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Definition of Outsourcing

Outsourcing Image 1


The process of shifting a function previously performed internally
to a supplier who is responsible to the company for its ongoing operations and


the use, by one company, of an external
provider of a service or manufacturer of a component

Related Terms:

outsourcing decision

see make-or-buy decision

contract manufacturer

an external party that has been granted an outsourcing contract to produce a part or component for an entity

contract vendor

an external party that has been granted an
outsourcing contract to provide a service activity for an entity

core competency

a higher proficiency relative to competitors
in a critical function or activity; a root of competitiveness
and competitive advantage; anything that is not a
core competency is a viable candidate for outsourcing

make-or-buy decision

a decision that compares the cost of
internally manufacturing a component of a final product
(or providing a service function) with the cost of purchasing
it from outside suppliers (outsourcing) or from another
division of the company at a specified transfer price

Outright rate

Actual forward rate expressed in dollars per currency unit, or vice versa.
he practice of purchasing a significant percentage of intermediate components from outside suppliers.

Outsourcing Image 2

third-party logistics

outsourcing of the moving and warehousing
of finished goods between manufacturer and merchant
and sometimes back to the manufacturer

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

capital budgeting decision

decision as to which real assets the firm should acquire.

decision making

the process of choosing among the alternative
solutions available to a course of action or a problem

Decision tree

Method of representing alternative sequential decisions and the possible outcomes from these decisions.

decision tree

Diagram of sequential decisions and possible outcomes.

decision variable

an unknown item for which a linear programming
problem is being solved

financing decision

a judgment made regarding the method
of raising funds that will be used to make acquisitions; it
is based on an entity’s ability to issue and service debt and
equity securities

financing decision

decision as to how to raise the money to pay for investments in real assets.

Outsourcing Image 1

Financing decisions

decisions concerning the liabilities and stockholders' equity side of the firm's balance
sheet, such as the decision to issue bonds.

investment decision

a judgment about which assets will be
acquired by an entity to achieve its stated objectives

Investment decisions

decisions concerning the asset side of a firm's balance sheet, such as the decision to
offer a new product.

make-or-buy decision

a decision that compares the cost of
internally manufacturing a component of a final product
(or providing a service function) with the cost of purchasing
it from outside suppliers (outsourcing) or from another
division of the company at a specified transfer price

Managerial decisions

decisions concerning the operation of the firm, such as the choice of firm size, firm
growth rates, and employee compensation.

Mutually exclusive investment decisions

Investment decisions in which the acceptance of a project
precludes the acceptance of one or more alternative projects.

preference decision

the second decision made in capital project evaluation in which projects are ranked according to their impact on the achievement of company objectives

screening decision

the first decision made in evaluating capital
projects; it indicates whether a project is desirable based
on some previously established minimum criterion or criteria
(see also preference decision)

Security selection decision

Choosing the particular securities to include in a portfolio.

special order decision

a situation in which management must determine a sales price to charge for manufacturing or service jobs outside the company’s normal production/service market


A broad, all-inclusive term that refers to the methods and procedures
of financial record keeping by a business (or any entity); it also
refers to the main functions and purposes of record keeping, which are
to assist in the operations of the entity, to provide necessary information
to managers for making decisions and exercising control, to measure
profit, to comply with income and other tax laws, and to prepare financial

Outsourcing Image 2

Adjusted present value (APV)

The net present value analysis of an asset if financed solely by equity
(present value of un-levered cash flows), plus the present value of any financing decisions (levered cash
flows). In other words, the various tax shields provided by the deductibility of interest and the benefits of
other investment tax credits are calculated separately. This analysis is often used for highly leveraged
transactions such as a leverage buy-out.

Agency costs

The incremental costs of having an agent make decisions for a principal.


The decision-maker in a principal-agent relationship.

Avoidable costs

Costs that are identifiable with and able to be influenced by decisions made at the business
unit (e.g. division) level.

business intelligence (BI) system

a formal process for gathering and analyzing information and producing intelligence to meet decision making needs; requires information about
internal processes as well as knowledge, technologies, and competitors

Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.

Capital budgeting

The series of steps one follows when justifying the decision to purchase
an asset, usually including an analysis of costs and related benefits, which
should include a discounted cash flow analysis of the stream of all future cash flows
resulting from the purchase of the asset.

capital investment analysis

Refers to various techniques and procedures
used to determine or to analyze future returns from an investment
of capital in order to evaluate the capital recovery pattern and the
periodic earnings from the investment. The two basic tools for capital
investment analysis are (1) spreadsheet models (which I strongly prefer)
and (2) mathematical equations for calculating the present value or
internal rate of return of an investment. Mathematical methods suffer
from a lack of information that the decision maker ought to consider. A
spreadsheet model supplies all the needed information and has other
advantages as well.


a management style that exists when top management
makes most decisions and controls most activities
of the organizational units from the company’s central headquarters

Contribution margin

The margin that results when variable production costs are subtracted
from revenue. It is most useful for making incremental pricing decisions
where a company must cover its variable costs, though perhaps not all of its fixed

Corporate finance

One of the three areas of the discipline of finance. It deals with the operation of the firm
(both the investment decision and the financing decision) from that firm's point of view.

Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.

costs of financial distress

Costs arising from bankruptcy or distorted business decisions before bankruptcy.


bits of knowledge or facts that have not been summarized
or categorized in a manner useful to a decision maker


a management style that exists when top
management grants subordinate managers a significant degree
of autonomy and independence in operating and making
decisions for their organizational units

Discounted payback period rule

An investment decision rule in which the cash flows are discounted at an
interest rate and the payback rule is applied on these discounted cash flows.

discretionary cost

a cost that is periodically reviewed by a
decision maker in a process of determining whether it continues
to be in accord with ongoing policies; a cost that
arises from a management decision to fund an activity at
a specified cost amount for a specified period of time, generally
one year; a cost that can be reduced to zero in the
short run if necessity so dictates

Expected future cash flows

Projected future cash flows associated with an asset of decision.

Federal Open Market Committee (FOMC)

Fed committee that makes decisions about open-market operations.


A discipline concerned with determining value and making decisions. The finance function allocates
resources, which includes acquiring, investing, and managing resources.

Financial planning

The process of evaluating the investing and financing options available to a firm. It
includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in
the form of a financial plan, and then comparing future performance against that plan.

financial reports and statements

Financial means having to do with
money and economic wealth. Statement means a formal presentation.
Financial reports are printed and a copy is sent to each owner and each
major lender of the business. Most public corporations make their financial
reports available on a web site, so all or part of the financial report
can be downloaded by anyone. Businesses prepare three primary financial
statements: the statement of financial condition, or balance sheet;
the statement of cash flows; and the income statement. These three key
financial statements constitute the core of the periodic financial reports
that are distributed outside a business to its shareowners and lenders.
Financial reports also include footnotes to the financial statements and
much other information. Financial statements are prepared according to
generally accepted accounting principles (GAAP), which are the authoritative
rules that govern the measurement of net income and the reporting
of profit-making activities, financial condition, and cash flows.
Internal financial statements, although based on the same profit
accounting methods, report more information to managers for decision
making and control. Sometimes, financial statements are called simply

Fixed-exchange rate

A country's decision to tie the value of its currency to another country's currency, gold
(or another commodity), or a basket of currencies.

Floating exchange rate

A country's decision to allow its currency value to freely change. The currency is not
constrained by central bank intervention and does not have to maintain its relationship with another currency
in a narrow band. The currency value is determined by trading in the foreign exchange market.

goal congruence

a circumstance in which the personal and
organizational goals of decision makers throughout a firm
are consistent and mutually supportive

gross margin, or gross profit

This first-line measure of profit
equals sales revenue less cost of goods sold. This is profit before operating
expenses and interest and income tax expenses are deducted. Financial
reporting standards require that gross margin be reported in
external income statements. Gross margin is a key variable in management
profit reports for decision making and control. Gross margin
doesn’t apply to service businesses that don’t sell products.

incremental analysis

a process of evaluating changes that
focuses only on the factors that differ from one course of
action or decision to another

input-output coefficient

a number (prefaced as a multiplier
to an unknown variable) that indicates the rate at which each
decision variable uses up (or depletes) the scarce resource


As a discipline, the study of financial securities, such as stocks and bonds, from the investor's
viewpoint. This area deals with the firm's financing decision, but from the other side of the transaction.

judgmental method (of risk adjustment)

an informal method of adjusting for risk that allows the decision maker
to use logic and reason to decide whether a project provides
an acceptable rate of return

Lending Policy

A course of action adopted by a financial institution to guide and usually determine present and future decisions in the light of given conditions.

Management accounting

The production of financial and non-financial information used in planning for the future; making decisions about products, services, prices and what costs to incur; and ensuring that plans are implemented and achieved.

management control

This is difficult to define in a few words—indeed, an
entire chapter is devoted to the topic (Chapter 17). The essence of management
control is “keeping a close watch on everything.” Anything can
go wrong and get out of control. Management control can be thought of
as the follow-through on decisions to ensure that the actual outcomes
happen according to purposes and goals of the management decisions
that set things in motion. Managers depend on feedback control reports
that contain very detailed information. The level of detail and range of
information in these control reports is very different from the summarylevel
information reported in external income statements.

management information system (MIS)

a structure of interrelated elements that collects, organizes, and communicates
data to managers so they may plan, control, evaluate
performance, and make decisions; the emphasis of the
MIS is on internal demands for information rather than external
demands; some or all of the MIS may be computerized
for ease of access to information, reliability of input
and processing, and ability to simulate outcomes of
alternative situations

management style

the preference of a manager in how he/she interacts with other stakeholders in the organization;
it influences the way the firm engages in transactions and
is manifested in managerial decisions, interpersonal and
interorganizational relationships, and resource allocations


A characterization of the magnitude of a financial statement item's effect on a
company's overall financial condition and performance. An item is material when its size is
likely to influence decisions of investors or creditors.


The study of firm and individual decisions insofar as they affect the allocation and distribution of goods and services.

Operational Earnings Management

Management actions taken in the effort to create stable
financial performance by acceptable, voluntary business decisions. An example: a special discount
promotion to increase flagging sales near the end of a quarter when targets are not being met.

Opportunity cost

Lost revenue that would otherwise have been realized if a different
decision point had been selected.

organizational structure

the manner in which authority and
responsibility for decision making is distributed in an entity

participatory budget

a budget that has been developed
through a process of joint decision making by top management
and operating personnel

Perfect market view (of capital structure)

Analysis of a firm's capital structure decision, which shows the
irrelevance of capital structure in a perfect capital market.

Perfect market view (of dividend policy)

Analysis of a decision on dividend policy, in a perfect capital
market environment, that shows the irrelevance of dividend policy in a perfect capital market.

performance management system

a system reflecting the entire package of decisions regarding performance measurement and evaluation


A set of procedures for evaluating a capital budgeting decision after the fact.

Posttrade benchmarks

Prices after the decision to trade.

Pre-trade benchmarks

Prices occurring before or at the decision to trade.


1) The total amount of money being borrowed or lent.
2) The party affected by agent decisions in a principal-agent relationship.

profit module

This concept refers to a separate source of revenue and
profit within a business organization, which should be identified for
management analysis and control. A profit module may focus on one
product or a cluster of products. Profit in this context is not the final, bottom-
line net income of the business as a whole. Rather, other measures
of profit are used for management analysis and decision-making purposes—
such as gross margin, contribution margin, or operating profit
(earnings before interest and income tax).


Formal written document to sell securities that describes the plan for a proposed business
enterprise, or the facts concerning an existing one, that an investor needs to make an informed decision.
Prospectuses are used by mutual funds to describe the fund objectives, risks and other essential information.

Randomized strategy

A strategy of introducing into the decision-making process a random element that is
designed to reduce the information content of the decision-maker's observed choices.

Relevant cost

The cost that is relevant to a particular decision – future, incremental cash flows.

relevant cost

a cost that is logically associated with a specific problem or decision

relevant costing

a process that compares, to the extent possible
and practical, the incremental revenues and incremental costs of alternative decisions

Replacement-chain problem

Idea that future replacement decisions must be taken into account in selecting
among projects.

revenue-driven expenses

Operating expenses that vary in proportion to
changes in total sales revenue (total dollars of sales). Examples are sales
commissions based on sales revenue, credit card discount expenses, and
rents and franchise fees based on sales revenue. These expenses are one
of the key variables in a profit model. Segregating these expenses from
other types of expenses that behave differently is essential for management
decision-making analysis. (These expenses are not disclosed separately
in externally reported income statements.)

risk-adjusted discount rate method

a formal method of adjusting for risk in which the decision maker increases the rate used for discounting the future cash flows to compensate for increased risk

Section 83(b) Election

The decision by an employee to recognize taxable income
on the purchase price of an incentive stock option within 30 days following
the date when an option is exercised and withhold taxes at the ordinary
income tax rate at that time.

Security market line

Line representing the relationship between expected return and market risk.
Security market plane A plane that shows the equilibrium between expected return and the beta coefficient
of more than one factor.
Security selection
See: security selection decision.

sensitivity analysis

a process of determining the amount of change that must occur in a variable before a different decision would be made

Short-run operating activities

Events and decisions concerning the short-term finance of a firm, such as
how much inventory to order and whether to offer cash terms or credit terms to customers.

Standard costs

A budget cost for materials and labour used for decision-making, usually expressed as a per unit cost that is applied to standard quantities from a bill of materials and to standard times from a

sunk cost

A cost that has been paid and cannot be undone or reversed.
Once the cost has been paid, it is irretrievable, like water over the dam
or spilled milk. Usually, the term refers to the recorded value of an asset
that has lost its value in the operating activities of a business. Examples
are the costs of products in inventory that cannot be sold and fixed
assets that are no longer usable. The book value of these assets should
be written off to expense. These costs should be disregarded in making
decisions about what to do with the assets (except that the income tax
effects of disposing of the assets should be taken into account).

Tobin's Q

Market value of assets divided by replacement value of assets. A Tobin's Q ratio greater than 1
indicates the firm has done well with its investment decisions.

Top-down equity management style

A management style that begins with an assessment of the overall
economic environment and makes a general asset allocation decision regarding various sectors of the financial
markets and various industries. The bottom-up manager, in contrast, selects the specific securities within the
favored sectors.

unit-driven expenses

Expenses that vary in close proportion to changes
in total sales volume (total quantities of sales). Examples of these types of
expenses are delivery costs, packaging costs, and other costs that depend
mainly on the number of products sold or the number of customers
served. These expenses are one of the key factors in a profit model for
decision-making analysis. Segregating these expenses from other types
of expenses that behave differently is essential for management decisionmaking
analysis. The cost-of-goods-sold expense depends on sales volume
and is a unit-driven expense. But product cost (i.e., the cost of
goods sold) is such a dominant expense that it is treated separately from
other unit-driven operating expenses.

unit margin

The profit per unit sold of a product after deducting product
cost and variable expenses of selling the product from the sales price of
the product. Unit margin equals profit before fixed operating expenses
are considered and before interest and income tax are deducted. Unit
margin is one of the key variables in a profit model for decision-making

vision statement

a written expression about the organization’s
future upon which all company personnel can base
their decisions and behavior so that everyone is working
toward the same long-run results







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