Profit Performance Measurement
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Transcript of Profit Performance Measurement
PROFIT PERFORMANCE MEASUREMENTINTRA COMPANY TRANSFER PRICINGPRODUCT PRICING METHOD
Capital employed
Rate of Return on Capital Employed Based on % age of profit to sales capital employed turnover
Rate of Return on Capital Employed
NPM TATO Rate of Return
10 % 2 20 %
8 % 2.5 20
6 % 3.3 20
Types of Profits
Gross profit sales –COGS Operating Profit GP-operating expenses Income Before tax Operating profit - interest Net income EBT-Tax
Departmental Rates of Return
Allocation of sales
Allocation of cost
Allocation of assets
Divisional Rate of Return On Capital Employed
Return on capital employed
Residual income figure
Calculation
Year Net Income
Investment
Cost of capital at 20%
Residual income
1 77 480 96 (19)
2 77 320 64 13
3 77 160 32 45
Present value of residual income
19.25
Importance of Rate of Return on Capital Employed
For internal profit measurement Internal control As a tool for planning Measuring operational profitability Cooperative efforts of divisions for
profit Establishing Budgets
Advantages
Management’s attention upon the earning the best profit possible on the capital
Measures management efficiency and effectiveness
Tie- financial planning, sales objectives, cost control and profit goal
Comparison of results Develop sense of responsibility
Limitations
Lack of agreement
Valuation of assets
Danger to long run interest
Neglect desirable activities
MULTIPLE PERFORMANCE MEASUREMENT
Previous years
Budget
Intra Company Transfer Pricing
Transfer price is a value assign to goods and services sold or rented from one unit of an organization to
another.
Fundamental Criteria of Transfer Pricing
Helps management to judge the profit
accurately division wise
Motivate the divisional manager
Increase management efficiency
Methods of Intra Company Transfer Pricing
Transfer Pricing based on Cost Market based Transfer Pricing Negotiated Transfer Pricing Arbitrary Transfer Pricing Dual Transfer Pricing
Transfer Pricing Based on Cost
Useful for centralized firm
Measuring management performance
Simplicity
Not suitable for decentralized company
Example
Chenab textile Weaving department’s final product
cost = Rs.60 Sewing department ‘s raw material =Rs.60
Market based Transfer Pricing
Best for profitability and performance measurement
Reflects a product profitability
Used in competitive markets
But it is difficult to calculate actual cost
Example
Chenab textile Weaving department’s final product
cost = Rs.60 Sewing department ‘s raw material =Rs.100
Negotiated Transfer Pricing
Setting of price by negotiation.
Diverts Company welfare
Time consuming
Stress to unit managers
Example
Chenab textile Weaving department’s final product
cost = Rs.60 but wants to sell at Market
price Rs.100 Sewing department ‘s raw material
wants to purchase at =Rs.60Negotiated Price = Rs.80
Arbitrary Transfer Pricing
Setting of price by negotiation but final
decision by top management
De motivation to unit managers
Hampers profit objective
Example
Chenab textile Weaving department’s final product
cost = Rs.60 but wants to sell at Market
price Rs.100 Sewing department ‘s raw material
wants to purchase at =Rs.60Price by top management = Rs.85
Dual Transfer Pricing
Different price for consuming &
producing division
Eliminate all encountered Problems
Example
Chenab textile Weaving department’s final product
cost = Rs.60 but records the sale at
Market price Rs.100 Sewing department ‘s raw material
records at Rs. 60
Product Pricing Methods
Pricing is a complex job
Coordination &cooperation of economists,
statisticians, market specialists,etc is
required
Cost-starting point of price determination
….contd
Price setting- an art Prices are influenced by Competitors Customers’ willingness Governmental regulations
Methods of price determination Profit Maximization
Sale price per unit
No. of uints to be sold
Total sales volume
VCper unit
FC Profit
16 60000 960000 420000 300000 240000
14 80000 1120000 560000 300000 260000
12 100000 1200000 700000 300000 200000
Pricing based on return on capital %age markup=capital employed x desired rate of
return on capital employed
total annual cost
%age markup= 20000000 x 20% =80%
5000000
Sale volume = total annual cost +(%age markup x total annual cost)
= 5000000+ (80% x 5000000) =9000000
…. contd
price = total cost+ (desired rate of return x total
capital employed)
sale volume in units
=$210000+(20% x 2000000)
50000
= $ 5
Conversion cost pricing
Conversion cost = DL + FOH
Item of cost Product A Product B
DM $6 $3
DL 2 4
FOH 1 2
TMC $9 $9
Sale Price 10 10
Gross Profit $1 $1
Other methods
Contribution Margin Price approach
to Pricing
Standard Cost for Pricing
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