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Differential Analysis Research Paper
Differential analysis is an approach or method of comparing two or more business alternatives to each other to efficiently and effectively make a decision that will enhance business organization growth. With strict adherence to the numerical approach, the business would compare the relevant costs of the alternatives and the resulting benefits of individual options.
Moreover, the key concept in understanding differential analysis is the concept of relevant costs, the analysis excludes 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; analyzing this difference or disagreement is a term called differential analysis.
Differential analysis as a management technique helps make managerial decisions about making or buying products, sustaining or dropping product lines, and keeping or dropping customers. Cadbury Nigeria Plc Lagos Nigeria is a significant market stakeholder for Nigeria’s food, beverages, and confectionery.
Using differential analysis is imperative for Cadbury to remain competitive in the market. Cadbury’s income statement for the year ended December 31, 2019, reveals 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 fee that is traceable to Cadbury product lines and pertinent to differential analysis.
In 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 performing differential analysis calculation. Typical calculation of differential analysis for all the product lines 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, 210,134Contribution margin………………………N3, 116, 673Fixed cost………………………………….N1, 819,571 Profit………………………………………N1, 297,102Sunk costs are non-essential costs to differential analysis, they are costs already incurred before the current research and cannot be eliminated by management decision.
For instance, when Cadbury Nigeria Plc purchased a machine that became obsolete quickly, the plastic bags produced could no longer be used for packaging due to government regulation to keep the environment safer and mitigate impacts on the landfill. The new rule makes the machine and the packaging of plastic bags obsolete, and Cadbury cannot influence or change government decisions. Thus, a sunk cost is an expense that cannot be reserved.
Furthermore, an opportunity cost refers to benefits or incomes forgone by choosing an alternative over another. Cadbury management must choose between alternate options, but the decision has 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 the differential analysis. It aids managers in determining the most profitable level of production and prices, as well as offering a quotation at a lower selling price to increase capacity.
The sale revenues and variable and fixed costs are critical financial data for the differential analysis of whether to drop or keep a customer or a product line with the exclusion of sunk cost, a nondifferential cost. Conversely, the calculation must include opportunity cost to decide 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 keep their eyes on pertinent qualitative details while making a decision.
