Cost Analysis, Profit Planning, and Control

1. Cost Analysis, Profit Planning, and Control MBA 603 Chapter 10 - Analyzing Financial Performance Reports

2. Calculating Variances • Professional managers strive to accomplish “Kaizen” or continuous improvement or exceeding budget in terms of revenue. • Effective management systems are hierarchical and concentrate on revenue and expenses in terms of BU performance. • Revenues and expenses can be sub divided into many levels depending upon the goals of senior management.

3. Calculating Variances - Continued • Variances become more actionable if they are analyzed against industry, market share, selling prices, or cost structures. • The analytical framework contains: • Identify causal factors that affect profits. • Break down overall profit variances by these causal factors. • Calculate only the impact of each variable at a time.

4. Calculating Variances - Continued • Add complexity in order beginning at the top and working progressively further downward. • Stop the variance analysis when you reach the level that no longer produce creditable answers. • Please Review Exhibits 10.2 and 10.3 in the text for further information.

5. Revenue Variances • In this area we focus on mix, selling price, and volume variances and each calculation should focus on product lines, business units, etc. • Selling Price Variance - Calculated by multiplying the difference between the actual price and standard price by the actual volume. (Review Exhibit 10.4).

6. Revenue Variances - Continued • Mix and Volume Variance - Two components are incorporated here, VolumeVariance results from selling more units than budget, while Mix Variance focuses on selling a different proportion of products than the budget. • Actual volume minus budgeted volume times the budgeted unit contribution per unit.

7. Revenue Variances - Continued • Mix Variance - The actual sales volume times the budgeted proportion less actual sales volume time budgeted unit contribution. (Review Exhibit 10.6). • Volume Variance - Actual sales time budgeted percentage less budgeted sales time budgeted unit contribution. (Review Exhibit 10.7).

8. Revenue Variances - Continued • Market Penetration and Industry Volume - Measurers the impact of market share and industry volume -i.e.., BU managers are responsible for market share, while they are not responsible for industry volume because that is a product of economic conditions. • Market Share Variance - Actual sales less industry volume times budgeted market penetration times budgeted unit contribution. ( Review Exhibit 10.9)

9. Revenue Variances - Continued • Industry Volume Variance - Actual industry volume - budgeted industry volume times budgeted market penetration times budgeted unit contribution. (Review Exhibit 10.9) • Please Review Exhibit 10.9 sections A,B,C, and D.

10. Expense Variances • Fixed Cost Variances are the difference between actual and budgeted because they are not affected by volume fluctuations. (Review Exhibit 10.10) • Variable Cost Variances are directly and proportionately affected by volume changes. Budgeted variable costs must be adjusted to actual production volume. (Review Exhibit 10.3)

11. Expense Variances - Continued • Budgeted Manufacturing Expense is adjusted to the amount that should have been spent at the actual level of production - each element of standard cost is multiplied by the production volume for that product. (Review Exhibit 10.11) • Spending Variance is the amount spent over the adjusted budgeted level. (Review Exhibit 10.11)

12. Expense Variances - Continued • The volume employed to adjust the manufacturing expenses is the manufacturing volume (units produced) not the sales volume which we used in determining the revenue variances. • Summary of Variances can be seen on Exhibit 10.12 which is employed by the majority of companies.

13. Time Period for Comparison • Most management reporting systems rely on the following time periods for analysis: • Month Actual vs Month Budget • Year to Date Actual vs Year to Date Budget • Current Year vs Last Year - Month & YTD • Forecast vs Actual - Month , YTD • Forecast vs Budget - Month, YTD • Numerous combinations

14. Focus on Gross Margin • Unit Gross Margin is the difference between selling prices and manufacturing costs. • Gross Margin is the difference between actual selling price and standard manufacturing cost. • Employing Standard Manufacturing costs rather than actual so inefficiencies do not affect the performance of the marketing organization.

15. Evaluation Standards • Management control systems in formal management reports of actual activities consist of: • Predetermined Standard or Budgets: Most firms use this tool and are not done haphazardly. • Historical Standards: they are readily available and based on past years. There are two problems: • Conditions may have changed from last year • Prior performance periods may be bad

16. External Standards • These are standards gleaned from the performance of other BU’s or companies in the same industry. • Bench Marking: The best managed company or BU becomes the basis for the measurement goal. • Reams of data can be found on the internet, Forbes, BusinessWeek, Dun & Bradstreet, etc.

17. Limitations on Standards • Standards or budgets must be constantly reviewed for changes in the business environment or economic conditions. • Inaccurate standards may be a product of: • Improperly set standards. • The standard was set properly but conditions changed that invalidated it.

18. Full Cost Systems • These systems are used in conjunction with inventory accounting. • There are two types of inventory measurement: • Full-Cost - fixed overhead costs are added to variable overhead costs, labor costs, and raw material costs, etc. • Variable Cost - everything is the same as above except fixed overhead costs are excluded. • The former is the defacto standard

19. Limitations to Variance Analysis • Variance analysis shows the amount but does not say why or what is being done about it. • Another problem is deciding if it significant and needs attention. • The more aggregated the reports the harder it is to identify source problems effectively. • Reports only show what has occurred but do not show the future effects of actions taken by a manager.

20. Management Action • Monthly profit reports should contain no surprises for management to react to. • Formal reporting should make managers enact desired actions to correct the situation without senior level pressure. • Monthly reviews are conducted of business operations with managers and senior level management to review the progress of new and old corrective actions.