Question

One division produces operating profit of $ 500,000 and the second division produces operating profit of $ 3 million. Which divisional manager is the best? Explain your answer.

Answer 1

One division produces operating profit of $ 500,000 and the second division produces operating profit of $ 3 million.

Based on the information given in the question, it cannot be said that which divisional manager is better. Decision cannot be made on the basis of absolute figures. In deciding the performance of divisional managers, we must consider the sales of the two divisions. Decision regarding the operating efficiency of the two divisions can be made on the basis of operating profit ratio of the divisions. Let us consider the following two scenarios assuming different sales of the two divisions:

(i) Division one sales = $1,000,000

Division second sales = $10,000,000

Operating profit ratio of division one = Operating profit/Sales

= 500,000/1,000,000

= 50%

Operating profit ratio of division second = Operating profit/Sales

= 3,000,000/10,000,000

= 30%

In this case, divisional one manager is better since operating profit ratio of division one is more than operating profit ratio of division second.

(ii) Division one sales = $2,000,000

Division second sales = $6,000,000

Operating profit ratio of division one = Operating profit/Sales

= 500,000/2,000,000

= 25%

Operating profit ratio of division second = Operating profit/Sales

= 3,000,000/6,000,000

= 50%

In this case, divisional second manager is better since operating profit ratio of division second is more than operating profit ratio of division one.

Hence, it can be concluded that a meaningful comparison can be made only on the basis of ratio analysis and not on the basis of absolute figures.

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