Making business decisions
Businesses make decisions using the information that they have available. It is important to ensure that any information used is:
- accurate
- sufficient
- up to date
Accurate
Information used to make decisions needs to be accurate and complete. Inaccurate or incomplete information is likely to lead to incorrect business decisions being made. The consequences of this could be serious, potentially leading to a business failing.
Sufficient
One set of data, particularly financial data, can be meaningless unless put into context. This might mean comparing it with historical data or data from similar businesses. This is particularly true for seasonal goodsCommodities that are sold to make a profit. and servicesA number of activities that serve the general public for different purposes e.g. restaurants and cinemas., such as ice cream, where comparing sales in the summer months against sales in the winter months would not give a realistic growth figure for the business.
Up to date
Information needs to be kept up to date to ensure that it remains relevant. It is not just the passing of time that makes information go out of date. Any significant changes in the market can make data less useful. For example, the emergence of a new competitor would make historical market share data less useful.
Other limitations
Even when the information used to make decisions is accurate, sufficient and up to date, the way that such information is used may have limitations. For example, the average rate of returnA method of comparing the profitability of different choices over the expected life of an investment. is often used to help a business make decisions by comparing the profitability of different investment options. However, this technique does not consider the effects of inflation on the value of cash. For example:
| Project A | Project B | |
| Cost of project | £10,000 | £10,000 |
| Additional profit in year 1 | £8,000 | £4,000 |
| Additional profit in year 2 | £4,000 | £8,000 |
| Total additional profit | £12,000 | £12,000 |
| Cost of project | |
| Project A | £10,000 |
| Project B | £10,000 |
| Additional profit in year 1 | |
| Project A | £8,000 |
| Project B | £4,000 |
| Additional profit in year 2 | |
| Project A | £4,000 |
| Project B | £8,000 |
| Total additional profit | |
| Project A | £12,000 |
| Project B | £12,000 |
The average rate of return for each option would be calculated as:
| Project A | Project B | |
| Average annual profit = | £12,000 ÷ 2 = £6,000 | £12,000 ÷ 2 = £6,000 |
| Average rate of return = | (£6,000 ÷ £10,000) × 100 = 60% | (£6,000 ÷ £10,000) × 100 = 60% |
| Average annual profit = | |
| Project A | £12,000 ÷ 2 = £6,000 |
| Project B | £12,000 ÷ 2 = £6,000 |
| Average rate of return = | |
| Project A | (£6,000 ÷ £10,000) × 100 = 60% |
| Project B | (£6,000 ÷ £10,000) × 100 = 60% |
In this example, the average rate of return is the same, so the technique shows no difference between these two investment projects. However, in project A, £8,000 additional profit is made in year 1 compared to £4,000 in project B. This is an important difference because of the effect of inflation. If inflation between year 1 and year 2 were 10%, then supplies that cost £8,000 in year 1 would cost 10% more in year 2. For example, in order to buy £8,000 worth of products in year 2, the business would need £8,800. As such, receiving larger amounts of returns sooner is better for a business, yet average rate of return does not take this into account.