ShortTerm DecisionMaking

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Chapter 19
Short-Term Decision-Making
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Short-Term Decision-Making
1. Introduction 2. Decision-Making 3. Short-term
Decisions 4. Contribution Analysis 5. Decisions,
Decisions i. Determining the most profitable
products ii. Cease production of any
products iii. Maximising a limiting
factor 6. Break-Even Analysis 7. Contribution
Analysis 8. Conclusion
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Introduction

• Businesses continually involved in
  decision-making
• Strategic long-term and short-term operational
  decisions
• Look here at short-term decisions

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Decision-Making

• Individuals and businesses continually make
  decisions
• Certain characteristics of decisions
• i. Forward-looking
• ii. Need relevant information (i.e., costs and
  revenues not affecting a decision should be
  ignored)
• iii. Capable of financial evaluation

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Contribution Analysis I

• Key Features
• Distinguish between fixed and variable costs
• Profit no longer key criterion
• Often calculations done on a per unit basis
• Contribution focuses on extra cost of an extra
  unit
• Fixed Costs
• - Do not change with production or sales.
• Irrelevant for short-term decisions
• Variable Costs
• - Do vary with production or sales
• Contribution
• - Sales less variable costs

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Contribution Analysis II
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Contribution Analysis III
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Contribution Analysis III
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Contribution Analysis IV

• What if sales of X and Y double or halve?
• i, If double, contribution doubles
• 
  
• X (8,000 x 2) 16,000
• Y (22,000 x 2) 44,000
• Contribution 60,000
• Fixed overheads (10,000)
• Net Profit 50,000

ii, If halve, contribution halves

X (8,000 ? 2)
4,000 Y (22,000 ? 2)
11,000 Contribution

15,000 Fixed overheads
(10,000) Net Profit
5,000
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Decisions, Decisions I

• Basic Approach
• 1. Identify fixed and variable costs
• 2. Allocate sales and costs to different products
• 3. Calculate contribution
• a. In total
• b. Where appropriate, per unit

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Decisions, Decisions II

• Determining most profitable products

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Decisions, Decisions III
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Decisions, Decisions IV

• Should we cease production of any products?

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Decisions, Decisions V
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Decisions, Decisions, VI

• Make or Buy Decisions

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Decisions, Decisions, VII

• Maximising a limiting factor

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Decisions, Decisions VIII
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Decisions, Decisions IX

• Throughput Accounting

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Break-Even Analysis I

• Break-even point at which a firm makes neither a
  profit nor a loss
• Bunter sells 15,000 meals at 20 each. Variable
  costs 8. Fixed costs 120,000
• Fixed Costs 120,000 10,000 meals
• Contribution 20 - 8
• per unit
• Break-even point thus 10,000 meals
• Break-even analysis assumes
• Linearity of sales and variable costs
• Fixed costs will remain fixed

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Break-Even Analysis II

• Margin of Safety
• Actual units sold - units at BEP 15,000 -
  10,000 50
• Actual Units 10,000
• What-if Analysis
• For example, what is profit or loss if 8,000
  meals are sold?
• 2,000 units less than BEP
• Therefore 2,000 meals x 12 contribution -
  24,000 loss

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Break-Even Analysis III
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Break-Even Analysis IV
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Contribution Graph I

• Contribution graphs can be used for multiproduct
  situations
• Relationship between contribution and sales
  defined as Contribution
• Sales

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Contribution Graph II
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Conclusion

• Businesses constantly face short-term decisions
• Sales less variable costs gives contribution
• Contribution can be used for short-term
  decision-making
• Break-even analysis and contribution/ sales other
  useful techniques