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"He Did What?!" Stop That With Formal Limits Of Authority.
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In last month's newsletter, I talked about the five criteria for an enabled organization. Two of the five discussed are:
- The organization understands that the charged person has authority to do what he is charged to do, and;
- The charged person knows what he can't do without proper permission or approvals.
In order to achieve these two conditions, formal limits of authority are very helpful and are critical in a larger organization. So, what exactly are "limits of authority?" It is a written authorization, to individuals within an organization, which allows them to commit the company to doing certain things. Things such as authority to enter into a sales contract, extend credit, make purchase commitments, make payments and so forth. This authorization is formal, documented, comprehensive and understood throughout the company. Note as well that these limits also tell someone, in a meaningful way, what he can't commit the company to do beyond defined parameters. For example, a salesman may be authorized to enter into sales contracts at list price and extend standard terms for a maximum volume over a fixed period of time. If the customer wants a better price and extended terms, or wants to increase the dollar commitment by increasing volume, he can read the limits of authority and know that the VP of sales must approve these requests (or perhaps even someone higher up in the organization). Why have formal limits of authority? In short, to prevent the "He did what!!?" situation. More particularly, the benefits are as follows. - It makes it easier. Formal limits of authority makes it easier to be an enabled organization. As I said above, people need to know others are empowered and those that are empowered need to know their limits. Limits of authority does just that.
- It reduces surprises. Preventing "He did that" does more than minimize the risk of bad, big decisions by junior managers. It forces "the boss" to explicitly authorize what someone can do - he can't be surprised or upset when that someone does "it."
- It eliminates guesswork. From the doer's perspective, he no longer has to wonder if he should, "run it by the boss first."
- It improves decision making. Formal limits of authority cuts back on one-off decision making and encourages systematic decision making. Decisions that many can make can become routinized with process. Only exceptions require special thinking and analysis.
- It eliminates confusion and finger pointing. When I was in the rent a car business, we rolled out limits of authority on a corporate-wide basis. Up until that point, it was up to each region to decide who had how much authority to do what, and that wasn't done in a clear, consistent, written manner. This meant that, depending on the region, some major decisions (things such as fleet levels which drove the biggest cost item, impacted pricing and could explain most profit variances) were made by region staff. But, we would look to the field general manager when his profits were off and the general manager would point to the fleet director. When we formally said fleet levels would be determined by the Region Fleet Manager, my boss, the Regional Vice President, knew whom to look to when profits disappeared.
- It encourages delegation. Formal limits of authority can be a way to nudge/push a founder/entrepreneur to really delegate as the business grows.
- It prevents expensive conflicts in partnership-based businesses. Limits of authority helps the partners agree upon and decide exactly what each partner can and cannot do without approval of other partners. I am not talking about LLC Operating Agreement stuff; I'm referring to day-to-day running the business stuff. Misunderstandings of this nature can get ugly and even litigious when between partners. Such disputes are sad, particularly when they could be prevented by clear limits of authority.
Here then, are some recommendations for getting the most out of limits of authority. - Focus more on the commitment than on the payment. Tight limits on making payments doesn't prevent the obligation. So focus on the terms of purchase orders and supply contracts: how long, size of dollar commitment and so forth. For sales contracts, specify price/margin, dollar and unit volume, length of commitment and credit terms.
- Real estate and operating leases should have special limits different from purchases. That goes for capital commitments and loans and other financing agreements.
- Have higher limits on disbursements, particularly when they are against properly committed obligations. Vary limits by disbursement type and be very granular when looking at disbursement types. For example, when I was in the rent a car business, my assistant controller could sign much larger checks for routine high dollar payments such as sales tax and airport concession fees. My signature was required at a much lower level for just about everything else. General managers had a very low dollar limit of $500 for locally issued checks (payables and disbursements were centralized in my office), but had a much higher limit for fees and taxes to register vehicles.
- Have confidence in the people you are empowering through limits of authority. If not, they should have lower limits (if lower limits means they can't get the job done, they shouldn't be in the job in the first place).
- Decide whether to be consistent across similar salary grades, job titles, etc., or to tailor the limits to the individual. There are merits to both.
For example, when I was with Container Corporation of America, limits of authority were rolled out on a standardized basis by plant size. There were about 30, roughly similar plants that came in three different sizes (capacity, revenue and headcount) and everything had been standardized for over 20 years. As CFO of the S. S. Pierce Company, on the other hand, my limit before I had to manually countersign checks was more than twice the limit of the Group VP Finance for all of food service. Why? There was no consistency in the food service group as it was a recent rollup of many acquisitions that had been performing poorly. In this case, limits were assigned on a case by case basis by corporate treasury and my business passed muster.
- Back up the limits of authority with a sound system of internal controls (internal audits, etc.). Otherwise, all is for naught. In the rent-a car example, all checks signed by general managers were audited. And yes, that control did flag a problem before it became a disaster. For larger companies, limits of authority should be part of COSO's Internal Control-Integrated Framework and also part of Sar-Box compliance.
- Finally, make sure people have sufficient authority to get the job done.
So there it is. Limits of authority not only empowers an organization, it makes it more effective and stops time wasted on, "He did what?!!" |
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Heard on the Street
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The parties in the Greek crisis agreed to kick the can down the road for the next few months. But, according to John Cochrane, an economics professor at the University of Chicago Booth School of Business, failure to come to terms down the road does not mean Greece has to exit the Euro (the so called, "Grexit"). Instead, Greece can do a "California." To find out just what Greece can learn from a larger, debt-ridden economy, read here. |
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Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent financial problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area. To ensure that you continue to receive emails from us, please add [email protected] to your address book today. Goodrich & Associates respects your privacy. We do not sell, rent, or share your information with anybody. Copyright © 2015 Goodrich & Associates LLC. All rights reserved. For more on Goodrich & Associates and the services we offer, click here.Newsletter developed by Blue Penguin Development |
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