APT TECHNICAL CPD - MAF SHORT TERM DECISION MAKING Short term - - PowerPoint PPT Presentation

APT TECHNICAL CPD - MAF

SHORT TERM DECISION MAKING

Short term decision making and pricing strategy

Nicholas Riemer Nicholas.Riemer@firstrand.co.za

Agenda

• Workflow to understanding short term decision making and

pricing strategy

• What is short term decision making and pricing strategy?

Generic Problem (theory)

• How to address short term decision making in industries and

APT context?

• How to address short term decision making in industries and

APT context?

• How to incorporate into your file

Workflow Approach

STDM Generic problem

• Objective of FM is maximisation of shareholders

wealth!

• Therefore the objective of all decision making is to

ensure maximisation of shareholders wealth.

• Short term – “non-routine”, “once-off” – so maximise

net cash inflows over short-term!

• Maximise contribution – remember relevant fixed

costs!

Theory of Relevance

• “Cash flow as a result of decision”
• “Difference between status quo and what I am

considering”

• Difference between Qualitative vs. Quantitative

(industry research comes in)

• Relevance and the following concepts:

– Avoidable cost / sunk cost / opportunity cost

Decision making considerations In industries

• Difference between Short-term and long-term decision

making

– LT

• Cash flows (or profit!?) (including all fixed and variable costs as well as

capital expenses)

• The time value of money
• Take risk into account through discount rate

– ST

• Cash flows? All costs? Capital expenses?

– Only costs relevant to the decision – mostly variable (in other words contribution) but could include relevant fixed cost as well as relevant capital expenditure (examples) (Only relevant info)

• Time value of money?

– No!

• Don’t take risk into account – assume certain!

Short Term Decision making

• What is contribution?

– Income from sales minus all variable costs (manufacturing

• r non-manufacturing)

– Recap “Costing” (Decision making vs. inventory valuation)

• Why is contribution so important?

– It indicates the change in “profit” assuming fixed cost does not change – Or it indicates the amount available to cover all fixed costs – If a division doesn’t make profit – should we close down? These are the types of practical applications of the theory.

Short Term Decision making

• Constraints

– What must we do? CULF – Basic principle! Maximisation of shareholders wealth – Qualitative vs. Quantitative.

Short Term Decision making from a practical view

• Types of ST decisions (Amongst others in

industries!):

– Special order / short term pricing

• Approach:

– Identify all variable cost (relevant) plus any relevant fixed cost plus relevant capital expenditure plus any opportunity cost. All these added together will be the minimum price achieving a contribution of zero. Any required contribution will be added to minimum price to determine the short term price – Therefor practically you would research short term contributions being made in that specific industry. – And then try and identify relevant costs in the pre release should this be triggered.

Types of decisions (continued)

– Make or buy decision (outsourcing)

• Approach:

– Determine what the product or service will cost if made by company: » Identify all variable cost plus relevant fixed cost plus relevant capital expenditure plus any opportunity cost and compare to » The cost of buying the product in or outsourcing the service » Should price for outsourcing be required then the cost to manufacture self will be the maximum outsourcing price » Again practical/industry research would be to get an idea

• f what competitors in the market are currently doing?

» Examine the balance sheet to see if assets are on balance sheet to manufacture or if outsourcing fee included in COS

Types of decisions (continued)

– Closing of a business unit or product range

• Approach:

– Which cost will be saved (avoided) over the short term should the unit / product be closed? – What income will be lost over the short term should the unit / product be closed? – The net between above two will indicate the financial implications of the closure (obviously non-financial consideration will have to be considered as well) – Practically, what real life qualitative aspects to be researched? – Labour law issues? – Tax issues ? – Possible accounting issues in segment reporting?

Other important aspects

• Qualitative factors – EXTREMELY NB!!

– Most of these points will come from industry research. – Think all disciplines when examining qualitative aspects – Always qualitative aspects to a decision, never the quantitative answer in isolation.

Pricing decision Generic problem

• Price taker vs. Price setter
• Cost plus vs. target
• Short vs. long-term pricing
• Strategy – Product differentiation.
• Pricing strategies

– Price skimming – Premium pricing – Penetration pricing – Loss leader – Product bundling/optional extras

Pricing decision

• Approaches to pricing:

– Cost (standard or actual?)

• Variable cost
• Absorption cost
• ABC-cost
• Mark up% (ignore demand)

– Target costing

• Selling price (as determined by marketers after market research)
• Required return (what return is required to earn fair rate of return
• n capital)
• Target cost

Building a file for coverage

• My File.
• Theory in terms of the short term decisions needed

summarized on a 1 pager. NB

• Coverage, all questions asked of you labelled for the trigger

in the pre release

• A summarized sheet with the different short term and

pricing decisions available with adv and disadvantages for each.

• The practical/industry information summarized relating to

the above topic

• All the information used for the above attached behind the

summaries for more detailed use when needed.

• All the best!