90% found this document useful (10 votes)
8K views16 pages

Product Profitability

Product profitability is defined as the difference between revenues earned from a product and the total costs associated with that product over a period of time. Product profitability analysis requires tracing all relevant costs to products and matching them with revenues. This informs management decisions around product pricing and portfolio analysis. Achieving accurate product profitability requires capturing costs at every point and modeling business processes to make profitable adjustments based on the data.

Uploaded by

brigadier7862391
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
90% found this document useful (10 votes)
8K views16 pages

Product Profitability

Product profitability is defined as the difference between revenues earned from a product and the total costs associated with that product over a period of time. Product profitability analysis requires tracing all relevant costs to products and matching them with revenues. This informs management decisions around product pricing and portfolio analysis. Achieving accurate product profitability requires capturing costs at every point and modeling business processes to make profitable adjustments based on the data.

Uploaded by

brigadier7862391
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 16

Product Profitability

Definition
Product Profitability
• Product profitability, simply defined, is the difference
between the revenues earned from, and the total costs
associated with, a product over a specified period of
time.

Product Profitability Analysis


• Product profitability analysis requires that all relevant
costs are traced to products and then matched to their
corresponding revenues. Such analysis can then inform
a wide range of management decisions such as product
pricing and product portfolio analysis.
Achieving Product Profitability

• Looking beyond revenue and gross margins to


uncover hidden profits and losses.
• By factoring in the real costs associated with each
product, you are able to make adjustments.
• Requires a level of accuracy and granularity.
• Requires accurate data capture and analysis at
every point.
• Modelling your business processes so that you are
able to make good decisions that lead to profitable
adjustments.
Benefits of Product Profitability
• A clear view of which products and product mixes are cost effective. In addition to
managing current results the analysis can refine product pricing strategies

• Single source of product data that can be utilized across the enterprise to facilitate a
true common reporting platform for product profitability

• Real-time analytic capability of what discounts can be given to customers while


accurately assessing the impact on margins to ensure margin protection

• Provide ‘what-if’ analysis for changes in the cost base allowing for re-forecasting and
preparation for changeable commodity markets

• Identify areas of growth in margin not just in revenue and accurately forecast
profitability of new products and proposed product mixes
Profit Parameters

• Gross Margin = Revenue – Cost of goods sold.


All costs are manufacturing costs. Some of them are fixed costs.

• Contribution margin = Revenue – Variable costs


Some variable costs are manufacturing costs, but some may be non-
manufacturing costs. None are fixed costs.

• Gross margin percent = Gross margin/Revenue

• Contribution margin percent = Contribution margin/Revenue


Profit Accounting Model

• The fundamental accounting equation


• Profit = Revenues – Costs
• Revenue = SP * units sold
» SP = selling price

• Costs = FC + VC(units manufactured)


» FC = fixed cost

» VC = unit variable costs.

• We are assuming that units manufactured equal units sold


Cost-Volume-Profit Analysis

• Changes in the level of revenues and


costs arise only because of changes in
the number of product (or service)
units produced and sold.
• Total costs can be divided into a fixed
component and a component that is
variable with respect to the level of
output.
Case Study – Cost-Volume-Profit
Analysis
• A Company manufactures and sells pens. Present sales
output is 5,000,000 per year at a selling price of Rs.5 per
unit. Fixed costs are Rs.9,000,000 per year. Variable
costs are Rs.2 per unit.

Product Sales Year 1 Year 2 Year 3 Year 4


Data
Product Pens
Cost per Pen 5 5 5 5
Sales Volume 2,500,000 3,000,000 5,000,000 7,500,000
Fixed Cost 9,000,000 9,000,000 9,000,000 9,000,000
Variable Cost 2 X 2,500,000 2 X 3,000,000 2 X 5,000,000 = 2 X 7,500,000
= 5,000,000 = 6,000,000 10,000,000 = 15,000,000

Operating Profit -1,500,000 0 6,000,000 13,500,000


Profit Analysis - Graph

12,000,0
00
9,000,00
0
6,000,00
0 Profit
3,000,00
Area
0
1,000,000 5,000,000 7,000,000
3,000,000
- Loss
3,000,00 Area
-
0 Break-even
6,000,00
- Point
0
9,000,00 3,000,000
0 Fixed Pens
Expenses
Rs.9,000,000
Absolute Profitability

• Absolute profitability measures the impact on the


organization’s overall profits of adding or
dropping a particular segment such as a product
or customer – without making any other changes.
Computing Absolute Profitability

• For an Existing Segment


– Compare the revenues that would be lost from
dropping that segment to the costs that would
be avoided.
• For a New Segment
– Compare the additional revenues from adding
that segment to the costs that would be
incurred.
Relative Profitability

• Relative profitability is concerned with ranking


products, customers, and other business
segments to determine which should be
emphasized in an environment of scarce
resources. • Managers are interested in
ranking segments if a
constraint forces them to make
trade-offs among segments.
• In the absence of a constraint,
all segments that are
absolutely profitable should be
pursued.
Relative Profitability

• Here is information developed by the


management of Matrix, Inc. concerning its two
segments:
Segment A Segment B
Incremental Profit Rs.10,000,000 Rs.20,000,00
0
Amount of constrained resources required 100 hrs 400 hrs

Segment A Segment B

Profitability Index 10,000,000 20,000,000


100 400
=1,00,000 =50,000
Case Study –
Product Sales Data
Product Sales Data
Product name xyz
Year 1 estimated unit sales 100
Year 1 unit price 400.00
Unit price compound annual growth rate (years 2 5.00%
through 5)
Year 1 market size (Rupees) 50,000,000
Market size (years 2 through 5) 10.00%
Year 1 variable cost per unit 250.00
Variable cost per unit (years 2 through 5) 5.00%
Year 1 fixed costs 250,000
Fixed cost (years 2 through 5) 3.00%
Target operating income (year 5) 100,000
Target market share (year 5) 2.00%
Scenario for Profitability
Product Sales Data Year 1 Year 2 Year 3 Year 4 Year 5

Unit prices 400.00 420.00 441.00 463.05 486.20


Unit costs 250.00 262.50 275.63 289.41 303.88
Fixed costs 250,000 257,500 265,225 273,182 281,377
Market size 50,000,000 55,000,000 60,500,000 66,550,000 73,205,000
Scenario 1: Based on target operating income
Unit sales 100 209 1,046 1,569 2,092
Sales 40,000 87,853 461,227 726,433 1,017,006
Operating income -235,000 -224,555 -92,265 -769 100,000
Market share 0.08% 0.16% 0.76% 1.09% 1.39%
Scenario 2: Based on target market share
Unit sales 100 301 1,506 2,258 3,011
Sales 40,000 126,474 663,991 1,045,786 1,464,100
Operating income -235,000 -210,072 -16,228 118,988 267,660
Market share 0.08% 0.23% 1.10% 1.57% 2.00%
Thank You

You might also like