering information about a job.
Job Evaluation begins with job analysis and ends at the determination of the worth of the job.

METHODS OF JOB EVALUATION

Ranking Method : Jobs are arranged from the highest to the lowest, in order of their values or merit
in the organisation. Job at the top has the highest value and job at the lowest has the lowest value.
Jobs are arranged in each department and then department rankings are combined to develop an
organisational ranking.
Sr No Rank Monthly salaries
1 Accountant 30000
2 Accounts clerk 18000
3 Purchase assistant 17000
4 Machine operator 14000
5 Typist 9000
6 Office boy 6000

Job Grading or Job Classification Method : This method works by assigning each job a grade,
level or class that corresponds to a pay grade for instance Grade I, Grade II, Grade III and so forth.
These grades or classifications are created by identifying gradations of some common denominations,
such as job responsibility, skill, knowledge, education required, and so on. Then, for each job grade
so created standard job descriptions are determined. Thereafter, such standard description is matched
with job descriptions in the organisation.
Class Rank Employees
Class 1 Executives Office manager, deputy manager
Class 2 Skilled workers Purchase assistant, cashier
Class 3 Semi skilled workers Typist, Machine operators
Class 4 Less skilled workers File clerks, Office boys

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 CHAPTER 12- TRAINING AND DEVELOPMENT
Factor-comparison Method : This method is a combination of ranking and point systems. All jobs
are compared to each other for the purpose of determining their relative importance by selecting four
or five major job elements or factors which are more or less common to all jobs. These elements are Training is an organised activity for increasing the knowledge and skills of people for a definite
not predetermined. These are chosen on the basis of job analysis. The few factors which are purpose.
customarily used are : (i) mental requirements (ii) skill (iii) physical requirements (iv) responsibilities
(v) working conditions, etc. OBJECTIVES OF TRAINING:

Job Daily Physical Mental Skill Responsibility Working (i) To impart to new entrants the basic knowledge and skill they need for an intelligent performance
wage effort effort condition of definite tasks; (ii) To assist employees to function more effectively in their present positions by
Electrician 60 11(3) 14(1) 15(1) 12(1) 8(2) exposing them to the latest concepts, information and techniques and developing the skills, they will
Fitter 50 14(1) 10(2) 9(2) 8(2) 9(1) need in their particular fields; (iii) To build up a second line of competent officers and prepare them
Welder 40 12(2) 7(3) 8(3) 7(3) 6(3) to occupy more responsible positions; (iv) To broaden the minds of senior managers by providing
Cleaner 30 9(4) 6(4) 4(5) 6(4) 5(4) them with opportunities for an inter-change of experiences within and outside with a view to
Labourer 25 8(5) 4(5) 6(4) 3(5) 4(5) correcting the narrowness of the outlook that may arise from over-specialisation; (v) To impart
customer education for the purpose of meeting the training needs of Corporations which deal mainly
Suppose the job of a painter is found to be similar to electrician in skill (15), fitter in mental effort with the public.
(10), welder in physical effort (12), cleaner in his responsibility (6) and labourer in working
conditions (4). The wage rate for this job would be (15+10+12+6+4) is 47. NEED AND IMPORTANCE OF TRAINING

MERIT RATING 1. Increasing Productivity : Instruction can help employees increase their level of performance on
their present job assignment.
Merit rating is a technique to evaluate the merits of duals according to job request merit. The personal 2. Improving Quality : Better informed workers are less likely to make operational mistakes.
abilities that an individual brings to his job, measured by the extent to which his output or quality of 3. Helping a Company Fulfil its Future Personnel Needs : Organisations that have a good internal
his work exceeds the minimum that can reasonably be expected for his basic rate of pay. educational programme will have to make less drastic manpower changes and adjustments in the
event of sudden personnel alternations.
Merit rating is a process through which the ability, efficiency and the potentiality of an employee are 4. Improving Organisational Climate : Production and product quality may improve; financial
evaluated for the purpose of determining wage rate, need of training and for determining the policy incentives may then be increased, internal promotions become stressed, less supervisory pressures
for promotions and transfers. ensue and base pay rate increases result. Employee morale also increases.
5. Improving Health and Safety: Proper training can help prevent industrial accidents.
METHODS OF MERIT RATING 6. Obsolescence Prevention : Training and development programmes foster the initiative and
creativity of employees and help to prevent manpower obsolescence, which may be due to age,
1. Rating Procedure : In this method, the abilities of an employee are compared with that of other temperament or motivation, or the inability of a person to adapt himself to technological changes.
employees. Under this method, the employees are divided into efficient and inefficient employee. 7. Personal Growth : Employees on a personal basis gain individually from their exposure to
This method adopts the technique of paired comparison. Therefore, the pairs of two employees each educational experiences.
are made according to the formula of N(N-1)Z and the more efficient employee in every pair is
underlined. The employee having maximum underline is treated as the most efficient employee TRAINING AND DEVELOPMENT
having maximum underline is treated as the most efficient employee whereas the employee having no
underline to his credit, is treated least efficient employee. Training Development
Training means learning skills and knowledge Development means the growth of an employee
2. Grading Method : Here different grades are divided for evaluating the ability of different for doing a particular job. It increases job skills. in all respects. It shapes attitudes.
employees and then the employees are placed in these grades. The grades are—Excellent, Very The term ‘training’ is generally used to denote The term ‘development’ is associated with the
Good, Good, Average, Bad, Worst. Every grade may again be sub-divided into three grades: (i) imparting specific skills among operative overall growth of the executives.
Highly Satisfactory (ii) Satisfactory (iii) Non-satisfactory. Employees can be placed in any of these workers and employees.
groups according to their abilities. Training is concerned with maintaining and Executive development seeks to develop
improving current job performance. Thus, it has competence and skills for future performance.
3. Man to Man Comparison Method : This is the method where, a master scale is used to evaluate a short-term perspective. Thus, it has a long-term perspective.
the qualities of different employees. The five scales of performance are determined for every job in Training is job-centred in nature. Development is career-centred in nature.
the master scale. For example, to measure the efficiency of employees, first of all the most efficient The role of trainer or supervisor is very All development is ‘self development’. The
employee is selected and after that the most inefficient employees are selected who are respectively important in training. executive has to be internally motivated for self-
more efficient than average efficiency and less efficient than average efficiency. These five development
employees become the base for measuring the efficiency of the totalemployees. Every employee of
the enterprise is compared with these five employees to evaluate their ability and efficiency.
METHODS OF TRAINING
4. Graphic Rating Method : In this method, the abilities of employees are evaluated through graph.
The abilities of all the employees are represented on a graph paper with the help of scale. Following The following methods are generally used to provide training :
qualities are included to evaluate the ability of employees such as Quantity of Job, Quality of job,
Regularity, ability to learn, ability to initiate, dependence upon other employees and officers, safety On-the-Job Training Methods : This type of training is imparted on the job and at the work place
aspects, ability to direct, ability to supervise, behaviour with other employees and officers. Under this where the employee is expected to perform his duties. It enables the worker to get training under the

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CHAPTER 13- WAGE AND SALARY ADMINISTRATION CHAPTER 14- COMPENSATION AND INCENTIVES

PRINCIPLES OF WAGE AND SALARY ADMINISTRATION
1) There should be a definite plan and system to ensure that differences in pay for jobs are based
upon variations in job requirements, means maintaining equity in the distribution of wages and
salaries in the organization.
2) Maintaining competitiveness in the wage market means the general level of wage and salary
should be reasonably in line with that prevailing in the market.
3) Matching employees’ expectations and it should avoid unjustified discrimination by providing
equal pay for equal work.
4) Reinforcing positive employee behavior and contribution to the organization, differences in the
compensation package should be based on contribution, productivity, job performance, achievement
etc.
5) The compensation system should formulate and define rules and regulations for determining,
changing, adjusting wages in the organization.
6) The compensation package must ensure fairness, should maintain harmonious relationship
between the employee and employer.
7) Compensation system should flexible enough so that future changes can be incorporated.
8) The wage and salary administration should take care of and comply all the rules and regulations
laid down by the legislator for protecting the employees’ interest.
FACTORS AFFECTING WAGE AND SALARY ADMINISTRATION
1) Demand and Supply: Demand for and supply of labour and its availability will have great
influence on the determination of wage rates. If there is a shortage of labour, the wages demanded
will be high. If, on the other hand labour is plentiful, workers will be too willing to work at low rates
of wages.
In layman’s language the word ‘compensation’ means something, such as money, given or received
as payment for service. The word compensation may be defined as money received in the
performance of work, plus the many kinds of benefits and services that organization provides their
employee
OBJECTIVES OF COMPENSATION PLANNING
A sound compensation structure tries to achieve these objectives:
To attract manpower in a competitive market.
To control wages and salaries and labour costs by determining rate change and frequency of
increment.
To maintain satisfaction of employees by exhibiting that remuneration is fair adequate and
equitable.
To induce and improved performance, money is an effective motivator.
VARIOUS MODES OF COMPENSATION
a)Wages and Salary- Wages represent hourly rates of pay and salary refers to monthly rate of pay
irrespective of the number of hours worked. They are subject to annual increments. They differ from
employee to employee and depend upon the nature of jobs, seniority and merit.
b) Incentives- These are also known as payment by results. These are paid in addition to wages and
salaries. Incentive depends upon productivity, sales, profit or cost reduction efforts. Incentive scheme
are of two types:
Individual incentive schemes.
Group incentive schemes.

2) Organization’s Ability to Pay: This is a major affecting factor in determining wage and salary
structure of an organization. Financial position and soundness of an organization can put it in a
position to offer attractive compensation package.
3) Prevailing Market Rate or “Going Wage Rate”: This is practically the major factor that induces
any organization to take it as a base while determining wage and salary structure for it. Prevailing
market rate is also known as ‘most comparable rate of wage’, and most popular method for wage rate
determination, especially for lower cadre positions.
4) Productivity: Productivity is measured in terms of output per man hour. It is a result of several
factors such as technology, labor efforts, method of doing work, management contribution and
support and so on.
c) Fringe Benefits- These are given to employees in the form of benefits such as provident fund,
gratuity, medical care, hospitalization, accident relief, health insurance, canteen, uniform etc.
d) Non- Monetary Benefits- They include challenging job responsibilities, recognition of merit,
growth prospects, competent supervision, comfortable working condition, job sharing and flexi time.
INCENTIVES
Incentives are monetary benefits paid to workmen in lieu of their outstanding performance.
Incentives vary from individual to individual and from period to period for the same individual.
KINDS OF INCENTIVES

5) Cost of Living: It is always expected that there has to be adjustment in pay rates in accordance
with prevailing cost of living. The changes in the cost of leaving affect purchasing power of the
person.
6) Trade Union’s Bargaining Power: Generally the mechanism for fixing of wages for majority of
workers is collective bargaining or negotiation, and collective bargaining and negotiations depends
upon the trade union’s strength. If there is a strong union operates in the organization, it may dictate
its terms on wage fixation and revision over a period of time and vice versa.
7) Job Requirements: From the organizational perspective appropriate job analysis and job
evaluation exercise is a base for the wage determination and revision. It is quite obvious also that
wages to be paid to the workers should be in accordance with the duties, responsibilities and the
efforts likely to be put for job performance
METHODS OF WAGE PAYMENT
Incentives can be classified under the following categories:
1. Individual and Organizational Incentives
2. Financial and Non-Financial Incentives
3. Positive and Negative Incentives
1) Individual and Organizational Incentives- Individual incentives are the extra compensation paid
to an individual for all production over a specified magnitude which stems from his exercise of more
than normal skill, effort or concentration when accomplished in a predetermined way involving
standard tools, facilities and materials. Organizational or group incentive involve cooperation among
employees, management and union and purport to accomplish broader objectives such as an
organization-wide reduction in labour, material and supply costs, strengthening of employee loyalty
to company, harmonious management and decreased turnover and absenteeism
2) Financial and Non-financial Incentives- Individual or group performance can be measured in
financial terms. It means that their performance is rewarded in money or cash as it has a great impact
on motivation as a symbol of accomplishment. Financial incentives include salary, premium, reward,
dividend, income on investment etc. On the other hand, non-financial incentives are that social and

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same working conditions and environment and with the same materials, machines and equipments method of Merit Rating, a report is prepared regarding Merit Rating of every employees and it is
that he will be using ultimately after completing the training. represented on a graph paper. It makes evaluation of employees very easy and simple.

1. On Specific Job : On the job training methods is used to provide training for a specific job such a
electrician motor mechanic pluming etc.
2. Job Rotation : The major objective of job rotation training is the broadening of the background of
trainee in the organisation. If trainee is rotated periodically from one job to another job, he acquires a
general background.
3. Special Projects : The trainee may be asked to perform special assignment, thereby he learns the
work procedure
4. Apprenticeship : Under this method, the trainee is placed under a qualified supervisor or
instructor for a long period of time depending upon the job and skill required. Wages paid to the
trainee are much less than those paid to qualified workers.
5. Vestibule Training : Under this method, actual work conditions are created in a class room or a
workshop. The machines, materials and tools under this method is same as those used in actual
performance in the factory. Eg airlines
5. Checking List Method : A list of necessary qualities for the performance of a job is prepared
under this method. The qualities of the employees are measured on the basis of the abilities of such
lists. If an employee possesses that quality, the sign + is marked in the list. If that quality is not
possessed by an employee the sign - is marked in the list. If there is a doubt regarding it, the sign of
(?) is marked in the list. On the basis these sign, the abilities of an employee are evaluated.
6. Descript Evaluation Method : In this method supervisor prepares a detailed report of the abilities,
efficiency and potentialities of the employees under his supervision. All the employees are evaluated
on the basis of these reports.
DISTINCTION BETWEEN JOB EVALUATION AND MERIT RATING
Difference Job Evaluation Merit Rating

Off-the-job Training Methods Meaning It is a technique by which Merit Rating is the process by
different jobs of an enterprise are which the ability, efficiency and
1. Special Courses and Lectures : Lecturing is the most traditional form of formal training method evaluated. potentiality of an employee
Special courses and lectures can be established by business organizations in numerous ways as a part evaluated.
of their development programmes. Procedure of evaluation In the process of job evaluation, In the process of Merit Rating,
2. Conferences : In this method, the participants pools, their ideas and experience in attempting to the job is evaluated by the ability, efficiency and the
arrive at improved methods of dealing with the problems, which are common subject of discussion. comparing it with other jobs potentiality of an employee are
3. Case Studies : A case is a written account of a trained reporter of analyst seeking to describe an evaluated
actual situation. Some causes are merely illustrative; others are detailed and comprehensive Relation It is related with the relative study It is related with relative study
demanding extensive and intensive analytical ability. This method increases the trainee‘s power of of different jobs of different employees.
observation, helping him to ask better questions and to look for broader range of problems. Basis of determining wages In the process of job evaluation, In the process of Merit Rating,
4. Brainstorming : This is the method of stimulating trainees to creative thinking. This approach and salaries the remuneration of an employee the remuneration of an
provides for a maximum of group participation and a minimum of criticism. A problem is posed and is determined employee is determined on the
ideas are invited. Quantity rather quality is the primary objective. basis of his efficiency, ability
5. Laboratory Training : Laboratory training adds to conventional training by providing situations and potentiality.
in which the trainees themselves experience through their own interaction some of the conditions
they are talking about. In this way, they more or less experiment on themselves. There are two
methods of laboratory training: simulation and sensitivity training.

Induction Training
The introduction of the new employee to the job is known as induction. It is the process by which
new employees are introduced to the practices, policies and purposes of the organisation. Induction
follows placement and consists of the task of orienting or introducing the new employee to the
company, its policy and its position in the economy. Induction literally means helping the worker to
get or with his own environment.

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psychological attraction which encourages people to do the work efficiently and effectively. Non- I. Time Rate Wage System: It is the oldest and the simplest form of wage fixing. Under this system,
financial incentive can be delegation of responsibility, lack of fear, worker’s participation, title or workers are paid according to the work done during a certain period of time at a rate of per hour, per
promotion, constructive attitude, security of service, good leadership etc.. day, per week, per fortnight, or per month or any other fixed period of time

3) Positive and Negative Incentives- Positive incentives are those agreeable factors related to work
situation which prompt an individual to attain or excel the standards or objectives set for him, where
as negative incentives are those disagreeable factors in a work situation which an individual wants to
avoid and strives to accomplish the standards required on his or her part. Positive incentive may
include expected promotion, worker’s preference, competition with fellow workers and own ‘s record
etc. Negative incentives include fear of lay off, discharge, reduction of salary, disapproval by
employer etc.
FRINGE BENEFITS
Employees are paid several benefits in addition to wages, salary, allowances and bonus. These
benefits and services are called ‘fringe benefits’ because these are offered by the employer as a
fringe.
KINDS OF FRINGE BENEFITS
II. Piece Rate Wage System: Under this system, workers are paid according to the amount of work
done or numbers of units produced or completed, the rate of each unit being settled in advance,
irrespective of the time taken to do the work
PROCESS OF WAGE DETERMINATION
1. Job Analysis and Job Evaluation: This may be the primary exercise that an organization needs to
carefully carry out with an intention to create base for wage determination. Job analysis reveals
information about tasks, duties, responsibilities and standards with proposed job is to be performed
by the employees. It also guides in terms of job specification i.e. skills, ability. Qualification and
experiences needed to perform the job with requisite performance standards. Job analysis gives
enough information about the job and the profile of the performer in order to perform that job.
Another important exercise that an organization needs to carry out is ‘Job Evaluation’. It is nothing
but finding out relative worth of a job, in terms its contribution and significance to the overall
organizational objectives.

1) Old Age and Retirement Benefits - these include provident fund schemes, pension schemes,
gratuity and medical benefits which are provided to employee after their retirement and during old
age as a sense of security about their old age.
2) Workman’s Compensation - these benefits are provided to employee if they are got ignored or
die under the working conditions and the sole responsibility is of the employer.
3) Employee Security- Regular wage and salary is given to employee that gives a feeling of security.
Other than this compensation is also given if there is lay-off or retrenchment in an organization.
4) Payment for Time Not Worked – Under this category of benefits, a worker is provided payment
for the work that has been performed by him during holidays and also for the work done during odd
shifts. Compensatory holidays for the same number in the same month are given if the worker has not
availed weekly holidays.
5) Safety and Health – Under this benefit workers are provided conditions and requirements
regarding working condition with a view to provide safe working environment. Safety and Health
measures are also taken care of in order to protect the employees against unhealthy working
conditions and accidents.
6) Health Benefits – Employees are also provided medical services like hospital facility, clinical
facility by the organization.
2. Determining Performance Standard and Wage Surveys: Having understood the job in
considerable detail an attempt is made to determine expected performance standard to be carried out
by the performer. Then, an organization must survey wage rates prevails in the market for the same
job or its similar type, so that attractive compensation package can be designed to induce good
quality of candidature to apply for the job in an organization.
3. Deciding Wage Structure and Rules for Its Administration: Based on collection of relevant
information and taking in to account some of the influencing factors, an organization should design
wage structure which includes slab for basic or minimum wages, incentives, and/or increment over a
period of time to gather with other financial and nonfinancial perquisites to be offered to an
employee. Attempt should be made to follow principles of fairness, equity and justice to gather with
transparency while designing wage structure and deciding rules for its administration

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 CHAPTER 15 – INDUSTRIAL RELATIONS
In the narrow sense, the term “Industrial Relation” refers to the nature of relationship between the
employers and employees in an Industrial enterprise. In the broad sense, industrial relation refers to
all types of relationship between all the parties concerned with the industry.
Its scope includes three rarely distinct areas:
Relations between managers and individual workers.
The collective relations between employers and labour (trade) union.
The role of government in the regulation of these relationships.
OBJECTIVES OF INDUSTRIAL RELATIONS
1. Industrial Relation safeguards the interest of labor and management through mutual understanding
and goodwill among those parties in the industry which actively participates in the process of
production.
2. To raise productivity of the industry at a higher level this is the need of the day to contribute to the
economic development of the country.
3. To avoid all forms of industrial conflict
4. To minimize labour turnover and absenteeism by providing job satisfaction to the workers and
increasing their morale.
5. To minimize the occurrence of strikes, lockouts and gheraos.
6. To encourage and develop trade unions in order to improve workers collective strength and
resolving their problems through collective bargaining.
7. To establish, develop and maintain industrial democracy based on employee’s participation in
management and profit of the industry.
8. To facilitate government control over industries in regulating production and for protecting
employment or where production needs to be regulated in public interest.
9. To check and ensure a healthy and balanced social order in the industry.
SIGNIFICANCE OF GOOD IR
1. Industrial Peace: Good industrial relations bring harmony and remove causes of disputes. This
leads to industrial peace, which is an ideal situation for an industrial unit to concentrate on
productivity and growth.
2. High Morale: Cordial industrial relations improve the morale of the employee. It implies the
existence of an atmosphere of cooperation, confidence, and respect within the enterprise.
3. Mental Revolution: Sound industrial relation completely transforms the outlook of employers and
employee. It is based on consultation between the workers and the management. This motivates the
workers to give their best to the organization and share the fruits of progress jointly with the
management.
4. Reduced Wastage and Increased Productivity: It helps in increasing production. Wastage of
man, material and machines are reduced to the minimum and thus national interest is protected. Thus,
they will contribute to the economic growth of the countries.
5. Programmes for Workers Development: New programmes for workers development are
introduced in an atmosphere of peace such as training facilities, labour welfare facilities etc. Hence,
full advantage of latest inventions, innovations and other technological advancement can be obtained.
Through these employee development programme, workforce easily adjust itself to required changes
for betterment.
INDUSTRIAL DISPUTES
Industrial Disputes Act 1947 defines any dispute or difference between employers and employers or
between employers and workers, or between workers and workers, which is connected with the
employment or non-employment or terms of employment or with the conditions of labour of any
person.
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a) Determining financial needs
This involves determining the total financial requirements of an organisation in terms
of long term and short term requirements.
b) Determining capital structure and sources of funds
The capital structure decides the blending of the owned and borrowed funds in the
total financial requirements. It also implies the determination of sources, timing and
procedure to obtain funds which an enterprise needs for its long term and short term
operations.
c) Investment decisions – It means investing the funds between the different
components of fixed and current assets.
d) Management of fixed assets – The investment in fixed assets is governed by the top
level policies like owning the asset, to hire or get it on lease, to make or buy the
components etc. It also formulates appropriate depreciation policies for replacement
of assets.
e) Working capital management – Working capital management 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 an
enterprise.
f) Management of earnings – Out of the total earnings available for equity
shareholders, how much should be retained in the business for reinvestment is an
important function.
g) Control over financial activities- Controlling as a management function brings
effectiveness in operational performance, and it pre-supposes planning and budgeting.
The following tools are employed in controlling the financial activities:
i) Standard costing – the actual cost is compared with the standard cost to find out
inefficiencies and the reasons for it
ii) Budget control – It is exercised through preparing various types of budgets
iii) Financial analysis – It is carried out by making use of various ratios to analyse the
financial status and activities of the enterprise.
iv) Break even analysis (Cost volume profit analysis) – This analysis is used to study
the effect of changes in selling price, volume of production, variable and fixed costs or a
combination of these factors on the profits for selecting these factors such that profit is
maximised.
2. Routine functions
a) Control on cash
b) Custody and safeguarding of documents
c) Record keeping
d) Management reporting
OBJECTIVES OF FINANCIAL MANAGEMENT
1. Profit maximisation – It has been traditionally argued that the primary objective of a
company is to earn profit, hence the objective of financial management is also profit
maximisation. This implies that the finance manager has to make his decisions in a manner
so that the profits of the concern are maximised. Each alternative therefore is to be seen as
to whether or not it gives maximum profit.
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discussion between them. The third party may be one individual or a group of people. The alternative
name for the third party is mediators. The conciliation officer can be appointed by the central and
state government to mediate in all disputes brought to his notice. The officer enjoys the power of civil
courts. He can call and witness disputing parties on oath and interpret the facts of the case. He is
expected to give judgment within 14 days of the commencement of the conciliation proceedings. His
judgment is binding on all the parties to the disputes.
When the conciliation officer fails to resolve the disputes between the parties, the government can
appoint a Board of Conciliation. It is not a permanent Board. It consists of a chairman and two or four
other members nominated in equal numbers by the parties to the disputes.
3) Collective Bargaining: it is a process by which employers on the one hand and representative of
the employees on the other, attempt to arrive at agreements covering the conditions under which
employees will contribute and be compensated for their services.
4) Code of Discipline: The code of discipline evolved by the Ministry of Labour and Employment.
The
code of discipline defines duties and responsibilities of employers and workers. The objectives of
promoting constructive co-operation between their representatives at all levels, avoiding stoppage as
well as litigation, securing settlement of grievance by mutual negotiation, conciliation and voluntary
arbitration, facilitating the growth of trade union and eliminating all forms of coercion and violence
of Industrial Relation.
5) Grievance Procedures: A grievance may be understood as an employee’s dissatisfaction or
feeling of personal injustice relating to his or her employment relationship. There are some condition
which may give rise to a grievance are like a violation of law, a violation of the intent of the parties
as stipulated during contract negotiation , a violation of company rules, a change in working
conditions or past company practices and a violation of health and /or safety standards.
6) Adjudication: it is means a mandatory settlement of an industrial dispute by a labour court or a
tribunal. Whenever an industrial dispute remains unresolved by the conciliation officer and the board
of conciliation, the matter is referred in a court of inquiry. A court of inquiry may consist of one
independent person or such numbers of independent persons as the appropriate government may
think fit and submit its report to the government within six months from the date of the
commencement of the inquiry. If settlement is not arrived at by the efforts of the above machinery,
three types of semi-judicial bodies are formed i.e. labour court, industrial tribunals and national
tribunals.
7) Consultative Machinery: It is set by the government to resolve disputes. The main function of
this machinery is to bring the parties together for mutual settlement of differences in a spirit of co-
operation and goodwill. Consultative machinery operates at the plant, industry, state and the national
level. At the plant level, there are works committees and joint management councils being bipartite in
character and at the industry level there are wage boards and industrial committees.
131
1. Public Issue of Shares: The company can raise a substantial amount of fixed capital by
issue of shares- equity and preference. In India, however, equity shares are more popular as
compared to preference shares. The issue of shares requires a number of formalities to be
completed such as approval of prospectus by S.E.B.I., appointment of underwriters,
bankers, and registrars to the issue, filing of the prospectus with the registrar of companies,
and so on.
2. Rights Issue of Shares: A Right issue is issue of shares to the existing shareholders of the
company through a Letter of Offer made in first instance to the existing shareholders on pro
data basis. The shareholders have a choice to forfeit this right partially or fully. The
company, then issue this additional capital to public. This is an inexpensive method as
underwriting commission, brokerage are very small. Rights issue prevents dilution of
control but it may conflict with the broader objective of wider diffusion of share capital.
3. Private Placement of Shares: This is a method of raising funds from a group of financial
institutions and others who are ready to invest in the company.
4. Issue of Debentures: When borrowed capital is divided into equal parts, then, each part is
called as a debenture. Debenture represents debt. For such debts, company pays interest at
regular intervals. It represents borrowed capital and a debenture holder is the creditor of the
company. Debenture holder provides loan to the company and he has nothing to do with the
management of the company.
5. Long Term Loans: The company may also obtain long term loans from banks and
financial institutions like I.D.B.I., I.C.I.C.I., and so on. The funding of term loans by
financial institutions often acts as an inducement for the investors to sub- scribe for the
shares of the company. This is, because, the financial institutions study the project report of
the company before sanctioning loans. This creates confidence in the investors, and they
too, lend money to the company in form of shares, debentures, fixed deposits, and so on.
6. Accumulated Earnings (Reserves): The Company often resorts to ploughing back of
profits that, is, retaining a part of profits instead of distributing the entire amount to
shareholders by way of dividend. Such accumulated earnings are very useful at the time of
replacements, or, purchases of additional fixed assets.
Shares:
A share can be defined as “A fraction part of the capital of the company which forms the
basis of ownership and interest of a subscriber in the company”. Precisely, a share is a small
part of the total capital. When the owned capital is divided into a number of equal parts,
then, each part is called as a share. A person who contributes for a share is called as a share-
holder.
Types of shares: Shares can be broadly divided into equity shares and preference shares
Equity Shares: Shares which enjoy dividend and right to participate in the management of
Joint Stock Company are called equity shares, or, ordinary shares. They are the owners and
real risk bearers of the company. Equity shares can be defined as per as our Indian
Companies Act (1956) as, “Shares which are not preference shares are equity shares, or,
ordinary shares”. Equity shareholders are the real owners of the company and, therefore,
they are eligible to share the profits of the company. The share given to equity shareholders
in profits is called “Dividend”. At the time of winding of company, the capital is paid back
last to them after all other claims have been paid in full.
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 MODULE 4 FORMS OF INDUSTRIAL DISPUTES
1) Strikes: A strike means a cessation of work by a body of persons employed in any industry acting
in combination or a concerted refusal under a common understanding of a number of persons who are
CHAPTER 1- FINANCIAL MANAGEMENT or have been so employed to continue work or to accept employment.

INTRODUCTION TO FINANCIAL MANAGEMENT 2) Lock Out: lock out is the counterpart of strike. Lock outs bring psychological pressure on the
workers to agree to his conditions or face closure of the units. Lockouts means the employer closes
Financial management can be explained with a simple scenario. For the purpose of starting down his factory where his workers are employed because he wants to force them to agree to his
any new business, an entrepreneur goes through the following stages of decision making: terms and conditions of service during the pendency of a dispute.

3) Gherao: Its means “to surround”. Gherao tend to inflict physical duress on the persons affected
and endanger not only industrial harmony but also create problems of law and order.

4) Picketing: It is primarily a method of drawing public attention towards the disputes and it is legal
so there is no violence is involved. In picketing, workers are dissuaded from reporting for work by
certain persons stationed at the gate of the factory.

5) Boycott: Boycott aims at disrupting the normal functioning of an enterprise, through forceful
appeals and negative behavioural acts.

While deciding how much finance to take from each source, the entrepreneur would keep in
mind the cost of capital for each source (interest/ dividend). As an entrepreneur he would
like to keep the cost of capital low.
Thus financial management is concerned with efficient acquisition (financing) and
allocation (investment in assets, working capital etc) of funds with an objective to make
profit (dividend) for owners.
In other words the focus of financial management is to address three major financial
decision areas namely, investment, financing and dividend decisions.
MEANING OF FINANCIAL MANAGEMENT:
Financial management refers to that part of the management activity, which is concerned
with the planning, & controlling of firm’s financial resources. It deals with finding out
various sources for raising funds for the firm.
Financial management is the art of planning, organizing, directing and controlling of the
procurement and utilization of the funds and safe disposal of profits to the end that
individual, organizational and social objectives are accomplished.
CAUSES OF DISPUTES
1) Wages and Allowances: The most important cause for disputes relates to wages. The demand for
increase in wages and allowances is the most important cause of industrial disputes. The demand for
wages and allowances has never been fully met because of inflation and high cost of living. High
inflation results in increased cost of living resulting in never ending demands from unions. There are
some more economic reasons who are the cause of industrial disputes are bonus, working conditions
and working hours, modernization and automation and demand for other facilities.
2) Union Rivalry: Most organizations have multiple unions. Multiplicity of unions leads to
interunion rivalries. If one union agrees to a wage settlement, another union will oppose it.
3) Political Interference: Major trade unions are affiliated to political parties. Political affiliated is
not peculiar to our country alone. Even a cursory assessment of labour movements around the world
would show that trade unions are, by their very nature, political and that politicization of the rule
rather than the exception. Everywhere trade union have been compelled to engage in political action
to obtain enough freedom from legal restraint to exercise their main industrial functions.
4) Managerial Causes: These causes include autocratic managerial attitude and defective labour
policies. In this includes failures of recognize the trade union, defective recruitment policies,
irregular layoff and retrenchment, defiance of agreements and codes, defective leadership, weak trade
unions.
5) Unfair labour Practices: The Industrial Dispute Act, 1947 is more specific about the unfair
labour practices.
SETTLEMENT OF INDUSTRIAL DISPUTES
If dispute could not be prevented on voluntary basis and do arise, steps have to be taken for their
settlement. Industrial Dispute Act 1947 as amended in 1982 provides several provisions for settling
the disputes.
Various methods and provision are for resolving disputes. More important of them are as follows:
1) Arbitration 2) Conciliation 3) Collective Bargaining 4) Code of Discipline 5) Grievance Procedure
6) Adjudication 7) Consultative machinery

1) Arbitration: it is a procedure in which a neutral third party studies the bargaining situation listen
to both the parties and gathers information and then make recommendation that are binding the
parties. It is effective because established by the parties themselves and the decision is acceptable to
them and relatively expeditious when compared to courts or tribunals. Delays are cut down and
settlements are speeded up. But it has some weakness also are it is expensive. The expenditure needs
to be shared by the labour and the management and judgment become arbitrary if there is a mistake in
selecting the arbitrator.
FUNCTIONS OF FINANCIAL MANAGEMENT 2) Conciliation: It is a process by which representatives of workers and employees are brought
1. Executive finance functions together before a third party with a view to persuading them to arrive at an agreement by mutual

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Preference Shares: Shares which enjoy preference as regards dividend payment and capital 2. Wealth maximisation – The primary goal of a firm is to maximise its market value and
repayment are called “Preference Shares”. They get dividend before equity holders. They implies that business decisions should seek to increase the net present value of economic
get back their capital before equity holders in the event of winding up of the company. The profits of the firm.
owners of these shares have a preference for dividend and a first claim for return of capital;
People buy shares of a company as an investment with an expectation to gain from the
when the company is closed down. But, their dividend rate is fixed.
increase in the wealth of the company. It means that they expect these shares to give them
Difference between preference shares and equity shares some returns. It is the duty of the finance manager to see that the shareholders get good
Basis of difference Preference shares Equity shares returns on the shares. Hence, the value of shares should increase in the share market. The
Right of dividend They are paid dividend They are paid dividend out share value is affected by many things. If a company is able to make good sales and build a
before equity shares of the balance profit good name for itself, in the industry, the company’s share value goes up. If the company
available after payment to makes a risky investment, people may lose confidence in the company and the share value
pref shareholders
may come down.
Rate of dividend Fixed Decided by Board of
Directors year to year Stockholder’s current wealth in the firm = (No. Of shares owned) * (Current stock
depending on profits. price per share)
Convertibility They can be converted into They cannot be converted
equity shares if the issue To achieve wealth maximisation, the finance manager has to take careful decisions in
provides so respect of:
Participation in management No right to participate They have the right
Voting right No voting right They have voting right
a) Investment decision - These decisions relate to the selection of assets in which funds
Differences Between Shares And Debentures will be invested by a firm. Funds procured from different sources have to be
Basis of difference Shares Debentures invested in various kinds of assets.
Ownership The share of a company Debenture-holders are The asset of a business firm includes long term assets (fixed assets) and short term assets
provides ownership to the creditors of a company who (current assets). Long term assets will yield a return over a period of time in future whereas
shareholders provide loan to the short term assets are those assets which are easily convertible into cash within an accounting
period i.e. a year. The long term investment decision is known as Capital Budgeting where
company
as the short term investment decision is identified as Working Capital Management.
Identity Person holding share is person holding debenture is
known as shareholder. known as debenture-holder b) Financing decisions – The second important decision is financing decision. The
financing decision is concerned with capital – mix, (Financing – mix) or Capital Structure of
a firm. The term Capital Structure refers to the proportion of debentures capital (debt) and
Certainty Of Return No certainty of return in Debenture-holder receives equity share capital. Financing decision of a firm relates to the financing – mix. This must
case of loss for the the interest even if there is be decided taking into account the cost of capital, risk and return to the shareholders.
shareholder. no profit Employment of debt capital implies a higher return to the share holders and also the
financial risk. There is a conflict between return and risk in the financing decisions of a
Convertibility Shares cannot be converted Debentures can be firm. So, the Finance Manager has to bring a trade – off between risk and return by
maintaining a proper balance between debt capital and equity share capital. On the other
into debentures. converted into shares
hand, it is also the responsibility of the Finance Manager to determine an appropriate
Capital Structure.
Control Shareholders have the right Debenture holders do not
to participate and vote in possess any voting right and b) Dividend decisions – The third major decision is the Dividend Policy Decision.
company's meeting. cannot participate in Dividend policy decisions are concerned with the distribution of profits of a firm to the
shareholders. How much of the profits should be paid as dividend? i.e. dividend pay-out
meeting.
ratio. The decision will depend upon the preferences of the shareholder, investment
opportunities available within the firm and the opportunities for future expansion of the
firm. The dividend payout ratio is to be determined in the light of the objectives of
maximizing the market value of the share. The dividend decisions must be analysed in
relation to the financing decisions of the firm to determine the portion of retained earnings
TIME VALUE OF MONEY as a means of direct financing for the future expansions of the firm.

Refer Module 2 , Chapter 2 Time Value of Money Methods of Raising Finance

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CHAPTER 2 – COSTING
Costing :
Cost refers to the amount of expenditure incurred on or attributable to a specified
article, product or activity.
Costing is defined as the technique and process of ascertaining costs. Costing or cost
accounting is a branch of accounting and has been developed due to the limitations of
financial accounting. Financial accounting is primarily concerned with record keeping
directed preparation of profit and loss account and balance sheet.
Costing includes “techniques” and “process” of ascertaining costs. The “technique” refers
to principles and rules which are applied for ascertaining costs of products manufactured
and services rendered. There are mainly two methods of costing known as job costing and
process costing. The “process” includes the day to day routine of determining costs within
the method of costing (either job or process) adopted by a business enterprise. Within
such a process there may be historical costing, marginal costing, absorption costing,
standard costing etc.
Objectives of Cost accounting
x Ascertainment of cost – The cost of each product, process, job or operation is
ascertained. Various techniques are employed for this purpose.
x Control of costs – Cost control aims at improving the efficiency by controlling and
reducing cost. This is achieved by the techniques of budgetary control and
standard costing used in cost accounting.
x Determining the selling price – Cost accounting provides cost information on the
basis of which selling prices of products or services may be fixed.
x Guide to business policy – Cost accounting aims at serving the needs of
management in conducting the business with utmost efficiency. These decisions
may include introduction of a new product, making or buying a component parts
from outside suppliers etc.
Methods of costing
Different industries follow different methods of costing because of the difference in nature
of their work. The various methods of costing are as follows:
Methods Description
3. Absorption or full costing – In this technique, all manufacturing costs, fixed and
variable, are charged to products, jobs, processes etc and are included in total cost
4. Variable or marginal costing – variable costing method charges only variable
production costs to products or jobs, and thus the cost of the products or jobs
consists of only variable production and not fixed production costs. The fixed
production, administration, selling and distribution costs are written off against
profits in the periods in which they arise.
5. Uniform costing – Truly speaking uniform costing is not a technique of costing, but
is an attempt by several undertakings and organisations to use similar costing
principles or practices. When a number of firms in an industry agree among
themselves to follow the same system of costing in detail, adopting common
terminology for various items and processes they are said to follow a system of
uniform costing.
Elements of cost
1. MATERIAL
The term material may be defined as anything that can be stored, stacked or stockpiled.
Material may be classified as direct material and indirect material.
Direct Material Cost
Direct materials are those materials which can be identified in the product and can be
conveniently measured and directly charged to the product. Thus, these materials directly
enter the product and form a part of the finished product. For example, timber in furniture
making, cloth in dress making, bricks in building a house. The following are normally
classified as direct materials:-
(i) All raw materials, like jute in the manufacture of gunny bags, pig iron in foundry and
fruits in canning industry.
(ii) Materials specifically purchased for a specific job, process or order, like glue for book
binding, starch powder for dressing yarn.
(iii) Parts or components purchased or produced, like batteries for transistor-radios.
(iv) Primary packing materials like cartons, wrappings, card-board boxes, etc.
Indirect Material Cost
Indirect Materials are the costs of which cannot be directly attributed to a particular cost
object. Indirect materials are those materials which do not normally form a part of the
finished product. These are:
(i) Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton waste,
bricks and cements.
(ii) Stores used by the service departments, i.e., non-productive departments like Power
House, Boiler House and Canteen, etc., and
(iii) Materials which due to their cost being small, are not considered worthwhile to be
treated as direct materials.
2. Labour

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(i) Production or Manufacturing overheads: It means the indirect expenditure Methods for allocation of overheads
incurred in connection with production operations. It is the aggregate of factory indirect 1. Percentage of direct labour
material cost, indirect wages and indirect expenses. Examples are lubricants, indirect This method makes use of cost of direct labour charged to a particular product as a
wages, consumables, factory power and light, etc basis for setting the overhead rate for the product.
(ii) Administration Costs: Administration costs are expenses incurred for general % of direct labour cost = % of overhead on cost
management of an organization. These are the expenses incurred in formulating policies, = Factory overhead for budget period x 100
planning, controlling, directing and motivating personnel of an organisation. Examples Direct labour cost for budget period
include (1) Salaries of office staff, accountants, directors (2) Rent, rates and depreciation of
office building (3) Postage, stationery and telephone (4) Office supplies and expenses (5)
General administration expenses
Eg A fabrication concern had factory overheads of Rs 4000 and the direct labour
(iii) Selling & Distribution Costs: Selling costs are indirect costs related to selling of
cost of Rs 12000. A) find the percentage overhead using the percentage of direct
products are services and include all indirect costs in sales management for the
labour cost method. B) If production order Z had a direct labour cost of rs 60, find
organization. Distribution costs are the costs incurred in handling a product from the time
it is completed in the works until it reaches the ultimate consumer. Selling function
the overhead cost for the production order.
includes activities directed to create and stimulate demand of company’s product and
secure orders. Distribution costs are incurred to make the saleable goods available in the Solution. A) % of overhead
hands of the customer. = Factory overhead for budget period x 100
Examples of selling and distribution costs are (1) Salaries and commission of salesmen and Direct labour cost for budget period
sales managers. (2) Expenses of advertisement, insurance. (3) Rent, rates, depreciation and
insurance of sales office and warehouses. (4) Cost of insurance, freight, export, duty, = 4000 x 100 = 33.33%
packing, shipping, etc., (5) Maintenance of Delivery vans. 12000
(iv) Research & Development Costs: Research & development costs are the cost for B. Overhead cost for production order Z
undertaking research to improve quality of a present product or improve process of = 60 * 33.33 % = Rs 20
manufacture, develop a new product, market research...etc. and commercialization
thereof. R&D Costs comprises of the following:-
2. Percentage of direct material cost
(1) Development of new product. (2) Improvement of existing products. (3) Finding new
This method charges an overhead rate commensurate with either the weight or the
uses for known products. (4) Solving technical problem arising in manufacture and
cost of direct material going into the product.
application of products. (5) Development cost includes the costs incurred for
commercialization / implementation of research findings. % of direct material cost = % of overhead on cost
= Factory overhead for budget period x 100
Components of cost Direct material cost for budget period
The four main components of cost 1) Prime cost 2) Works Cost 3) Office cost 4) Total cost Eg a) a sugar mill had its overheads of rs 60000 while it purchased sugarcane worth
1. Prime cost: It consists of the cost of direct material, direct labour and direct expenses Rs 2,40,000. Find the percentage overhead using the percentage of direct material
specifically attributable to the job. This is also known as direct cost cost method. B) if a particular batch had a direct material cost of Rs 30,000,
2. Works cost: It comprises of prime cost and factory overheads. This is also known as determine its overheads.
factory cost, production or manufacturing cost.
3. Cost of production: It is the sum total of works cost and office and administration Solution. A) % of overhead on cost
overheads. This is also known as office cost. = Factory overhead for budget period x 100
4. Total cost: It comprises of the cost of production and selling and distribution overheads. Direct material cost for budget period

COST SHEET = 60000 x 100

240000
= 25%

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It refers to the manpower employed to convert raw material into finished products. It
represents the human efforts or work force. Labour is of two types: Direct labour and
indirect labour.
Direct Labour
It is that labour which can be conveniently identified or attributed wholly to a particular
job, product or process or expended in converting raw materials into finished goods.
Wages of such labour are known as direct wages. Thus it includes payment made to the
following groups of labour:
(i) Labour engaged on the actual production of the product or in carrying out of an
operation or process.
(ii) Labour engaged in adding the manufacture by way of supervision, maintenance, tool
setting, transportation of material etc.
(iii) Inspectors, analysts etc., specially required for such production.
Indirect Labour
The labour / employee cost which cannot be directly attributed to a particular cost object.
In other words paid to labour which are employed other than on production constitute
indirect labour costs. Example of such labour are: charge-hands and supervisors;
maintenance workers; men employed in service departments, material handling and
internal transport; apprentices, trainees and instructors; clerical staff and labour employed
in time office and security office.
3. Expenses
All expenses other than the cost of material and labour included are included under the
head expenses. They are direct expenses and indirect expenses
Direct Expenses
Direct expenses are expenses relating to manufacture of a product or rendering a service
which can be identified or linked with the cost object other than direct material cost and
direct employee cost. Such expenses are charged directly to the particular cost account
concerned as part of the prime cost. Examples of direct expenses are: (i) Excise duty; (ii)
Royalty; (iii) Architect or Supervisor’s fees; (iv) Cost of rectifying defective work; (v)
Travelling expenses to the city; (vi) Experimental expenses of pilot projects; (vii) Expenses
of designing or drawings of patterns or models; (viii) Repairs and maintenance of plant
obtained on hire; and (ix) Hire of special equipment obtained for a contract.
Indirect Expenses
Indirect expenses are expenses which cannot be allocated but which can be apportioned to
or absorbed by cost centres or cost units such as rent, insurance, municipal taxes, general
manager salary and canteen and welfare expenses, power and fuel, cost of training new
employee lighting and heating, telephone expenses, etc.,
Overheads
Overheads comprise of indirect materials, indirect employee cost and indirect expenses
which are not directly identifiable or allocable to a cost object. Overheads may also be sub-
divided as:
Job costing In this method of costing, cost of each job is ascertained
separately. It is suitable in all cases where the work is
undertaken on receiving customer’s order like a printing press,
motor workshop etc.
Batch costing It is the extension of job costing. A batch may represent a
number of small orders passed through the factory in a batch.
Each batch here is treated as a unit of cost and thus separately
costed. Here cost per unit is determined by dividing cost of the
batch by the number of units produced in the batch.
Contract costing Here the cost of each contract is ascertained separately. It is
suitable for firms engaged in the construction of bridges, road,
buildings etc. This is similar to job costing. The difference
between job and contract is that job is small and contract is big.
Single or output Here the cost of a product is ascertained, the product being the
costing only one produced like bricks, coal etc
Process costing Here the cost of completing each stage of work is ascertained,
like the cost of making pulp and cost of making paper from pulp.
In mechanical operations, the cost of each operation may be
ascertained separately; the name given is operation costing
Operating costing It is used in the case of concerns rendering services like
transport, supply of water,etc
Multiple costing It is a combination of 2 or more methods of costing outlined
above. Suppose a firm manufactures bicycles including its
components, the parts will be costed by the system of job or
batch costing but the cost of assembling the bicycle will be
computed by single or output costing method. The whole system
of costing is known as multiple costing.
Techniques (types) of costing
This refers to the manner of ascertaining costs of a product, job, activity etc. It also
indicates what types of costs are being ascertained such as historical costs, standard cost,
absorption cost, marginal cost etc.
The following are the techniques of costing:
1. Historical costing – It is the system of costing under which costs are determined
after they have been incurred
2. Standard costing – Here standard costs are determined and used, and then
compared with the actual costs to determine the extent of variances so that
remedial action can be taken. Standard costs are predetermined costs in
conformity with the most efficient operation and use of the resources within the
firm

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Cost sheet is a statement which is prepared to present the detailed costs of total
B. Overheads = 30000 x 25% production during the period in question. It provides information about the cost per unit at
= Rs 7500 different stages of the total cost of production

Factory overheads eg. Indirect materials, indirect wages, factory rent and rate, factory
lighting, power and fuel, factory cleaning , fixed assets insurance etc
3. Prime cost percentage rate
Prime cost percentage rate = % overhead
Office and administrative overheads eg office rent and rate, office salaries, office lighting
= Factory overhead for the budget period x 100 and heating , office building insurance, telephone, printing and stationery etc.
Prime cost for budget period
Selling and distribution overheads eg showroom rent and rates, lighting and heating,
Eg. A) fabrication and assembly shop had its total overheads of Rs 10000. It used salesmen salaries, commissions, travelling expenses of salesmen, advertising etc
direct material worth Rs 10000 and paid rs 15000 as direct labour charges.
Calculate the % overhead. B) If one product has its prime cost as rs 5000 , Specimen cost sheet
determine overheads on cost related to it
Period from ______________ Cost units
Solution To ____________________ _________
Amount Amount
a) = % overhead Cost items (Rs) (Rs)
= Factory overhead for the budget period x 100 Direct material xxx
Prime cost for budget period Direct labour xxx
= 10000 x 100 Direct expenses xxx
10000 + 15000 PRIME COST xxxx
= 40% of prime cost Add: Production/ Factory OH xxx
FACTORY COST xxxx
Add: Administration OH xxx
b) Overhead on cost = 5000x 40%
COST OF PRODUCTION xxxx
= Rs 2000
Add: Opening stock of finished goods xxx
Less: Closing stock of finished goods xxx
4. Labour hour rate COST OF GOODS SOLD xxxx
Rate per hour of direct labour = Factory overhead for budget period Add: Selling and distribution OH xxx
Direct labour hours for budget period COST OF SALES xxxx
Eg . A fitting and assembly shop had its factory overheads of Rs 120000 and the
production for the period in terms of direct labour was 24000 hours. A) Find the
rate per direct labour hour b) If a particular job takes 20 labour hours, calculate the
overhead applied. Allocation of overheads
Once the total overhead expenses have been found out using the above cost sheet,
Solution a) Rate per hour of direct labour = Factory overhead for budget period the next step is to apportion the overheads to each product, job or process
Direct labour hours for budget period If an industry is making only one product, a uniform charge for overhead may be
= 120000 = Rs 5 possible, but if a number of different products are being manufactured, an
24000 equitable base must be sought out to charge, each product with a fair and
b. Overhead = Rs 20 x 5 = Rs 100 reasonable share of overhead cost, so that the total cost (direct and indirect) of
each product may be calculated.

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BREAK-EVEN ANALYSIS (3) Convention of Materiality: - Materiality means relevance or importance or
significance. It is generally accepted in the accounting circle that the accounting
Refer Module 1, Break even analysis statements and records must reveal all material facts.
(4) Convention of full disclosure: - The accounting convention of full disclosure
implies that accounts must be honestly prepared and all material information must
be disclosed therein.

CHAPTER 3 - ACCOUNTING
Accounting is called the language of business. Accounting is defined as a system for
recording and reporting business transactions, in financial terms, to interested parties
who use this information as the basis for performance assessment, decision-making
and control.
Accounting is the art of recording, classifying and summarising the financial
transactions and interpreting the results thereof.
OBJECTIVES OF ACCOUNTING
The following are the main objectives:
1. To keep systematic records.
2. To ascertain the operational profit or loss.
3. To ascertain the financial position of the business.
4. To make information available to various users.
5. To protect business properties.P
6. To facilitate rational decision making.
7. To ascertain the cost of production and selling price.
8. To control expenditure of business.
9. To satisfy the requirements of law.
10. To calculate the amount due to and due from others.
ACCOUNTING CONCEPTS OR PRINCIPLES
Accounting concepts are those assumptions, principles or conditions on which the
accounting system is based. Principles are set of rules to be followed in accounting.
The following are important accounting concepts or principles:
1. Business Entity Concepts: According to these concepts, a business is treated as
separate Entity distinct from its owner. This means that in accounting the business
and owner must be treated separately. Thus, when one person invests amount into
the business, it will be deemed to the liability of the business. The concept of
separate entity is applicable to all forms of business.
2. Going concern concepts: According to this, it is assumed that business will exist
for a long time. There is no intention to liquidate the business in the immediate
future.
TYPES OF ACCOUNTS
1. Asset accounts – it represents the different types of economic resources owned by a
business. Eg Cash, cash at bank, building, inventory, goodwill, accounts receivable.
2. Liability accounts – It represents the different types of economic obligations by a
business, such as accounts payable, bank loans, bonds payable, accrued interest.
3. Equity accounts – represents the residual equity of a business (after deducting from
Assets all the liabilities) including retained earnings and appropriations
4. Revenue accounts or income – represent the company’s gross earnings and
common examples include sales, service revenue and interest income.
5. Expense accounts – represent the company’s expenditures to enable it to operate.
Eg. Electricity and water, rent, depreciation. Interest, insurance
6. Contra-accounts – represent the value of which are opposite the 5 above
mentioned types of accounts. For instance, a contra-asset account is accumulated
depreciation. This label represents deductions to a relatively permanent asset like
building.
BRANCHES OF ACCOUNTING
1. Financial accounting which is concerned with recording and processing all
transactions with transactions with outsiders and events affecting the position
of the firm. This leads to the preparation of the annual profit and loss account
(or similar statement) and the balance sheet.
2. Cost accounting seeks to ascertain the cost of each product or job produced
or undertaken by the firm. In financial accounting, expenditure incurred is
recorded as such but, in cost accounting it will be analysed job-wise or
product wise. Unlike financial accounting, cost accounting has to depend a
great deal on estimation.
3. Management accounting has the objective of collecting systematically and
regularly all such information as will help management in discharging its
functions of planning, control, decision making etc. It draws both on
financial accounting and cost accounting.
ACCOUNTING PROCESS
Accounting process begins when a financial transactions takes place. Firstly day to
day transactions are recorded in the journal or subsidiary books. From the journal
the transactions move further to ledger. Here entries are posted in the appropriate
accounts, and then accounts are balanced to get the effect of debit and credit. These
balance moves to a statement called trial balance. From the trial balance, we can

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RULES OF DEBIT AND CREDIT The term posting means transferring the debit and credit items from the journal to
The transactions in the journal are recorded on the basis of the rules of debit and their respective accounts in the ledger. It is the process of recording the transaction
credit. For this purpose business transactions have been classified into three from journal to ledger.
categories:
1. Transactions relating to persons FORMAT OF LEDGER
2. Transactions relating to properties and assets
3. Transactions relating to incomes and expenses

On this basis it becomes necessary for the business to keep an account of:
1. Each person with whom it deals
2. Each property and asset it owns
3. Each item of income or expense
The accounts falling under the first head are called “Personal accounts”. The
accounts falling under second head is termed as real accounts. The accounts falling
RULES REGARDING POSTING OF ENTRIES IN LEDGER
under the third head are called Nominal accounts.
1. Separate account is opened in ledger book for each account and entries from
journal posted to respective accounts
Personal accounts
2. It is a practice to use words ‘To’ and ‘By’ while posting transactions in the
Personal accounts include the accounts of persons with whom the business deals.
ledger. The word ‘To’ is used in the particular column with the amounts
These accounts can be classified into three categories:
written on the debit side while ‘By’ is used with the accounts written in the
1. Natural Personal accounts – The term natural persons means persons who are
particular column of the credit side. These ‘To’ and ‘By’ have no meanings
creation of God. For example, Ram’s Account, Amal’s account etc
but are used to represent the account debited and credited.
2. Artificial Personal accounts – These accounts include accounts of corporate
3. The concerned account debited in the journal should also be debited in the
bodies or institutions which are recognised as persons in business dealing.
ledger but the reference should be of the respective credit account.
Eg. Account of a Limited company, account of Cooperative society, account
of insurance company etc.
DIFFERENCES BETWEEN JOURNAL AND LEDGER
3. Representative personal accounts – These are accounts which represent a
Journal Ledger
certain person or group of persons. For example if rent is due to landlord, an
outstanding rent account will be created. Similarly in case of salaries due to
1. It is the book of prime entry 1. It is the book of final entry
employees. 2. As soon as transaction originates 2. Transactions are posted in the
The rule for personal account is it is recorded in journal ledger after the same have been
Debit the receiver 3. Transactions are recorded in recorded in the journal
Credit the giver order of occurrence ie according 3. Transactions are classified
to the order of dates according to the nature and are
Eg if cash has been paid to Ram, the account of Ram will be debited. If cash is
grouped in the concerned
received from Amal, the account of Amal will be credited 4. Narration (brief description) is accounts
* Liabilities – are considered as personal accounts written for each entry 4. Narration is not required
A decrease is recorded as debit 5. Relevant information cannot be
An increase is recorded as credit ascertained readily eg cash in 5. Since transactions of particular
Eg Capital a/c represents the owner of the business and hence it is a personal hand cannot be found out easily nature are grouped at one place
account. 6. Final accounts can’t be prepared therefore relevant information
directly from journal can be ascertained
All other liabilities imply the amounts we owe to others (persons or
7. Accuracy of the books can’t be 6. Ledger is the basis of preparing
organisations) and thus are Personal accounts tested final accounts
7. Accuracy of the books is tested
Real Accounts 8. Journal is not balanced by means of list of balances

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prepare trading and profit and loss accounts and balance sheet. The different stages
through which the transactions move from journal to final accounts are collectively
known as accounting cycles or accounting process.
THE ACCOUNTING CYCLE
1. Recording of transactions – This is done in the book termed as journal
2. Classifying the transactions – This is done in the book termed ledger
3. Summarising the transactions- This includes preparation of trial balance,
profit and loss account and balance sheet of the business
4. Interpreting the results – This involves the computation of the various
accounting ratios to know about liquidity, solvency and profitability of the
business
JOURNAL AND LEDGER
Journal and ledger are both used for recording transactions in manual accounting.
But first we record transaction in journal. But ledger is the books in which different
accounts are contained.
After making journal, every journal entry is transferred to different accounts. Rule is
that Debit account will be transferred to the credit account and credit account will be
transferred to the debit side of the debit account in the ledger. So journal is the base
for creating the accounts of ledger.
In journal accountant passes the journal entries based on three rules of double entry
system. But this rule is not applied while we create ledger accounts.
In manual accounting cash book is the subsidiary book that covers both journal and
ledger because system of passing journal entries and posting effect will
automatically cover in cash book. So there is no need to pass separate journal entries
relating to bank and cash and also no need to make bank or cash account
FORMAT OF JOURNAL
JOURNAL
Journal records all daily transactions in the order in which they occur. A journal may
be therefore defined as a book containing a chronological record of transactions. It is
book in which transactions are recorded first of all under the double entry system.
Thus journal is the book of original record.
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8. Every account in the ledger is
balanced at appropriate time
TRIAL BALANCE
Trial balance is a statement containing the various ledger balances on a particular
date. This statement is prepared to check the correctness of ledger posting and
balancing of accounts. If the total of the debit balances is equal to the credit
balances, it is implied that posting and balancing of accounts are correct
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3. Money measurement concepts: Accounting records only those transactions
which are expressed in monetary terms. Transactions which cannot be expressed in
money do not find place in the books of accounts.
4. Cost Concepts: According to this concept, all transactions are recorded in the
books of accounts at actual price involved.
5. Dual aspect Concepts: according to this concept, every transaction has two
aspects. These two aspects are receiving aspect and giving aspect. These two aspects
have to be recorded. The basis of this principle is that for every debit, there is an
equal and corresponding credit.
6. Realization Concept: According to this principle revenue is said to be realized
when goods or services are sold to be a customer. It emphasizes the fact that the
mere receipt of an order for goods or services cannot be taken for the realization of
revenue. So advanced payment received from a customer cannot be considered as
revenue earned.
7. Matching Concept: According to this concept, cost of a business of a particular
period is compared with the revenue of that period in order to ascertain net profit or
net loss.
8. Accounting period Concept: According to this assumption, the life of a business
is divided into different periods for preparing financial statements. Generally
business concern adopt twelve months period for measuring the income of the
concern. This time interval is known as accounting period.
9. Accrual: Accounting attempts to recognize non-cash events and circumstances as
they occur. Accrual is concerned with expected future cash receipts and payments. It
is the accounting process of recognizing assets, liabilities or income amounts
expected to be received or paid in future. Common examples of accruals include
purchases and sales of goods or services on credit, interest, rent (unpaid), wages and
salaries, taxes. Thus, we make record of all expenses and incomes relating to the
accounting period whether actual cash has been disbursed or received or not.
BASIS OF ACCOUNTING SYSTEM
Cash or receipt basis is the method of recording transactions under which revenues
and costs and assets and liabilities are reflected in accounts in the period in which
actual receipts or actual payments are made. “Receipts and payments account” in
case of clubs, societies, hospitals etc., is the example of cash basis of accounting.
Accrual or mercantile basis is the method of recording transactions by which
revenues, costs, assets and liabilities are reflected in accounts in the period in which
they accrue. This basis includes considerations relating to outstanding; prepaid,
accrued due and received in advance.
ACCOUNTING CONVENTIONS
Accounting conventions are the customs and traditions which guide the accountant
while preparing accounting statements.
(1) Convention of consistency: - This convention follows that the basis followed in
several accounting periods should be consistent. This means the methods adopted in
one accounting year should not be changed in another year. Then only comparison
of results is possible.
(2) Convention of conservatism: - This is a convention of playing safe, which is
followed while preparing the financial statements. The idea of this convention is to
consider all possible losses and to ignore all probable profits.eg we consider for bad debts
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Real account may be of following types:
1. Tangible real accounts – Tangible real accounts relate to such things which
can be touched, felt, measured etc. Eg cash account, building account,
furniture account. Bank is a personal account as it represents the account of a
banking company, an artificial person
2. Intangible real accounts – These accounts represent such things which cannot
be touched. Of course they can be measured in terms if money. Eg patent’s
account, goodwill account etc
The rule is
Debit what comes in
Credit what goes out
Eg a building has been purchased for cash, building account should be debited and
cash account credited
Nominal accounts
These accounts are opened in the books to simply explain the nature of transactions.
They do not really exist. Eg in a business, salary is paid to the manager, rent is paid
to landlord. Nominal accounts include accounts of all expense, losses, incomes and
gains. The examples of such accounts are rent, rates, lighting, insurance etc.
The rule is
Debit all expenses and losses
Credit all incomes and gains
POSTING
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FINAL ACCOUNTS
Final account means accounts. Which are prepared at the final stage to give the
financial position of the business. It consists of trading account profit and loss
account and balance sheet.
TRADING ACCOUNT
Trading account gives the overall result of trading, that is purchasing and selling of
goods. The result of trading accounting may be gross profit or gross loss. If the sale
proceeds exceed the cost of goods sold the difference is gross profit. Opening stock,
purchases, direct expenses, are debited and sales and closing stock are credited to
this account.
Format of Trading account
PROFIT AND LOSS ACCOUNT
Profit and loss account is prepared to ascertain the net profit or net loss of the
business for an accounting period. The amount of gross profit is shown on the
credit side. Indirect expenses, operating expenses and losses are shown on the
debit side of this account and all incomes and gains are shown on the credit side. If
credit side is more than debit side, the difference is net profit. A specimen of Profit
and Loss account is shown below:
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CHAPTER 4- MARKETING MANAGEMENT
INTRODUCTION
Marketing is everywhere and it affects our day- to-day life in every possible manner.
Formally or informally people and organizations engage in a vast number of activities that
could be called as marketing. Good marketing is no accident, but a result of careful planning
and execution. It is both an art and science.
DEFINITION
In the words of Philip Kotler “Marketing is the human activity directed at satisfying needs
and wants through an exchange process.”
TRADITIONAL AND MODERN CONCEPT OF MARKETING
Traditional concept of marketing
According to this concept, marketing consists of those activities which are concerned with
the transfer of ownership of goods from producers to consumers. Thus, marketing means
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x Current assets - The current assets are assets which are reasonably
expected to be realised in cash or sold or consumed during the normal
operating business cycle. They are acquired with the intention of sale or
conversion into cash. Eg cash, accounts receivable (debtors), prepaid
expenses, inventories etc
x Investments - They are securities held by business for investment
purposes. The intention is to hold those securities for the long run at
least longer than a year.
x Fixed Assets - They are those physical assets that are to be used in the
conduct of the business.
x Miscellaneous expenditure and losses
2. Liabilities - It represents what the business entity owes others. The liabilities
may be classified into current and long term liabilities.
The Companies Act classifies them as follows:
x Share Capital – This is divided into two types – equity and preference
capital.
x Reserves and Surplus – These are the profits which have been retained in
the firm. Reserves and surplus along with the equity capital represents
owner’s equity.
x Secured Loans – These denote the borrowings of the firm against which
specific collateral security have been provided. The important
constituents of secured loans are debentures, loans from financial
institutions and loans from commercial banks
x Unsecured loans – These are the borrowings of the firm against which no
specific security has been provided. They include fixed deposits, loans
and advances from promoters, unsecured loans from banks
x Current liabilities and provisions – It consists of the money due to
suppliers of goods and services brought on credit, advance payments
received, accrued expenses, provisions for taxes, dividends, gratuity etc.
The total of the asset side of the balance sheet is equal to that of the liabilities side
Total assets = Total liabilities + Owner’s equity
Specimen of Balance Sheet is given below:
FORMAT IN ACCOUNT FORM
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IMPORTANCE OF MARKETING
1. Marketing concept enables the organisation to be aware of changes. An organisation
practising the concept keeps feeling the pulse of the market through continuous
market audit, market research and consumer testing
2. The purpose of any marketing concept is the satisfaction of the consumers. It is the
consumers who willing to pay for selling convert economic resources into wealth,
things to goods.
3. Another distinguishing feature of the marketing concept is integrated management
action ie all the different functions of the business must be tightly integrated with
one another keeping marketing as the pivot
4. An efficient marketing set up increases the volume of sales and thus reduces the
cost of distribution of products and services
5. A marketing function maintains a regular interaction with the existing and potential
consumers to ascertain their needs
6. Marketing creates an infrastructure of various activities like warehousing,
insurance, transportation, etc due to which employment opportunities are created
MARKETING PROCESS
Marketing process refers to the activities connected with marketing of goods and services. It
is the matching process by which a marketer offers tailor made marketing mix that can
precisely meet with consumer demand of a certain market within the limits set by the
society.
Marketing process involves three basic steps:
1. Concentration – Concentration is the collection of goods from the different
marketers at a central point for sale at required places. Concentration involves
numerous activities such as buying, collecting and assembling, storage and
warehousing, standardization and grading, financing and risk bearing. The goods
needed for consumption by ultimate consumers are to be made available at central
point from where the product can be purchased the customers.
2. Equalization – It is the intermediate activity between concentration and dispersion.
The process of equalization involves the proper adjustment of supply at all the
centres of distribution in the light of the prevailing market conditions. The process
involves storage and transportation of goods in required quantities. Transport brings
about equalization of supplies place wise, whereas warehousing enables
equalization of supplies time wise
3. Dispersion – It is the process concerned with the distribution of goods from the
markets to the users or consumers. The assembled stock of goods must be sub-
divided into smaller lots required to meet the needs of buyers. The goods produced
by manufacturers are distributed through different channels for sale to consumers.
The intermediaries are engaged in this activity.
MARKETING MANAGEMENT
Marketing management is the process of scanning the environment, analysing market
opportunities, designing marketing strategies, and then effectively implementing and
controlling marketing practices.
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FORMAT IN REPORT FORM

As At 31.03.2014 As At 31.03.2013
(Amount in Rs.) (Amount in Rs.)
I SOURCES OF FUNDS:

1 Share Capital
2 Reserves and Surplus BALANCESHEET
3 Secured and unsecured Loans
4 Current Liabilities and Provisions x A Balance sheet indicates the financial condition of a business at a given
point of time.
Total x As per Companies Act, the balance sheet of a company may be prepared in
II APPLICATIONS OF FUNDS: account or report form.
x Balance sheet is a statement showing the assets and liabilities of a business
1 Fixed assets: on a particular date. It shows how the assets of the firm and how the assets
a.Gross Block
are financed by different types of capital. The assets are displayed on one
side and the sources of assets or the liabilities are displayed on the other.
b.Less:Depreciation
x A balance sheet measures a firm’s liquidity and profitability. It measures
c.Net Block
liquidity in the sense that it shows whether the firm is able to pay of its debts
d.Capital Work in Progress
in short run circumstances. Similarly solvency means the firm’s ability to
meet all its long term and short term debt
2 Investments
x The assets and liabilities are displayed in a particular order, say, in the order
3 Current Assets, Loans and Advances of their permanence
a. Inventories
b. Cash and Bank Balances
c. Receivables The items shown in the Balance sheet include:
d. Other Current Assets 1. Assets – Assets are economic resources owned by the business which will
e. Loans and Advances
provide future service benefits and can be measured in terms of money.
Total
Assets are classified as:

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Marketing management is the art and science of choosing target markets and getting,
keeping and growing customers through creating, delivering and communicating superior
customer value.
OBJECTIVES OF MARKETING MANAGEMENT
Marketing management is mainly concerned with those activities which lead towards to
achieve long term profits by satisfying customer needs and wants. However the main
objectives of the marketing management are:
1. To create new customers and attract them towards firm and services, through
promotion mix.
2. Every marketing activity revolves around the preferences of consumers in the
modern marketing. Therefore selling is not only sufficient but satisfaction of
consumers is important
3. Marketing mix ie 4 P’s of marketing should be planned in such a manner so as to
meet the different requirements of all customers
4. To generate sufficient profits for the growth of business and to survive in the market
5. To build the goodwill of the business by initiating image activities such as sales
promotion, publicity and advertisement, high quality product, reasonable price etc.
It also helps to raise the living standard of people.
DIFFERENCE BETWEEN MARKETING AND SELLING
selling of goods and services. In other words, it is the process by which goods are made
available to ultimate consumers from their place of origin. The Traditional concept of
marketing corresponds to the general notion of marketing, which means selling goods and
services after they have been produced. The emphasis of marketing is on sale of goods and
services. Consumer satisfaction is not given adequate emphasis. Viewed in this way,
marketing is regarded as product/sales oriented.
Modern concept of marketing
According to the modern concept, marketing is concerned with creation of consumers.
Creation of customers means identification of consumer needs and organizing business to
satisfy these needs. Marketing in the modern sense involves decisions regarding the
following matters
1. Products to be produced
2. Prices to be charged to customers
3. Promotional techniques to be adopted to contact and influence existing and potential
customers.
4. Selection of middlemen to be used to be used to distribute goods and services.
Modern concept of marketing requires all the above decisions to be taken after due
consideration of consumer needs and their satisfaction. The concept of marketing is
regarded as consumer oriented as the emphasis of business is laid on consumer needs and
their satisfaction.
EVOLUTION OF MARKETING CONCEPT

Marketing
1. Emphasis is on customer’s needs
and wants
2. Marketer first determines the needs
and wants of the customers and
then delivers the product to satisfy
those needs and wants
3. Management is profit oriented
through customer satisfaction
4. Planning is long term oriented
5. Marketing creates time, place and
possession utilities for satisfactory
exchange of goods and services
6. It is a function that converts needs
1. Exchange concept – The exchange concept holds that the central idea of marketing
exchange is an important part of marketing, but marketing is a much wider concept.
2. Production concept- The production concept is one of the oldest concepts of business. It
holds consumers will prefer products that are widely available and inexpensive. Manager of
production business concentrate on achieving high production efficiency, low cost and mass
distribution.
3. Product concept – This concept holds that consumers will prefer those products that are
high in quality, performance or innovative features. Managers in these organization focus on
making superior products and improving them. Sometimes this concept leads to marketing
myopia. Marketing myopia is shortsightedness about business. Excessive attention to
production or the product or selling aspects at the cost of customer and his actual needs
creates this myopia.
Selling
4. Selling concepts – This concept focuses on aggressively promoting and pushing its
products, it cannot expect its products to get picked up automatically by the customer. The
1. Emphasis is on the product
purpose is basically to sell more stuff to more people in order to make more profits.
2. Organisation first makes the 5. Marketing concepts – The marketing concept emerged in the mid 1950’s. The business
product and then figures how to generally shifted from a product centered, make and sell philosophy, to a customer centered,
sell it sense and respond philosophy. The job is not to find the right customers for your product,
but to find right products for your customers. The marketing concept holds that the key to
achieving organizational goals consist of the company being more effective than
3. Management is sales volume
competitors in creating, delivering and communicating superior customers value. This
oriented
concept puts the customer at both the beginning and the end of the business cycle. Every
4. Planning is short run oriented department and every worker should think customer and act customer.
5. Selling is transfer of ownership of
goods. It creates only possession

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 to products utility.
7. It emphasizes more on needs of
buyer 6. It is an activity that converts the
goods into cash
7. It emphasizes more on needs of
seller
MARKETING ENVIRONMENT
It includes all those factors which are external to a firm and which affect the Marketing
process. Marketing environment is constantly spinning out new opportunities and new
threats, and the firms find their marketing collapse. Therefore, the company’s Marketing
executives must constantly monitor the changing Marketing scene and observe the changing
environment through Marketing research. The Marketing Environment includes non-
controllable variables that effects the company’s ability to serve its markets.
CONTROLLABLE FACTORS
The controllable factors are well within the grip of the firm and easy to adjust them to suit
the changes. These consist of Marketing policies and Marketing strategies. Framing of
marketing policies is the responsibility of top management and marketing strategies are
developed by middle level management. The selection of target marketing, Marketing
objectives and Marketing control are the other controllable factors which also helps in
framing Marketing strategies.
UNCONROLLABLE FACTORS
Controllable variables will have to be filtered through various uncontrollable environmental
factors before they reach to the customers. The uncontrollable environmental consist of two
levels i.e., micro environment and macro environment.
MICRO - ENVIRONMENT VARIABLES
It consists of elements or forces that influence marketing directly. It includes Supplier,
Marketing Intermediaries, Customers, Competitors and the General Public.
Supplier - One who supply the resources to a company. Any shortage of Supply
affects the Marketing function and thus, should avoid dependence on any single
supplier.
Marketing Intermediaries- They are the middlemen who create place Utility, Time
utility and Quantity utility. These include Physical Distribution Firms, Transport
Companies, Marketing Consulting Firms, Marketing Services Agencies and Assist
the company in promoting the right products to the right markets.
Customers - It refers to consumer markets, industrial markets, reseller markets,
international markets and govt. markets having its own characteristics.
Public- The marketing decisions considerably influenced by public relations, govt.
policies, the press, the legislatures and the general public.
MACRO - ENVIRONMENT VARIABLES
Macro-environment consists of forces affecting the entire society or economy at large.
Microenvironment influences entire industry as a whole
Demographic environment
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This is the type of promotion mix that helps and persuades one or more prospects to
purchase a good or service or to act on any idea through the use of oral presentation. Eg
sales presentations, sales meeting, sales training and incentive programmes for intermediary
salespeople.
3. SALES PROMOTION
Sales promotion includes all those activities other than advertising, personal selling, public
relations and publicity that are intended to stimulate customer demand and improve
marketing performance of sellers. They are incentives designed to stimulate the purchase or
sale of a product usually in the short term. Eg coupons, product samples, rebates, etc
Sales promotion vs advertising
1. Advertising is an indirect approach of influencing customers to buy a product,
whereas sales promotion is a direct inducement of consumers to try the product
2. Advertising has long term objectives whereas sales promotion has immediate task
of increasing current sales
Objective of sales promotion
1. To introduce new products or services – sales promotion is often used to motivate
prospective consumers to try new products and services.
2. To attract new customers – sales promotion measures play an important role in
attracting new customers. Samples, gifts, prizes etc are used to encourage
consumers to shift to new brand
3. To induce existing customers to buy more – product development, offering 3 for the
price of 2, discount coupons, are some sales promotion techniques to motivate
existing buyers to buy more
4. Helps the firm to remain competitive – most of the firms undertake sales promotion
activities in order to remain in the competitive market.
5. To increase sales in off season – many products like air coolers, fans, refrigerators,
air conditioners, etc have seasonal demand. Manufacturers make efforts to maintain
a stable demand throughout the year through discounts and off season price
reduction.
Types of sales promotion
1. Consumer promotions – intended directly to consumers. Eg price
reductions, free samples etc
2. Trade promotions – They are targeted towards retailers. Eg trade
allowances, trade contests
Tools of Sales Promotion
(i) Free samples: You might have received free samples of shampoo, washing powder,
coffee powder, etc. while purchasing various items from the market. Sometimes these free
samples are also distributed by the shopkeeper even without purhasing any item from his
shop. These are distributed to attract consumers to try out a new product and thereby create
new customers.
(ii) Premium or Bonus offer: A milk shaker along with Nescafe, mug with Bournvita,
toothbrush with 500 grams of toothpaste, 30% extra in a pack of one kg. are the examples of
premium or bonus given free with the purchase of a product. They are effective in inducing
consumers to buy a particular product.
(iii) Exchange schemes: It refers to offering exchange of old product for a new product at
a price less than the original price of the product. This is useful for drawing attention to
product improvement.
(iv) Price-off offer: Under this offer, products are sold at a price lower than the original
price. ‘Rs. 2 off on purchase of a lifebouy soap, Rs. 15 off on a pack of 250 grams of Taj
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MARKETING MIX
In the words of Philip Kotler, “Marketing Mix is the set of controllable variables and their
levels that the firm uses to influence the target market.” Marketing mix is a combination of
various elements, namely, Product, Price, Place (replaced by Physical Distribution) and
Promotion. Marketing mix refers to two things:
1. A list of important elements or ingredients that make up this marketing programme
2. The list of forces having bearing on the marketing operations
The various important elements of marketing mix are briefly discussed as follows;
PRODUCT: It is the thing possessing utility. It is the bundle of value the marketer offers to
potential customers. Today manufacturers are realizing that customer expects more than just
the basic product. Therefore the product must satisfy the consumers needs. The
manufacturer first understands the consumer needs and then decides the type, shape, design
,brand, package etc. of the goods to be produced. The product is a marketer’s primary
vehicle for delivering customer satisfaction.
PRICE: it is the amount of money asked in exchange for product. It must be reasonable so
as to enable the consumer to pay for the product. While fixing the price of a product, the
management considers certain factors such as cost, ability of the consumers, competition,
discount, allowances, margin of profit etc.
PLACE (PHYSICAL DISTRIBUTION): It is the delivery of products at the right time and at
the right place. It is the combination of decision regarding channel of distribution
(wholesalers, retailers etc. ), transportation, warehousing and inventory control.
PROMOTION: This is also termed as marketing communication. It consist of all activities
aimed at inducing and motivating customers to buy the product. The selection of
alternatives determine the success of marketing efforts. Some firms use advertising, some
others personal selling or sales promotion. Thus promotion includes advertising public
relations, personal selling and sales promotion.
Recently Packaging and People are two more elements of marketing mix that have been
emerged.
These are discussed as follows.
PACKAGING: Packaging is the art, science and technology of preparing goods for transport,
sale and exchange. A well designed pack is invaluable in building brand loyalty with the
customer. Packaging must be such that a customer is impressed at the very moment he or
she sees the product.
PEOPLE :It consists mainly of the people to whom goods are sold(consumer) and the people
through whom goods are sold(sales people, wholesalers, retailers etc.) people include
competitors also. This factor will be the reason as well as resources for success in
marketing.
PROMOTION MIX
This is an assortment of advertising, sales promotion, public relation, personal selling and
direct marketing.
1. ADVERTISING
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™For effective market segmentation and target marketing, it is essential to have
an understanding of consumers and their behaviour.
CONSUMER BUYING PROCESS (CONSUMER DECISION MAKING
PROCESS)
Buying is a mental process. A decision to buy a product is taken after passing
through different stages. The buying decision process involve the following five
stages.
1. RECOGNITION OF AN UNSATISFIED NEED:
All buying decisions start with need recognition. When a need is not satisfied it
creates tension. This tension drives people to satisfy that need. Then need becomes
motive. Thus motives arise from needs and wants. The force that converts needs into
motives is called motivation.
2. IDENTIFICATION OF ALTERNATIVES:
After recognizing a need or want consumers search for information about the
various alternatives available to satisfy it. If the need is usual, such as hunger, thirst
etc. the consumer may rely on past experience of what satisfies this need. If needs
are unusual or unfamiliar, consumer may seek additional information from friends,
family, media, sales people etc. it is only through this information search that we can
identify the means of satisfying our need.
3. EVALUATION OF ALTERNATIVES:
By collecting information during the second stage, an individual comes to know
about the brands and their features. Now he compares the alternative products or
brands in terms of their attributes such as price, quality, durability etc. during the
evaluation stage he may consider the opinion of others such as wife, relatives and
friends. Then he selects the brand that will give him the maximum utility (or that he
thinks the best).
4. PURCHASE DECISION:
Finally the consumer arrives at a purchase decision. Purchase decision can be one of
the three, namely no buying, buying later and buying now. If he has decided to buy
now, he will decide the shop (dealer) to buy it from, when to buy it, how much
money to spend etc. After deciding these, he will go to the shop chosen and buy the
product of the brand chosen.
5. POST PURCHASE BEHAVIOUR:
It refers to the behaviour of a consumer after purchasing a product. After the
consumer has actually purchased the product/brand he will be satisfied or
dissatisfied with it. If he is satisfied with the product he would regularly buy the
brand and develop a loyalty. He recommends the brand to his friends and relatives.
The negative feeling which arises after purchase causing inner tension is known as
Cognitive Dissonance (or Post Purchase Dissonance). The post purchase dissonance
is also called Buyer’s Remorse.
FACTORS INFLUENCING CONSUMER BEHAVIOUR/ BUYING
DECISIONS
(DETERMINANTS OF CONSUMER BEHAVIOUR)
All factors which determine the buying or consumer behaviour are broadly classified
into six.
Psychological factors, Social factors, Cultural factors, Personal factors, Economic
factors and
Environmental factors.
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Advertising is any paid form of non-personal communication of ideas, goods or
services by business firms identified in the advertising message intended to lead
to sales, immediately or eventually.
It is a paid form of mass communication and can be traced to an identified sponsor. Eg print
ads, radio, television, brochures, billboard, posters, motion pictures etc
Personal channels include direct selling, direct marketing etc. Non personal channels
include advertising, sales promotion etc
Role of Advertising
• For the firm, the function of advertising is to produce knowledge for consumers and to
generate interest among them in order to create demand for its product.
• For consumers, advertising allows them to learn about the distinctive characteristics
claimed by the manufacturer. Advertising also helps them to save personal time, since the
information reaches them directly without their having to collect it.
Importance of advertising
Advertising has become an essential marketing activity in the modern era of large scale
production and serve competition in the market. It performs the following functions:
1. Promotion of Sales : It promotes the sale of goods and services by informing and
persuading the people to buy them. A good advertising campaign helps in winning new
customers both in the national as wet as in the international markets.
2. Introduction of New Product : It helps the introduction of new products in the
market. A business enterprise can introduce itself and its product to the public through
advertising. A new enterprise can't make an impact on the prospective customers without
the help of advertising. Advertising enables quick publicity in the market.
3. Creation of Good Public Image : It builds up the reputation of the advertiser.
Advertising enables a business firm to communicate its achievements in an effort to satisfy
the customers' needs. This increases the goodwill and reputation of the firm which is
necessary to fight against competition in the market.
4. Mass Production : Advertising facilitates large-scale production. Advertising
encourages production of goods in large-scale because the business firm knows that it will
be able to sell on large-scale with the help of advertising. Mass production reduces the cost
of production per unit by the economical use of various factors of production.
5. Research : Advertising stimulates research and development activities. Advertising has
become a competitive marketing activity. Every firm tries to differentiate its product from
the substitutes available in the market through advertising. This compels every business firm
to do more and more research to find new products and their new uses. If a firm does not
engage in research and development activities, it will be out of the market in the near future.
Types of advertising
1. Consumer advertising – It deals with consumer goods.
2. Industrial advertising – These are used in the operation of a business or become part
of another product.
3. Trade advertising – These are mainly to encourage middlemen like wholesalers and
retailers to purchase and promote the products of the sponsoring manufacturer
4. Product advertising – It deals with non-personal selling of a particular good or
service
5. Institutional advertising – It is concerned with promoting a concept, an idea, a
philosophy, or goodwill of the company in the eyes of the shareholders, employees,
consumers etc
6. Cooperative advertising – It is sponsored jointly by manufacturers and wholesalers
or retailers and the cost is shared
2. PERSONAL SELLING
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Psychological Factors
The following are the important psychological factors:
1) Consumer Needs and Motivation: All buying decisions start with need
recognition. People always seek to satisfy their needs. When need is not satisfied it
drives people to satisfy that need. Then the need becomes a motive. Thus motive
arises from needs and wants. The force that converts needs into motives is called
motivation.
2) Perception: It is the process of selecting, organizing and interpreting information
in order to give meaning to the world or environment we live in. the way the
consumers display selective attention, distortion or retention motivates marketers to
design the product, package, promotional themes etc. The marketers should
understand the consumer perception and convert perception into a buying response.
3) Learning: Learning is the process of acquiring knowledge. Generally, learning
results in four ways- Listening, Reading, Observing and experiencing. The
importance of learning theory for marketers is that they can create demand for a
product by associating it with strong drives, using motivating cues and providing
positive reinforcement.
4) Belief and Attitude: A belief is a descriptive thought that a person holds about
something. Such thoughts are based on learning, opinion or faith. For example, A
consumer believes that Maruti cars are less costly and fuel efficient. Attitude means
a person’s feelings towards a particular object or situation.
Social Factors
The major social factors are as follows
1) Reference Group: consumer behaviour is influenced by various groups within
society known as reference groups. We have several reference groups with whom an
individual associate such as friends, relatives, classmates, club memberships etc. In
each groups there is an opinion leader whose style is adopted by others. Marketers
often identify such opinion leaders and develop advertisement featuring them as
endorsers.
2) Role and Status: A person takes up many roles in different situations in his /her
life. He can be son, father, husband, employee etc. Each role has a status. A person’s
role and status influence his general as well as buying behaviour.
3) Family: Family is one of the important factors influencing buying behaviour.
Cultural Factors
Culture determines and regulates our general behaviour. The major cultural factors
are as follows:
1) Culture: Culture simply refers to values and beliefs in which one is born and
brought up. It is a set of Ideas, Customs, Values, Art and Belief that are produced or
shaped by a society and passed on from generation to generation. Culture influence
what we eat and wear, how we relax and where we live etc.
2) Sub-Culture: It is based on religion, language, geographic region, nationality,
age etc. It is a segment within a large culture that shares a set of beliefs, values or
activities that differ in certain respects from those of the main or overall culture. The
food habits are different in different parts of India.
3) Social Class: A social class is a group of people with similar values, interest and
behaviour within a society. Consumers buying behaviour is determined by the social
class to which they belong rather than by their income alone. The social class is
based on income, education, occupation, family history, wealth, lifestyle, area of
residence etc.
Personal Factors
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It includes factors such as population growth, change in age-group, marriages,
family sizes, movement of people from big cities to rural or sub urban areas, literacy
etc. It is essential for the market to understand the demographic forces in a country
which helps him frame optimal marketing-mix.
Socio-cultural environment
¾Sociological Factors Consumers being social animal and their life style is
deeply influenced by the social set up. It is found to have deep influence on
consumer taste, temperament, life and living. The needs, desires, hopes and
aspirations of the consumers are necessary to be understood.
¾Psychological The study about the behaviour, attitude, temperament, mentality
and personality is must and how there wants and needs can be best satisfied?
¾Anthropological these factors are vital in noting the national and regional
characters, cultures and sub cultures and the pattern of living.
Economic environment
It comprises of economic system of the country, affects the demand structure of any
industry/ product. Changes in economic conditions provides marketers with new
challenges and threats. Various economic factors which directly affect the
Marketing strategies are discussed below.
¾Role of Govt: Marketing in greatly influenced by the role of govt. through
fiscal policies, industrial regulations, economic controls, import-export policies etc.
Monetary and Non-Monetary policies of the Govt. also determine the tempo of
economic development.
¾Consumers: Consumer welfare and interest should be taken into consideration
while preparing marketing programme. The marketer is to make available quality
products at reasonable prices, in sufficient qualities, at required time interval.
¾Competition: Healthy competition is always in the interest of customers
whereas unhealthy competition is harmful and leads toward increasing cost and
waste.
¾Price: It is determinant of the fate of any business. If the Price is too high,
reduces the consumer and consumption and if too low, the producers and marketers
are left in the lurch.
Ethical environment
In the race of earning more and more profits, business people disintegrate the ethical
values from the business. This leads to adulteration, limitation etc. resulting in
socio-economic pollution of minds and relations.
Political/Legal environment
The legal environment for marketing decision is characterized by various laws
passed by Central or State Govt. and even by local administration. Govt. agencies,
political parties, pressure groups and laws create tremendous pressure and
constraints for marketer. Marketing managers required full knowledge and
understanding of political philosophy and ideologies of major political groups and
legal environment for framing marketing strategies and growth of business.
Physical environment
It refers to the physical distribution of goods and services. It needs the in depth study
of cost and convenience involved in the process of physical distribution of products
from producer to consumer end.
Technological environment
It helps to shape changes in living style of the consumers. It has the responsibility of
relating changing life- style patterns, values and changing technology to market
opportunities for profitable sales to particular market segment
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Mahal tea, Rs. 1000 off on cooler’ etc. are some of the common schemes. This type of
scheme is designed to boost up sales in off-season and sometimes while introducing a new
product in the market
(v) Coupons: Sometimes, coupons are issued by manufacturers either in the packet of a
product or through an advertisement printed in the newspaper or magazine or through mail.
These coupons can be presented to the retailer while buying the product. The holder of the
coupon gets the product at a discount. For example, you might have come across coupons
like, ‘show this and get Rs. 15 off on purchase of 5 kg. of Annapurna Atta’.
(vi) Fairs and Exhibitions: Fairs and exhibitions may be organised at local, regional,
national or international level to introduce new products, demonstrate the products and to
explain special features and usefulness of the products. Goods are displayed and
demonstrated and their sale is also conducted at a reasonable discount.
(vii) Money Back offer: Under this scheme customers are given assurance that full value
of the product will be returned to them if they are not satisfied after using the product
4. PUBLIC RELATIONS
This is the process of non-paid non-personal stimulation of demand for a product, service,
or business unit by planting significant news about it or a favourable presentation of it in the
media. Eg newspapers and magazine article reports, tv and radio presentations, charitable
contributions, speeches, seminars etc.
5. DIRECT MARKETING
It is the communication tool used to communicate with the customers directly by using
telephone, online mediums and other tool
CONSUMER BEHAVIOUR
Consumer behaviour is actions of consumers in the market place and the underlying
motives for those actions. Marketers expect that by understanding what causes
consumers to buy particular goods and services, they will be able to determine
which products are needed in the market place, which are obsolete and how best to
present those goods to the consumer.
The study of consumer behaviour is the study of how individuals make decisions to
spend their available resources ( time, money, effort ) on consumption related items.
NEED OR IMPORTANCE OF STUDY OF CONSUMER BEHAVIOUR
It is important for the marketers to understand the buyer behaviour due to the
following reasons.
™The study of consumer behaviour for any product is of vital importance to
marketers in shaping the fortunes of their organisations.
™It is significant for regulating consumption of goods and thereby maintaining
economic stability.
™It is useful in developing ways for the more efficient utilisation of resources of
marketing. It also helps in solving marketing management problems in more
effective manner.
™Today consumers give more importance on environment friendly products.
They are concerned about health, hygiene and fitness. They prefer natural products.
Hence detailed study on upcoming groups of consumers is essential for any firm.
™The growth of consumer protection movement has created an urgent need to
understand how consumers make their consumption and buying decision.
™Consumers tastes and preferences are ever changing. Study of consumer
behaviour gives information regarding colour, design, size etc. which consumers
want. In short, consumer behaviour helps in formulating of production policy.
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Personal factors are unique to a particular person. These factors include
demographic factors and are as follows.
1) Age: Need and wants are determined by age. So buying changes with age, Taste
for food, clothing and recreation etc. changes with age.
2) Stages in the Life Cycle: People buy different goods during different life cycle
stages. Life cycle of an individual refers to the different phases of his or her life.
3) Occupation and Economic Status: Occupation influences product choice,
brands beliefs etc. It determines income, buying power and status.
4) Life Style: It indicates how people live, how they spend their time, how and what
they choose and where they shop. It is the way people eat, drink, spend leisure time,
work and so on.
5) Personality: Personality refers to the unique psychological characteristics of an
individual.
Personality of consumers influences brand preference and choice of products.
6) Self-Image: Self image implies what one thinks of himself/herself .It is the way
one sees
himself/herself or wishes to see himself/herself or wants to be seen by others. Self-
concept is an important factor to marketers in planning advertising campaign.
Economic Factors
The various economic factors which determine consumer behaviour are as follows:
1) Personal Income: Gross income of a person is composed of disposable and
discretionary income. When disposable income rises, the expenditure on various
items will increase and vice versa.
2) Family Income: It is the aggregate income of all members of a family. The
family income remaining after the expenditure on the basic needs of the family is
made available for buying goods, durables and luxuries
3) Income Expectations: If a person expects any increase in his income he will buy
durables on hire purchase etc, if his future income is likely to decline he will restrict
his expenditure to bare necessities.
4) Savings: When a person decides to save more, he will spend less on comfort and
luxuries.
5) Liquidity Position: If an individual has more liquid assets, he goes in for buying
comfort and luxuries.
6) Consumer Credit: If Consumer Credit is available on liberal terms, expenditure
on comfort and luxuries will increase.
Environmental Factors
The various environmental factors which determine consumer behaviour are as
follows:
1) Political Situation: In state monopolies, consumers have to be satisfied with a
limited range of products, but in market oriented economy like that of USA,
consumers have wider choice.
2) Legal Forces: Consumers make purchases within the legal framework. All
purchase dealings are carried on within legal limits.
3) Technological Advancements: Technological advancements bring wide range of
changes in products/ services and makes consumers go in for latest products.
4) Ethical Considerations: Buying behaviour is influenced by the sense of social
morality and ethical considerations.
MARKETING RESEARCH
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The intention of project planning is to ensure that the right resources are available at the
right time and to anticipate problems. This means that all interested constituents must be
involved during project planning.
Project planning can be time consuming, difficult and expensive especially, if the details
about the tasks to be performed are not clear. Planning the development of a new product
that requires process technology that has not yet been invented is challenging. In these
situations only general project plans can be made initially and as the project processes,
however, more specific plans must be made.
STAGE 3: Operational Phase
Under this phase, the project team has been assembled and work on the project now
begins. Monitoring progress, updating project plans, and keeping the team on track are key
managerial responsibilities during the stage. Dealing with requests for changes in the work
to be done or in the project objectives is perhaps the most challenging task of all.
STAGE 4: Termination Phase
Under this phase, work on the project has been completed or impulsively halted. During
this phase, the success and failure of the project (including its organisational structure) are
analysed, a detailed report for the future project team is prepared, and the team
members are assigned other tasks.
Although projects tend to be unique in one aspect or another a good post completion audit
can help managers. Good analysis and understanding create knowledge that is useful now.
And avoiding past mistakes as well as taking advantages of improved organisational forms,
planning and control techniques, and management styles helps a firm design and manage
projects more effectively and efficiently in future.
GANTT CHARTS FOR PROJECT MANAGEMENT
In dealing with complex projects, a pictorial representation showing the various jobs to be
done and the time and money they involve is generally helpful. One such pictorial chart was
developed by Henry Gantt. It consists of two coordinate axes, on representing the time
elapsed and the other, jobs or activities performed.
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thought to be more knowledgeable about new products for advice. At later phases of
the PLC, the firm may need to modify its market strategy. For example, facing a
saturated market for baking soda in its traditional use, Arm & Hammer launched a
major campaign to get consumers to use the product to deodorize refrigerators.
Deodorizing powders to be used before vacuuming were also created.
Product Introduction/ Development Stage
This is the first stage in product life cycle. Before a new product is introduced in the
market place, it should be created first. The processes involve in this stage include
generation of idea, designing of the new product, engineering of its details, and the
whole manufacturing process. This is also the phase where the product is named and
given a complete brand identity that will differentiate it from the others, particularly
the competitors. Once all the tasks necessary to develop the product is complete,
market promotion will follow and the product will be introduced to the consumers.
Product development is a continuous process that is essential in maintaining the
product’s quality and value to consumers. This means that companies need to
continuously develop or innovate their products to out ride new and existing
competitors.
Product Growth Stage
This is a period where rapid sales and revenue growth is realised. However, growth
can only be achieved when more and more consumers will recognize the value and
benefits of a certain product. In most cases, growth takes several years to happen,
and in some instances, the product just eventually died without achieving any rise in
demand at all. Hence, it is important that while the product is still in the
development and introduction stages, a sound marketing plan should be put in place
and a market and primary demand should be established.
Product Maturity and Saturation Stage
In the maturity stage, the product reaches its full market potential and business
becomes more
profitable. During the early part of this stage, one of the most likely market
scenarios that every business should prepare for is fierce competition. As business
move to snatch competitor’s customers, marketing pressures will become relatively
high. This will be characterised by extensive promotions and competitive
advertising, which are aimed at persuading customer to switch and encouraging
distributors to continue sell the product.
In the middle and late phases of the maturity stage, the rate of growth will start to
slow down and new competitors will attempt to take control of the market. In most
cases, many businesses falls and lose money in these stages as they focus more on
increasing advertising spending in hope of maintaining their grip of the market.
Product Decline Stage
The decline stage is the final course of the product life cycle. This unwanted phase
will take place if companies have failed to revitalize and extend the life cycle of
their products during the maturity stage’s early part. Once already in this phase, it is
very likely that the product may never again recover or experience any growth,
eventually dying down and be forgotten.
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4. To minimise production delays, interruptions and conflicts – this is
achieved by identifying all activities involved in the project, their precedence
constraints etc
5. To minimise the total project duration
Stages in network analysis
The stages of a project are three:
1. The breakdown of the project into a set of individual jobs or activities
which are then arranged into a logical network. An activity is an operation or
process which uses time and other resources.
2. The estimation of the duration of each activity, the setting up of the
project schedule and the identification of the jobs which control the
completion of the project.
3. The estimation of the resource requirements of each activity; the
rescheduling of the activities to meet a resource objective or the reallocation
of money or other resources to improve the schedule.
Advantages of Network analysis
1. It clearly shows the interdependencies between jobs to be performed in
the context of a project and thus enables people to see not only the overall
plan but the ways in which their own activities depend upon or influence
those of others.
2. By splitting up the project into smaller activities, it assists in the estimation
of their durations and thereby leading to more accurate target dates
3. Its identification of the critical path has two advantages: a) if the
completion date has to be advanced, attention can be concentrated on
speeding up relatively few critical jobs b) Money is not wasted on speeding
up ‘non-critical’ jobs
4. It enables hard controls to be applied since any deviation from schedule is
quickly noticed
5. It allows the total requirements of men, materials, machinery and space
resources to be readily calculated and also indicates where the delaying of
non-critical jobs may be used for optimal utilisation of resources
Steps in Network (PERT/CPM) analysis
Step 1 – Planning
The planning phase is started by splitting the total project into small projects.
These smaller projects are divided into activities and are analysed by the
department or a section. The relationship of each activity with respect to other
activities are defined and established and the corresponding responsibilities and the
authority are also stated. Thus the possibility of overlooking any task necessary for
the completion of the project is reduced substantially.
Step 2 – Scheduling
The ultimate objective of the scheduling phase is to prepare a time chart showing
the start and finish time for each activity as well as its relationship to other
activities of the project. Moreover, the schedule must pin point the critical path
activities which requires special attention if the project is to be completed in time.
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CHAPTER 5 – PROJECT
MANAGEMENT
A project may be defined as a group of connected activities with a defined
starting point, a defined finish and need for central intelligence to direct it.
Project management is a specialized branch of management which has evolved in
order to coordinate and control some of the complex activities of modern industry.
Project management is the planning, organising, monitoring and controlling of
tasks and resources to accomplish a defined objective, usually with the
constraints of time and costs.
Project life cycle
Projects have a clear beginning and a clear end and often seem to take a life of their own.
Natural life of the project comprises of four phases:
1. Conception phase
2. Formative phase
3. Operational phase
4. Termination phase
STAGE 1 : Conception phase
During the conception phase, the idea for a project is studied. If it appears beneficial or
feasible, the idea is turned into a project proposal. A ‘go’ or ‘no go’ is then made.
Project proposals include the expected benefits, estimates of the resources (money,
equipment etc ) required for the project, and the project’s duration.
A proposed project is not evaluated on its individual merits alone. The degree to which it
supports the firm’s strategy and fits in with other projects currently under way is considered,
and the proposal compared with other proposals. Which project gets added to the firm’s
group of projects and when they will commence are strategic decisions.
STAGE 2: Formative stage
During this phase, the objectives of the project are clearly defined, the type of project
organisation (line, line & staff, functional, matrix etc) is selected and a project
manager is appointed. The proposal is transformed into a master project plan. Detailed
schedules, resource requirements and budgets are developed.
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For non- critical activities, the schedule must show the amount of slack or float time
which can be used advantageously when such activities are delayed or when limited
resources are to be utilized effectively. In this phase it is possible to resource
requirements such as time, manpower, money, machines etc.
Step 3- Allocation of resources
Allocation of resources is performed to achieve the desired objective. A resource
is physical variable such as labour, finance, equipment and space which will impose
a limitation of time for the project. When the resources are limited and conflicting
demands are made for the same type of resource, a systematic method for allocation
of resources becomes essential.
Step 4 – Controlling
The final phase in project management is controlling. Critical path method facilitates
the application of the principle of management by expectations to identify as that is
critical to the completion of the project. By having progress reports from time to
time and updating the network continuously, a better financial as well technical
control is exercised over the project.
History of Network Analysis
z Developed in 1950’s
z CPM by DuPont for chemical plants
z PERT by U.S. Navy for Polaris missile
CPM (Critical Path Method) was developed by Du Pont and the emphasis was on
the trade-off between the cost of the project and its overall completion time (e.g. for
certain activities it may be possible to decrease their completion times by spending
more money - how does this affect the overall completion time of the project?)
PERT (Program Evaluation and Review Technique) was developed by the US
Navy for the planning and control of the Polaris missile program and the emphasis
was on completing the program in the shortest possible time. In addition PERT had
the ability to cope with uncertain activity completion times (e.g. for a particular
activity the most likely completion time is 4 weeks but it could be anywhere
between 3 weeks and 8 weeks).
Application of Network (PERT/CPM) Analysis
1. Preparation of bids and proposal for large projects
2. Development of new weapon system and new manufacturing projects
3. Design, development and marketing of a new project
4. Research and development works
5. Simple projects such as remodelling, moving to a new house, home clearing
and painting.
6. Maintenance and repair work (eg nuclear plant, oil refinery , ship and other
large operations)
7. Manufacture and assembly of large items such as airplanes, ships and
computers
8. Construction projects (eg. Power plant buildings, highways, bridges, houses,
space shuttle etc)
9. Installation of a management information system
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Marketing research focuses on understanding the customer, the company, and the
competition. These
relationships are at the core of marketing research. Companies must understand and respond
to what
customers want from their products. However, this relationship is always influenced by
competitors and how their products are received by your market. Thus, you must clearly
identify the customer, company, and competition before developing a research project.
There are several important factors you must consider before you begin, including:
•
•
Your customers and competition
Awareness and image of your product
• Product usage
• Undiagnosed problems with your product
• Customer desires and needs for new product development
The steps in marketing research are:
1. Formulating the problem
2. Cost value analysis
3. Method of inquiry
4. Research design- data collection design, planning and survey design
5. Data collection
6. Analysing and interpreting data
7. Research report
THE PRODUCT LIFE CYCLE
Products often go through a life cycle. Initially, a product is introduced.
Since the product is not well known and is usually expensive (e.g., as microwave
ovens were in the late 1970s), sales are usually limited. Eventually, however, many
products reach a growth phase — sales increase dramatically. More firms enter with
their models of the product. Frequently, unfortunately, the product will reach a
maturity stage where little growth will be seen. For example, in the United States,
almost every household has at least one color TV set. Some products may also reach
a decline stage, usually because the product category is being replaced by something
better. For example, typewriters experienced declining sales as more consumers
switched to computers or other word processing equipment. The product life cycle is
tied to the phenomenon of diffusion of innovation. When a new product comes out,
it is likely to first be adopted by consumers who are more innovative than others—
they are willing to pay a premium price for the new product and take a risk on
unproven technology. It is important to be on the good side of innovators since
many other later adopters will tend to rely for advice on the innovators who are
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The length of a bar indicates the duration job or activity takes for completion. Some jobs
can be taken up concurrently and some will have to be completed before others can begin.
Hence, some of the bars run parallel or overlap each other time-wise and some run serially
with one bar beginning after another bar ends.
However in a programme where there are a large number of activities that can be started
with a certain degree of concurrency, the gantt chart cannot show clearly the
interdependencies among the various efforts or activities.
Network Analysis
Network analysis is a technique used for administration of a project which consists of
several activities having a definite inter-relationship among them.
It is the technique used for planning, scheduling and controlling large and complex projects.
Each activity is identified by means of a starting event and a finishing event so that normal
duration of the activity can be determined.
Network is a pictorial representation of the interrelationship of all types of activities
and has come to forefront for planning, scheduling and controlling the complex project
consisting of number of work contents.
When the project involves carrying out a large number of different tasks, the project planner
has to decide,
x Which tasks must be done first before others can be started?
x Which task could be done at the same time?
x Which tasks must be started as soon as possible and completed on schedule if
the planned completion date for the entire project is to be achieved?
Network analysis helps managers to plan when to start various tasks, to allocate resources so
that the tasks can be carried out within schedule, to monitor actual progress and to find out
when control action is needed to prevent a delay in completion of the project.
The events and activities making up the whole project are represented in the form of a
diagram or chart.
Objectives of network analysis
The objectives of network analysis are:
1. Minimisation of idle resources – Allowing for large variations in the use of
limited resources may disturb the whole plan. Thus effort should be made to
avoid the cost incurred due to idle resources.
2. To minimise the total cost – The total cost of the project can be calculated
and then efforts can be made to minimise the cost by calculating the cost of
delay in completion of an activity of the project in addition to the cost of the
resources required to carry out the jobs at various speeds.
3. To trade off between time and the cost of the project – The idea of trade
off between time and cost of the project is centered on the idea that duration
of the same activities can be cut down if additional resources are allocated to
them.
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 10. NASA space exploration projects
Drawing a network diagram
The first step in the analysis of any project is to produce a list of activities which
make up the project. The details of the list will depend on the nature of the
individual project. In each case, the immediately preceding activity or activities
must be identified. These immediate predecessors’ activities must be completed
before a given activity can begin. For example when building a house, the roof
cannot be built until the walls are completed.
The usual form of network diagram is an activity on arrow diagram, which means
that each activity on a project is represented on the diagram by an arrowed line.
A project is analysed into its separate tasks or activities and the sequence of
activities is presented in network diagram. The flow of activities in the diagram is
from left to right. An activity within a network is represented by an arrowed line,
running between one event and another event. An event is simply the start and/or
completion of an activity, which is represented on the network diagram by a
circle (called a node).
Event Event Event
1 Activity A 2 Activity B 3 Expected Time (te) = (to + 4tm + tp)/6
However in research projects various activities are based on judgement. A reliable
time estimate is difficult to get because the technology is changing rapidly. The time
values are subject to chance variations.
The CPM system of networks omits the probabilistic consideration and is based on a
Single Time Estimate of the average time required to execute the activity.
In PERT analysis, there is always a great deal of uncertainty associated with the
activity durations of any project. Therefore, the estimated time is better described by
a probability distribution than by a single estimate. Three time estimates are made as
follows:
1) The Optimistic Time Estimate (to): Shortest possible time in which an activity
can be completed in ideal conditions. No provisions are made for delays or setbacks
while estimating this time.
2) The Most Likely Time (tm): It assumes that things go in normal way with few
setbacks.
3) The Pessimistic Time (tp): The max. possible time if everything go wrong &
abnormal situations prevailed. However, major catastrophes such as earthquakes,
labour troubles, etc. are not taken into account.
The expected time (mean time) for each activity can be approximated using the
weighted average i.e.

Events are usually numbered, just to identify them , in this example Event 1 is the
start of Activity A, event 3 is the completion of activity B, and even 2 is both the Slack
completion of A and the start of B. The slack time or slack of an event in a network is the difference between the latest
event time & earliest event time
DEFINITIONS OF TERMS

• A project can be defined as a set of large number of activities or jobs (with each DISTINCTION BETWEEN PERT & CPM
activity consuming time & resources) that are performed in a certain sequence
determined.

• A network is a graphical representation of a project, depicting the flow as well as

the sequence of welldefined activities & events.

• An activity (Also known as task & job) is any portion of a project which
consumes time or resources and has definable beginning & ending.

• Event (Also known as node & connector) is the beginning & ending points of an
activity or a group of activities.

PERT – Program Evaluation & Review Technique – It is generally used for those
projects where time required to complete various activities are not known as a priori.
It is probabilistic model & is primarily concerned for evaluation of time. It is event

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 oriented.
Project Crashing: CPM – Critical Path Analysis – It is a commonly used for those projects which are
x Involves the use of additional resources with a view to reduce the project repetitive in nature & where one has prior experience of handling similar projects. It
duration. is a deterministic model & places emphasis on time & cost for activities of a project
x Crashing increases direct cost of doing activities but reduces overheads,
which is usually a function of time.
x There are usually compelling reasons to complete the project earlier than the
originally estimated duration of critical path computed on the normal basis of
a new project.
Direct Cost: This is the cost of the materials, equipment and labour required to
perform the activity. When the time duration is reduced the project direct cost
increases.
Indirect Cost: It consists of two parts: fixed cost and variable cost. The fixed cost is
due to general and administrative expenses, insurance, etc. Variable indirect cost
consists of supervision, interest on capital, etc.
The total project cost is the sum of the direct & the indirect costs.
Optimum duration is the project duration at which total project cost is lowest.

Critical Path Method (CPM)

Once the network representation of the project is completed and properly labelled,
the next object is to determine the critical path. CPM is a graphical technique for
planning and scheduling of projects. This technique involves the preparation of the
network in the form of arrow diagram and its analysis to indicate the critical path.

After preparing the network diagram and indicating the time for each activity, we
mention the various possible paths for determining the critical path. The critical path
is the longest path or the path which takes the maximum time in the completion of
the project.

Float
Activities which are not on the critical path are non-critical and they can within
limits start late and /or take longer than the time specified, without holding up the
completion of the project as a whole.
The total float for any activity is the amount of time by which its duration could be
extended up to the point where it would become critical. This is the same as the
amount of time by which its duration could be extended without affecting the total
project time.

Programme Evaluation and Review Technique (PERT)

CPM assumes that the time values are deterministic or the variation in time is
insignificant. But no recognition is given to the fact that expected activity time is the
mean of a distribution of possible values which could occur. The assumption of
deterministic values is valid in regular jobs such as maintenance of a machine,
construction of a building or road, etc as these are done from time to time and
various activities could be timed well.

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