A make or buy decision compares avoidable internal cash costs with fully landed outside costs and any feasible alternative contribution from released capacity. Finish with a sourcing bridge, a supplier quote ceiling and a zero-redeployment check.
Updated: 29 October 2026.
Define the output before comparing the source
A make or buy decision compares producing a required component internally with purchasing the same acceptable output. Start with the requirement, not the accounting cost per unit. Your useful result is a reproducible change in future cash costs and a maximum supplier quote under explicit capacity assumptions.
Our exercise requires one hundred usable components within one month. Either make all of them or buy all of them. There is no partial outsourcing, new equipment purchase or staff dismissal in the model. Revenue from the main finished product stays identical, so including it in both columns would not change the difference.
Every number is a fictional teaching input. None is a supplier price, Anar client case or measured business improvement. Arithmetic was executed separately; no manufacturing, supplier inspection or desktop save-and-reopen test occurred. The supplier comparison addresses two outside offers. This exercise adds the genuinely different alternative of internal production.
Freeze the month, yield and avoidable payments
Both sources must deliver one hundred accepted whole units to the same specification and deadline. For this exercise, internal yield is one hundred percent and the outside supplier delivers one hundred acceptable units without replacements. If your actual process loses units, rebuild input quantities rather than comparing a hundred raw units with a hundred usable ones.
This is a short-horizon nominal cash comparison without discounting. All figures use the same currency and tax basis, with no differential tax or exchange effect. Material payment dates, financing and longer-term contract consequences are outside this particular model. A different horizon can change which costs are avoidable.
| Internal payment for the required batch | Amount |
|---|---|
| Materials | 400 |
| Labor payable only if this batch is made | 300 |
| Variable energy and consumables | 100 |
| Batch preparation payable only for making | 100 |
| Allocated fixed expense remaining under both choices | 300 |
The labor line is additional paid work that disappears when the batch is purchased. It is not an existing monthly salary that remains payable. The preparation payment is also wholly avoidable within this month. Test those conditions in actual agreements before describing an accounting line as a saving.
ACCA’s relevant-cost discussion separates decision-dependent future cash flows. OpenStax considers both cost and operational conditions in make-or-buy decisions. These sources support the approach, not our invented amounts or the reliability of an actual outside supplier. Keep the numerical example separate from verified commercial evidence.
Calculate both cash paths without deleting common overhead
Making requires 400 + 300 + 100 + 100 = 900 of avoidable future payments. The allocated fixed expense of 300 continues whichever source is chosen. Exclude it from the difference, or add it to both columns. Do not charge it only to making and pretend purchasing eliminates the payment.
Past equipment purchase spending and its accounting carrying value do not change in this exercise. Neither is a new cash outflow caused by today’s sourcing choice. No machine sale or rental receipt is assumed. The repair-or-replace comparison handles a different decision about an existing asset and its disposal alternatives.
The fictional supplier quote is 9 per accepted component. Buying one hundred costs 900, plus a single freight payment of 50 and incremental receiving inspection of 50. Fully landed outside cash cost is therefore 1,000. There are explicitly no other setup, transition, rejection or return charges in this model. Missing real charges must remain unresolved, not become zeros.
With no useful alternative for the released capacity, making at 900 requires 100 less than buying at 1,000. This is our zero-redeployment scenario, not the final answer for every workshop. The profit-margin guide concerns other measures; neither this payment difference nor the contribution below is automatically net profit.
Can released capacity support a specific alternative?
Making the required batch occupies two hundred minutes on one scarce machine. Buying releases those same minutes during the same month. The exercise explicitly supplies alternative demand for forty whole units of another item. Each uses five minutes on that very machine. There are no other resource, staffing, setup or timing restrictions in this small scenario.
Forty times five equals two hundred minutes, so the alternative fits exactly. Its receipt per unit is twelve and all additional cash costs are seven. Incremental contribution is five per unit and two hundred for forty. That is not the full revenue of four hundred eighty: two hundred eighty of extra cash cost must be deducted first.
This demand is stipulated only for practice. In a real decision, idle time is not evidence of orders, and a sales target is not confirmed feasible demand. If the same machine cannot actually be used, or another resource prevents completion, do not include a convenient two hundred benefit. Record the limitation before calculating a quote ceiling.
Making comparison cost = 900 Buying comparison cost = 1000 − 200 alternative contribution = 800 Buying minus making = 800 − 900 = −100
The negative sign indicates a lower comparison cost for buying under these inputs. An independent bridge gives new outside payments 1,000, less avoided making payments 900, less alternative contribution 200: again −100. Alternatively charge the foregone opportunity to making, giving 1,100 versus buying at 1,000. Use either presentation, never both together.
The product-mix exercise chooses quantities among competing products. Here one specific alternative use is supplied, not optimized across a catalog. Multiple competing jobs, shared resources and minimum batches require a separately justified opportunity value. No universal greedy optimization claim follows from this arithmetic.
Derive the quote ceiling and test both sides
Let q be the supplier price per accepted component. Other outside charges remain 50 plus 50, and the feasible alternative contribution remains 200. Buying has comparison cost 100q + 100 − 200. Set it equal to the internal 900: 100q − 100 = 900, giving q = 10. This is conditional cost indifference, not permission to place an order.
| Supplier unit quote | Buying after alternative contribution | Buying minus making |
|---|---|---|
| 9.90 | 890 | −10 |
| 10.00 | 900 | 0 |
| 10.10 | 910 | +10 |
Check the original quote of nine: one hundred times nine plus one hundred minus two hundred equals eight hundred. The supplier can cost more than the avoidable internal payments per unit because buying also permits the specified alternative work. That explanation disappears if the alternative is unavailable.
With explicitly no alternative work, use zero contribution. Then 100q + 100 = 900 and the ceiling falls to eight. At the original quote of nine, making is lower by one hundred. Unknown alternative demand is not proof of zero demand; label the zero case as a scenario rather than disguising missing evidence.
If alternative demand is only twenty units, contribution is one hundred. Those units use one hundred minutes and leave one hundred unused. The ceiling is then nine, and the original quote produces a tie. This demand-cap sensitivity shows why released capacity cannot simply be valued as automatically sold output.
Keep operational feasibility outside the arithmetic verdict
A nominally cheaper source may fail the required quality or arrival date. Preserve specification acceptance, sample results, supply continuity and who bears rejected-unit costs. This exercise makes no factual claim about any real company. If essential evidence is missing, the sourcing decision remains unresolved even when a column is lower.
Recheck the avoidability horizon. A payment cancelable next quarter may still be committed this month. A fixed charge can be relevant if this decision genuinely removes it, while a variable-looking labor allocation may be irrelevant if payroll does not change. Keep the contractual evidence beside each input, rather than trusting its account label.
Alternative receipts and supplier payments may also occur on different dates. Use a separate cash-flow plan for advances, material payments, customer collection and repayment obligations. A favorable monthly total does not prove that cash is available when required, and this worksheet does not establish financing availability.
If a new fact adds a minimum batch, capacity interaction or different accepted yield, preserve the old version and rebuild the affected quantities. Do not repair the conclusion by adding unsupported revenue. A transparent unresolved question is more useful than a precise answer based on an impossible alternative.
Save a short decision bridge with its reversal condition
On Windows, open Notepad from Start and create a blank document. Open Calculator separately from Start. Write the one-month horizon, accepted quantity and source versions first. Record avoidable payments, unchanged overhead, outside charges and the alternative’s demand and machine minutes. Fifteen minutes is a practice target, not observed speed.
Fictional V1:100 accepted units; one month; all make or all buy Avoidable make400+300+100+100=900 Common fixed300 remains under both; effect on difference0 Outside100×9+50+50=1000 Released200minutes; alternative40×5minutes=200 Alternative40×(12−7)=200, not revenue480 Buy comparison800; make900; buy-minus-make−100 Quote equality10; checks9.90/10/10.10 No alternative:quote equality8; making lower100 Evidence gaps, owner and next review:[...]
Choose File → Save As and save make-buy-V1.txt in Documents under a new name if necessary. Close the document and reopen that saved file. Locate the nine-hundred internal total, one-thousand outside total, two-hundred contribution, negative-one-hundred bridge and both quote ceilings. Readback is a reader task, not a desktop operation we claim to have performed.
Save the twenty-unit alternative-demand sensitivity as V2. Put the conditional conclusion in your decision log: buying has lower comparison cost if the supplied forty-unit alternative is feasible; making is lower when no alternative work exists; operational and cash checks are still required. This preserves both the answer and the fact capable of reversing it.
Frequently asked questions
Does removing allocated overhead create a saving?
Only a payment genuinely removed by the decision is a saving. Common continuing overhead does not change the difference.
Can alternative sales revenue be counted as the benefit?
No. Deduct all incremental cash costs and verify the alternative fits real demand, resources and the same horizon.
What is the ceiling without alternative work?
For these fictional inputs, zero alternative contribution reduces the supplier unit-price equality point to eight.
Does a quote below ten authorize purchasing?
No. Ten is a conditional arithmetic threshold; quality, delivery, cash timing and approval still require evidence.
