Question

Discussion: Profitability Analysis

A large, downtown hotel allocated all of its restaurant labor costs on the basis of revenue dollars. This hotel had seven restaurant outlets that were vastly different, including banquet, room service, a bar, a 24-hour restaurant, and a fine dining facility. There are obvious differences in the way labor resources are consumed in these various outlets. However, the most glaring example was in the banquet operation. Since banquets were not regularly scheduled events, the banquet manager hired servers as contract laborers. These costs were not included in the restaurant labor pool. Suggest at least two steps the manager should take to ensure that all labor is factored into the profitability analysis. The textbook discusses level 1, 2 and 3 variances. Suggest the variance analysis that would pinpoint the issue with the budget. Provide specific examples.

Answer 1

Answer:

Meaning of Profitability Analysis

In cost accounting, profitability analysis is an analysis of the profitability of an organisation's output. The main aim of a business is to earn profits. Thus a company has to attract the customer and retain the earning. This is known as profitability analysis.

In Simple terms – An analysis of cost and revenue of the firm which determines whether or not the firm is profiting is known as profitability analysis.

Profitability analysis mainly has a focus on three criteria

1. Customer profitability analysis (CPA) – Which calculates revenue coming from customers less all costs.

2. Customer product profitability analysis – This equation helps calculate the profitability per product and per customer.

3. Implementing Total Quality Management (TQM) – TQM increases the total quality.

Now let’s focus on Steps to Successful Profitability Analysis:

· Gross Profit Margin: Your gross profit margin is the amount of your sales revenue minus the cost of your goods. In conjunction with your other numbers, your gross profit margin can tell you if your products are profitable enough, if you need to increase sales or if your expenses, like sales costs, are too high.

· Net Profit Margin: It is sometimes simply called the profit margin. To get this number, subtract your expenses from your revenues to get your net profit. Then divide that by your revenue.

· Analysis by comparing with Past: By comparing your current numbers by your past performance, you’ll know if you’re moving in the right – and more profitable – direction and be able to pinpoint areas that need attention.

· Benchmark Industry Profitability Ratios: Different industries have different levels of profitability. Real estate, health care, and financial services tend to have high profit margins. Other industries, like autos, and grocery, have margins that are much lower. Benchmark your industry before looking at your profitability so you know what to aim for.

· Understand Customer Valuation: Your customers are the source of your revenue – and your profits. A low valuation customer who typically later purchases high margin items is a good investment. But you need to understand which is which before you can make smart strategy decisions.

Meaning of Variance Analysis

Variance analysis is the quantitative investigation of the difference between actual and planned behavior. This analysis is used to maintain control over a business. For example, if you budget for sales to be $20,000 and actual sales are $16,000, variance analysis yields a difference of $4,000.

This level of detailed variance analysis allows management to understand why fluctuations occur in its business, and what it can do to change the situation.

Different Types of Variance

1. Purchase price variance: The actual price paid for materials used in the production process, minus the standard cost, multiplied by the number of units used.

2. Labour rate variance: The actual price paid for the direct labour used in the production process, minus its standard cost, multiplied by the number of units used.

3. Fixed overhead spending variance: The total amount by which fixed overhead costs exceed their total standard cost for the reporting period.

4. Selling price variance: The actual selling price, minus the standard selling price, multiplied by the number of units sold.

5. Labour efficiency variance: Subtract the standard quantity of labor consumed from the actual amount and multiply the remainder by the standard labour rate per hour.

6. Variable overhead spending variance: Subtract the standard variable overhead cost per unit from the actual cost incurred and multiply the remainder by the total unit quantity of output.

7. Material yield variance: Subtract the total standard quantity of materials that are supposed to be used from the actual level of use and multiply the remainder by the standard price per unit.

8. Variable overhead efficiency variance: Subtract the budgeted units of activity on which the variable overhead is charged from the actual units of activity, multiplied by the standard variable overhead cost per unit.