Presentation on theme: "Chapter 15 Short-term Planning Decisions. What are Relevant Costs & Revenues? s They are future costs & revenues. s They are included in making decisions."— Presentation transcript:
What are Relevant Costs & Revenues? s They are future costs & revenues. s They are included in making decisions. s Past (sunk) costs are always irrelevant.
Other cost terms: s Incremental Costs: Cost increases resulting from a change of activity. s Avoidable Costs: A cost which can be reduced or eliminated. s Opportunity Cost: Forgone profits when one activity is chosen over another.
Relevant costs/revenues are used to make the following types of decisions: s Whether to accept a special order. s How many units of inventory to buy. s Whether to drop (or add) a product.
Relevant costs/revenues are used to make the following types of decisions: s Whether to make or buy a product or part. s Whether to sell a product as is or to process it further. s What product mix to sell.
Economic Order Quantity (EOQ) s Inventory costs include: –Carrying Costs: storage, handling, insurance, opportunity costs –Order Costs: costs of placing and receiving an order.
Carrying costs s increase as the amount of inventory on hand increases
Ordering costs s increase when more orders are placed.
EOQ for a merchandiser: s take the square root of: 2SO C
EOQ for a manufacturer: s take the square root of: 2UO C
Legend: s S = total annual sales s O = order cost per order s C = carrying cost per unit s U = total annual raw materials used
How to decide to drop a product: s Drop only if avoidable costs are > revenue produced from the product. s Put another way - total profit would increase if product were dropped.
Should a part/product be purchased or made? s Many factors to consider: –If making, must have the “know-how”. –How will the decision affect current business relationships? –How reliable is the supplier? Is quality an issue? s Basically, determine relevant costs of each alternative.
Sell “as is” or process further? s Process further if incremental revenues >incremental costs of processing further.
Product Mix decisions: s What combination of products should a company produce/sell?
Where should advertising dollars go: s Using the assumptions in the book: basically, “push” that item which has the highest contribution margin per unit. –Remember, CM per unit is sales price minus variable costs.
How many units should be produced? s When there a constraints (scarce resources), produce the unit which provides the greatest CM per the constraint.