Christy Burch and Myung Lim, partners, compared their current income statement with their income statement of a year ago. They noted that sales were 12.0% higher than a year ago. They also noted that the total expenses were 20.0% higher than a year ago. What type of analysis should be done to determine whether the increase in expenses is justified? Explain your answer

Christy Burch and Myung Lim, business managers, compared their current income statement with the income statement of a year ago. They noted that sales were 12.0% higher than a year ago. They also noted that the total expenses were 20.0% higher than a year ago. What type of analysis should be done to determine whether the increase in expenses is justified?

To determine whether the increase in expenses is justified, a thorough analysis known as expense analysis should be conducted. This type of analysis involves comparing and evaluating the various expense categories and their changes over time. It helps in identifying the reasons behind the increase in expenses and determining if they are reasonable and justifiable or if there might be any inefficiencies or issues that need to be addressed.

Here's how you can perform an expense analysis to make this determination:

1. Identify and categorize the expenses: Start by identifying and categorizing all the expenses incurred by the business. This can include categories such as cost of goods sold, operating expenses, administrative expenses, marketing expenses, etc.

2. Compare expense categories: Compare the expense categories between the current income statement and the income statement from a year ago. Calculate the percentage change in each expense category.

3. Analyze significant changes: Focus on the expense categories with the most significant changes in percentage. These are the categories that require closer scrutiny to understand the reasons behind the increase.

4. Investigate the reasons: Dig deeper into the significant expense categories to identify the specific reasons for the increase. This could involve analyzing factors such as inflation, changes in pricing, increase in sales volume, changes in production processes, new investments, changes in staff or labor costs, changes in suppliers, or any other relevant factors.

5. Assess impact on overall profitability: Evaluate the impact of the expense increase on the company's overall profitability. Determine if the increase in expenses is outweighed by the increase in sales or if it has adversely affected the company's profitability. This can be assessed by comparing the net income or profit margin of the two income statements.

6. Analyze industry benchmarks: Compare the expense ratios and trends with industry benchmarks or similar companies to see if the expenses are within the expected range or if there might be any anomalies.

7. Take corrective actions: If any unjustified expense increases are identified, consider taking corrective actions to optimize the expenses, improve efficiency, reduce wastage, negotiate better pricing, or make any necessary adjustments to ensure the expenses align with the company's financial goals.

By conducting a thorough expense analysis, Christy Burch and Myung Lim can gain insights into the reasons behind the increase in expenses and can make informed decisions to justify or modify them accordingly.