Sources of profits - Strategic Management

Analysis by broad department or subsidiary can only be regarded as a starting point. The next stage should be a detailed examination of profitability and prospects on a product basis, in terms of geographical sales, where relevant (e.g. by export market), and by distribution method. This is one of the many stages when the accounting methods of the firm should be queried. Although most companies have detailed costs by product, the exercise should question the bases on which these are calculated. This usually means looking at the way in which certain costs are allocated. Queries of this nature do not necessarily mean that the cost accounting system is ‘wrong’.

In fact workable alternatives to the allocations used by the cost accountants may be difficult to establish for regular reporting purposes, although they may be ascertainable for an ad hoc exercise such as the corporate appraisal. The cost accountant’s job is to ensure that all costs are apportioned somewhere,so that at the end of the day the company does not find items it has not recovered. The planner is more interested in the dynamics of change: he or she wishes to see what would be left if a particular product or activity were carried out in a different way.

Many costs which are allocated to products or activities are apportioned on some form of percentage basis, spread evenly across the activity. Thus it is quite common to find transportation costs charged at a flat percentage of sales value: order-processing costs, sales force costs, and various other variable overheads may be allocated in the same way. The assumption is that all these costs fall on products in a normal distribution.In fact this is an erroneous assumption because these costs fall unevenly in a highly skewed distribution. Transport costs will vary with order size and distance from depot. Order processing costs will vary with the number of lines on the invoice: it costs no more to process an order for £1000 than for an order of £1 of the same product.

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Strategic Management Topics