Meaning of controllable profits
For managerial evaluation, there are different responsibility centers inside any organization. These include revenue center, profit center, cost center, and investment center.
Controllable profits are a concept wherein the performance of divisional managers is evaluated based upon the responsibility center in which they have been assigned.
Controllable profits mean revenue minus controllable expenses. These profits help to decide divisional managers’ performance over the period so that annual evaluation for bonuses can be done. Some of the examples of controllable expenses are wages and salaries, raw material costs, etc.
So, there are two important terms for calculating controllable profits:
Controllable profits = Revenue – Controllable costs
However, there are some items that are not included in the controllable costs such as rent, taxes, depreciation, insurance, etc.
Controllable profits example
A company had three different segments of clothing for men, women, and kids. They have hired 3 divisional managers for these segments. These divisional managers are responsible for making the day-to-day decisions that have an impact on their assigned product segment.
If the manager of the kid’s division has high efficiency on purchases and incurrence of cost controllable profits of that division will be high. Based upon it, the bonus and performance evaluation of that manager can be done.
Difficulty while evaluating controllable cost and the non-controllable cost
In a decentralized organization where depreciation is being incurred, there may be confits among different responsibility centers.
For example, depreciation is a non-controllable expense for any profit center because this is an allocation to that department while the same depreciation is a controllable expense for the investment department because they can decide upon how much plant and machinery or investments needs to be done in a certain period.
It is essential to identify controllable costs and non-controllable costs inside the company so that controllable profits can be calculated in an accurate manner.
Application of controllable profits concept in companies:
- This reporting concept is being used by those organizations which are located at different locations or countries. Many times, this is also applicable for retail chain companies like Walmart. The work performance of managers can be evaluated by controllable profits while the overall success of any division can be determined by the net profit. For example, in restaurant business, raw materials, salary expenses etc. are under the control of the restaurant manager. So, for calculating controllable profits these expenses only be reduced from the total revenue along with other variable expenses. While at the same time rent, interest, etc. are not under the control of the unit-level manager, so these will be categorized under non-controllable expenses.
- Different business function managers keep on taking decisions that impact controllable profits. For example, sales managers have direct decisions about selling commission to be paid, advertisement expenses to be incurred and distribution facility to be created, etc. These all decisions increase or reduce the long-term controllable profits of the company.
Short-run and long-run impact of controllable cost:
Most variable overheads are generally controllable in the short run because they are influenced due to day-to-day decisions of the divisional managers. It also ensures and creates a performance standard for the managers so that resources can be optimally utilized.
Draft controllable profit statement
For a better understanding of the term controllable profits, a draft income statement has been prepared as below:
Draft of divisional restaurant income statement showing controllable profit and net profits for the year 2021.
|c||Total sales (a+b)||125000||100%|
|Cost of goods sold|
|f||Total cost of goods sold (d+e)||37000||42%|
|g||Gross profit (c-f)||88000||84%|
|j||Uniform for staff||1000||13%|
|k||Paper and plastic supplies||1500||19%|
|m||Repair and maintenance||400||5%|
|o||Total controllable cost (h+i+j+k+l+m+n)||8000||100%|
|p||Controllable profit (g-o)||80000||64%|
|q||Non controllable expenses||2000||10%|
|v||Other fixed cost||1000||5%|
|w||Total non-controllable cost (q+r+s+t+u+v)||20200||100%|
|x||Net profit (p-w)||59800||48%|
So, if the company wants to decide about bonus and performance evaluation of the manager, in that case, they can use $80,000 as the controllable profit.
Difference between controllable profit and net profits
|Sr. No.||Basis||Controllable profit||Net profits|
|1||Meaning||When only controllable expenses are reduced from the total revenue of the company, it is known as controllable profits. Sales advertisement cost is an example of controllable cost.||This is a residual profit amount that is available after reducing all operating and non-operating expenses of the organization.|
|2||Formula||Revenue – controllable cost||Revenue – operating cost – nonoperating cost.|
|3||Controllability||The expenses while calculating controllable profits are under the preview and decision of divisional managers.||The expenses while calculating net profits depends upon the overall goal and policy of the organization.|
Controllable profits provide a broad overview for the performance of divisional managers. Once these performance standards are set, it can be helpful for the annual appraisal of managers who are working with the company.
Also, controllable profits can be compared with peer company comparison too so that performance comparison in the industry can also be done.