1. Profitability
Profitability analysis (also sometimes referred to as financial analytics) is a relatively new cross-enterprise discipline that unlocks profit potential to drive performance. Once a management and accounting-driven reporting exercise, it is now being used to help all parts of a company gain the insight necessary to deploy limited resources in pursuit of the most profitable opportunities. Company departments and divisions, such as sales, marketing, operations and engineering, can use profitability analysis to answer simple profit-focused questions in the context of Profitability
Profitability analysis primarily involves developing profitability models that depict business problems. Such a paradigm requires calculating various analysis scenarios that are based on who is ultimately using the analytical insights.

2. Tools to profitability analysis so that they can effectively
Assess the right profitability measures that optimize business performance.
Move from merely a costing-oriented profitability reporting exercise to a forward-looking profitability modeling paradigm.
Undertake profitability analysis for different dimensions of profitability (for example, customer, channel, product and so on).
Use statistical and advanced analytical techniques to predict profitability outcomes better and thereby work towards optimizing resource inputs.
Tie profitability analysis to all other enterprise performance management processes such as planning, consolidation and control, strategy management

3. Profitability analysis framework
Revenues
Volume
Price
Costs
Fixed
Variable

4. Technique for Profitability Analysis
Cost Volume Profit Analysis
Target Profit Analysis
Du-pont Analysis

5. Cost Volume Profit Analysis
Voltar company manufactures and sells a telephone answering machine. The company’s contribution format income statement for the most recent year is given below:
Management is anxious to improve the company’s profit performance and has asked for an analysis of a items.
Particulars
Total
Per Unit
Percent of sales
Sales (20000)
$60
100%
Less Variable Exp.
900000 45 ?
Contribution Margin
300000
$15
Less Fixed Exp.
240000
$60000
Net Operating Income

6. Cost Volume Profit Analysis
Required:
1. Compute the company’s CM ratio and v.exp. Ratio
2. Compute the company’s BEP in both units and sales dollars

7. Cost Volume Profit Analysis
1. CMR= CM/SP=$15/$60=25%
VER=VE/SP=$45/$60=75%
2. Sales= V.Exp.+ F.Exp + Profit
$60Q=$45Q+$ $0
$15Q=$240000
Q=16000 units or at $60 per unit, $960000

8. Target Profit Analysis
Refer to the data of Voltar Company. Assume that nest year management wants the company to earn a minimum profit of $90,000. how many units will have to be sold to meet this target profit figure?
Equation Method:
Sales= V.Exp.+ F.Exp + Profit
$60Q=$45Q+$ $90000
$15Q=$330000
Q=22000 units or at $60 per unit, $960000
Contribution Margin Method: =
=22,000 units

9. DuPont System of Analysis
Objective:
Find out why a company’s profitability, as measured by ROA and ROE, is higher or lower than the industry average ROA or ROE or last year’s company ROA or ROE.
Example: Kohls – company wanted to grow fast, and was able to grow ever faster than its planned growth rate because its profitability as measured by ROE was higher than expected
DuPont formula:
ROA = Net Profit Margin x Total Asset Turnover
Pricing and expense control captured by Net Profit Margin
Efficiency of asset use captured by Total Asset Turnover
Company’s over- or underperformance on ROA is due to one or both of these causes, or “drivers”

10. DuPont System of Analysis
Modified DuPont formula:
ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage Multiplier
Financial Leverage Multiplier, or “Equity Multiplier” as some call it, is really a debt ratio
More assets financed with debt mean less assets financed with equity, so higher this number is, the greater the use of financial leverage
Company can “lever up” ROE by using more debt
Company’s over- or underperformance on ROE is due to one of three causes, or “drivers”
NPM
TAT
FLM
Compare company to itself over time and to industry for most recent year when doing your DuPont analysis of ROE

11. DuPont System of Analysis
Example:
Kohls has NPM of 7%, TAT of 2, FLM of 1.5
Department stores industry has NPM of 8%, TAT of 1.5, and FLM of 1.25
Format to show your DuPont analysis:
Conclusion: Kohls has a much better ROE than its industry because (1) its use of assets is more efficient (it generates more sales per dollar of asset investment) and (2) because it uses more debt financing. Kohls pricing or expense control are inferior to the industry, however, and the use of debt constitutes a greater risk for Kohls because it may not be able to handle the interest payments and principal repayment.
Company/Industry
ROE
NPM
TAT
FLM
Kohls
21.0% 7% 2
1.5
Dept. store industry
15.0% 8%
1.25

12. Productivity and Profitability Relationship
Profitability refers to profit earning capacity of an enterprise. It is one of the best measurements of evaluating of overall performance of an enterprise.
But measurement of productivity alone cannot identify the causes of productivity changes. Profitability may be changed due to productivity or price cost movement.
Therefore it is necessary to segregate profitability into productivity and price recovery. Considering the relationships among 3ps (Productivity, Profitability and Price recovery) profitability is defined as the product of productivity and price recovery.

13. Productivity and Profitability Relationship
The following demonstrates this relationship:
Output Value = Output Quantity x Unit Price Profitability = Productivity x Price Recovery Input Value = Quantity Used x Unit Cost
Where:
Profitability =
Productivity =
Price Recovery =

14. Productivity and Profitability RelationshipIF
THEN
Case
Profitability
Productivity
What will happen
What should be done 1
HIGH
Financial condition will be sound and stable
Maintain or increase productivity further 2
LOW
High profitability may not be sustained on a long-term basis .In the long run low productivity will eat up profits.
Improve productivity 3
The company may soon be operating at a loss and may be on the bring of a shut down.
Improve profitability; strengthen market strategy, market research, market promotion, advertising and pricing policy. 4
Shut down / bankruptcy.
Improve productivity and strengthen market.