PM - Decision Making Techniques
Contents
Cost-Volume-Profit Analysis........................................................................................................ 2
DIFFERENT TECHNIQUES: ........................................................................................................ 2
LIMITATIONS: ........................................................................................................................... 6
Make or Buy and Other Short Term Decisions............................................................................ 7
MAKE OR BUY DECISION:......................................................................................................... 7
SHUT-DOWN DECISION: .......................................................................................................... 8
ONE-OFF CONTRACTS: ............................................................................................................. 8
JOINT PRODUCTS: .................................................................................................................... 9
Dealing with Risk and Uncertainty in Decision Making............................................................. 10
RISK VS UNCERTAINTY: .......................................................................................................... 10
PAY-OFF TABLES: ................................................................................................................... 10
DECISION TREES: .................................................................................................................... 14
SENSITIVITY ANALYSIS: .......................................................................................................... 15
SIMULATIONS AND SCENARIO PLANNING: ........................................................................... 16
1
,Cost-Volume-Profit Analysis
DIFFERENT TECHNIQUES:
Cost-volume-profit analysis is used to determine how changes in costs and volume affect a
company's operating income and net income.
There are a number of techniques that can be used to understand how changes in cost and
volume impact on profits:
1) Break-even point. This tells us the volume of sales at which we make a zero profit. To
make a zero profit, we just need to ensure that:
Total contribution = Fixed costs
Contribution = Sales revenue - Variable costs
Contribution per unit = Sales price per unit - Variable costs per unit
The break-even formula can be defined as:
Fixed costs
Break-even volume =
Contribution per unit
Break-even volume Fixed costs
Break-even revenue = x =
Contribution to sales ratio (see below)
Selling price per unit
Fixed costs
Break-even for multi-product =
Weighted average contribution per unit
Total contribution
Weighted average contribution per unit =
Total volume sold
2
, 2) Margin of safety. This tells us how far our sales volume can fall before we start incurring
a loss. The larger the margin of safety, the better, this means that sales would have to
drop some way before we start making a loss. It is calculated as follows:
Margin of safety (volume) = Budgeted sales volume - Break-even sales volume
Margin of safety (volume)
Margin of safety (as a %) = x 100%
Budgeted sales volume
3) Contribution to sales ratio. This ratio tells us how much of our revenue is converted to
contribution to cover our fixed costs. The higher the c/s ratio, the better, as this means
that we are generating a higher contribution per $ of revenue.
Contribution per unit
Contribution to sales ratio =
Selling price per unit
Total contribution
Weighted average C/S ratio =
Total revenue
3
Contents
Cost-Volume-Profit Analysis........................................................................................................ 2
DIFFERENT TECHNIQUES: ........................................................................................................ 2
LIMITATIONS: ........................................................................................................................... 6
Make or Buy and Other Short Term Decisions............................................................................ 7
MAKE OR BUY DECISION:......................................................................................................... 7
SHUT-DOWN DECISION: .......................................................................................................... 8
ONE-OFF CONTRACTS: ............................................................................................................. 8
JOINT PRODUCTS: .................................................................................................................... 9
Dealing with Risk and Uncertainty in Decision Making............................................................. 10
RISK VS UNCERTAINTY: .......................................................................................................... 10
PAY-OFF TABLES: ................................................................................................................... 10
DECISION TREES: .................................................................................................................... 14
SENSITIVITY ANALYSIS: .......................................................................................................... 15
SIMULATIONS AND SCENARIO PLANNING: ........................................................................... 16
1
,Cost-Volume-Profit Analysis
DIFFERENT TECHNIQUES:
Cost-volume-profit analysis is used to determine how changes in costs and volume affect a
company's operating income and net income.
There are a number of techniques that can be used to understand how changes in cost and
volume impact on profits:
1) Break-even point. This tells us the volume of sales at which we make a zero profit. To
make a zero profit, we just need to ensure that:
Total contribution = Fixed costs
Contribution = Sales revenue - Variable costs
Contribution per unit = Sales price per unit - Variable costs per unit
The break-even formula can be defined as:
Fixed costs
Break-even volume =
Contribution per unit
Break-even volume Fixed costs
Break-even revenue = x =
Contribution to sales ratio (see below)
Selling price per unit
Fixed costs
Break-even for multi-product =
Weighted average contribution per unit
Total contribution
Weighted average contribution per unit =
Total volume sold
2
, 2) Margin of safety. This tells us how far our sales volume can fall before we start incurring
a loss. The larger the margin of safety, the better, this means that sales would have to
drop some way before we start making a loss. It is calculated as follows:
Margin of safety (volume) = Budgeted sales volume - Break-even sales volume
Margin of safety (volume)
Margin of safety (as a %) = x 100%
Budgeted sales volume
3) Contribution to sales ratio. This ratio tells us how much of our revenue is converted to
contribution to cover our fixed costs. The higher the c/s ratio, the better, as this means
that we are generating a higher contribution per $ of revenue.
Contribution per unit
Contribution to sales ratio =
Selling price per unit
Total contribution
Weighted average C/S ratio =
Total revenue
3
