Theory: decisions and liquidity management

For those in a hurry: in practice decisions are always complex, but why?

Decisions arise where there is a choice between different courses of action
The decisions to be taken depend on the decision-makers, on the company’s goal and on the information available.
The quality of the decision-making process as a whole depends on the quality of the individual steps.
Being able to trace decisions is particularly important within companies.
Decisions on the use of liquidity have to be taken on the basis of an appropriate level of information. In the worst case, legal consequences loom.

What is a decision in the first place?

Something has to change! That is how a process of reflection often begins, one that then leads to a decision. In theory, an essential feature of the concept of a decision is the ability to choose between different courses of action, preceded by dissatisfaction with, or a sense of not being satisfied by, the current situation or the development to be expected. The classic situation, in other words: do we go left or right?

All of this, of course, on the condition that the will to remove the dissatisfaction exists. So we have agreed that we will move forward and not stand still. In addition to the ability to choose, there are the aspects of being oriented towards the future and towards people, so that in theory a decision is ultimately defined as

”… a choice directed at the future between alternative actions or goals, by which an individual or a group of people attempts to resolve a conflict situation. The precondition is the will to put the chosen solution into practice.”

In what follows we take a closer look at the decision-making process, that is, at forming and enforcing a decision.

The company as a system

In connection with decisions, a company consists of three subsystems – the

goal system,
information system and
social system.

These three systems influence not only the individual phases of a decision, they also influence each other. This happens because goals are set in the goal system, yet those goals are influenced by the differing objectives of the decision-makers.

It was in Düsseldorf, at a presentation given by a large bank, that a motivational trainer once said something that made a lasting impression on me:

Companies achieve their goals DESPITE the targets we set our employees. Employees are disloyal towards targets but loyal towards the company.

This remark nicely illustrates the possible tensions between a goal system and the social system, that is, employees’ individual goals and visions. But something else resonates in this example as well. Namely the differing and imperfect level of information.

On the one hand, then, there is tension between the social system and the information system, that is, employees’ individual wishes and ideas based on the information available to them. These in turn influence the quality of the goal-setting process, that is, the setting of goals (in the goal system) on the basis of imperfect or subjective information.

What effect does this have, or what effect can it have? On this, Staehle, one of the scientific forefathers in the field of management, recorded the following finding from his research:

Strategic measures ordered from above are implemented only 25% of the time. Empirical studies confirm that 75% of strategic ideas peter out. Strategies coming from all levels of the hierarchy have a 75% chance of being implemented.

Further factors influencing the quality of a decision are

the motivation and
the intellectual abilities of the decision-makers,
the creativity of the person deciding,
their social skills,
their manual skills and
their basic attitude towards the future.

The principle of rational choice

The company’s three subsystems also influence every single phase of the decision-making process. In theory, the process is also called the “principle of rational choice” and is presented as follows:

Stage of dissatisfaction – the problem at hand is clarified through a root cause analysis. The decision-maker intends to solve the problem.
Search phase – here the possible solutions have to be selected and weighed up. The aim is to “identify the possible alternatives and the limiting data and to specify the underlying objective”. The search phase is therefore determined by the decision-making methodology, by the alternative outcomes and by the underlying objective.
Optimisation phase – this is characterised by the actual act of deciding, preceded by a ranking of the assessed courses of action.
Enforcement phase – this is characterised by recording the decision and communicating it. The subsequent implementation and control of execution is frequently identified as yet another decision problem, since in most cases execution takes place by delegation to subordinate units.

The first three phases are also referred to as the process of forming a decision. The quality of this process depends heavily on the quality of the individual preceding stages.

The phases of the decision-making process are to be understood as “formal phases”. This means that every decision, whatever constraints may influence the process, can be broken down into these phases. I beg your pardon? Every decision we take can be broken down into these theoretical phases? We had better take a closer look at that.

Only the quality with which the individual phases are worked out distinguishes the above system of rational choice from decisions as they are practised. In this context, Staehle names the following limitations of the principle of rational choice:

Bounded rationality – because of numerous influences, the decision-maker settles for a satisfactory solution. “Our decision was fine as it was.”
Contextual rationality – the scope for decisions is limited by the environment and by conflicting goals. “We could not have done it any better in that situation.”
Procedural rationality – procedures and techniques are used to try to take as “good” a decision as possible.
Retrospective rationality – the decision is only justified after it has been taken.

Decision theory builds on “procedural rationality”, that is, on the attempt to take as good a decision as possible. It tries to create decision routines by means of problem-solving procedures.

The theory is intended to make the decision easier for the user and to bring it as close as possible to rationality. It therefore demands judgement and experience from the decision-maker, combined with facts from the company.

The decision-maker is also forced to state the alternative courses of action, to assess the probability of possible states of the environment occurring and to quantify the consequences arising from the combination of a course of action and a state of the environment.

This makes the decisions taken traceable – management responsibility becomes apparent. One problem when introducing decision theory procedures into companies, however, is the professional qualification the decision-makers require. This problem can be remedied by internal training or by external consultants.

In the course of studying decisions, the literature has modified the model of rational choice and developed it further towards a better understanding of complex decision-making situations. Two of these models are briefly explained below.

Muddling through or the model of incrementalism As in the model of bounded rationality, the decision-maker looks only for satisfactory solutions. He tries to achieve this by proceeding step by step – a form of procedural rationality. “With this approach the yardstick is not a set of superordinate goals; rather, planning and decision-making behaviour resembles muddling through, and evaluation processes and political negotiation processes.” The decision-maker is therefore influenced not by superordinate goals but by the current problem situation.
Conflict model of decision-making The conflict model highlights the emotional side of the decision-maker and its importance. Decisions are bound up with feelings (hatred, fear, anger and above all stress). Because of these feelings, decision-makers end up in serious conflicts, are filled with anxiety and shy away from deciding. Stress in particular affects the decision-making situation (especially the search for information) and thus, not least, the quality of the decision to be taken. An appropriate level of stress that the decision-maker can cope with should therefore be aimed for in order to achieve optimal decision-making behaviour. With too little stress he neglects the search for information, and with too much stress he baulks at the effort, takes a purely emotional decision or none at all.

Within organisations the individual phases of a decision take on particular importance, namely when it comes to being able to trace decisions. For this reason the formal organisational structure, or organisational efficiency, has a significant influence on the quality of the decision-making process. It therefore supports procedural rationality.

It is particularly important to bring out the strong influence of the company’s information system on the other subsystems and on the individual phases of a decision. This applies above all to the topic of liquidity. We have already established that liquidity is indispensable for the company’s continued existence. Decisions on the use of liquidity have to be taken on the basis of an appropriate level of information. A lack of information or neglect of the monitoring of liquidity can lead to serious legal problems for the managing directors.

In this respect, being able to trace decisions in the area of liquidity management is of fundamental importance. After all – where decisions are documented appropriately – issues such as slight or gross negligence can be ruled out unambiguously.

Types of decision in a company

Regarding the basic types of decision in a company, the literature offers the following classification:

Routine decisions and genuine or one-off decisions In the first part of the theory series, decisions taken by company management were already described as genuine decisions. Accordingly, these “genuine” decisions cannot be delegated. Heinz Wissenbach further identifies a genuine decision “where the decision problem is new, has to be thought through and calls for a resolution for which, at best, similar precedents exist.” With routine decisions, goals and means can be defined at least for certain periods of time. Furthermore, experience from the past can contribute considerably to solving routine problems.
Decisions about goals and about means Decisions about goals were identified above as the first and highest task of the dispositive factor, and decisions about means as decisions about the route by which those goals are to be reached. Decisions about goals therefore involve fixing “what one wants to strive for oneself or requires others to strive for.”
Individual and group decisions These aspects were already covered in the process of goal formation, where it was established that personal as well as business expectations feed into the company’s decisions about goals. The differing personal goals that arise above all in group decisions are an important influencing factor and must be taken into account in such decisions under all circumstances.
Well-structured and poorly structured decision problems Well-structured decision problems are characterised by a defined number of possible solutions, by information about the consequences, by clearly formulated premises and by solution algorithms. If one of these features is missing, we speak of poorly structured problems. In practice this is frequently the case. Intuition, resourcefulness, experience and so on are elements of problem-solving behaviour in poorly structured decision situations. To support problem-solving further, company management has to draw on all the information available and weigh it up.

In summary, it can be said of business practice that the decision-maker almost always encounters complex decision-making processes. These are characterised by poorly defined and poorly structured decision problems.

The description “poorly defined” arises in this context because the desired end state cannot be defined unambiguously in advance. “The decision problem is poorly structured because the number of alternatives is impossible to survey and no specific solution program exists for selecting the optimal one from the multitude of alternatives within a reasonable time.” We also know this as: “you can’t see the wood for the trees.”

Topics covered in the theory series

Part 1: companies, goals and liquidity

Part 2: corporate management and liquidity management

Part 3: decisions and liquidity management

Part 4: reporting in the company

Credits: Photo by Kate Joie on Unsplash