Profitability Analysis 1. With more accurate product costs generated by an effective ABC system, managers can conduct in-depth analyses of...
1. Product Profitability Analysis
Original Activity-based Costing (ABC) systems focus on manufacturing costs and their
assignment to products. With more accurate product costs generated by an effective ABC
system, managers can conduct in-depth analyses of profitability of their products. They
can correctly assess the profitability of individual products or product lines to identify
profitable products and unprofitable products. .
For companies producing numerous products or models, profitability analysis will
become critical because the overall profitability of the company can disguise the poor
performance of individual products. It is important to see that all products are profitable
in the long run.
ABC database with the information about activities, costs, and cost drivers can provide
numerous insights into ways that managers could transform unprofitable products into
profitable ones. Pricing strategy can be re-evaluated for each product. It may be possible
to identify activities that can be eliminated or performed more efficiently. The decision to
drop some of the unprofitable products may be made to improve overall profitability of
2. Customer Profitability Analysis
Studies have shown that only 20 percent of a companyâ€™s customers contribute to profits and
the remaining 80 percent generate losses. Moreover, with increasing importance of customer
satisfaction and market-oriented strategy, the costs of marketing and distribution have been
increasing rapidly in recent years. These costs are not directly related to the products, but
rather associated with individual customers or market segments.
Customer profitability analysis is an approach to cost management that identifies the costs and
benefits of serving specific customers or customer types to improve an organizationâ€™s overall
profitability. Just as ABC can reveal product profitability, customer profitability analysis
based on the ABC information can identify profitable and unprofitable customers. This piece
of information allows organizations to take appropriate actions to increase their profitability.
Like the case of the products, the overall profitability of a company can disguise the poor
performance of individual customers. Allocation of customer-related costs to individual
customers based on appropriate cost drivers will allow managers to assess the
profitability of individual customers or customer groups more correctly.
An analysis of customer differences on both revenues and costs can provide important
insight into why differences in customer profitability exist. ABC can also help the
company analyze customer-related activities
so that customer profiles can be developed.
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