Analyzing Costs

Learning Objectives

  • Summarize the concept of different costs analyzed for different purposes

So what matters in one decision, may make no difference at all in another decision. As a manager, you will have the opportunity to make many decisions.

Let’s watch some examples:

Now, you can see, that what may be relevant in one decision, will not be in another. We need to use our skills we have been working on throughout this course to determine whether a particular cost matters when we are looking at different decisions.

You will need different costs for different purposes. But how will you decide which ones are relevant? Every time you come to a new situation, it will be important to evaluate, to get those irrelevant costs, that may cloud your decision making skills, out of the way.

Let’s practice identifying relevant costs. Are you ready? Let’s say you’re taking a fishing trip to Canada and you’re deciding whether it’s better to drive your own car or to fly and ship your fishing equipment. What would we need to look at to determine which made more sense? Might there be other costs besides the actual monetary costs?

  • Car: Gas, insurance, maintenance and repairs, and depreciation
  • Fly: Cost of the ticket, plus the cost of shipping the fishing stuff.

Which costs do we need to worry about? Well, the flying, both costs are relevant. If we fly, those happen. But what about the car? Well, what costs would happen  whether we drive to Canada or not? The insurance is gonna happen, whether we drive or fly, right? So that cost is irrelevant! We could figure out the exact amount of depreciation and repairs related to the miles we would be driving to Canada, and factor those in as well while working on that decision.

What might a non-monetary (qualitative) cost be to driving? The hours it takes to get there, as opposed to the flight? If you fly, you will get more time to fish. So even if driving is cheaper, you might decide to fly, right? The quality of the trip may be improved by flying.

So what is the take-away here?

Every single decision you need to make as a manager, will require you to analyze the costs, decide which ones are relevant or irrelevant, and then analyze the remaining costs, including the non-monetary (qualitative) ones and come to a conclusion.

We, as managers, need to look at the total cost, then decide what the differential costs are. We then need to reconcile those two sets of costs, to come to the best decision in a given situation.

Are you ready to take on that challenge?

Practice Questions