Profit Center Analysis Jack Davis, CPA, MBA SDSU-CES, Area Management Specialist

Profits squeezed? Everyone knows their costs, don’t they? Do you know how these costs behave?

Word List Cost Behavior Variable Costs. –Variable Costs per unit are constant. Fixed Costs. –Fixed costs per unit vary with production level. Mixed Costs. –Semi-variable costs change in total with changes in production level, but not proportionately.

Terms to Recognize Cost volume profit analysis –Profit = Sales (S) – Variable Costs (VC) – Fixed Costs (FC) Contribution Margin –Sales -- Variable Costs –Contribution Margin Ratio (Sales – Variable Costs)÷ Sales

Breakeven Point Sales (in dollars) = Fixed Costs / Contribution margin ratio Sales (units) = Fixed Costs / Contribution margin per unit

Cost or Revenue ($) Quantity Produced Break-Even Diagram

Cost or Revenue ($) Quantity Produced Break-Even Diagram

Cost or Revenue ($) Fixed Cost Total Cost Total Revenue Break Even Quantity Quantity Produced Fixed Cost Variable Costs Profit / Loss Corridor Break-Even Diagram Break Even Quantity

Cost or Revenue ($) Total Cost Total Revenue Break Even Quantity Quantity Produced Fixed Cost Variable Costs Profit / Loss Corridor Break-Even Diagram Increased Fixed Costs Total Cost Break Even Quantity

Management Hubs Profit Centers. –Subunit that has responsibility for generating revenue as well as for controlling costs. Cost Centers. –Subunit that has responsibility for controlling costs but does not sell product. i.e. service departments.

Cost Allocation Cost Objective Cost Pools Allocation base Relates the cost pool to the cost objective

Profit Center Analysis Organize business into subunits, profit center & cost centers. Track variable costs to profit centers. –Control escalators Allocate asset use to subunits. Evaluate on contribution margin and amount of capital invested.

Cost-Volume-Profit Diagnostics

Differential Analysis Decision method to chose among alternative courses of action. –Additional Processing –Make or buy –Drop enterprise Outsourcing Core competencies

Vocabulary Differential costs and revenue –The additional cost or revenue incurred when one alternative is chosen over another. Sunk cost. –Costs that are already incurred & not reversible. Opportunity Costs. –The benefit given up by selecting one alternative over another. i.e. Interest on stored grain.

Process or Sell SellAdditional Processing Differential Rev. & Costs Revenue Less: Prior Costs Add. Costs Gain (loss)

Produce or Purchase MakeBuySavings (Costs) Cost to Buy( ) Variable Costs Fixed Costs Total

Differential Analysis Discontinued Operations Cost allocation death spiral. – What will happen to common costs if enterprise is dropped? –They are allocated over remaining enterprises. Which may make those enterprises seem unprofitable.

CONTACT INFORMATION PROFIT CENTER ANALYSIS Agustin Arzeno SDSU Cooperative Extension Service 1905 Plaza Blvd. Rapid City, SD (605) Jack Davis SDSU Cooperative Extension Service PO BOX 397, 302 S Dumont Woonsocket, SD (605)

SOURCES - MANAGERIAL ACCOUNTING by James Jiambalvo,University of Washington, John Wiley & Sons, Inc. - WEIGHING THE VARIABLES, by David M. Khol, American Bankers Association and Doane Agricultural Services. - ADVANCED MANAGEMENT ACCOUNTING, 2 ND ED. Robert S. Kaplan, Anthony Atkinson. - FARM BUSINESS MANAGEMENT FOR THE 21 ST CENTRUY, Purde Extension, West Lafayette, IN Profit Center Analysis - Can I survive in Ag?, Dwayne Griffith, Montana State University -EXEX 5046 YOUR ANNUAL FINANCIAL CHECK-UP. SDSU Extension Economics -AGRICULTURAL FINANCIAL REPORTING AND ANALYSIS, by Arnold Oltmans, Danny Klinefelter, & Thomas Frey. Doane Agricultural Services, St. Louis, MO.