Management by exception refers to the practice of only investigating variances

Management by exception is a business management strategy that states that managers and supervisors should examine, investigate and develop solutions for only those issues where there is a deviation from set standards, norms, business practices, or any other financial goals like profits deviation, quality issues, infrastructure issues, etc. instead of examining and dealing with each routine business activities.

Table of contents

• What is Management by Exception?
  • Explanation
  • How does it Work?
    • #1 – Measurement Phase
    • #2 – Projection Phase
    • #3 – Selection Phase
    • #4 – Observation Phase
    • #5 – Comparison Phase
    • #6 – Action Phase
  • Management by Exception Examples
  • Management by Exception vs. Passive Management by Exception
  • Advantages
  • Disadvantages
  • Conclusion
  • Recommended Articles

Explanation

Management, by exception, is the system of spotting and reporting a situation to management only when there is an actual requirement of a manager-level staff. The basic purpose is to utilize management time in the most efficient and best possible manner by involving them only when there is an important deviation from the routine or normal business results.

As a result, they will have more time to look into an important matter involving major variances and can give their best in fine-tuning the problem. In contrast, lower-level staff may handle other minor matters directly. In this system, management is provided with a concise, unvaried comparative full detailed report covering all major aspects of the issue. It helps management detect and clear the hurdles that need decision-making and take the best suitable actions.

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How does it Work?

Management by exception works in the following phases-

#1 – Measurement Phase

Under this first step of management by exception, data regarding business operations are accumulated and evaluated, which includes measuring the performance of all the available inputs ranging from efforts used to achieve goals for the business, its optimization,, cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more, how financial resources are being used to provide services or manufacturing goods for profit, use and wastage of raw materialsRaw MaterialsRaw materials inventory is the cost of products in the inventory of the company which has not been used for finished products and work in progress inventory. Raw material inventory is part of inventory cost which is reported under current assets on the balance sheet.read more and its economy through buying, processing and storing till the delivery of finished goods.

This information involves almost all factors used for quantifiable measurements, such as applying time standards, stock data, balance sheet data, finished goods inspection results, stock available for sales, machinery utilization data, current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more, etc.

#2 – Projection Phase

This phase examines the measurements used that are useful for achieving business objectives. Based on historical data, projections are prepared by applying statistical knowledge such as significance, probability, confidence, standard deviationStandard DeviationStandard deviation (SD) is a popular statistical tool represented by the Greek letter 'σ' to measure the variation or dispersion of a set of data values relative to its mean (average), thus interpreting the data's reliability.read more, sample size, and correlation. After this, plans are developed according to the forecast. In the current scenario, a complete forecast strategy is extensively checked from all possible outcomes like procedures and existing policies, capability and adequacy of equipment and staff, organization structure, etc. If required, plans may be amended.

#3 – Selection Phase

Under this phase, after thoroughly screening all the plans, the best one is selected and implemented. Accordingly, the system is adopted, which the management thinks is best for achieving business objectives.

#4 – Observation Phase

Under this phase, the selected process, strategy progress, and performance are monitored periodically. The system must possess qualities like it must be automatic, reliability, and adequate. Adequacy here means data must be precise, neither too big nor too small; it must be up to the mark carrying all relevant information required.

#5 – Comparison Phase

Under this phase, work progress is evaluated and compared with a predesigned roadmap to identify deviations, if any. Depending on the nature of deviation, it is categorized as major, minor, or any other class of deviation.

#6 – Action Phase

Further action points are developed based on the deviation identified under the comparison phase. Strategies are implemented to bring the capacity and performance to the desired level or to make any forecast change to ensure optimal performance.

Management by Exception Examples

Financial Example: The chief financial controller (CFC) of Henry Inc. is heavily engaged with varied works, meetings, and other engagements. To reduce the burden of his work, management has once, after thorough analysis, developed the following defined limits beyond which matter needs to be reported to CFC and require its prior approval: –

ABP Sales and expenses were $8,00,000 and $6,00,000 whereas actual sales and expenses were $ 6,00,000 and 3,00,000. Determine whether the matter needs to be reported to CFC?

Solution:

1. Revenue: Actual revenue is $6,00,000 which is more than 50% of ABP ($8,00,000 x 50% i.e. $ 4,00,000) Also more than $5,00,000. Therefore, this mater will not be reported to CFC as conditions are not met.
2. Expenses: Actual expenses are $3,00,000, which is more than 40% of ABP ($6,00,000 x 40%, i.e., 2,40,000) and had also exceeded the $2,50,000 limit, here matter becomes crucial and needs to be reported to CFC for further analysis and decision making for correction and matching with set standards.

Management by Exception vs. Passive Management by Exception

Active management by exception is where the management is active in advance to deal with the situations, assisting in problems, has real-time participation in all activities, and keeps an eye on what his staff is doing to overcome mistakes.

The second one is passive management by exception, where management interrupts only when the desired goals are not met, the change in planning needs to be done, and corrective actions are required. This method usually comes into action only in case an unusual event happens. Each method is important, and one can choose either based on business requirements.

A passive approach is useful for businesses with a relaxed environment and staff understanding their roles and responsibilities. It may help to encourage staff morale and be independent. While an active approach can be used by less attentive, new employees with lower staff, more stringent organizations as they need step by step guidance to complete their work.

Advantages

• It helps in the best possible time utilization as managers are asked to resolve problems only at crucial levels.
• As managers are free from routine work, they can apply their full energy with concentrated efforts on critical problems.
• Due to the limited workload, managers can undergo an in-detailed analysis of the work.
• Management activities and control are increased by management by exception.
• It helps in accessing past trends and old work easily.
• It predicts the management opportunities and problems that may arise in future.
• Both qualitative and quantitative efforts are involved in this process.
• It lowers the amount of financial and operational results viewed by the management.
• It helps the lower and subordinate staff to implement their ideas to achieve the desired target.

Disadvantages

• It is based on past results with which current data is compared. Accordingly, if the past data is improper, there may be problems in current decision-making.
• It needs a detailed study, observation, and reporting system, so it requires a financial analyst who makes summaries and reports and presents them to the management, hence requiring an additional workforce.
• The system will not warn until the problem occurs, i.e., it acts as corrective instead of preventive.·      
• It cannot measure human behavior. Therefore, sometimes it is difficult to implement.

Conclusion

Management by exception is a management strategy that requires management to ensure its engagement only when there are recorded deviations from the set standard, norms, and benchmarks. It also indirectly helps boost employee morale as they become part of decision-making and problem-solving, which would otherwise have been dealt with by manager-level staff, indirectly giving employees a sense of authority and responsibility.

Recommended Articles

This has guided what management is by Exception & its Definition. Here we discuss the examples of management by exception, how it works, and its advantages and disadvantages. You can learn more about it from the following articles –

What is management by exception in standard costing?

What is the relationship between the process of standard cost variance analysis and management by exception?

What does management by exception entail chegg?