Profit Variance Analysis Ken Homa

PVA Profit Variance Analysis Objective: Disaggregate a change in profits from one period to another by isolating major contributing factors, e.g. Volume Price Inflation (cost) Program spending Productivity

Profit Variance Analysis Base Profit Profit Increase Price Cost Inflation Productivity Programs Volume New Profit

PVA Simplified Analytical Process (Price first) Restate (inflate) base period (P1) sales using current period (P2) prices, i.e. multiply by any cost increases Recalculate the profit or loss Difference in P&L from prior year nominal values is attributable to sales price Restate base period costs by multiplying by the cost increases from P1 to P2 These intermediate results are P1 @ P2 prices & costs Difference in P&L from prior step values is attributable to cost inflation Calculate real volume growth Divide current period (P2) sales by restated (inflated) P1 sales Answer is ‘real volume growth’ from P1 to P2 continued …

PVA Simplified Analytical Process (Price first, continued) Apply the real growth factor to all base period (P1) inflated value levels (for sales and costs) Recalculate the profit or loss Difference in P&L from prior step values is attributable to volume growth Subtract the P&L from the prior step to the original current period (P2) P&L (expressed in nominal or “current P2” dollars) Difference in P&L from prior step values is attributable to productivity Note: if there is a change in program spending (e.g. productivity enhancing initiatives) … calculate the nominal change year-to-year before calculating productivity Note: to calculate ‘inflation recovery’, compare the P&L change attributable to price to that attributable to cost inflation, e.g. if ‘price’ is $8,000 and cost inflation is $10,000 then 80% of cost inflation is ‘recovered’ in price

PVA Simplified Analytical Process (Volume first) Calculate real volume growth: Restate (inflate) base period (P1) sales using current period (P2) prices Divide current period (P2) sales by restated P1 sales Answer is ‘real volume growth’ from P1 to P2 Apply the real growth factor to all base period (P1) dollar levels These intermediate results are P2 @ P1 prices & costs Recalculate the profit or loss Difference in P&L from P1 nominal values is attributable to volume growth Using the results from the prior step, restate sales by multiplying by the sales price increase from P1 to P2 These intermediate results are P2 @ P2 prices, but P1 costs Difference in P&L from prior step values is attributable to sales price continued …

PVA Simplified Analytical Process (Volume first,continued) Using the results from the prior step, restate costs by multiplying by the cost increases from P1 to P2 These intermediate results are P2 @ P2 prices & costs Recalculate the profit or loss Difference in P&L from prior step values is attributable to cost inflation Subtract the P&L from the prior step to the original current period (P2) P&L (expressed in nominal or “current P2” dollars) Difference in P&L from prior step values is attributable to productivity Note: if there is a change in program spending (e.g. productivity enhancing initiatives) … calculate the nominal change year-to-year before calculating productivity Note: to calculate ‘inflation recovery’, compare the P&L change attributable to price to that attributable to cost inflation, e.g. if ‘price’ is $8,000 and cost inflation is $10,000 then 80% of cost inflation is ‘recovered’ in price