Mini project report

On project engineering

Haldia Institute of Technology

SUBMITTED BY: SUBMITTED TO:

1. Arpan Mondal (16/CHE/058) Keka Rana Mam
2. Arnab Das (16/CHE/059)
3. Arnab Das (16/CHE/060)

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Acknowledgement:-
The success and final outcome of this project required a lot of guidance and assistance
from many people and we are extremely previleged to have got this all along the
completion of my presentation.All that we have done is only due to such supervision
and assistance and we would not forget to thank them.
We respect and thank Mrs. Keka Rana for providing us an opportunity to do the Mini
Project on “ Profitability Analysis Method”and giving us all support, guidance which
made me complete the presentation duly. I am extremely thankful to her for providing
me such a nice support and guidance , although she had busy schedule.

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 Contents:-

Serial no. Topic Page no.

01 Acknowledgement 2
02 Profitability Analysis Method 4
03 Objective 4
04 Customer Profitability analysis 6
05 Total quality management 7
06 Break even analysis 9
07 Break even analysis for sales 10
08 Return on investment 11
09 Net present worth 13
10 Discounted cash flow rate of 15
return(DCFR)
11 Difference between DCFR and NPV 16
12 Conclusion 16

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Profitability Analysis Method:-

Profitability analysis is a component of enterprise resource planning (ERP) that allows

administrators to forecast the profitability of a proposal or optimize the profitability of
an existing project. Profitability analysis can anticipate sales and profit potential
specific to aspects of the market such as customer age groups, geographic regions, or
product types. In cost accounting, profitability analysis is an analysis of the
profitability of an organisation's output. Output of an organisation can be grouped into
products, customers, locations, channels and/or transactions.

In order to perform a profitability analysis, all costs of an

organisation have to be allocated to output units by using intermediate allocation steps
and drivers. This process is called costing. When the costs have been allocated, they
can be deducted from the revenues per output unit. The remainder shows the unit
margin of a product, client, location, channel or transaction.

After calculating the profit per unit, managers or decision makers can use the outcome
to substantiate management decisions. Managers can decide to stop selling loss
making products, to reduce costs for loss making customers or to increase sales in
profitable locations.

Objective:-
The main aim of a business is to earn profits. Thus a company has to attract and retain
those customers who are profitable. This is known as profitability analysis or customer

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profitability analysis (CPA). In Simple terms – An analysis of cost and revenue of the
firm which determines whether or not the firm is profiting is known as profitability
analysis

The 20-80 marketing principle says that 80% of the profits arrive from 20% of
customers. This principle recently received a modification from Mr Sherdan who is a
known marketing analyst. According to Sherdan the principle can be modified as 20-
80-30, wherein 80% of the profits come from 20% of the customers and 30% of this
profit is spent in managing the unprofitable customers!! A startling revelation.

Furthermore, it is not necessary that the top 20% will contribute 80% profits. This is
because they too have a cost consideration. A lot of the profits are spent in giving
service to the top 20%. Furthermore, the top 20% also receive the most discounts. The
smaller customers on the other hand do not require too much service, they do not get
much discounts and they pay in full. Thus when we compare profitability vis a vis cost
vs revenue, we find out that both the repeat customers and one time customers are
equally important. This is the reason that saturated industries generally go after new
customer acquisition rather then just concentrating on existing customers. And this is
also the reason why industrial products manufacturers generally stick with their small
customer group rather than going all out for new customer acquisition. Thus the
question is, What makes a profitable customer? A profitable customer is a person,
household, or company that over time yields a revenue stream that exceeds by an
acceptable amount the company’s cost stream of attracting, selling, and servicing that
customer.

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Although customer satisfaction is measured in most companies, measuring individual
customer profitability is not a known practice. For example – Several banks think that
measuring customer profitability is a very tedious process.

Customer Profitability analysis:-

The customer profitability analysis is bases on activity based costing and helps in
calculating the revenue coming from customers while at the same time removing all
costs from it thereby calculating the actual profitability per customer. To read in detail
about customer profitability analysis click here. The CPA is a very important tool for
profitability analysis and is frequently used.

Customer product profitability analysis:-

Firms like HUL and P&G have a wide variety of product portfolio. So what would be
their benefit per customer per product? To calculate this, the customer product
profitability analysis can be used. To read more about it click here. This profitability
analysis method can be used to find out both – profitable customer as well as
profitable products.

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Increasing company profitability:-
Companies don’t need to produce products with high value itself, but also products
which are competitive in the market because of their pricing. As commented by
Michael porter – Cost leadership is one of the leading sustainable competitive
advantages a firm can have. Thus a company has to take care of its cost which will
subsequently bring its profitability. Furthermore, any advantage the firm has, should
be seen as a customer advantage. Developing on customer advantages will result in
increasing the overall company profitability.

Total Quality Management:-

Profitability of the firm also depends on its ability to continuously improve its
products and processes. TQM involves everyone and the concept believes that with
involvement of the top management, the workforce, suppliers and even customers, the
overall output of the firm can be increased and thus the firm will always meet
customers expectations thereby thoroughly satisfying them and therefore increasing
the overall profitability of the firm.

Thus profitability analysis leads to the firm discovering the areas where it is profitable
and where it is not. It can help the firm decide where it can lower the cost and where it
can increase value. Thus in the end, we come to the point mentioned at the start of the
article. The motive of a business is to earn profits and profitability analysis helps the
firm achieve the same aim.

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Here are the profitability ratios that small business owners should look at regularly:

• Gross Profit Margin Ratio.

• Operating Profit Margin Ratio.
• Net Profit Margin Ratio.
• Other Common Size Ratios

The three measurements of profits — gross profit, operating profit and net profit — all
come from your company's income statement.

As a reminder, here is a definition of gross profit, operating profit and net profit. (As
you will see, the definitions build on one another, reflecting the way net sales are
affected by increasing expense components.)

Gross profit = Net sales minus the costs of goods sold.

(As a reminder — Net sales = gross sales less any returns and discounts.)

Operating profit = Gross profit minus selling and administrative expenses

(Administrative expenses = salaries, payroll taxes, benefits, rent, utilities, office
supplies, insurance, depreciation, etc.)
Operating profit includes all expenses except income taxes.

Net Profit = Operating profit (plus any other income) minus any additional
expenses and minus taxes.
Net profit is what is known as "the bottom line."

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Each of these three terms is simply a way of expressing profit when different
categories of expense are included. Gross profit is the difference between sales and the
costs of goods sold. Operating profit is the difference between sales and the costs of
goods sold plus selling and administrative expenses. And finally, net profit is the
difference between net sales and all expenses, including income taxes.

The three ways of expressing profit can each be used to construct what are known as
profitability ratios. This is done by dividing each item into net sales and expressing the
result as a percentage. For example, if your company had gross sales of $1 million last
year, and net profits were $50,000, that's a ratio of 50,000/1,000,000 or 5%.

There are several reasons that ratios are expressed as percentages. This makes it easy
to compare your company's results at different time periods. It also allows you to
compare your company's results with those of your peers or competitors, and with
industry "benchmark" ratios .

BREAK-EVEN ANALYSIS:-
The term "break-even analysis" is another phrase which may seem complex, but the
concept behind it is actually quite simple.

Break-Even is the point at which revenues equal expenses. Until your company
reaches break-even, you are generating red ink; your costs for materials, labor, rent
and other expenses are greater than your gross revenues. Once you pass the break-
even point, revenues exceed expenses. After break-even, a portion of each dollar of
sales contributes to profits. It is only when you pass break-even that profits begin to be
generated.

Break-even analysis is a simple but effective tool you can use to evaluate the
relationship between sales volume, product costs and revenue.

It is certainly useful for you to calculate your company's current break-even point. If
your company is profitable you may want to know how much breathing room you
have should revenues take a dip. If your company is losing money, knowing the break-
even point will tell you how far you are from beginning to turn a profit.

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Break-Even Analysis For Sales:-
To calculate the sales break-even point for your business you should have (or be able
to estimate) three pieces of
information about your business
• Fixed expenses
• Variable expenses (expressed as a percentage of sales)
• Sales
Using just these three pieces of data, you can perform a break-even analysis for your
company. Before we do that, however, let's quickly review the concepts of fixed and
variable expenses.
Expenses that are defined as "fixed" do not vary with sales. They are the day-to-day
expenses that your business will incur regardless of how sales volume is increasing or
decreasing. Some examples of fixed expenses include overhead, administrative costs,
rent, salaries, office expenses, and depreciation.
Variable expenses, on the other hand, do vary with sales. Let's say your company
makes paper clips by cutting and bending pieces of wire. As you sell more paper clips,
you have to buy more wire. The expense for wire varies with your sales. Typical
variable expenses include the cost of goods sold (as shown on the income statement)
and variable labor costs (like overtime wages or salaries for sales personnel.) Variable
expenses will increase and decrease according to sales volume.

At the break-even point, Sales = Fixed Expenses + Variable Expenses

or

S=F+V
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sales at the break-even point are equal to expenses. Until sales reach the break-even
point no profits can be recorded, but the next sales dollar will contribute to profits.

Now, let's calculate the level sales must reach to achieve break-even. To do it, we will
find what percentage current variable expenses are of total sales.

Return on investment (ROI):-

Return on investment (ROI) is a ratio between the net profit and cost of investment
resulting from an investment of some resources. A high ROI means the investment's
gains favorably to its cost. As a performance measure, ROI is used to evaluate the
efficiency of an investment or to compare the efficiencies of several different
investments. In purely economic terms, it is one way of relating profits to capital
invested. Return on investment is a performance measure used by businesses to
identify the efficiency of an investment or number of different investments.

Purpose:-
In business, the purpose of the return on investment (ROI) metric is to measure, per
period, rates of return on money invested in an economic entity in order to decide
whether or not to undertake an investment. It is also used as an indicator to compare
different investments within a portfolio. The investment with the largest ROI is
usually prioritized, even though the spread of ROI over the time-period of an
investment should also be taken into account. Recently, the concept has also been
applied to scientific funding agencies (e.g., National Science Foundation) investments
in research of open source hardware and subsequent returns for direct digital
replication.

ROI and related metrics provide a snapshot of profitability, adjusted for the size of the
investment assets tied up in the enterprise. ROI is often compared to expected (or
required) rates of return on money invested. ROI is not net present value-adjusted and

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most schoolbooks describe it with a "Year 0" investment and two to three years
income.

Marketing decisions have an obvious potential connection to the numerator of ROI

(profits), but these same decisions often influence assets usage and capital
requirements (for example, receivables and inventories). Marketers should understand
the position of their company and the returns expected.

Calculation:-
For a single-period review, divide the return (net profit) by the resources that were
committed (investment):

return on investment = Net income / Investment

where:
Net income = gross profit − expenses.
investment = stock + market demand + claims.

or

return on investment = (gain from investment – cost of investment) / cost of

investment

or

return on investment = (revenue − cost of goods sold) / cost of goods sold

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Risk with Return On Investment usage:-
As a decision tool, it is simple to understand. The simplicity of the formula allows
users to freely choose variables, e.g., length of the calculation time if overhead cost
should be included, or details such as what variables are used to calculate income or
cost components. To use ROI as an indicator for prioritizing investment projects is
risky.

Payout Period:-
 The period of time during which benefits on an annuity or retirement account
are paid.
 In entrepreneurship, a period of time in which cash flow is negative. This
especially applies to an early part of a company's history before it has recovered
start-up costs and operating expenses.
 In stocks, dividends per share divided by earnings per share, expressed as a
percentage. Stock analysts use this ratio to compute how much of a company's
profits it pays in dividends, and perhaps how that compares to other, similar
companies. Stockholders prefer companies that pay more in dividends.

Net present worth:-

the net present value (NPV) or net present worth (NPW) applies to a series of cash
flows occurring at different times. The present value of a cash flow depends on the
interval of time between now and the cash flow. It also depends on the discount rate.

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NPV accounts for the time value of money. It provides a method for evaluating and
comparing capital projects or financial products with cash flows spread over time, as
in loans, investments, payouts from insurance contracts plus many other applications.

Calculation of NPW:-

Net present value (NPV) is determined by calculating the costs (negative cash flows)
and benefits (positive cash flows) for each period of an investment. The period is
typically one year, but could be measured in quarter-years, half-years or months. After
the cash flow for each period is calculated, the present value (PV) of each one is
achieved by discounting its future value (see Formula) at a periodic rate of return (the
rate of return dictated by the market). NPV is the sum of all the discounted future cash
flows. Because of its simplicity, NPV is a useful tool to determine whether a project or
investment will result in a net profit or a loss. A positive NPV results in profit, while a
negative NPV results in a loss. The NPV measures the excess or shortfall of cash
flows, in present value terms, above the cost of funds. In a theoretical situation of
unlimited capital budgeting a company should pursue every investment with a positive
NPV. However, in practical terms a company's capital constraints limit investments to
projects with the highest NPV whose cost cash flows, or initial cash investment, do
not exceed the company's capital. NPV is a central tool in discounted cash flow (DCF)
analysis and is a standard method for using the time value of money to appraise long-
term projects. It is widely used throughout economics, finance, and accounting .

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DISCOUNTED CASH FLOW RATE OF RETURN (DCFR):-
Discounted cash flow rate of return(DCFR) is a valuation method used to estimate the
value of an investment based on its future cash flows. DCF analysis finds the present
value of expected future cash flows using a discount rate. A present value estimate is
then used to evaluate a potential investment.

CALCULATIONS OF DCFR:-
 The discounted cash flow formula is derived from the future value formula for
calculating the time value of money and compounding returns.

 DPV is the discounted present value of the future cash flow (FV), or FV
adjusted for the delay in receipt;
 FV is the nominal value of a cash flow amount in a future period;

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  r is the interest rate or discount rate, which reflects the cost of tying up capital
and may also allow for the risk that the payment may not be received in full.
 n is the time in years before the future cash flow occurs.

DIFFERENCE BETWEEN DCFR AND NPW:-

 There is a difference. Both Discounted Cash Flows Rate (DCFR) and Net
Present Value (NPV) are used to value a business or project, and are actually
related to each other but are not the same thing.
 DCF is the sum of all future cash flows of a given project or business or
whatever, discounted to present day (because money in the future is worth less
than it is today.
 NPV is calculated using the DCF and subtracts the cost of the investment.
Basically, it tells me, "If I have to spend $$ TODAY to generate all this future
cash flow, am I getting more OR less than what I paid?" If' the NPV is negative,
then effectively I would be giving away money. If it is positive, then I would be
getting back something for making the investment over that time period .

Conclusion:-
 Profitability Analysis Method is used to determine the profitability of an
organisation's output. Output of an organisation can be grouped into products,
customers, locations, channels and/or transactions.
 In order to perform a profitability analysis, all costs of an organisation have to
be allocated to output units by using intermediate allocation steps and drivers.

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 This process is called costing. When the costs have been allocated, they can be
deducted from the revenues per output unit. The remainder shows the unit
margin of a product, client, location, channel or transaction.
 After calculating the profit per unit, managers or decision makers can use the
outcome to substantiate management decisions. Managers can decide to stop
selling loss making products, to reduce costs for loss making customers or to
increase sales in profitable locations.

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