Measuring Profitability for Business Growth

Introduction

The net profit of any profit is calculated after deducting the manufacturing, production and selling of expenses. The profits of any company directly go to owner of the business. In cases where there are no shareholders, a business owner can decide to use profits as capital. In most cases, devoid of sufficient capital or financial resources collected through profits, a business is likely to fail. Therefore, no entity can survive for a loner period without making any profits. Measuring a company’s profitability helps both current and future evaluation of the company. In this case, the tools that can be applicable in management in relations to profit making is the CIMA Strategic Scorecard. CIMA strategic scorecard leads to profitability by providing a simple, effective process that will help the company to focus on strategic facts and address the right issues. The CIMA strategic score card is framed in four dimensions that ensures business profitability. These are the business strategic position, risk and opportunities, strategic options, and the execution of the strategy. It implies that the business can work efficiently with the management accountant to promote success in the entity. It can also help to ensure high level of strategy, and therefore keeping the country in the run. The process of preparing a scorecard has the ability of helping the management accountant to focus on various strategic issues that would lead to strategic issues. Besides, the scorecard has the potential of identifying various gaps in knowledge and analysis, therefore improving the quality of information presented in the government, which leads to improved decision making and profitability. Another, accounting tool that ensures company profitability is the breakeven point. Management accountants should consider to reduce the breakeven point whenever possible to increase profitability. The tools that can be used in reducing the break-even point include; Cost analysis, which reviews all the fixed costs to determine if any of them can be eliminated. Besides, this technique reviews the variable cost to determine if they can remove, because such measures increases margins and decreases the breakeven point. Secondly, margin analysis also reduces the break-even point by monitoring the product margins and increase the rate of sales to the highest margin items possible. Thirdly, outsourcing is another tool which reduces the break-even point. If an activity includes a fixed cost, then a management accountant considers outsourcing to turn it into a per-unit variable cost, which eventually decreases the breakeven point.

The report contains advice to John Taylor pertaining to cost-volume-profit analysis (one of the many short-term decision-making techniques). These areas relate to explanations of the actual profit if the hotel is operating at 100% capacity, break-even, the number of bookings required per year to achieve his target return on investment, ROI at 10%, margin of safety, price discrimination proposals, and suggestions to John of the alternative pricing and promotion strategies to raise the profit profile of his hotel. Appropriate calculations are included in the attached appendix.

The application of BEP to help in analysis of the profitability

Break-even facilitates any entity in determining the cost structures, and the sum of units that ought to be sold to realize a profit. This framework gives a clear picture of whether a business venture is worth pursuing or not. In the event that the business already exists the break-even analysis can be helpful in determining pricing, promotional programs and controlling costs. Break-even analysis uses the following assumptions; the total fixed cost will be constant at all the output levels, all the expenses incurred can be perceived to be either variable or fixed cost, the entity has a predictable product matrix and produced only one type of product, the costs and revenue realized through product sales is affected only by the sales volume, the unit variable would remain constant because the change in total variable cost is perceived to equivalent to the level of output, and lastly other facets such as production, technology and efficacy also remain constant.

Cost Classification

As stated in the assumptions of Break-Even analysis, costs are classified either as fixed costs or viable costs, as explained below.

Fixed cost

These are constant costs that prevail irrespective of the number of units a company has or is producing. They include costs such as start-up costs, and other capital expenses that are not necessarily paid periodically. Costs such as rent, insurance, utility bills and repairs also perceived to be fixed, because their variations can be insignificant and at the same time these expenses do not directly depend on the number of items produced or owned. In this case, the following costs can be considered to be fixed.

Business rates = 0. 16 million Eur

Maintenance and repairs= 0.25 million Eur

Depreciation of fixtures, fittings and equipment = 0.06 million Eur

Salaries (Assist managers, bars/ restaurant and facilities manager) = 0.15 million Eur

Wages- Full time staff = 0.14 million Eur

Fixed administration cost = 0.114-0.0588= 0.06 million Eur

Advertising= 0.04

Variable cost

A variable cost is normally associated with the number of goods and service a company provides. An entities variable cost is likely to increase or decrease with the production volume. In cases where the production volume increases, the viable cost is likely to increase, and if the volume reduces the viable cost also reduces. Variable costs include the cost of direct labor, cost of raw materials, and utility cost. In this case these costs are;

Administration= 0.0588 million Eur

Part time reception, bar, kitchen and Housekeeping staff =0.15 million Eur

= 350 days * 84 days* 5 Eur= 0.15

Other costs = 0.03 million Eur

Rooms (half board basis) = 0.32 million Euros; Half board = cost of meal (11 Eur) * 84 booking * 350 days

Semi variable costs

Semi-variable cost is also referred to as semi-fixed cost, and it comprises of a mixture of both fixed and variable components. A semi-variable cost is incurred in spite of the activity volume, while the variable portion occurs as a function of the activity. In this case, the following costs represents semi-variable costs.

Electricals and utilities = 0.03 million Eur

Administration= 0.0588 million Eur

Application of BEP techniques

Break-even is the point of no loss or profit. At break even point, the revenue collected by the business is the total cost and its contribution margin equals to the total fixed cost. According to the operational days stated, Taylors hotel operates on 50-weeks year (instead of the normal year which has 52 weeks), and he has 60 twin bedded rooms at his disposal. Ideally, the maximum number of guests the hotel can hold should total up to 100%, meaning that all the twin-bedded rooms are fully occupied, totaling up to 120 guests (assuming that each bed will have one guest). Hence the maximum number of guests that the hotel can serve in a year of its operation is 42,000. For Tyler to break-even, Hanna, and Dodge (2017) recommended the use of the following formula; BEP= total fixed cost/ contribution margin per unit. The contribution margin is derived by subtracting variable costs from the sales. By following this formula, John’s break-even point is 19, 565 bookings annually. Birt, Chalmers, Maloney, Brooks, Oliver, and Bond (2019) commended the use of the following formula when deriving the margin of safety; Actual sales – break-even sales. In this case, the actual sales were 1.32 million Eur, while the break-even sales are 0.88 million Eur. Therefore, Johns marginal safety is 0.44 million Eur.

Margin of Safety

The margin of safety involves a financial ratio that evaluates the amount of sales that supersede the break-even point. In short, this is the revenue earned after a company or department pays of its fixed and variable costs that are related with the production of goods and services. Birt, Chalmers, Maloney, Brooks, Oliver, and Bond (2019) commended the use of the following formula when deriving the margin of safety; Actual sales – break-even sales. In this case, the actual sales were 1.32 million Eur, while the break-even sales are 0.88 million Eur. Therefore, Johns marginal safety is 0.44 million Eur. This calculation shows how stable and safe the business is in regards to becoming bankrupts. Therefore, the margin of safety reveals how safe a business is in the market.

Price Discrimination

Price discrimination involves a selling system that charges clients various prices for the same product or service that is based on what the seller can obtain and at the same time the customer can agree to the terms. In cases of pure discrimination, the vendor charges every customer the maximum price the client is willing to pay. In some price discrimination the seller groups the customer in clusters based on some characteristics and charges every group a different price. Management accountants need price discrimination to increase their profitability. Price discrimination improves profitability by allowing unprofitability business to avoid bankruptcy. In some situations, it can be possible that there is no one price that would help a firm to make the projected profits. Even so, price discrimination could help a firm to turn a loss into a marginal profit. It meant that a business activity can run instead of closing down. It is obvious that price discrimination is important for clients due to the fact that it increasing their choices of services and goods. For instance, devoid of price discrimination transport companies (off-peak, and peak) would realize huge losses. Some clusters of consumers can benefit from cheaper prices. Price discrimination implies that companies have an incentive to reduce price for groups of consumers who are rather sensitive to prices. For instance, if a company gives a 10% reduction to students. It is a common knowledge student typically have lower income and their demands are more elastic; this means that they are likely to benefit from lower prices. These groups are mostly poorer as associated to the average consumer. Lastly, price discrimination renders a firm more profitable; this could help a company to invest in improved capacity. For instance, an airline which maximizes profit from price discrimination can invest in upgrading its technology. To make a clear judgment and a rational decision on John’s strategy, there is need to calculate, how much money he will generate in weekdays and the amount he is likely to generate during the weekend. On weekends, where John has 90% room occupancy, he generates 0.68 million, and on weekends where he as 75% occupancy he makes 0.27 million based on the new tariff, he wants to introduce. In total if John was to implement this strategy, he will generate an income of 0.95 million Eur every year. From the calculations above, it is clear that the price discrimination strategy will not be beneficial to Tylor, and therefore, he should not pursue the strategy. In comparison to his normal operation, where Tylor records 70% occupancy per year, he generates 1.3 million Eur, while if pursuing this policy, he will record an income of 0.95 million, which is less by 0.35 million Eur. In short, if John sticks to his price discrimination strategy, he will record a loss of 0.35 million and should, therefore, desist from implementing it. Instead of using this price discrimination strategy, he used instead of using a loyalty scheme, whereby he offers discounts based on customer loyalty. In other words, the more a client spends, the greater the rewards. The same strategy will ensure that a strong base of clientele who are loyal to his brand. He should also consider offering coupons to clients at a certain time of the day, week, month or year.

Conclusion

The hotel owner should consider reducing the number the expenses incurred when running the business to ensure continued profits. Besides, for profit maximization the business should consider establishing plan to maximize the number of units to be occupied by guests, especially during the weekday. From the analysis conducted using various methodologies such as the Break-even analysis, and the margin of safety, it is clear that the hotel as per its current situation is stable, but needs more input in terms of strategies, advertising and reducing the costs incurred in the business. Using such mechanisms cannot only ensure sustainability, instead they also promote business sustainability.

References

Birt, J., Chalmers, K., Maloney, S., Brooks, A., Oliver, J. and Bond, D., 2019. Accounting: Business reporting for decision making. John Wiley & Sons.

Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for decision making. John Wiley & Sons.

Hanna, N. and Dodge, H.R., 2017. Pricing: policies and procedures. Macmillan International Higher Education.