Earnings Management

Written by Patricia Tunstall
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Earnings management should lead to greater profits for a company whose accountants and managers understand the relationship between sales and costs. Simply put, any business that markets products must look closely at sales price and volume, and the costs attendant on sales activity. Profit is not just selling, it also is controlling expenses.

Operating earnings, or profit, are earnings before interest and income tax (EBIT). Always, EBIT should be adequate to cover the company's capital expenditures. If it is not, the business must determine the best way to obtain enough capital to invest in assets that lead to sales.

Profit Performance

There are three overriding factors that contribute to profit performance: contribution margin per unit, sales volume, and fixed expenses. An accountant would be able to educate a manager on the importance of these three to earnings management. A smart manager would consistently track them to be sure their relationship is balanced.

Contribution margin is the amount remaining after deducting the cost of goods sold expense and other variable expenses from sales revenue. This is a very important figure, because it represents the amount of money available to cover fixed expenses and make profits. Earnings reports from the accountant to the manager should facilitate communication between the two so the manager is always aware of adjustments that must be made among these three elements.


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