Overview 4 - Overview The first topic covered by this unit...

Overview
The first topic covered by this unit is financial modeling. Financial modeling allows an
organization to test certain assumptions with respect to the operating and financial aspects of the
organization. The basic financial model is the cost-volume-profit model. This model involves the
use of breakeven analysis in which you determine the quantity of what must be produced and
sold in order to breakeven. A critical aspect of this analysis is the determination and application
of various types of costs such as fixed, variable and step costs. Operating leverage is another
aspect of this analysis. Operating leverage uses fixed costs to maximize the profitability of the
organization when there are increases in operating activity. Multiple product financial modeling
is another tool that is used. This type of modeling is where an organization sells multiple
products and each product type in the mix has different characteristics that can impact the
breakeven analysis. A change in the composition of the mix can impact the financial analysis.
Multiple cost drivers can also be used in financial modeling in order to gain a greater depth of
knowledge when examining the operating decisions of the organization.
This unit will also examine differential costs. These are costs which change as a result of changes
in activities. Differential costs are relevant costs in that the focus of the analysis should only be
on the costs that change based on the alternatives chosen. Underlying this analysis is
determination of cash flow. The use of cash versus accounting income is used because cash is a
medium of exchange and is a common objective measure. In addition, not only is the
determination of costs important but pricing is also an element of operating decisions. Customer
demands, competitors’ actions and costs of the products are major influences on pricing
decisions. Some organizations focus on the product life cycle as its impacts costing. The time
horizon is also an important aspect of these pricing decisions. In addition to the financial issues,
legal issues, such a predatory pricing and dumping, can impact the pricing decision. Many
organizations make decisions based on cost, however, there is an alternative focus: target costing.
With target costing an organization first determines a target price and then a target cost is
established. In addition, there are other tools such as the use of the cost drivers determined under
Activity Based Costing. Product choice decisions, Make-or-Buy decisions, adding and dropping
parts of the operations and joint products decisions are also discussed. This unit also examines
the Theory of Constraints and the impact that such constraints have on the operation. Inventory
management and the innovations in inventory management and flexible manufacturing will also
be discussed.