Managers make lots of short-term decisions. We will begin looking at how managers make decisions and how to determine if information gathered is relevant to the process.
The decision making process
When managers make decisions, they go through a five step process. We may not even be aware that we are actually going through these steps as we make decisions. You have probably unconsciously gone through this process in your own decision making.
1. Define the goal
Whenever we made decisions, there is a goal. The goal can be something simple like “I’m hungry and need to eat something for lunch.” Whenever you are making decisions, there is a goal in mind. The more fully you can define the goal, the better you will be at gathering information later on. If you are hungry and want to decide what to eat for lunch, perhaps you add healthy to the goal. Not just a lunch, but you want to have a healthy lunch.
2. Identify alternative courses of action
You have a solid goal, now it’s time to figure out your alternatives. Let’s use our lunch example. What are some healthy options for lunch? You could eat at home or at the school dining commons. You could go out to eat. If you went out to eat, where could you go? A sit down restaurant is one option. Fast food is another. At this stage we are not assessing the alternatives. Identify the alternative courses of action that appear to fit your goal.
3. Gather and analyze information
In step 2, we didn’t think a lot about the alternatives, other than just identifying them. In step 3, we begin to gather information.
If you ate in the dining commons, it would be free (if you have a meal plan). There are lots of choices, hopefully some of them are healthy. They have a salad bar and you are really craving salad and an iced tea. If you went to the dining commons, you would probably run into some of your friends.
The sit down restaurant also has a salad bar and iced tea. The trip would cost you about $15 including tip. Since the restaurant is a bit expensive, it would be difficult to convince a friend to go with you.
The fast food restaurant doesn’t have very good salad options but does have iced tea. Since you want a salad, you decide to remove the fast food restaurant from your alternatives.
Therefore, we are left with two alternatives: Salad bar and iced tea at the dining commons with friends or salad bar and iced tea at a sit down restaurant alone.
As we start to analyze the information, you might notice that there are some things in common between our two alternatives. The meal and beverage are the same under both of the alternatives. When information is the same among all alternatives, that information is irrelevant to the decision being made. They are irrelevant because they will not change which alternative you choose. Irrelevant information should be removed from the information you use to make your decision. Therefore, we need to remake our chart.
Now, all we are left with is the relevant information. Relevant information has two key characteristics:
- It differs among the alternatives
- It happens in the future
Many times, when we are making decisions, we think about things that happened in the past. Maybe yesterday you had fast food for lunch and you didn’t feel great about it afterward. Is that relevant to where you are going to go for lunch today? No. Costs that happened in the past are called sunk costs and are not relevant to the decision you are making now.
Only consider the relevant information when making decisions. It will allow you to consider less information and help speed up the decision making process.
4. Choose the best alternative
Sometimes choosing the best alternative is not easy. We cannot just rely on the numbers. We must also consider the qualitative information. Qualitative information is information outside the scope of dollars and cents. There are always other factors that should be considered that cannot be measured. For example, maybe you have a test this afternoon and really need some time to study. Driving to the restaurant would eat up some of your studying time but going to the dining commons means a loud environment and it might be hard to study with your friends at the table. It might be worth losing a few minutes driving and spending $15 to have some quiet time to study.
When making actual decisions, heavily weigh the quantitative factors. If the two alternatives are close, don’t forget to weigh the qualitative factors as well.
5. Implement the alternative
Once you have made your decision, now is the time to implement it. In this case, go to lunch. In most business decisions, implementation is not that easy. Take the steps necessary to put the alternative chosen into action.
One final step
Well done! You’ve made your decision and implemented it. There is one final step that should be taken after your alternative has been put into action. The last step deals with the controlling aspect of managerial accounting. Once your plan has been implemented, you need to review your decision. The review process includes determining if the alternative chosen was the right one and if all of the assumptions made during the decision making process were accurate. You cannot be a successful manager if you do not follow-up after the fact to determine if the choice you made was the right one.