One of the opportunities managers can take in order to maximise shareholder wealth is to make the “right” decisions at the right time. Managers need to have a developed understand of the past to be able to make decisions which will present the best outcome for the firm in the future. How can accounting help a manager to understand which decisions to make? I am not sure yet. We make decisions every single day – what to wear to work, what to eat for breakfast. I assume that managers make business decisions all the time as well. However, I am led to believe from Martins writing that he is referring to the “big” decisions in a business. What could these big decisions be? Deciding whether to purchase a new item of technology or machinery to product outputs more efficiently? To terminate an employee who does not have the firm’s best interests at heart?
Most decisions require managers to choose where to allocate resource and capital. The manager must weigh up the opportunity costs and ensure they choose the option which will maximise profits because rarely does a firm have unlimited capital and resources. Do any firm ever really have unlimited capital? Being a millennial, my mind automatically shifts to Kylie Jenners make up brand. Kylie Jenner is one of the richest individuals in the world – “Youngest Self-Made Billionaire”. But I still think Kylie Jenner would have some limitations about how much makeup she could produce, how many factories she can afford to have operating and how many products she can afford to produce. Would Kylie Jenner also be limited by the demand for her product? If she had no limitations on resources and capital and continued to produce makeup, wouldn’t her business get to a point where they created surplus product because every person who wanted to purchase the item already has purchased it? Would the products eventually sit on the shelf?
Costs which have been created from decision in the past are known as sunk costs. The idea of sunken costs automatically makes me think of a saying I have come to live by – “You can’t change the past so there is no use worrying about it”. In FINC19011 I learned that past cost should not be considered when deciding to invest in a future project because whether we invest or not, the cost have already been incurred. For example, if I was deciding whether or not to invest in my sisters Macrame business and I had an accountant make some recommendations for me and those recommendations cost me $100, I would not include that $100 in the costing for that project because I have already paid the fee regardless of whether I decide to invest in the project. I wonder if Martin will argue the same point or whether he will agree with my FINC19011 teacher and say that sunken costs are irrelevant.
If a cost can be avoided by selecting one option over another, it would be considered a differential cost. A differential cost is a cost which is not common to all options. I struggle to think of an example of a differential cost in my sisters Macrame business. However, my Mum travels from her home in Cessnock each month to a wholesale cleaning product distributor in Newcastle. When deciding whether to purchase a new vacuum or mop next month, the cost of fuel to travel to Newcastle is common to both decisions so this cost would not be considered when deciding between the two options. However, the cost of biannual vacuum service will only be incurred if the decision to select the vacuum is taken. I don’t think that example quite hits the nail on the head but it is all I can come up with at this stage.
In life we only have a restricted amount of time to accomplish everything we want to do. This idea keeps me up at night. The older I get the faster time seems to be ticking over. Why, as a society, are we not more concerned about our limited time? If we were told the world would end in 12 months, five years or even ten years, I am sure all of our resource would be dedicated to preventing imminent death. However, because we do not know when our time will be up, it is as if we do not have any sense of panic or urgency to get things done. I understand this is the same in business – time is a resource that is constantly depleting. Or is it? Just because we die does not mean that business’ die. Management is just handed onto the next in line. I am not exactly sure of the implications of this concept for business yet.
Product mix decisions involve choosing which amounts of each product to produce or sell when a firm has limited inputs for both options. Martin’s process states that firms must discard any products which have a negative contribution margin and then rate the remaining product by their contribution margin. This makes me wonder why a firm would not just stock the one product with the largest contribution margin? Unless possibly they can produce up to the amount which there is demand for and then switch to the next highest rated product?
Depending on the industry which a firm operates in and their products, some firm’s business requires large capital outlays whereas others only requires small capital investment. This makes me think of my friend who recently became a Tupperware consultant. She tried to convince me to become a consultant as well. However, after she explained that I would have to outlay over $1000 for my “kit”, it was a no for me. The kit is required to host parties as your kit is your demonstration products. For me, $1000 was a huge capital investment when I was only expected to make $30 – $50 per party. I thought to myself “what if I don’t make back the $1000, I have outlaid to start up”. In a previous chapter, Martin argued that the greater the fixed cost of a firm, the greater the risk involved. I wonder if it is similar for capital outlay. Is the greater the initial capital investment, the greater the risk? For example, if the Tupperware kit had only cost $100, I probably would have thought to myself “I will give it a go, all I can lose is $100”.
Decisions about investments with high capital cost would be harder to make than investments with low capital costs. My partner and I are currently thinking about buying a bigger home before we have children. We keep going back and forth about whether it would be the right decision, or will we get ourselves to far in debt that we cannot manage. We are looking at purchase a home for around $650,000 – $750,000 and we will plan to live in this new home for the rest of our lives. I would consider this a long-term large capital investment decision. On the other hand, last year we purchased a jetski for $26,000 which we will probably keep for 3-5 years. This decision was an easier decision, we didn’t even really discuss it. We both knew we wanted the jetski and saved and bought it without too much consideration or worry. Whereas in regard to the purchase of a new home, we are constantly speaking to each other about, talking to our friend and colleagues for advice. I can understand why long-term capital investment decision are important and hard to make – because the risk and consequences can be so much greater.
A dollar today is worth more than a dollar tomorrow because if you invested that dollar today, you could earn interest and it be worth more tomorrow (not much, but it would be). Another factor to be considered is that a dollar today is worth more than a dollar tomorrow because a dollar tomorrow will be “eaten away at” by inflation (very small amount of inflation, but inflation none the less). I have learned about this concept in FINC19011 as well. Before I was introduced to the time value of money, I had never thought of this concept. I thought it was ridiculous, a dollar is a dollar! But I have now come to realise I was wrong. My grandma does not trust the bank. She has told me stories about when she was a young girl, her mother (my great grandma) went to the bank one day to get money and the bank was closed and did not re open. They could not access any of their money. And even when the bank did re open, they did not get their savings back. So, my grandma hides her money in old books. She has thousands of dollars stashed in books on her bookshelf. She has done this as long as can remember. If she had $10,000 in her books back when I was 10 (15 years ago) and she had invested it into the Goal Saver Bank Account Martin discusses, she would have $12,806 today. She should have kept it in the bank – but you can’t tell my grandma that!
The payback period is a method used to asses an investment option. The quicker an investment option recoups the initial capital outlaid for the project, the less risky it is considered to be. For example, if I had of signed up to be a Tupperware consultant my initial investment would have been $1000. If I earned $30 per party and hosted 1 party per month, I would have made $360 per year. If I divide my initial investment by my annual cashflow (1000/360) I can calculate that it would take me 2.78 years to recoup my initial outlay meaning my payback period would be 2.78 years. I think 2.78 years is a lengthy amount of time to have to recoup my investment for a side hustle. Plus it means that I would have to work for 2.78 years before I could even start “making money”.
NPV is a method of calculating the value which is added to a firm by accepting an investment opportunity or project. NPV provides a dollar figure calculated by discounting the future cash flows of the project. Reading about this I wonder where do you draw the line for future cashflow? Can’t an investment have unlimited future cashflows? Do you limit the cashflows to a certain time frame, such as the first five years? I look forward to seeing an example of this concept, I usually understand these concepts better once I have seen them demonstrated.
The DCF method discounts future cash flows to appease the time value of money law. However, using the DCF method has one major drawback. Eventually all figures, no matter how large, if discounted far back enough will become nothing. This cannot be true I don’t believe; I don’t think that any amount of money can become nothing – Its value may become small but it must still have some value I would think.
The “what the hell” decision in my experience is usually a risker decision but one I make with great optimism and bravery. I don’t think a have ever truly made a decision with complete disregard and I don’t think Marilyn Munroe did either. I think saying “What the hell” just makes us braver to make decisions we have weighed up, stewed over and contemplated. Most of my “what the hell” decision have been me “following my heart” rather than my “head”. Saying “what the hell” is like giving myself permission to be a little bit reckless. I can’t imagine a manager being even a little bit reckless in business. Although, at my work we do have one landlord who is a self-made millionaire, with over 40 investment properties. My boss always says this landlord “had the balls to take a risk and it paid off”. Maybe the most successful business people, have been the bravest? Maybe you only really ever get ahead by making the decisions everyone else was too scared to make?
No decision is ever just about the numbers because in the foundations of firms are people. People with emotions who sometimes “follow their heart” or their “gut”. While accounting can give managers of a firm all the support and facts, they need to make a decision, the numbers cannot make the decision for the manager. I wonder if I will be good at making business decisions? I hope so.
Make it Account 