Customer / Product Line Analysis

Written by the Controller | CFO Advisor Team

A question for every business – What drives your company’s profitability? This is the most fundamental question a business leader must answer.

The first step in answering the question is to identify profitability in detail at the product and/or customer level. Many companies look solely at sales volume and presume that these clients or products provide the greatest value to the business. This may not always be the case.

A company that sells various products to various customers at various prices must understand the sources of profit or loss. Small businesses may make price concessions on high volume products and/or large customers. Without careful analysis of profitability by product and customer a company may find these concessions are slowly eroding its profitability. Even worse, a company can neglect a lower volume higher profit product or customer and erroneously make a decision to discontinue the line or customer. A company’s monthly performance must be viewed in detail to unmask unprofitable product lines or customers that may be “hidden” in the overall picture.

Business models are often used to support the decisions the owner must make that affect the success of the company. One such tool is the break-even analysis. The break-even point is a calculation of sales volume, where the total costs are covered, but no profit yet exists. At this point total revenue equals total costs. The break-even point equation is:

Fixed Costs = Revenues less Variable Costs

Fixed Costs are expenses that do NOT vary with sales - such expenses exist even if no sales occurred. Variable Costs are expenses that vary directly with sales and are expenses that exist only because sales were made. Part of every sales $ goes toward variable costs.

Another tool is Contribution Margin… defined as the amount left AFTER paying variable costs that goes to pay fixed costs. Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products. Essentially it is Sales less Variable Costs. Variable costs are all the costs that are specifically attributed to the sale. Measuring each job's contribution would be a great indicator of how jobs compare to each other. All the other costs (fixed) are pooled together and allocated any way you want. Obviously the critical piece is to have the accumulation of contribution margin exceed the total fixed costs. It is calculated as follows:

Product Revenue - Product Variable Costs
Product Revenue

The phrase "contribution margin" can also refer to a per unit measure of a product's gross operating margin, calculated simply as the product's price minus its total variable costs.

Consider a situation in which a business owner determines that a particular product has a 35% contribution margin, which is below that of other products in the company's product line. This figure can then be used to determine whether variable costs for that product can be reduced, or if the price of the product could be increased. If these options are unattractive, the owner may decide to drop the unprofitable product in order to produce an alternate product with a higher contribution margin.

Similar analysis can be performed to determine profitability by customer. Certain customers, through the demands they place on the business may use a greater share of the company resources than others. It is important to note these differences between customers especially when you are being requested to make price concessions.

BIK’s outsourced Controller|CFO Advisors can help you assess the profitability of your company’s product lines and customers.

The BIK Controller|CFO Advisors:

Tony Battaglia
Tim Beck
Al Knox
Larry Schmitt

Together we can perform a variety of accounting and financial services to help your business run more efficiently and economically.  Our objective will be to improve your bottom line through better processes and procedures. Contact us today at cfoservices@bikcpa.com or call 847-281-3209. 

Visit our web-site at www.bikcfoservices.com.