Differential Analysis

Differential Analysis

Differential analysis is a decision making technique that involves evaluating factors that are different or unique to potential alternatives (Business Dictionary, n.d.). This method of decision making utilizes the concept of relevant costs. Other terms associated with differential analysis are, relevant cost approach, and incremental analysis. In general differential analysis follows four steps. These include:

1. Gather all costs associated with each alternative.

2. Drop sunk costs.

3. Drop the costs that do not differ between alternatives.

4. Select the best alternative based on the remaining cost data.

(All Business, n.d.).

An example of how to use differential analysis is as follows.

ABC electronics store makes its highest profits on smaller subsidiary ABC branded electronics sold in store (i.e. Batteries, USB storage drives, alarm clocks etc.). Additionally ABC sells other consumer brands such as Sony, Panasonic, etc. though at much smaller margins. These non ABC products are generally what bring customers into the stores and eventually to sales of subsidiary products. Should ABC electronics drop small margined products and focus solely on ABC products?

Alternative 1: Drop all none ABC products

Alternative 2: Keep all products

Differential Analysis | Alternative 1 | Alternative 2 | Differential Amount | Alternative 1 is: |

Sales Revenue | 100,000 | 150,000 | (50,000) | Worse |

Variable Costs | 50,000 | 80,000 | (30,000) | Better |

Contribution Margin | 50,000 | 75,000 | (20,000) | Worse |

Fix Costs | 30,000 | 45,000 | (15,000) | Better |

Profit | 20,000 | 30,000 | 10,000 | Worse |

The result show that even though expenses are lower, the revenues and ultimate profits are still higher if ABC electronics keeps their own branded products as well as other branded products. (Heisinger & Hoyle, 2014).

When to use Differential Analysis

Differential analysis is best suited for...