Academic journal article International Journal of Management

Modelling the Influences on the Importance of Profitability Analysis in Decision Making

Academic journal article International Journal of Management

Modelling the Influences on the Importance of Profitability Analysis in Decision Making

Article excerpt

This paper assesses the influence of the level of competition, product customization and operating unit size on the level of importance of profitability analysis in decision making. Given that the level of importance is measured on a three-point scale, which is an ordinal scale rather than an interval scale, the influence of the three constructs is tested using ordinal regression rather than ordinary least squares regression. Using the questionnaire responses from 189 British management accountants, the results of the ordinal regressions show that none of the independent constructs are related to the level of importance attached to profitability analysis. Consequently, as well replicating these results, there is a need to refine the model by including new constructs.

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Profitability analysis consists of an internally produced management accounting report that identifies and matches the revenues and costs to show the profit for each item included within a particular cost object, such as a product or customer (Drury and Tayles, 2006). In the case of product profitability analysis, the identification of low profit or loss making products may lead to product-based decisions that try to increase product profits by increasing their price, reducing their cost, subcontracting their production, redesigning them or discontinuing them (Drury and Tayles, 2006). To the author's knowledge, the only major empirical research paper about the general use of profitability analysis is Drury and Tayles (2006). Using a sample of 187 questionnaire respondents from UK operating units, they found that the majority of respondents prepared product and/or customer profitability analysis at least annually and that respondents considered that profitability analysis was important in decision making. In addition, Chenhall and Langfield-Smith (1998) identified product profitability analysis as an important current and future management accounting practice. Having identified that profitability analysis is important, the objective of this paper is to develop and test a model of the influence of the level of competition, product customization and organizational size on the level of importance of the use of profitability analysis. The rest of the paper is organized into a further four sections. Section two proposes three propositions concerning the influence of the level of competition, product customization and organizational size on the importance of profitability analysis. Section three describes the research methods in terms of the ordinal regression method used to test the research model and a questionnaire survey of British management accountants. Section four reports the ordinal regression analysis results. Section five offers some conclusions to the research.

Research Propositions

Competition

Prior research has observed a positive relationship between the level of competition in the market and the intensity of use of management accounting systems (Khandwalla, 1972; Mia and Clarke, 1999). It can be argued that as the level of competition increases it is necessary for firms to make more use of their management information systems to obtain the data required to make decisions to compete effectively in markets. Given that profitability analysis is a part of this information system, it may become more important in decision making. If firms do not recognise the importance of profitability analysis, then a competitor or competitors may take advantage of errors arising from decisions based on incomplete information. In as related area, Guilding and McManus (2002) found that the perceived merit of customer profitability analysis was related positively to the level of the competition. Consequently, it is expected that operating units facing a high level of competition would be likely to attach a higher level of importance to profitability analysis in decision making. Hence:

P, : As the level of competition increases, the level of importance of profitability analysis in decision making increases. …

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