Question

Define Pareto’s Rule and provide an example of how we use Pareto’s Analysis in accounting or auditing

Answer 1

Pareto analysis, also termed as 80/20 rule, refers to an analysis method based on the concept that makes an assumption that 20% of the included variables in an analysis would be responsible for 80% of the results. Today Pareto’s Rule is applied and used by business managers in almost all industries to know which issues lead to the most problems within their organizations, departments, or sectors. It leads to an improvement in the business with the efficient use of resources in areas including staff evaluation, procurement, inventory management, marketing, supplier relationship management and customer relationship management.

For example: An organisation may discover a recent rise in goods returns from its online retail clothing website. As the number of returns is above a specified threshold, the analysts in an organisation begin researching and tracking the problems. The main problem appears to be a technical glitch with the company's website that does not communicate accurately the size of clothing selected by online buyers across the numerous departments. Moreover due to the poor customer service the shoppers prefer for refund instead of an exchange of clothing. Thus the entire issues translate to lost revenue for the organisation, the analysts score the main concerns based on the amount of loss of revenue attributed to each concern: technical glitch, lack of good customer service, and client loss in the long-term.