by A large business intends to make a profit. Shareholders and directors focus on the bottom line to determine if the entire company has cleared a profit, but what about specific segments, or units, within the organization? As an office-equipment manufacturer, can we determine how the stapler product line is doing?
Business unit profitability analysis can help us determine how profitable a given business unit is. In the analysis, we will evaluate sales and expenses for that unit. Expenses include equipment, floor space, salaries, etc. There are a couple of approaches to business unit profitability analysis, but the underlying principle is the same:
- What is our income for the business unit?
- What are the expenses?
We’ll get into the details below, but we can consider a business unit profitable if sales are greater than the expenses. Once that question is answered, we can ask if that margin is good enough. Let’s take a look at some approaches we can use to analyze business unit profitability.
Full Cost Approach
The full cost approach looks at ALL expenses related to the business unit and assumes they impact that business unit. For example, the building space used to make both staplers and binders still benefits the stapler production: according to the full cost approach, these expenses count against the stapler business unit also.
Other full cost expenses could include managers’ or directors’ salaries, taxes, rent, utilities, and marketing.
Analytical Approaches
There are a couple of ways to approach business unit profitability analysis. We can use a full cost approach or a contribution approach.
Contribution Approach
Much like product profitability analysis, the contribution approach narrows the focus to only look at sales and expenses related directly to the stapler product line. Profit margin is then sales minus direct expenses.
The benefit to this approach is that it cuts out those other expenses, such as floor space for production. Since our company makes office supplies, we will always have that expense, even if we cut out stapler production. Why should we count these expenses against the stapler line?
