Appendix B
Profitability Analysis
Solutions to Questions
B-1 Absolute profitability measures the impact on overall profits of adding or dropping a
particular segment, such as a product or customer, without making any other changes.
B-2 Relative profitability involves ranking segments, each of which may be absolutely
profitable, for the purpose of making trade-offs among the segments. Such trade-offs are
necessary when a constraint exists. Otherwise, they are not necessary.
B-3 Every business that seeks to maximize profits has a constraint. No business ever has
had or ever will have infinite profits. Whatever prevents a business from attaining more
profits is its constraint. The constraint might be a production constraint, it might be
managerial time or talent, or it might be some internal policy that prevents the firm from
progressing, but every profit-seeking organization faces at least one constraint. The same is
true for almost all nonprofit organizations, which generally seek more of something”€”be
it more health care, more land preserved from development, more art, or some other
objective.
B-4 The absolute profitability of a segment is measured by the difference between the
incremental revenues from the segment and the incremental (avoidable) costs of the
segment. Consequently, to measure absolute profitability, one would need the incremental
revenues and costs of the segment.
B-5 The relative profitability of a segment is measured by the profitability index, which is
computed by dividing the incremental profit from the segment by the amount of the
constrained resource required by the segment. Consequently, to measure relative