Cost characteristics and decision making

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Unformatted text preview: acteristics and Decision-Making Ramifications As a student, you can probably think of many things you wish you could do over. You may have taken an exam and regretted some stupid mistake. You knew the material but fumbled in your execution. Or, maybe you did not really know the material; your judgment about how much to study left you doomed from the start! Business people will experience similar feelings. Perhaps inventory was shipped using costly overnight express when less expensive ground shipping would have worked as well. Perhaps parking lot lights were unnecessarily left on during daylight hours. Hundreds of examples can be cited, and management must be diligent to control against these types of business execution errors. Earlier chapters discussed numerous methods for monitoring and controlling against waste. Remember, each dollar wasted comes right off the bottom line. For a public company that is valued based on a multiple of reported income, a dollar wasted can translate into many times that in lost market value. On a broader scale, business plans and decisions might be faulty from the outset. There is really no excuse for stepping into a business plan when it has little or no chance for success. This is akin to going into a tough exam without preparing. Regret is perhaps the only lasting outcome. The overall theme of this chapter is to impart knowledge about sound principles and methods that can be employed to make sound business decisions. These techniques won’t eliminate execution errors, but they will help you avoid many of the judgment errors that are all too common among failing businesses. 1.1 Sunk Costs VS. Relevant Costs One of the first things to understand about sound business judgment is that a distinction must be made between sunk costs and relevant costs. There is an old adage that cautions against throwing good money after bad. This has to do with the concept of a sunk cost, and it is an appropriate warning. A sunk cost relates to the historical amount that has already been expended on a project or object. For exa...
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