Financial Decision Making - Further short-term decisions

Further short-term decisions

Financial Decision Making – Further short-term decisions

Making short-term decisions

• Examples of short-term decisions• Considering relevant costs and revenues– Differential /incremental costs and revenues– Material and labour costs

• Non-financial issues

• Reading:– Management Accounting for Business chapter 4

Financial Decision Making – Further short-term decisions

Examples of short-term decisions

• Special pricing decisions• Make/ buy decisions• Discontinuing operations• Product mix with limited capacity

Financial Decision Making - Further short-term decisions

Relevant costs

• Costs which change as a result of the decision or vary between options

• Ignore sunk (historic) costs• Ignore future costs which are not affected by

the decision– Eg fixed costs (note: short-term assumption)

• Can often focus on contribution

Financial Decision Making – Further short-term decisions

Relevant costs of materials

• Generally the future replacement cost• Is the item in stock?– Is it required for making other items?– Could it be sold if not used? - opportunity cost– Will it cost anything to dispose of it?

Financial Decision Making – Further short-term decisions

Relevant cost of labour

• Is there spare labour?• What will the staff do if we don’t use them

here? – opportunity cost• Will additional staff be required for this

contract?

Financial Decision Making – Further short-term decisions

Non-financial issues

• Need to consider non-financial issues alongside finance such as:

• Marketing• Quality• Reputation• Human resources

Financial Decision Making – Further short-term decisions

Special pricing decisions

• Relates to one-off orders• Minimum price = total relevant cost• Need to consider opportunity costs

• Example – the price of the car with the reconditioned engine in week 2

Financial Decision Making – Further short-term decisions

Make or buy (outsourcing)

• Should we buy this component in or make it ourselves?

• Should we undertake this activity or buy in a service?

Financial Decision Making – Further short-term decisions

Discontinuing operations

• Various possible scenarios:– Closing a sales office– Stopping production and sale of a product

• Consider impact on costs and revenues• May be significant non-financial factors to

consider

Financial Decision Making – Further short-term decisions

Product mix with capacity constraints

• What products should be made if capacity is limited?

• Limitation may be resources, space, machine time

• Aim to maximise profit - by maximising contribution

• Single constraint – choose products with highest contribution for each unit of limited resource