Make or Buy Decisions in Cost Accounting | Explained with Example and Analysis
1. What Are Make or Buy Decisions?
➡️ These are decisions where a company decides whether to manufacture a product internally or buy it from an external supplier.
🔁 Why Is It Important?
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Helps in cost-saving
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Impacts employee retention
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Affects factory efficiency
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Useful during expansion or cost-cutting
🎯 2. Situations That Call for Make or Buy Decisions
✅ When the company is already making a product
✅ But the same product is available in the market at a cheaper price
✅ Need to evaluate:
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Is buying cheaper in the long run?
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Can we maintain quality & supply?
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Are there hidden costs in outsourcing?
📌 3. Key Factors to Consider Beyond Cost
| 🔎 Factor | 📋 Description |
|---|---|
| ✅ Quality | Is the external quality matching internal standards? |
| 🔁 Consistency of Supply | Can the vendor deliver regularly without delays? |
| 📉 Demand Fluctuation | Can the supplier adjust during high/low demand periods? |
| 🔐 Confidentiality | If the product involves a secret design or process, it must be made in-house |
| 🤝 Supplier Reliability | Is the supplier trustworthy and sustainable? |
🧠 4. Numerical Illustration
A company is considering whether to buy an item or continue making it internally.
📊 Given Data:
| Particulars | Buy (Rs.) | Make (Rs.) |
|---|---|---|
| Sales | 16,00,000 | 16,00,000 |
| Variable Cost | 11,20,000 | 10,24,000 |
| Fixed Cost | 3,60,000 | 4,00,000 |
| Capital Required | 8,00,000 | 9,00,000 |
📑 5. Statement of Cost & Profitability
| 🔹 Particulars | Buy (Rs.) | Make (Rs.) |
|---|---|---|
| Sales | 16,00,000 | 16,00,000 |
| – Variable Cost | 11,20,000 | 10,24,000 |
| ✅ Contribution | 4,80,000 | 5,76,000 |
| – Fixed Cost | 3,60,000 | 4,00,000 |
| ✅ Profit | 1,20,000 | 1,76,000 |
| 🔁 P/V Ratio (C ÷ S × 100) | 30% | 36% |
| 💰 Profit on Sales (P ÷ S × 100) | 7.5% | 11% |
| 📈 ROI (P ÷ Capital × 100) | 15% | 19.6% |
✅ 6. Decision & Analysis
🟩 Making the item in-house is better, because:
➡️ Profit increases by ₹56,000
➡️ P/V Ratio improves by 6%
➡️ Profit Margin on sales increases by 3.5%
➡️ Return on Capital Employed increases by 4.6%
💡 Conclusion: Despite a slight increase in fixed costs, making the product internally results in better financial performance.
🧷 7. Summary Table
| ✅ Aspect Evaluated | 🔍 Best Option |
|---|---|
| Cost Savings | ✅ Make |
| Profitability | ✅ Make |
| P/V Ratio & ROI | ✅ Make |
| Confidential Design Needed | ✅ Make |
| Market Price Cheaper Only | ❌ Buy (but analyze other factors) |
🧾 8. Final Thought
📌 Make or Buy is not just a cost comparison — it’s a strategic decision that considers quality, secrecy, reliability, and long-term value.