Once your business has been up and running for a little while and you have managed to start stepping back and study the performance of your organization, profitability at the business level may no longer be sufficient for your needs.
Product profitability is a means of establishing which of your products are actually driving the profit numbers and which are potentially holding you back. At the Gross Profit level, it is fairly straightforward to do as long as your bookkeeping is on point and you are careful to record your income and costs properly. By using a well-structured chart of accounts, and a little excel, you can monitor the gross profit margins and levels of each of your products in order to determine how each product is performing. To take it a step further you could then structure the analysis around which channels you use to sell your products and determine which of these drive your profit and which make losses.
Effective analysis of the profitability of your channels or products allows you to undertake the following:
- Make decisions on whether to continue or stop products or product lines
- Make decisions on whether to continue with each sales channel e.g. physical stores and/or online selling
- Allow you to focus your sales & marketing efforts to either support well performing products or channels or even shore up products that you feel could perform well if supported better
- Allow you to make decisions on allocation of scarce resources such as cash, labour hours or raw materials
- Enable the decision-making process around product pricing
- Enable the decision-making process around raw material purchasing
While product profitability can be undertaken at a whole profit level, small business owners that may not have the relevant skills or knowledge at their disposal, and don’t have the financial resources would be better served to undertake this at the Gross Profit level. This is a much more-simple means of understanding the profitability of your product lines and takes away the arbitrary guesswork they would need to undertake in order to be able to allocate their more general overheads to product lines and products.
In summary, product profitability doesn’t have to be a complicated process for business owners as long as the fundamentals are set up correctly and they, or their accounting staff are diligent in how they record income and costs. However, the benefit to the business owner when making operational decisions around products and channels of sale can add a great deal of value to the bottom line of their business.