Cost Analysis, Profit Planning, and Control

MBA 603

Chapter 10 - Analyzing Financial Performance Reports

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.

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.

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.

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).

Revenue Variances - Continued

• Mix and Volume Variance - Two components are incorporated here, Volume Variance 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.

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).

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)

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.

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)

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)

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.

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

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.

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

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.

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.

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

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.

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.