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Lecture Managerial accounting for managers (4e) - Appendix B: Profitability analysis

Perhaps more than any other information, managers would like to know the profitability of their products, customers, and other business segments. Accordingly, this appendix provides a coherent framework for measuring profitability. It distinguishes between absolute profitability and relative profitability. | Profitability Analysis Appendix B Appendix B: Profitability Analysis Perhaps more than any other information, managers would like to know the profitability of their products, customers, and other business segments. Accordingly, this appendix provides a coherent framework for measuring profitability. It distinguishes between absolute profitability and relative profitability. Absolute Profitability Absolute profitability measures the impact on the organization’s overall profits of adding or dropping a particular segment such as a product or customer – without making any other changes. Absolute profitability measures the impact on the organization’s overall profits of adding or dropping a particular segment such as a product or customer – without making any other changes. For example, if Coca Cola were considering closing down its operations in the African country of Zimbabwe, managers would be interested in the absolute profitability of those operations. Computing Absolute Profitability | Profitability Analysis Appendix B Appendix B: Profitability Analysis Perhaps more than any other information, managers would like to know the profitability of their products, customers, and other business segments. Accordingly, this appendix provides a coherent framework for measuring profitability. It distinguishes between absolute profitability and relative profitability. Absolute Profitability Absolute profitability measures the impact on the organization’s overall profits of adding or dropping a particular segment such as a product or customer – without making any other changes. Absolute profitability measures the impact on the organization’s overall profits of adding or dropping a particular segment such as a product or customer – without making any other changes. For example, if Coca Cola were considering closing down its operations in the African country of Zimbabwe, managers would be interested in the absolute profitability of those operations. Computing Absolute Profitability For an Existing Segment Compare the revenues that would be lost from dropping that segment to the costs that would be avoided. For a New Segment Compare the additional revenues from adding that segment to the costs that would be incurred. For an existing segment, compare the revenues that would be lost from dropping the segment to the costs that would be avoided. For a potential new segment, compare the additional revenues from adding the segment to the additional costs that would be incurred. In practice, figuring out what costs would change and what costs would not change if a segment were dropped or added can be very difficult. Activity-based costing can be helpful in this regard, but care must be exercised to ensure that a given cost will really change. For examples of the measurement of absolute profitability see: “Segment Income Statements and the Contribution Approach” in Chapter 5. “ABC Action Analysis” in Appendix 6A. “Adding and Dropping Product Lines and Other Segments” in