Decision Making Flashcards
Accountants view of cost behaviours
Assumes that the total cost and total revenue vary on a straight line basis as the volume of output and sales increases
Economists view of cost behaviour
Sees total cost varying in a non-linear manner due to economies of scale and sees total revenue gradually levelling off as customers reach the point where they do not wish to buy more of the item
Contribution
Defined as sales minus variable cost
How to calculate break even point
Contribution per unit is compared with fixed overhead cost to calculate break-even point
Fixed costs Break even point = ———————
Contribution per unit
A break even chart and a profit volume chart are useful ways of showing how
Contribution and profit change as the volume of output and sales increases
Break even analysis
Can be used to explore the effect of changing unit selling price, unit variable cost or fixed cost
Why does break even analysis have limitations
It is only suitable for short term decision making and can only focus on one product at a time
A break even chart
Is a graph that shows sales and costs over a range of activity, including the activity level at which total costs equal total sales and at which the business makes neither a profit nor a loss
Cost volume profit analysis means
Comparing sales revenue with variable cost and fixed cost to calculate profit or loss over a range of activity, to help with short-term decision making
Profit volume chart
A graph on which the horizontal axis shows the volume, measured by activity levels in £s of sales, and the vertical axis shows the profit at that activity level
Profit/volume ratio
Calculated as contribution as a percentage of sales value
Calculation of contribution can be paper in short term for decisions such as
- decisions on special orders
- abandonment issues
- limiting factors
- make or buy
If the market accepts full cost pricing
Pricing decisions may be related to cost
If there is heavy competition and manufacturers take whatever price they can get in the market
Pricing decisions may be related to marginal cost
Marginal cost
the cost added by producing one additional unit of a product or service.
Profit/ volume ratio
Contribution per unit
—————————— X 100
Selling price per unit
A budgetary system
Serves the needs of the management in making judgements and decisions, exercising planning and control and achieving effective communication and motivation
Long range planning
Begins with a vision statement setting out a vision for the future direction of the organisation
From this vision the long range objectives are set covering a period of perhaps three to five years
Strategy
Describes the courses of action to be taken in achieving the long-range objectives
The different functions of the organisation will work together in developing the strategy
Budgetary planning and control
Provides a method of quantifying the strategy of the business
A budget
A detailed plan which sets out, in money terms, the plans for income and expenditure in respect of a future period of time
It is prepared in advance of that time period and is based on the agreed objectives for that period of time, together with the strategy planned to achieve those objectives
Administration of a budget requires
A budget committee which will design the strategy, co-ordinate the inputs and communicate the objectives and strategy
Budget preparation usually starts with
The sales budget because sales are the critical factor
After the sales budget
Operational budgets are formed, leading to a finance plan and then the master budget
Master budget
Consists of a budgeted profit and loss account, a budgeted balance sheet and a budgeted cash flow statement
Budgets may be
Participative through a bottom-up process
Or imposed through a top-down process
A negotiated budget
Based on a mixture of both approaches (participative and imposed)
Co-ordination and review by the budget committee may lead to
A further round of negotiation in order to arrive at the best position for the entity as a whole, before final acceptance by the budget committee
The benefits of budgeting are seen in
Planning, control, communication and co-ordination
They also provide a basis for performance evaluation
Control through the use of standard costs per unit leads to
A more specific analysis than is available where control is through the use of budgets
Budgets give only the total cost of each line item
