Relevant and irrelevant costs

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Types of Costs in Business Decision-making

Let us first describe three major types of costs that a business decision can incur. The overt expenses are those that directly result in dollar outflows and limit the company's profitability. Explicit expenses have been reported in financial records and can be audited. Because of their clarity, explicit costs are taken into account by managers on a daily basis.

Implicit expenses, on the other hand, are less obvious because they are not calculated in dollars and do not result in observable money spent. However, implicit costs still are costs and therefore require to "give up\" something, what doesn't get the record in the financial documentation of the company. Management only in a case of decision-making or comparison of alternatives uses this category of costs, as they require additional time and sources to define and measure.

The last category - sunk costs - are ones what been produced and cannot be recovered. That is important to exclude them from taking in account when making a decision about future, as those costs been already done with any decision.

Relevance of Costs in Decision-making

Based on costs classification the point by the first partner (the name should be changed) is more relevant than of the second (the name should stay the same). The reason is the second partner appeal to sunk costs: business cards, vehicle paint, signage, ads in Yellow Pages (all with the old name). More correct with making the decision about future would be to count explicit costs for new advertising (with changed name). On the other hand, the other explicit (and sunk) costs they have already done are acquiring of new technology, possibly instruments for new tree services, but that group produces opportunities for getting new additional benefits and profits.

The implicit cost of changing the company name is a loss of reputation, goodwill, clients loyal to the old brand. However, that transition may be done softly, so most of the old clients will be aware of the change and loyal to the "new" company as well.

The implicit cost of not changing the company name is a loss of potential clients interested in services of tree cutting and winter grass installation, as they won’t be aware all the company possible services.

Explanation of "Contribution Analysis"

Discussion 2: Explain what is meant by "contribution analysis". Carefully define the term and provide examples to illustrate it.

Contribution analysis is a term having a number of meanings, as it may be related to business and accounting, decision-making, research, evaluation of activities and policies.

Within the method of "contribution analysis" in accounting, management is getting information about particular products through comparing the direct costs and the selling prices. That method makes clear how every additional sold unit of a product affects net income covering fixed costs and where the company has bottlenecks.

In marketing, contribution analysis is a method of discovering correlations between abnormalities in customer behavior, marketing metrics, and out-of-bound values.

The broader meaning of contribution analysis, however, suppose analysis of any planned activity, an economic decision, change in the policy and its contribution to the documented results. It may be presented as a clear six steps procedure from choosing the problem to checking additional evidence of the activity’s contribution to result, where in the center is a challenging of the developed theory of change.

In general, under contribution analysis, we should mean discovering of hidden effects of economic decisions, both positive (benefits) and negative (costs). For example, the person what have the payment system based on the amount of work done and a limited amount of time making a decision about education, studying any new skill, what possibly will increase its productivity. Even if the education is given free the costs here are that money lost as time spent for studying instead of the work. The obvious benefit is possible ability to do the same work 10% faster in the future and produce more money per hour. The implicit benefit is a new segment of clients with tighter requirements, what been closed for worker before education. The other opportunity what can see such person is reduced hours for sleeping and keep the same time for work and added education. In this case, hidden cost is a health as well as the quality of work and stability of knowledge.

November 09, 2022

Business Life

Subject area:

Company Accounting Decision

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