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Profitability analysis: What has happened

Anonymous A asked on Apr 22, 2018 - 2 answers


When facing the question: "our profitability declined by 10%, what has happened, and how to overcome them"

Shouldn't I start with the R-C relation (while adding the mix for qualitative analysis;considering different components in the mix per industry) ? I dont want to come across as someone who memorizes this, but I cant overlook it as well.

The analysis later on, on how to improve, should take a different structure to be tailored upon the situation.

Looking to hear your thoughts on how I can structure it initially.

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replied on Apr 22, 2018
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In my opinion, it is absolutely fine starting with the standard Revenue and Costs structure to understand why profitability has declined. Effetively driving down each of these will lead to identifying the key issues that are impacting the case and you can then address more specifically how to fix them.

However, you are right to try and avoid being too generic and memorising standard structures. Remember though, that this should not mean that you shouldn't use simple structures if they make sense. The most important thing if you do use them is to ensure that you have understood the key issues / levers that matter to the case in question and bring them out in the second and third levels of your structure. That is how you avoid appearing to have memorised structures. For example, in a profitability tree, avoiding a generic Fixed vs Variable cost breakdown and instead identifying the key cost buckets that really matter for the client in question - these will be different if considering manufacturing vs pharma vs oil and gas.

Let me know if you have any more questions.



replied on Apr 22, 2018
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I would recommend the following approach:

1) Ask clarifying questions:

- Clarify the business model (i.e. how the business works and what are the revenue streams / core products or business lines). Why do you need to know the revenue streams? Because it's one of the most critical pieces in understanding the business model. An example is Oil&Gas with up-, mid- and down- streams that are completely different businesses.

- Clarify the objective both in money terms and timeline (e.g. Our objective is to increase profits by 5M in 5 years). When you have a to select from several options in a case - clarify the selection criteria

- Clarify other possible limitations if you feel that it's necessary

2) You make a classic profitability structure adapting it to the case. Sometimes cases are not that easy as just declining profits. For example, if the profits are lower than planned, it is either because we have problems with profits or we have problems with planning. Try to be MECE here.

3) While you do your structure and split revenues into price and quantity - addproactively the 3rd box with the "Mix". Thus you show your business sense and demonstrate that you know the most common case traps. Pls note that the "mix" can be anything - geography, customer, product, etc. You split the costs into fixed and variable.

3) Costs I would split into Fixed and Variable

4) I would start the case by checking whether its increasing revenues, declining costs, or both - so that you could eliminate the part that is irrelevant

5) If it is the quantity problem I would further analyze whether it's the external market problem or internal one


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