Decision Making
What Is Decision Making ?
Decision-making is the act or process of selecting a course of action from multiple alternatives, particularly in situations where choices must be made based on certain criteria or preferences. It involves cognitive processes that lead to the selection of a belief or action among various possible options. This process can be rational, relying on logical reasoning and analysis, or it can be influenced by emotions and biases, leading to more intuitive or even irrational choices.
Almost everything we do in life results from choosing between alternatives, and the choices we make result in different consequences.Whether we know it or not decision making is a part of our every day life.
Some Personal Examples:
- What are we having for dinner ?
- Do we rent or buy a house ?
- Do we need a new car ?
- What clothes to wear today ?
- Stay in or go party ?
Almost every aspect of being in business involves making decisions and choosing between alternatives, and each alternative typically has one or more consequences. Understanding how businesses make decisions paves the way not only to better decision-making processes but potentially to better outcomes.
Decisions made by businesses can have short-term effects or long-term impacts, or in some situations, both. Short-term decisions often address a temporary circumstance or an immediate need while long-term decisions align more with permanent problem solving and meeting strategic goals. These two types of decisions require different types of analyses and different types of accounting and non-accounting information.
What is considered short-term and what is considered long-term?
Accounting distinguishes between short-term and long-term decisions not only because of the difference in the general nature of these decisions but also because the types of analyses differ significantly between short-term and long-term decision categories. As the time horizon over which the decision will have an impact expands, more costs become relevant to the decision-making process. In addition, when a time element is considered, there will be additional factors such as interest (paid or received) that will have a greater influence on decisions. The table below provides examples of short-term and long-term business decisions.
Examples of Short-Term and Long-Term Business Decisions
Short Term
- Accepting a special production order
- Determining the best product mix from current products
- Outsourcing a part or service
- Further processing or refining a current product
- Pricing
- Add or Discontinue Decisions-Product or Product Line
Long Term
- Buying new equipment versus repairing-upgrading old equipment
- Choosing which products to manufacture
- Expanding the business including new locations, stores, plants, and equipment
- Diversifying by buying another business
The process of decision-making in a managerial business environment can be summed up in these steps:
- Identify the objective or goal. For a business, typically the goal is to maximise revenues or minimise costs.
- Collecting relevant data and understanding the context surrounding the decision.
- Identify alternative courses of action that can achieve the goal or address an obstacle that is hindering goal achievement.
- Perform a comprehensive analysis of potential solutions. This includes identifying revenues, costs, benefits, and other financial and qualitative variables.
- Decide, based upon the analysis, the best course of action.
- Implementing the chosen alternative.
- Review, analyse, and evaluate the results of the decision.
In carrying out step four of the managerial decision-making process, analyzing the alternatives, tools used include differential analysis for short term decisions and capital budgeting for long term decisions.
In addition to the decisions discussed above, a business also has to deal with its normal routine decisions such as managing cash, customers, sales, suppliers, employees, and inventory to name a few which also have tools for aiding in the decisions.
A rule to keep in mind to aid in these decisions is the Pareto Principle, or 80/20 rule, which states that about 80% of the consequences result from 20% of the causes. This concept can be used by businesses to focus their efforts on the most crucial areas that produce the best results. By identifying and ranking the crucial components that are most crucial to success, businesses can optimize their impact and resources. An example of the use of this rule can be used when analyzing sales.This rule implies that 20% of a company's clients account for 80% of its sales or that 20% of its goods or services generate 80% of its revenues.