TRANSFER PRICING AND RESPONSIBILITY CENTERS-slp
Don-Don
mod2ppslp.pptmCOST-VOLUME-PROFIT ANALYSIS
MORRLUM WATERPROOF FLOORING MATERIALS
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Determining Customer Profitability
Customer profitability is used at Morrlum to track the costs both fixed and variable to individual customers at a particular duration.
Since Morrlum is new entity in business of flooring materials, the customer profitability analysis can only take them form of a forecast as opposed to default retrospective approaches.
Customer profitability at Morrlum is used to determine crucial decisions such as customer focus groups resource allocations.
The following is the customer profitability analysis projection for Morrlum;
Sales – variable costs – fixed costs = operating income
The decisions include actions on; target profitable who should be retained, non target profitable customers who should be monitored, targeted customers who are not profitable but must be transformed and untargeted unprofitable customers who should be replaced.
Customer profitability as a tool for decision making has however aced criticism for segmenting customers and using timeframes that limited e.g. considering only one year in the evaluation.
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Determining Customer Profitability Continued
The fixed and variable costs to be tracked to individual customers include: marketing, service provision costs, shipping costs/delivery costs and returns costs.
The customer profitability calculation at Morrlum adopts a segmentation code classifying customers via average revenue per transaction; customer G ($100 per transaction), customer H ($60 per transaction). Below is the proposed calculation for CPA at Morrlum.
| Customer G | Customer H | |
| Average cost per transaction | $100 | $70 |
| Fixed costs | ($32) | ($23) |
| Variable costs | ($24) | ($15) |
| Revenue costs | $44 | $32 |
The Pareto principle found that 80% of customers to a firm are unprofitable and in most cases only 20% of the customers accounted for 100% of the profits. It is therefore of utmost importance that firms consider this metric in decision making process.
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Revenue & Profitability Assumptions Effects
A CVP involves assumptions on constancy on sales prices, fixed and variables costs and every produced unit is sold.
By performing a CVP under these assumptions, the management at Morrlum are able to better evaluate the break even points which characterized by Fixed costs/contribution point. The following diagram sums up the effects CVP analysis; .
Total sales
300,000
250,000 Break-even point
Revenue 200,000 Variable cost
150,000
100,000
50,000 Fixed costs
22,500 82,596 165,192
Number of square feet expected to be sold.
A cost volume profit (CVP) analysis determines the sales required to meet operating income/profit targets.
It is of importance to note that some customer costs increase at a faster rate than sales. The graph above serves to illuminate a lot of these issues.
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Why Special Pricing for Some Markets
Pricing model for commodities is dependent on various factors including: customers behaviour, quality concerns, economic standards of a market and target sales.
For a company like Morrlum, its pricing may vary depending on regional disparities as presented through the above conditions.
The pricing for water proof floors in New York for example may range between $3 -$5, this is below the average pricing set by Morrlum at $2.20 - $3.8.
By selling the water proof flooring materials at the range between $3- $4.8 for example, would not mean exploitation but it would signal sales at the pricings that consumers are willing to pay for.
The need to break even in regions where business conditions aren’t favourable may also reflect in the pricing model.
The cost of operations in Milwaukee for example maybe at $245,789 for a Morrlum store annually but the same cost maybe $ 320,345 in Dallas. This differential amount in costs could be shouldered by customers in Dallas through slightly higher costs than those in MilwaukeeA classic example of how pricing dynamics vary is in the electronics market where in Asia they are priced lower as opposed to Europe where customers are willing to pay more for the same products.
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Advantage & Drawbacks of CVP Analysis
Advantages
A CVP analysis is essentially easy to calculate.
The concept of CVP analysis is quite simple to understand.
A CVP analysis assists managers in planning and forecasting the future based on understanding of customer trends.
Disadvantages
A CVP fails to consider the treatment of costs that have both fixed and variable costs.
A CVP analysis has too many assumptions including streamlining business products into one single unit, as a result of this and other assumptions such as constancy of costs the CVP analysis mostly fails to effectively account for costs during season highs.
The benefits of cost volume analysis in a business far outweigh the drawbacks hence it is important for businesses such as Morrlum to consider this cost accounting management tool.
The concept of CVP analysis is quite simple to understand. For most people in business as the terms used are part of their everyday business language.
A CVP analysis is essentially easy to calculate as it requires no major accounting information background.
Using a CVP in planning and forecasting the future based on understanding of customer trends.
A CVP analysis classifies costs into variable and fixed costs thereby failing to consider the treatment of costs that have both components e.g. a firm could pay telephone services monthly but also incur talk time charges too.
assumptions in CVP leading to streamlining of products as a result of this and other assumptions such as constancy of costs the CVP analysis mostly fails to effectively account for costs during season highs.
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