B2 Strategic Planning: Techniques for Forecasting, Budgeting, and Analysis-Profitability and Pricing analysis Flashcards
Profitability and Pricing Analysis
Contribution Approach (Direct Costing)
&
Absorption Approach (GAAP)
Formulas
Contribution approach
used for breakeven analysis.
Revenue
- VC (DM +DL + Variable OH +Variable SG&A)
=Contribution Margin
- Fixed Costs (Fixed OH +Fixed SG&A)
= Profit
Absorption Approach (GAAP)
Revenue
- COGS(DM+DL+OH-fixed and variable) {product costs}
= Gross Margin
Less operating expenses (SG&A-fixed and variable) {period costs}
=Net income
Profitability and Pricing Analysis
Contribution Margin Ratio
Contribution Margin / Revenue
Profitability and Pricing Analysis
Absorption Approach vs Contribution Approach-biggest difference is the treatment of what?
The main difference is the treatment of fixed factory overhead. SG&A are period costs under both methods.
Profitability and Pricing Analysis
Contribution Approach (Direct Costing)
vs
Absorption Approach (GAAP)
Absorption-all fixed factory overhead treated as product cost and included in inventory values. GOGS includes both fixed costs and variable costs
Contribution-All fixed factory overhead is treated as period cost and is expensed in the period incurred. Inventory values include only the variable manufacturing costs, so COGS includes only variable costs-not gaap
Profitability and Pricing Analysis
- Contribution Approach (Direct Costing)*
- &*
- Absorption Approach (GAAP)*
Effect on Income
Production Greater than Sales=Inventory increases- if units produced exceed units sold, then some units are added to ending inventory and income is higher under absorption costing than variable costing
- under absorption costing, a portion of FOH is included with each unit of ending inventory (on B/S, not I/S)
- under variable (direct) costing, all FOH is considered a period cost and is expensed during the period
Sales Greater than Production=Inventory Decrease-if units sold exceed units produced, then ending inventory is less than beginning inventory and income is lower under absorption costing than under variable.
- under absorption, fixed MOH is carried over from a previous period as a part of beg inventory and is charged to cost of sales
- under variable (direct) costing, those fixed costs were charged to income in a previous period.
Profitability and Pricing Analysis
Absorption Costing
Benefits and Limitations
Benefits
- Is GAAP
- IRS requires this method for financial reporting
Limitations
- level of inv affects net income b/c fixed costs are a component of product cost
- NI is less reliable (esp for perform evals) than variable method b/c cost of product includes fixed costs and, therefore, the level of inventory affects net income
Profitability and Pricing Analysis
Variable (Direct) Costing
Benefits and Limitations
Benefits
- Variable and fixed costs are separated and can be easily traced to and controlled by mgmnt
- Net Income more reliable than Absorp.Costing method(esp for perform evals) b/c cost of product does not include fixed costs and, therefore, the level of inventory does not affect net income
- Variable costing isolates the contribution margins in f/s to aid in decision making
Limitations
- not GAAP
- IRS does not allow for financial reporting
Profitability and Pricing Analysis
Breakeven(BE) Computation
BE in Units
Total Fixed costs / contribution margin per unit
Profitability and Pricing Analysis
Breakeven(BE) Computation
BE in Dollars
Unit Price x breakeven point (in units)= BE point (dollars)
Profitability and Pricing Analysis
Breakeven(BE) Computation
Contribtion Margin Ratio
Contribution margin/sales
Profitability and Pricing Analysis
CVP-Profit Performance
Required Sales Volume for Target Profit
Sales Units Needed to Obtain a Desired Profit formula
Sales (units)= (Fixed Cost+Pretax profit/CM per unit
Profitability and Pricing Analysis
CVP-Profit Performance
Required Sales Volume for Target Profit
Sales Dollars Needed to Obtain a Desired Profit formula
Sales dollars= VC + FC + pretax profit
Profitability and Pricing Analysis
Margin of Safety
excess of sales over BE sales and generally expressed as either dollars or a percentage.
Profitability and Pricing Analysis
Target Costing
Technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume.
Target cost= market price - required profit
example
market price per unit = $5
required profit margin=60%
desired profit=$5 x 60%=$3
Target Costs=$5 - $3 = $2
Marginal Analysis
used when analyzing business decisions such as the introduction of a new product or changes in output levels of existing products, acceptance or rejection of special orders, making or buying a product or service, selling or processing further, and adding or dropping a segment. Focuses on relevant revenues and costs.
Marginal Analysis
vocab and relevant or not?
Direct Costs
Prime Costs
Discretionary Costs
Incremental Costs
Opportunity Costs
Irrelevant Costs
Sunk costs
Controllable Costs
Avoidable costs
Unavoidable Costs
- Direct costs-costs that can be identified or traced to a given cost object. Usually relevant.
- Prime Costs-include DM and DL and are generally relevant
- DiscretionaryCosts-costs arising from periodic budgeting decisions by mgmnt to spend in areas not directly related to mfg. Generally relevant
- Incremental costs(aka marginal costs, differential costs, or out of pocket costs)-additional costs incurred to produce an additional amount of the unit over the present output. Relevant and inc all VC and any avoidable fixed costs
- Opportunity Costs-cost of foregoing the next best alternative when making a decision. Relevant.
- Irrelevant Costs-costs that do not differ among alternatives and should be ignored in marginal analysis
- sunk costs-unavoiable b/c incurred in past and cant be recovered. Not relevant
- Controllable Costs-costs that are authorized by the business unit manager or the decision maker. Controllable costs are relevant if they will change as a result of selecting different alternatives.
- Avoidable Costs and Revenues-result from chossing one course of action instead of another. They are relevant
- Unavoidable Costs-Costs will be the same regardless of the chosen course of action. not relevant
Marginal Analysis
Special Order Decisions
Presume Excess Capacity
If selling price per unit is greater than variable cost per unit than accept
Marginal Analysis
Special Order Decisions
Presumed Full Capacity
Price > VC per unit + opp cost per unit
Marginal Analysis
Make Vs Buy
Excess Capacity
Relevant costs=avoidable costs
Marginal Analysis
Make Vs Buy
No Excess Capacity
Relevant Costs=Avoidable costs + opportunity costs
Forecasting and Projection
Decision Models
Sensitivity Analysis
Also called “what if” analysis. A risk mgmnt tool that is used to test the effect of specific variables on overall profitability. Managers incorporate sensitivity analysis into the budgeting process to determine which variables are the most sensitive to change and therefore will have the biggest impact on the bottom line.
Forecasting and Projection
Decision Models
Forecasting Analysis
Extension of sensitivity analysis
Involves predicting future values of a dependent variable (the variable one is trying to explain) using info from previous time periods. Dependent variables can be Revenues and Expenses.
Forecasting and Projection
Regression Analysis
Simple Linear Regression Model (y=a + Bx)
(y=a + Bx)
Forecasting and Projection
The Coefficient of Correlation (r) Intrepretation
positive correlation = +1
negative= -1
no correlation= 0
Forecasting and Projection
The Coefficient of Determination (R2)
is the proportion of the total variation in the dependent variable (y) explained by the independent variable.
Forecasting and Projection
High-Low Method
used to estimate fixed and variable portions of cost
- Compare high and low volumes and costs
- divide difference between high and low dollar total costs by the difference in hgih and low volumes to obtain VC per unit
- use either high or low volume to calc VC by multiplying the volume times the VC per unit
- subtract total calculated VC from total costs to obtain fixed costs
formula
TC=FC + (VC per unit x # of units)
Budgeting
Master Budgets (annual business plan)
Documents specific short-term operating performance goals for a period, normally one year or less
aka as static budgets, annual business plans, profit planning, or targeting budgets
Budgeting
Master Budgets (annual business plan)
Which Proforma F/S?
- Balance Sheet
- Income Statement
- Statement of Cash Flows
Budgeting
Master Budgets (annual business plan)
- Operating Budgets
- Financial Budgets
Operating:
- Sales budgets-first budget prepared and drives the development of most other components of the master budget.
- Production budgets
- Selling and Admin budgets
- Personnel budgets
Financial:
- Pro forma f/s
- Cash budgets
Budgeting
Master Budgets (annual business plan)
Establishing Required Level of Production Formula
Budgeted sales
+Desired ending inventory
-Beginning Inventory
=Budgeted Production
Budgeting
Master Budgets (annual business plan)
Direct Materials Budget
- # of units to be purchased formula*
- cost of DM to be purchased*
- DM usage budget*
- Units of DM needed for a production period
+ Desired ending inventory at the end of the period
- Beg Inv at the start of the period
=Units of DM to be purchased for the period
- Units of DM to be purchased for the period
x cost per unit
=cost of DM to be purchased for the period
- Beg inv at cost
+ purchases at cost
- end inv at cost
=DM usage (cost of material used)
Budgeting
Master Budgets (annual business plan)
Cost of Goods Sold
Cost of goods manufactured
+ Beg finished goods inventory
- Ending finished goods inv
=COGS
example
DM used - 1,432,000
DL - 1,480,000
FactoryOH (variable)- 370,000
Factory OH (fixed)- 300,000
Finished Goods Beg- 1,000,000
Finished goods End- 750,000
Compute COG Manufactured
DM used 1,432,000
DL 1,480,000
FOH Variable 370,000
FOH Fixed 300,000
=Total cost of goods manufactured 3,582,000
Plus finished goods, beg 1,000,000
=Goods Available for Sale 4,582,000
Less finished goods, ending (750,000)
=COGS 3,832,000
Budgeting
Master Budgets (annual business plan)
Cash Budget Format
- Beginning Cash
- Cash collections from sales (add)
- Cash Disbursements for purchases and operating expenses (subtract)
- =Computed Ending Cash
- -Cash requirements to sustain operations (subtract)
- =Working Capital loans to maintain cash requirements
Budgeting
Master Budgets (annual business plan)
Capital Budgets
Allow mgmnt to evaluate the capital additions or the org, often over a multi year period. Highly dependent on the availability of cash or credit, and they generally involve L-T commitments by the org
Budgeting
Flexible Budgets
Use in conjunction with master budget. Allows for adjustments for changes in production or sales and accurately reflects expected costs for the adjusted output.
Budgeting
Flexible Budgets
Benefits and Limitations
Benefits
- display different volume levels within the relevant range to pinpoint areas in which efficiencies have been achieved or waste has occurred.
Limitations
- highly dependent on the accurate indentification of fixed and variable costs and the determination of the relevant range.
Variance Analysis
tool for comparing some measure of performance to a plan, budget, or standard for that measure. Used for planning and control purposes and can be used to evaluate revenues and costs. Comparison of actual results to the annual business plan is the first and most basic level of control and evaluation of operations.
Variance Analysis
Performance Report
Step 1: budget vs actual
Step 2: prep flexible budget
Actual results may be easily compared with budgeted results. However, usefulness is limited by the existence of budget variances that may be strictly related to volume
Example
Budgeted
Sell 10,000 units at $15 a piece
CM % = 20%
FC= $25,000
Actual
Actual units sold= 8,000 (totaling $112,000 in revenues)
Variable expenses= $100,800 and FC = $24,000
Units: 10,000 8,000
Budget Actual Variance F/U
Revenue 150,000 112,000 (38,000) U
Variable Exp (120,000) (100,800) 19,200 F
CM 30,000 11,200 18,800 U
Fixed Costs (25,000) (24,000) 1,000 F
Net Income(loss) 5,000 (12,800) (17,800) U
Variances need significant analysis before they are useful. The favorable variance in varaible expenses, for example, don’t represent efficiencies. Budgeted CM ratios are 20%; actual cm ratio are 10%. Sales in units were off budget by 20%, yet revenues are down by 25%. Something is wrong but what?
Step 2:
see page 50
Variance Analysis Using Standards
Std Costing Systems
Std costs in aggregate, measure the costs the firm expects that it should incur during production.
Variance Analysis Using Standards
Std Costing Systems
Uses
- Cost control
- Data for performance evaluations (variance analysis)
- Ability to learn from standards and improve various processes.
Variance Analysis Using Standards
Direct Materials and Direct Labor Variance (PURE DADSDADS)
- DM Price Variance*= Actual Quantity purchased x (Actual price - Standard Price)
- DM quantity Usage variance* = Standard Price x (Actual quantity used - Std quantity allowed)
DL Rate variance= Actual hours worked x (Actual rate-Std rate)
DL Efficiency Variance= Std rate x (Actual hours worked-Std hours allowed)
Difference x Actual (DA)
Difference x Actual (DS)
Difference x Actual (DA)
Difference x Actual (DS)
Variance Analysis Using Standards
VOH and FOH variances
VOH Rate (spending) variance= Actual Hoursx (Actual Rate-Std Rate)-tells managers whether more or less was spent on Variable OH than expected.
VOH Efficiency variance= Std Rate x ( Actual hours - Std hours allowed for actual production volume)-tied to the efficiency with which labor hours are utilized.
FOH Budget (spending) variance= Actual Fixed OH-Budgeted fixed OH-
FOH Volume Variance=Budgeted Fixed OH - Std Fixed OH cost allocated to production*
*Based on Actual production x Std Rate
Balanced Scorecard
gathers information on multiple dimensions of an org’s performance defined by critical success factors necessary to accomplish the firm’s stragtegy.
Balanced Scorecard
Critical Success factors
- Financial-Responsibility segment/SBU
- Internal business processes-Efficient/effective operations
- Customer Satisfaction-customers happy
- Advancement of innovation and human resource development (learning and growth)
