A profitability model for tactical planning

Simple models reflecting changes in aggregate company behaviour in response to changes imposed by management decisions and/or factors outside the direct control of management provide useful tools for tactical planning purposes. One such model is discussed in this paper. The model enables management to assess explicitly and quantitatively the effect on the rate of return on capital employed of primary causes of change in any of the key variables affecting company performance, such as the unit price, the unit cost, the output level and the capital employed. Simple functional relationships are proposed between the major variables in the model, such as the level of output and the unit cost, the unit price and the volume of sales, the working capital requirements and the general level of the firm's activity, etc. and these are based on analytical considerations, empirical evidence and a series of assumptions. These relationships give rise to a set of parameters which are incorporated in the model and describe the operational (cost structure), financial (capital structure) and marketing (elasticity of demand) position of the company under study. Numerical results obtained from the model seem to suggest that the sensitivity of the rate of return to some of the parameters and underlying assumptions is relatively small, implying that the inter-dependence between some of the variables can be ignored, thus simplifying the problems associated with data collection and model evaluation. Both the model and the methodology of analysis employed are flexible enough to allow: (1) application of the model to alternative sets of functional relationships between variables and/or underlying assumptions; (2) further decomposition of the model to include additional variables depending on the particular objectives of the study; (3) modification of the model to explore the effects of management decisions or those of changes in external factors on productive unit and product profitability; and (4) analysis of models reflecting the effects of changes which are imposed on the system on measures of business performance other than the rate of return on capital employed.