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Profitability Management

Contents:
Definition of Profitability Management Profitability reporting options in the R/3 System Business purposes of CO-PA and EC-PCA Aspects of Profitability Management Approaches

SAP AG 1999

SAP AG

AC610

2-1

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Profitability Management: Unit Objectives

At the conclusion of this unit, you will be able to: Describe the business purposes of Profitability Analysis and Profit Center Accounting in the R/3 system Identify information which can be obtained in Profitability Analysis and Profit Center Accounting Clarify the aspect and scope of profitability management in the R/3 System

SAP AG 1999

At the end of this unit, the course participant should be able to accomplish these tasks.

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AC610

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Course Overview Diagram (2)

Actual Data

Basic Settings

Transfer Prices

Profitability Management Information System

Profit Center Planning

SAP AG 1999

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AC610

2-3

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Unit Business Scenario - CO-PA

Both cross-company and company-specific reporting is required, in multiple currencies Multidimensional Profit and loss reporting across elements of the sales force, product lines, customers and other organizational units is required Sales details, cost-of-sales details, contribution margins, production variances, and period cost details are required Actual period costs (S,G, & A) are to be allocated across organizational entities at month-end Reporting for Capital Investments, and P & L accounts is required
SAP AG 1999

The corporation has legal entities in Germany, Italy, and the United States, and it requires the ability to report sales and profitability both across the corporation in a corporate currency and within each of the legal entities in their local currencies. The sales managers, Sam Sales and Randy Revenue, require summarized sales performance figures, like revenue, discounts, and surcharges both along as well as across the lines of the company's sales structure, product lines, and customers. They also desire sales and marketing expenses along these lines as well. The company President, Bob Big, wants all month-end costs (such as freight and G&A expenses) accrued in CO but not in FI during the month, so bottom-line profitability can be estimated at any time; at month-end, he wants the actual costs in CO allocated realistically across the sales channels and areas of responsibility areas. The accountant, Carrie Cash, requires profitability reports at month-end along the company's areas of responsibility, such as plants or departments. In addition she also want to track capital investments such as assets, and report certain financial key performance indicators.

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AC610

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Terminology in Profitability Management
Gross Gross Sales Sales Sales Sales Deductions Fixed Deductions Net Costs Sales Sales Product Variable Costs Costs Variances Inventory Inventory Return on Return on Investment Investment Economic Economic Margins Margins
Profit Profit

Full Absorption Period Period Accounting Costing Accounting Standard Cost-of-Sales Accounting Costing

Contribution Margin Margin

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Cash Cash Flow Flow

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AC610

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Methods of Profitability Management

Cost-of-sales accounting
Revenue Sales deductions Cost of sales .

Period accounting
Revenue Sales deductions Stock changes Capitalized internal activities Changes to work in process .

Gross results
Sales and Marketing costs Administration costs Research and development

Total output
Material costs Personnel costs Depreciation Interest ...

SAP AG 1999

Two accounting methods used for generating profitability statements are the cost-of-sales method and the period accounting method. Applying either method to a given set of business transactions under a given set of laws yields the same bottom-line result (profit) in concept. The difference is in how the overall profit and loss picture is presented. Companies must choose to use one of these methods for generating their legal financial statements. The choice is often determined by country-specific legal requirements. However, the methods facilitate two different types of analyses, both of which a company may want to conduct, so internally there may be efforts to track information in both manners. With this method, the emphasis is on matching the revenues for goods and/or services provided (the value that a company gains as a result of sales) against the related expenses for those items (the value that is lost when products are transferred out of the company). Therefore, this accounting method displays profit and loss information in a manner optimized for conducting margin analyses, and as such it is optimal for the sales, marketing, and product management areas. With this method, the emphasis is on summarizing the activity and situational change over a period of time, for a given organizational unit. Therefore, this accounting method presents the revenues and primary expenses that have been incurred during a given period of time and the changes in stock value levels, work-in-process, and capitalized activities. As such, it is optimal for the production and profit center areas.

Cost-of-sales accounting

Period accounting

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AC610

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Views of Profitability Management

Responsibility Accounting Revenue Salaries Material ... Profit ROI ... 2000 468 230 1000 12

Profitability Analysis by Market Segments Revenue Discounts COGS Contr.Margin Marketing ... 2000 100 460 1440 230 Profitability Segments

Profit Centers

Procurement
SAP AG 1999

Production

Distribution

Sales

Sales Reporting: CO-PA lets you analyze the profitability of segments of your market segments structured according to products, customers, orders, and summarizations of these and other characteristics as well as organizational units such as company codes or business areas. The aim is to provide your sales, marketing, planning, and management organizations with decision-support from a market-oriented viewpoint. Responsibility Reporting: EC-PCA lets you analyze internal profit and loss for profit centers. This makes it possible for you to evaluate different areas or units within your company. You can structure profit centers according to region (branch offices, plants), function (production, sales), or product (product ranges, divisions). Profit Center Accounting is a component of the module "Enterprise Controlling".

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AC610

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Typical Questions in Profitability Analysis

Contribution of Individual Market Segments

Which are the largest and fastest growing customers?

Margin goals of Individual Sales Entities

Did the sales force reach their contribution margin goal? What was the success of the most recent sales promotion for a product line?

Success of Marketing Activities

Revenue and Cost Structure

What is the impact of a pricing strategy for a group of customers?

SAP AG 1999

The best way to illustrate the purpose of Profitability Management in the R/3 system is to think about some of the typical questions which can be answered, in this case by Profitability Analysis.

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AC610

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Profitability Analysis by Market Segments
Region Product Customer Sales office

Business Unit

Reporting Dimensions
Sales Quantity Sales Revenue Customer discount Sales commission Direct sales costs Net revenue Direct material costs Variable production costs Contribution margin I Material overhead Fixed production costs Contribution margin II Variances Contribution margin III Overhead costs Operating profit
SAP AG 1999

Determine and analyze the profitability of market segments

Revenue
f it Pro

Cost

ss Lo

The business purpose of Profitability Analysis is to provide profitability-oriented performance information on a company's market segments or sales channels, in order to support corporate planning and decision-making, especially in the areas of sales and marketing. The definitions of both 'market segments' and 'performance figures' are freely definable, allowing for maximum flexibility in market evaluation. The definition of a market is configured in the system through the selection of characteristics that are to be the subjects of analyses. Performance figures may either be profit and loss account balances or freely defined value fields. Market segments are normally some combination of information regarding customers, products, and the selling organization. Performance figures are normally measurements of quantities, revenues, discounts, surcharges, product costs, margins, period costs, etc. The results of Profitability Analysis can be analyzed with a multidimensional reporting tool, which allows the dynamic sorting and rearranging of data to provide multiple perspectives within a single report.

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AC610

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Typical Questions in Profit Center Accounting

Contribution of an organizational unit

What is the operating profit for a profit center

Return on Capital

Which asset value is attributed to a profit center?

Cost Management

Which responsibility areas exceeded their plan last months?

Management of Internal Sales & Services

What goods and services are exchanged within the corporation?

SAP AG 1999

The best way to illustrate the purpose of Profitability Management in the R/3 system is to think about some of the typical questions which can be answered, in this case by profit center accounting.

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AC610

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Responsibility Accounting by Profit Center
Accounts Profit Centers

Reporting Dimensions
Sales Revenue Sales Deductions Cost of Goods Sold Operating Profit Liabilities Accounts Receivables Invested Capital in Assets Inventory Cost of Capital Return on Investment

Determine and analyze profit, balance Answers and financial ratios by Profit Center

Profit
ROI Equity Turnover Return on Sales Economic Profit

Invested Capital

SAP AG 1999

EC-PCA lets you calculate internal operating results for profit centers. A profit center represents an organizational subunit that operates independently on the market and bears responsibility for its own costs and revenues. You organize your organization into profit centers by assigning the master data of each profit-relevant objects (materials, cost centers, orders, projects, sales orders, assets, cost objects, and profitability segments) to a profit center. All the business transactions in the R/3 System which are relevant for cost and profits are updated in the profit centers at the same time they are processed in the original module, and organized according to cost and revenue elements. This transforms all the flows of goods and services within the company into exchanges of goods and services between profit centers. This profit center structure applies for both actual postings and profit center plan data. It is also possible to treat a profit center as an investment center. In addition to the flows of goods and services, you can transfer selected balance sheet line items (fixed assets, payables and receivables, material stocks, and work in process) to profit centers on a periodic basis. This makes it possible to calculate such key figures as profit on sales, return on investments and cash flow.

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AC610

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Reporting

Profitability Analysis
Value Fields Revenues Sales deductions 1,000,000 100,000 -------------Net revenues 900,000 Var. material costs 400,000 Var. production costs 190,000 Prod. variances 10,000 -------------Contribution margin 1 300,000 Material overhead 50,000 Production overhead 50,000 -------------Contribution margin 2 200,000 Research & develop. 10,000 Marketing 50,000 Sales and administration 40,000 -------------Contribution margin 3 100,000

Profit Center Accounting

Cost and Revenue Elements 800000 Revenues 1,000,000 808000 Sales deductions 100,000 -------------Net revenues 900,000 893000 Cost of sales 690,000 231000 Price differences 10,000 651000 Research & develop. 10,000 671000 Marketing 50,000 655000 Sales and Administration 40,000 -------------Profit 100,000 157000 Acc. Payables 800,000 140000 Acc. Receivables 1,200,000 300000 Inventory 450,000 ... Cost of Capital (11%) 82,000 Economic Profit 18,000

SAP AG 1999

The method of determining period operating results in Profitability Analysis is based on the assumption that a company's success can be measured primarily on the basis of its transactions with other companies. The aim is to supply the sales, marketing, product management, controlling, and corporate planning teams with decision-support information. This sales-oriented approach in CO-PA means that no contribution to the organization's success is made until a sales transaction has been completed. Consequently, the products sold are transferred to CO-PA in accordance with the cost-of-sales accounting method and provide information on the sales revenue and sales deductions. This net revenue is then compared with the cost of sales. These costs consist of the cost of goods manufactured of the products sold or services rendered plus any production variances known. To round off your profitability data, you can also assign overhead costs to profitability segments in the course of your period-end closing activities.

SAP AG

AC610

2-12

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Flows of Actual Values in Profit Center Accounting
Profit-Center Accounting
CO
ECPCA

Profitability Analysis Product Cost Controlling

Cost object

Overhead Cost Controlling

Processes

Cost Centers Internal Orders

Cost and Revenue Element Accounting FI

Revenues Discounts

SD
SAP AG 1999

Profit Center Accounting (EC-PCA) is a statistical accounting component. This means that it takes transaction data posted in other components and represents it from a profit-center-oriented point of view. The postings in EC-PCA are statistical postings, since the profit center is not itself an account assignment object in Controlling. The integration of the R/3 system makes it possible to post profit-relevant data to Profit Center Accounting automatically as soon as the transaction is originally posted. The system either transfers the relevant items from the original postings or creates additional postings.

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AC610

2-13

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Objects in Profitability Management
Profit-Center Accounting
CO

Profit Center Profit Center Groups Accounts Profitability Segments Characteristics Characteristic values Value fields or accounts

ECPCA

Profitability Analysis

COPA

FI

SAP AG 1999

Profitability segments are the market channels or strategic business units that are to be analyzed in CO-PA. They may be combinations of product, customer, and sales structure information, and/or may encompass company code, business area, and profit center information. Since reporting margins and other profitability figures along marketing lines (as defined by these profitability segments) is the primary purpose of CO-PA, its design has been optimized for producing profit and loss statements under the cost-of-sales accounting format and philosophy. Profit centers are areas of responsibility within a company for revenues and expenses, as well as certain assets and liabilities in some cases. All profit centers are arranged into a standard hierarchy representing the entire organization. Since reporting performance information along responsibility-oriented organizational lines (as defined by this profit center hierarchy) is the primary purpose of EC-PCA, its design has been optimized for producing profit and loss statements under the period accounting format and philosophy. However, cost-of-sales accounting in EC-PCA is also now possible with the aid of functional areas.

SAP AG

AC610

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Organizational Units & Master Data
Operating Concern Profit Segment Profit Segment Controlling Area Profit Centers Profit Centers Company Codes Company Codes Profit Centers Company Codes Profit Segment

Cost Center Cost Center Cost Center Cost Object Project

Plant

Sales Organization

Order
SAP AG 1999

The operating concern is the highest reporting level within CO-PA; it defines the limit of sales and marketing information which can be reported together from this module. One or more controlling areas are assigned to an operating concern when organizational structures are defined. Often, corporations have only a single operating concern, which is recommended for the sake of simplicity and convenience if all controlling areas and company codes share the same fiscal calendar The controlling area is an organizational unit delimiting the organization's independent cost accounting operations (cost center accounting, profit center accounting, and order accounting). Company codes are assigned to controlling areas when organizational structures are defined. Often, a 1:1 relationship exists between the company code and the controlling area. However, a controlling area can also incorporate several company codes to take cross-company cost allocations into account. The company code is an independent accounting unit within a client. The legal requirements of a balance sheet or profit and loss statement are fulfilled on the company code level. Plants are assigned to company codes when organizational structures are defined. The plant represents a production facility. It is the primary organizational unit in the SAP R/3 Materials Management and Production Planning application components.

SAP AG

AC610

2-15

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Parallel Currencies in Profitability Management
Profitability Analysis Costingbased
COPA

Company Code Currency

Operating Concern Currency

Accountbased

Transaction Currency

Company Code Currency

Controlling Area Currency

Profit Center Accounting

DEM Lira Euro

ECPCA

Transaction Currency

Company Code Currency

Special EC-PCA Currency

SAP AG 1999

In costing-based CO-PA, all amounts are stored at minimum in an operating concern currency, which is specified in the operating concern attributes. It is also possible to configure the attributes to store values in the local currency as well; this has the effect of doubling the stored transaction data, though. Account-based CO-PA stores all transaction in three currencies, the transaction currency, the local currency, and the controlling area currency. Profit Center Accounting can store transactions in the transaction currency, the local currency, and a special profit center accounting currency.

SAP AG

AC610

2-16

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Different Views of a Corporation

Group

TP Company code 1 Production Company code 2 Semifinished gds. Production Finished goods TP

Company code 3 Sales companies

Legal

(Intercompany) TP Division 1 Profit center (Intracompany)

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TP Division 2

TP

Division 3

Division 4

Different decision-makers in a company need different types of information. For this reason, those responsible for the individual group companies require profitability data to be represented from the viewpoint of each company code and to match the income statement from external reporting. For the group head office, the group as a whole is generally the most important view. This means that the basis for decision-making requires the group to be represented as a business unit and to eliminate intercompany profits. Especially if company units such as profit centers are to be run like independent companies, the profit center managers require the equivalent type of information. In such cases, sales between profit centers within a company are also taken into consideration.

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AC610

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Parallel Valuation Views

Group

Legal

Profit Center

Group Company 1 Company 2 Company 3

Profit Center 1

Profit Center 2

SAP AG 1999

The view of the individual company and the valuation of business transaction according to legal reporting requirements only represents one of several possible perspectives. Balance sheet and tax considerations play an important role in the financial statements of the individual companies. In addition to this legal view, though, successful corporate and group management needs other information that shows business activities from the point of view of the whole group or of individual profit centers. Corporate controlling for the entire group requires you to valuate these business transactions using group production costs. Moreover, in many groups the management structures do not correspond to the individual legal accounting units. Internal prices guide the activities of the individual profit centers according to market principles. Consequently, value flows represented from the point of view of profit centers are vital for the purposes of internal management and profitability.

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AC610

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Summary I

Comparison
Aims of Profitability Accounting Methods

CO-PA costing-based Market Profitability Cost-of-Sales Accounting Profitability Segments Profit-Related Key Figures

CO-PA account-based Market Profitability Cost-of-Sales Accounting Profitability Segments Profit-Related Key Figures

EC-PCA profit centers Enterprise Controlling COS & Period Accounting Profit Centers Profit-Related and Financial Key Figures

Objects to be analyzed Key Figures

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AC610

2-19

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Summary II

Comparison
Currency translation Organizational Aspects Reconciliation with FI

CO-PA costing-based

CO-PA account-based

EC-PCA profit centers

Transaction Operating Concern Transaction CompCode/Pft Ctr. Company Code CompCode/CO Area Currency Currency Currency

Operating Concern Posted and Estimated Values

Controlling Area

Controlling Area

Posted Values

Posted Values

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AC610

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Definition of Profitability Management: Unit Summary

You are now able to: Understand the Aims of Profitability Management Identify the objects to be reported in Profit Center Accounting and Profitability Analysis Understand the financial key figures provided by each application Discuss aspects such as organizational structure, currencies and transfer prices

SAP AG 1999

SAP AG

AC610

2-21