Reporting management accounting information and supporting decision making
Relevant information for decisions
Short-term decisions should use relevant costs: future, incremental cash flows that differ between alternatives. Contribution (sales less variable costs) is the key measure. Common decisions include special orders, make or buy, shutdown, sell or process further, and limiting-factor allocation. In a limiting factor situation, rank products by contribution per unit of the scarce resource, not contribution per unit.
Break-even and CVP
Break-even units = fixed costs ÷ contribution per unit. Margin of safety = (budgeted sales − break-even sales) ÷ budgeted sales. With multiple products, use weighted average contribution per unit or the contribution-to-sales ratio. Investment appraisal tools - payback, NPV, IRR and ARR - should be chosen for the decision at hand; NPV is preferred because it considers the time value of money and all cash flows.
Reporting
Reports should be structured: title, purpose, findings, conclusion, recommendation. Address the reader, who may be non-financial, so define terms and avoid jargon. Separate facts from assumptions, quantify where possible, and include non-financial factors such as quality, supplier reliability, staff morale and reputation.
Traps
- Including apportioned fixed overhead in a short-term decision.
- Ignoring opportunity cost of using scarce capacity.
- Treating sunk costs as relevant.
- Ranking by contribution per unit rather than per limiting factor.
- Thinking payback captures the time value of money, or that NPV ignores qualitative issues.
Worked example
Product A gives contribution £10 per unit and uses 2 kg; Product B gives £6 per unit and uses 0.5 kg. Per kg of material: A = £5, B = £12, so make B first. Rule of thumb: with a scarce resource, maximise contribution per unit of the constraint.