A Deeper Look at Divisions

In business ownership there are many costs that are incurred. Whether these cost come from advertising, manufacturing, salaries, repairs, or warranties they are always there. But between all these costs there are two common themes between them. All costs are either a division cost, or general cost. Divisions are small separations of your company within itself. The company itself is not literally divided, however for accounting cost it is considered in this fashion. There are some costs that a division might incur or in other words a cost that, if that division were to disappear, the cost would disappear also. The other costs are general cost, or the cost cannot be attributed to one part of the company. These costs are dealt with in a unique way because they are allocated throughout the company. Each division’s statement of earnings will have part of the companies general costs built into its expense (generally fixed expenses).

So let’s say, as a business owner, you are presented with the earning statements of the two divisions within your company. Division A is earning $600,000 a year, and Division B is losing $200,000 a year. You job, as the owner, is to make the very tough decision to either drop the losing division, or keep it and continue to lose money. Interestingly enough you find the $370,000 of the cost ($900,000) are sunk costs, or in other words they will not go away when the division does. They are general costs. Subsequently if you are to drop Division B, sales in Division A ($4,000,000) will drop by 10%. You are now tasked with making the decision on whether it is cost effective to drop Division B or not.

Upon further inspection you will see that with the decrease in overall contribution margin ($940,000) added to the fixed cost that you will lose ($530,000) will result in an overall loss of $410,000. This is considerably larger than the $200,000 the division was losing before. So as you can see Division B consumes a large portion of the general company cost. So by dropping it you will lose more money than you would normally lose. This leads to the first general rule of business and accounting, nothing is what it seems, always look deeper.