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# Profitability analysis framework

Volume Revenues Price Profitability Fixed Costs Variable

. “load” factor for airlines. skill of production workers.g. – volume of units sold. number of parts.Terminology Revenue driver – any factor that causes a change in the total revenue of a product or service e. change in selling price how to measure volume? Differs by type of business – patient days for hospitals.g.quality of materials. patients treated . sales per square feet for retailers Cost driver – any factor that causes a change in the total cost of a product or service e.

More Terminology Variable cost – cost that changes in total in direct proportion to changes of a cost driver (e.g. Gross profit margin – Sales (\$) – total cost of goods sold (variable and fixed product costs) ... food in restaurant) Fixed cost – cost that does not change in total despite changes in a cost driver (e. restaurant property taxes) Contribution margin – Sales (\$) – total variable costs (product and period costs) vs.g. materials in production. facility rent.

Cost-Volume-Profit Analyses Breakeven level – point of volume where total revenues = total costs -> no profit or loss Number ö æ Unit Number ö æ Unit ç ÷ ç ÷ sales x of variable x of ç ÷ ç ÷ .Fixed costs = Operating income ç price ç cost units ÷ units ÷ è ø è ø """ """ ! """ " """" ! Sales Variable costs Þ Unit ö æ Number ö æ Unit ÷ ÷ ç ç ÷ − Fixed costs = Operating income ç sales .variable ÷ x ç of ç units ÷ ç price costs ÷ ø ø è "" " """ ! è Contribution margin .

salaries.000.000 pairs of shoes \$9 per pair . • cost per pair of shoes = \$21. Unit ö æ Number ö æ Unit ç ÷ ç ÷ ç sales . advertising.\$21) x N – \$360.000 = 40. etc) = \$360.000 = 0 ð N= \$360.variable ÷ x ç of ÷ − Fixed costs = 0 ç price ÷ ç units ÷ costs ø è è ø = (\$30 . • fixed costs (rent.Breakeven analyses example Example – sales volume at retail shoe store needed to breakeven – • selling price per pair of shoes = \$30.

What if ……? What if we desire operating profit of \$135.\$21) x N – \$360.000 ð N= \$360.000 = 55.000 pairs of shoes \$9 per pair of shoes .000 + \$135.000 = \$135.000? Þ (\$30 .

\$30.250 pairs of shoes \$8 per pair of shoes .000 = 41.What if ……? What if we change our compensation scheme? Current pay structure -> 2 employees with salaries of \$25.000 .000) = \$0 N= \$330.000 plus \$1 per pair of shoes sold Þ [\$30 – (\$21 + \$1)] x N – (\$360.000 Proposed pay structure -> 2 employees with base salaries of \$10.

Profitability analysis framework Volume Revenues Price Profitability Fixed Costs Variable Revenue issues • specific to firm • market-wide Cost issues • components of cost structure – by function. product line. geographic • impact of strategy/positioning on cost structure (low cost vs. high quality) .

Profitability analysis framework Sample Bank Profitability Issue Tree Sales Volume Decreasing Market Share Declining Product-related Problems Product Quality Poor Revenues Decreasing Overall Market Size Decreasing Service-related Problems Product Mix Problematic Breadth of Product Line Inadequate Depth of Product Line Inadequate Bank’s Branch Network Profitability Declining Prices Decreasing Transaction Fee Level Declining Distributionrelated Problems Interest Rates Decreasing Non-interest Expenses Increasing Variable Costs Increasing Expenses Increasing Interest Expenses Increasing Fixed Costs Increasing .