MGMT ACC Module 4: Decision Making
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Assumptions of CVP Analysis
- 1. Revenue/Cost functions are LINEAR
- 2. Price/unit Variable cost/Fixed cost can be accurately determined and remain constant over relevant range
- 3. Sales equals Production
- 4. Price/costs known with certainty
- 5. Sales Mix known
CVP for Multiple Products
Assumes known, constant sales mix for products, then treated as single unit of sale
Methods for CVP Multiple Products
- 1. For each unit, calculate unit CM
- 2. For each unit, multiple unit CM by sales mix3. Sum weighted CM for all products
- 4. Calculate 'package' break-even point in units (FC/Unit CM)
- 5. Multiply package units by sales mix
Choosing the optimal mix that maximises total contribution margin given the constraints faced by the firm
Theory of Constraints
- Technique which takes both a short-term optimisation approach and a long-term approach to managing constraints for continuous improvement.
- - Only one constraint @ a time
- Focuses on 3 operational measures of systems performance
- 1. Throughout
- 2. Inventory
- 3. Operating Expenses
Rate @ which organisation generates money through sales
Throughput = (Sales Revenue - Unit-level Variable expenses)/Time
All money organisation spends turning materials into throughput
In terms of TOC, money spent on items that don't have to be immediately expensed
All money organisations spend in turning inventory into throughput, represents all other money an organisation spends
5 step process for improving performance
- 1. IDENTIFY organisations constraints
- 2. EXPLOIT the binding constraints
- 3. SUBORDINATE everything else to decisions made in Step 2
- 4. ELEVATE organisation's binding constraints
- 5. REPEAT process as a new constraint emerges to limit output
1. IDENTIFY organisations constraints
Internal and external constraints identified, optimal product mix is identified as one that maximises throughput
2. EXPLOIT the binding constraints
Drum-Buffer-Rope (DBR) system
Drum = major binding constraint, can be more than one.
Time Buffer (or Buffer) = inventory needed to keep constrained resource busy for a specific period of time. Purpose: protect throughput of entity from any disruption that can be overcome within specific period
- Rope = actions taken to tie rate at which material is released into the plant. Purpose: ensure WIP inventory doesnt exceed time buffer limit.
3. SUBORDINATE everything else to decisions made in step 2
All remaining departments should be subordinated to the needs of the drummer constraint
4. ELEVATE organisation's binding constraints
Next step is to embark on a program of continuous improvement by reducing the limitations that the binding constraints have on the organisation's performance.
5. REPEAT process
Objective = continually improve performance by managing constraints, don't allow inertia to cause a new constraint. Focus on next-weakest link
Doubt about the likelihood (probability) of specific outcomes
"Maximising the minimum gain"
- Maximise the minimum outcome, whatever's taken, the worst possible outcome will occur
Weight the outcome following each event by it's probability
Outcome X Probability
Sum the weighted values, adopt the highest EV
Visual representation of a range of outcomes when there are successive alternatives leading to different outcomes.
What does decision trees do?
Helps identify possible outcomes of joint alternative courses of action
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