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Management's Decision Making Process
Information used for Decision Making
Financial Information |
Non-financial Information |
Revenues |
Effect on employee turnover |
Costs |
Environment |
Profitability |
Company's image |
Accept/Decline an order at a special price
Criteria: Accept if Contribution Margin is positive |
Assumptions:
- Other products not affected by special price
- Other customers don't get special price |
No change in fixed costs, only variable cost change |
Retain or replace equipment
Criteria: Replace if new asset increases net income |
Book value: original cost of asset
Salvage Value: money earned when reselling asset
Useful Life: how long asset is expected to generate revenue |
Eliminate/Retain unprofitable business segment
Criteria: drop item if improves net income, retain segment unless FC > lost CM |
Need to know if FC are
- Avoidable
- Unavoidable: must be allocated on remaining segments |
Allocate limited ressources
Criteria: select product that maximizes net income |
Short term decision: focus on product with greatest CM unit
Long term decision: can constraint be reduced/eliminated
- Change CM unit
- Remove limitations on ressources |
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Incremental Analysis Approach
Maximize net income |
Identify expenses that vary with decisions |
Key Cost Concepts
Relevant costs |
Opportunity Costs |
Sunk Costs |
Cost in future |
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Cost in past |
Make/buy components or finished products
Criteria: Outsource if cost saving is positive |
Advantages:
- Frees up capacity for other use
- Shifts production risks to the supplier |
Disadvantages:
- Potential loss of quality control
- Hard to move back insource |
Sell product or Process further
Criteria: Process further until revenue < costs |
Produce multiple product simultaneously from single raw material
- Some products can be sold as is
- Some products can be processed further
- Products identifiable from each other at split-off point |
Theory of Constraints
Used to identify and manage constraints to achieve goals |
Requires identifying and constant attempts to reduce/eliminate constraint |
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