How to Determine Costs & Make Decisions

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  • 0:04 Making Decisions,…
  • 0:37 Product Lines and…
  • 1:16 Outsourcing
  • 1:53 Using a Constrained Resource
  • 2:50 Joint Product Costs
  • 3:40 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Determining costs and making decisions are the most important jobs of a manager. In this lesson, we see just how linked the two practices are for businesses of all sizes.

Making Decisions, Determining Costs

Businesses are constantly under pressure to make the best decisions possible. However, there is never a shortage of decisions to be made. From deciding whether or not to continue a product line to deciding how to treat a joint product, companies are constantly trying to make sure that they are maximizing profits while minimizing costs.

This lesson will examine decisions regarding starting or stopping production on a good, outsourcing, using a constrained resource, and understanding how joint product costs can help companies make even more money.

Product Lines and Special Orders

A crucial rule of business is that a company can only be expected to offer a product line if it is profitable. Depending on the stage of the product, this could mean different things. For a product that is just being introduced, the money made from its sale should be enough to cover variable costs, fixed costs, and make a profit.

Meanwhile, if a good has been sold for a while and is facing discontinuation, a company should keep it around only if its sales price is greater than variable costs. That means that it is still contributing money towards fixed costs and profits.

Finally, special orders should be treated like new product lines; they should only be pursued if they are profitable.

Outsourcing

Another decision that is driven by a desire to save money is whether to outsource, or allow another company to perform one of your business functions. Here, the analysis is pretty simple: can you save money by having someone else do it all for you?

Distribution is often outsourced. After all, many of us look for only a small number of companies to deliver our packages. Some companies have their own delivery trucks, and this is profitable for them to do so. However, for many companies, the costs of maintaining warehouses, distribution centers, and trucks is simply too much. Instead, they find it cheaper to outsource these tasks.

Using a Constrained Resource

Let's say that you run an ice cream truck. It's the middle of summer, and freezer space on board is limited. In this instance, space is a constrained resource, because it is limited in availability. Of course, your ice cream varieties have different variable costs and take up different amounts of space in your truck. For example, a box of twelve ice cream sandwiches takes up half the room as a box of twelve ice cream tacos, yet while you can make a profit of $1.00 per ice cream sandwich, you can make $2.50 per ice cream taco.

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