Determining Which Products or Services are Most Profitable
Your most profitable products are the tickets to success
Most companies deal with more than one product or service. Inevitably, some products/services are more profitable than others—and you can’t make sound business decisions without knowing which is which. Understanding which products or services are most profitable, gives you the basis for marketing, inventory and pricing strategies.
“In order to build on your success and grow the bottom line, you have to focus on the areas of the business that have the highest profit contribution margins,” said Keith Bookbinder, CPA, managing partner, Lougen Valenti Bookbinder and Weintraub, LLP. “It’s fairly simple to figure out your direct costs—what you pay for the product or raw materials used to manufacture a product—but not as simple to determine your indirect costs.” Indirect costs come under the general category of “overhead” and include marketing, internet and web sites, software, storage fees, personnel, freight, machinery and packaging, etc. Since these costs are not directly related to one product or service, it’s necessary to allocate a percentage of them to the various products that you sell.
“For example, your company makes Widget A and Widget B. It takes six hours to make Widget A, and two hours to make Widget B,” Bookbinder said. “If your plant operates on an eight-hour workday, Widget A would use up 75 percent of your labor and machine resources, and Widget B uses 25 percent. “You assign the cost of labor and machinery accordingly, 75 percent to Widget A, 25 percent to Widget B.” Once you have calculated all the costs involved in producing an item or providing a service, you can determine where to set the price in order to be profitable. If, however, you find your product is not competitively priced for your industry, you’ve got to ask the questions, can you reduce expenses or, is it worth continuing to manufacture that product?
“The profitability of each product or services is key to steering your business in the right
direction. Do you continue with the items that are not that profitable, depending on the more
profitable ones to carry the rest? Where do you spend your marketing dollars? Where do you
look to expand?” Bookbinder asked. “You can’t plan long-term without reliable information about
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