Research Paper On Differential Analysis Method
Differential analysis is an approach or method of comparing two or more business alternatives to each other to efficiently and effectively make decision that will enhance business organization growth. With strict adherent to numerical approach, the business would compare relevant costs of the alternatives and the resulting benefits of individual alternative. Moreover, the key concept in understanding differential analysis is the concept of relevant costs, the analysis exclude sunk costs and ones that are the same for all the alternatives will be ignored. Jim B. (2021).
Conversely, differential revenues and costs show the variance in revenues and costs among alternative courses of action; and analyzing this difference or variance is term differential analysis. Differential analysis as a management technique is useful in making managerial decisions that are relative to making or buying products, sustaining or dropping products lines, as well as keeping or dropping and customer.
Cadbury Nigeria Plc Lagos Nigeria is one of the major market stakeholders of food beverages and confectionery in Nigeria. Using differential analysis is imperative for Cadbury to remain competitive in the market. Cadbury income statement for the year ended December 31, 2019; reveal revenues and cost of sales respectively as N39, 326,807 and N31, 001,209. The income statement also shows selling expenses of N5, 208,925, a variable cost that is traceable to Cadbury product lines and pertinent to differential analysis. Addition, the income statement show general and administrative (overhead) expenses of N1,819,571, a fixed cost of rent, utilities, salaries, and insurance which are relevant to perform differential analysis calculation.
Typical calculation of differential analysis for all the products line or brands by using Cadbury Nigeria Plc income statement for the year ended December 31, 2019 is illustrated below:
Sales revenues…………………………….N39, 326,807
Variable costs ………………..…………..N36, 210,134
Contribution margin………………………N3, 116, 673
Fixed cost………………………………....N1, 819,571
Sunk costs are non-essential costs to differential analysis, they are costs already incurred prior to the current analysis and cannot be eliminated by management decision. For instant when Cadbury Nigeria Plc purchased a machine that becomes obsolete in short time, and the plastic bags produced can no longer be use for packaging as a result of government regulation to keep the environment safer; and mitigate impacts on the land fill. The new regulation makes the machine and the packaging plastic bags obsolete and Cadbury cannot influence or change government decision. Thus, sunk cost is expense that cannot be reserved. https://corporatefinanceinstitute.com/resources/knowledge/accounting/differential-cost/
Furthermore, an opportunity cost refers to benefits or incomes that are forgone by choosing an alternative over another. Cadbury management must choose between alternate options, but the decision have to be made after due consideration for the opportunity cost of not getting the benefits inherent in the option not chosen. Opportunity cost unlike sunk cost is considered in differential analysis, it aids managers to determine the most profitable level of production and prices as well as offer a quotation at a lower selling price to increase capacity. https://corporatefinanceinstitute.com/resources/knowledge/accounting/differential-cost/
The sale revenues, variable and fixed costs are paramount financial data for the differential analysis of whether to drop or keep customer or a product line with exclusion of sunk cost, a non differential cost. Conversely, opportunity cost has to be included in the calculation to make decision among multiple alternatives.
Conclusion: Business organizations sometimes have to consider qualitative i.e. non-monetary and intangible benefits of the various alternatives when performing differential analysis. Qualitative information like quantitative data plays a significant role in differential analysis and managers must not their eyes to pertinent qualitative information while making decision. Examples of qualitative information that are also critical to decision making are government policy and political stability etc.
Jim B. (January. 31, 2021). What is differential Analysis.Wisegeek. https://www.wisegeek.com/what-is-differential-analysis.htm
Nnamdi M. (2021. January, 11). Cadbury Nigeria Plc announce closed for Q4 2020 Financial Statements.Investogist. https://investogist.com/cadbury-nigeria-plc-announce-closed-for-q4-2020-financial-statements/?sfw=pass1612725600