Calculating Profit Margin on a ongoing business.

[krammer]

Folks,

I have recently joined our family bakery business after being in IT for years. Our business is doing pretty decent and We have 5 bakery outlets all together. We do all the manufacturing from raw materials(flour, sugar etc) and sell the products(bread, cookies etc) in these outlets. My dad has assigned me the task to come up with our daily revenue, overall profit margin from our business on a daily basis or monthly and I am going nuts trying to figure out how to achieve this. We have close to 100 products we manufacture also we have few hundreds of products we get from other vendors which we do as second sales like chocolates, cereals etc.
Can you give me some insight about how should I go about to come up with these figures. I believe the thumb rule is
Profit = Sales Price – Cost Price including Expenses (employee wages, power bills, rent etc) but doesn't seem to help me here. I am lost figuring out how to put these parameters in a paper.

Thanks in advance
K

[Freelancier]

Not to sound flippant, but an MBA would help some, just because that's pretty much the basics of what they teach. I'm also in IT and getting an MBA really helped when it came to helping customers figure out where the money was going in a business, which then helped me justify where to beef up their IT spending :) .

Now, for the IT part: do you track materials in/out/used for each batch/etc.? When a train comes in with flour or oil, do you track how much went into the tank/silo and then track how much is used for every batch that's mixed, how many items come off the line, how much waste is rejected by QA, etc.? That's something IT is good at, tracking stuff as they move around the plant and out to the customer. Once you start tracking everything, you can start figuring out where your margins are.

And, yes, I've been where you are, but as a vendor for a really really big cookie company helping them get their hands around this problem.

As for the specific question, you have fixed costs that are there even if you don't do anything and you have variable costs that are incurred on each batch you mix. The per-batch costs are pretty easy to figure, since you have stuff in, energy used, stuff out, all measurable against the one batch. The fixed costs -- the building, the people, QA, accounting, etc. -- are more fun, because you not only have to compute that on a yearly basis, but then you get to assign part of the cost to each batch, based on your best guess of how much of those costs are incurred by a batch. In other words, if you need three people to man the line for one type of product, then those three people's salaries and benefits are directly attributable to every batch that comes off the line. But then you have everyone else who are needed just to keep the lights on in the building, and those you take a portion based on time running or # of batches or some other decision you make about how to apportion those costs.

And your accountant -- if they're any good -- can help you out here with getting the calculations figured out.

[nealrm]

I'm sure at what stage your accounting system is at, so I will start basic and move up.

First, start off easy. Have a bank account that is only used for the business. All expenses and deposits go into that account. The change month to month shows profit and loss. It is a fairly crude, but simple. Based on your comments, you have really outgrown this type of system. But if you currently have nothing you can use this until you get the a better system in place.

Next, get an accounting program. Quickbooks is one example. Assign costs to each of your products and then enter sales and waste on a daily bases. This will help you determine the profit on individual items and overall. Once the data is in place, most of what you want is in the standard reports.

[ArcSine]

K, you're halfway there with your rule of thumb; "profit" is a dollar amount measured as the difference between Revenue and Costs, and then "profit margin" is a percentage measured as the ratio Profit : Revenue. The revenue part is usually pretty easy and I'm sure you've got good stats on your revenue numbers broken down by lines, products, divisions, etc.

The challenges in profit margin calcs arise from the costs side of the equation, and there are two that usually dominate:
• What costs to include in the calculation of "profit"; and
• How to allocate those costs which are traceable to more than just one single product.

But chuck the idea that there exists some Official Way To Compute Profit Margin as set forth in the Big Book Of Accounting. Every company computes profit margin stats using cost inclusion and cost allocation decisions that are most informative and insightful for the particular situation at hand. In many outfits you'll find multiple versions of margin stats in their management reports. For example, you might get the best assessment of department heads' performance with margin math which excludes certain overhead costs for which the heads have no control. Similarly, you'd include / exclude various costs in other margin calcs, depending on what you want those tea leaves to tell you. (OTOH, when your purpose is to compare your numbers against your industry or your peers, you'll wanna employ the same calculation methodology as they used in order for the comparison to have any value.)

Great advice already in previous posts, particularly with respect to some of the more nitty-gritty issues to consider. And indeed, a good accounting program like QuickBooks can spit out various flavors of margins with ease. But if you happen to be fluent in Excel-ese or some similar spreadsheet app (and you can get your raw data imported easily into the app), you can really go to town with analyzing your margins with other informative variations. (Just avoid coming down with a debilitating case of analysis paralysis. :)).

I may've rambled off down a tangent that's more complex than anything you need at the moment. Disregard the unnecessary stuff if so. But do start with the notion that margin calc methodology isn't set in stone for one and for all. Your (and your dad's) own intimate knowledge of the company's product lines, production processes, distribution arrangements, and so on, will be your best guide in figuring out which costs to compare against which revenues. Study the company's details under a bright light and go from there.

[huggytree]

if you cant figure out HOW to figure it out id hire an accountant to show/teach you how

you need to know exactly how much each item costs YOU....if not you may be selling them at cost or below w/o even knowing it

[Mr Rewire]

I just look at what I had to spend of every dollar to earn it and that is my profit margin.

[krammer]

Guys,

Thanks for the feedback...I have already started using some of those...I guess now I need to sit down and do the math. WIll come back with more queries once I start digging deeper..

K

[tallen]

indeed, a good accounting program like QuickBooks can spit out various flavors of margins with ease. But if you happen to be fluent in Excel-ese or some similar spreadsheet app (and you can get your raw data imported easily into the app), you can really go to town with analyzing your margins with other informative variations. (Just avoid coming down with a debilitating case of analysis paralysis. :)).

Just to point out that as powerful as programs like QuickBooks are, the results you get out will only be as good as the data you put in. You need to take a look at your Chart of Accounts and book-keeping processes to make sure that you are tracking expenses (and revenues) at the level of detail necessary for the types of results you want.

[Paul]

Just adding to, and repeating some of, the information in the previous posts.

Calculating your overall profit margin is relatively easy from a basic set of financial statements.

To separate items purchased for resale from manufactured goods is a little more work and per item calculations are even more work.
For items purchased for resale;

The gross margin is simply the difference between your cost and what you sold it for. The net margin is the same except your costs include commissions, freight, delivery, storage expenses etc.

As example a resale item costs you $20, you sell it for $ 30, your gross profit is $ 10. Your markup is 50% and your margin is 33.3%. If it costs you another $ 5 in direct costs like commission, freight etc then your total cost is $ 25 and your profit is $ 5 and your margin is 16.6%.

A quick calculation for margin is the profit divided by the price. IE. 30-20=10 then 10/30=.333.

For manufactured items;

To figure out the margin on individual manufactured good is much more complex, especially when you are sharing raw materials among products such as sugar and flour. You actually can’t do it unless you have kept track of how much of each raw material is used for different products.

But, you can still figure out the average margin on manufactured products fairly easily.

Take the total sales of manufactured goods over a period of time, deduct the total cost of materials and do the same calculations as above. You can then break it down to margin per dollar so you can figure your daily and weekly margins and profits.

To be more definitive include direct productions costs such as energy use for ovens, commissions, delivery, production personnel and other expenses directly related to the manufacture and sale of products.

Use the longest time period possible. That way it will include waste and loss and even out price and cost fluctuations.

If you do have info about how much raw material is used per item then you can break it down even further to per item profits and margins.

Don’t include non-manufacturing costs to figure the margins on products. Only include that for total profitability for the business. Although, for your own info you can include that by allocating a portion of fixed overhead to the cost of goods.

[krammer]

Thanks Paul that was very informative.

As you all know I am a newbie to accounting and it sucks just relying on stuff I read. So based on my research on internet I sat down to calculate profit for one of our type of bread.
These are the stats I prepared.
Selling Price Variable Cost Fixed Cost Contrib Margin Contrib ratio BE(units) BE($)

20 8.5 11340 11.5 57.50% 986.0869565 226800

Variable cost
Materials Inventory

flour 6.8
egg 0.32
cp 0.12
improver 0.32
salt 0.01
milk 0.06
oil 0.2
sugar 0.6
sf 0.05
VC = 8.48 rounding to 8.5
*****************************************
Fixed Cost

Salary 216
gas 100
power 61.53846154
Packing cover 0.2

F.C Total 377.7384615 * 30 =11340.
********************************************
But my question is am I on the right track :confused:. I just need to find out the profit margin for our different products. Do I really need to worry abt Variable cost and fixed cost,Break even etc or just need to figure out the cost of goods sold(COGS) for each product never bother abt VC / FC and calculate profit from selling price. Please guide me. What are other parameters to consider.

TIA
K

[ArcSine]

Your first line of sample computations is correct, except for breakeven $s. Breakeven happens at just over 986 units, and at unit revenue of twenty bucks per, that's about 19,722 of sales dollars at the BE output level.

But on that point---and to segue into one of your questions---you don't need to worry about BE analysis just yet. It (along with its parent cost-volume-profit analysis, of which BE is a subset) is an area into which you might find yourself naturally exploring later, as you get more familiar with this stuff, and different management-intel applications of these concepts start coming into your view.

Just start with figuring out how to use the product composition data you've gathered to answer the basic question of, "How much profit is each product generating, per unit, after deducting from the unit revenue just those variable costs that are directly traceable to the final unit?" (This would correspond to the $11.50 unit contrib margin ("ucm"), in your example.) Do likewise for all of your products.

By itself, the ucm packs a good deal of information. Particularly when you set up a schedule showing each product, its corresponding ucm, its periodic sales volume in units (monthly, weekly, quarterly, or whatever), and a final column showing each product's total dollar margin per period (given as ucm times unit volume).

Afterwards, you can tackle the matter of allocating fixed costs and non-directly-traceable variable costs to individual products, if you want to. I emphasize that last qualification because, depending on what intel you and your dad want to squeeze from the numbers, this part may or may not be important. In either event, just gaining experience with analyzing and comparing the products' respective ucms will give you some insights into where you might want to take it next, say, regarding further analyses that incorporate the fixed-costs aspect of your biz.

[Paul]

Just start with figuring out how to use the product composition data you've gathered to answer the basic question of, "How much profit is each product generating, per unit, after deducting from the unit revenue just those variable costs that are directly traceable to the final unit?" (This would correspond to the $11.50 unit contrib margin ("ucm"), in your example.) Do likewise for all of your products.

.

I agree. For now just figure out the profit margin on each item based on the direct variable costs. Then look at how much profit each product contributes to the total profit. Look at the fixed costs (overhead) as they relate to the overall margin on all sales.

Knowing that info is critical to any further analysis and will give you plenty of info to work with for now.

[broudie]

Just adding to, and repeating some of, the information in the previous posts.

Calculating your overall profit margin is relatively easy from a basic set of financial statements.

To separate items purchased for resale from manufactured goods is a little more work and per item calculations are even more work.
For items purchased for resale;

The gross margin is simply the difference between your cost and what you sold it for. The net margin is the same except your costs include commissions, freight, delivery, storage expenses etc.

As example a resale item costs you $20, you sell it for $ 30, your gross profit is $ 10. Your markup is 50% and your margin is 33.3%. If it costs you another $ 5 in direct costs like commission, freight etc then your total cost is $ 25 and your profit is $ 5 and your margin is 16.6%.

A quick calculation for margin is the profit divided by the price. IE. 30-20=10 then 10/30=.333.

For manufactured items;

To figure out the margin on individual manufactured good is much more complex, especially when you are sharing raw materials among products such as sugar and flour. You actually can’t do it unless you have kept track of how much of each raw material is used for different products.

But, you can still figure out the average margin on manufactured products fairly easily.

Take the total sales of manufactured goods over a period of time, deduct the total cost of materials and do the same calculations as above. You can then break it down to margin per dollar so you can figure your daily and weekly margins and profits.

To be more definitive include direct productions costs such as energy use for ovens, commissions, delivery, production personnel and other expenses directly related to the manufacture and sale of products.

Use the longest time period possible. That way it will include waste and loss and even out price and cost fluctuations.

If you do have info about how much raw material is used per item then you can break it down even further to per item profits and margins.

Don’t include non-manufacturing costs to figure the margins on products. Only include that for total profitability for the business. Although, for your own info you can include that by allocating a portion of fixed overhead to the cost of goods.

Hi Paul, being a non-accountant I've been struggling on how to compute product margins as well (right now I can figure out the profitability of my business), as I develop products and need to decide which ones to keep and which ones to discontinue.

So for product margin, I include:
- manufacturing cost
- transportation costs
- storage costs

should I pro-rate stuff like office space, electricity, etc?

[Freelancier]

should I pro-rate stuff like office space, electricity, etc?
You can, but if all you're trying to do is figure out relative profitability, using the same calculation for each is likely going to be enough... provided that none of the products use a differing amount of those other costs. For example, if one product requires twice the energy or twice the manpower or requires more storage space to produce than another, then you need to reflect that in your calculations.

The more "real costs" you can assign to each product, the better your calculations will be, but that often requires more measurement than many places are ready to do. For example, you might not be metering every oven in a bakery to determine daily energy use per line, and adding those meters is a cost that some places may not want to incur. It's when you get into arbitrarily assigning costs to different products that people get into trouble, since those arbitrary allocations are often just politically inspired instead of reality based.

If you can measure it, you can count it in your costs... but that only works if you can count it for all of the products.

[tallen]

I agree with Freelancier, that --in general-- you need sufficiently detailed measurements in order to adequately allocate costs. However there are situations where it may be possible to estimate (model) some measurements. For example, meters on the different ovens would be great, but if you know the rated wattage or fuel consumption rate of each oven, and how many hours they are on, you can calculate a reasonable estimate of the electricity or fuel used, and thus include that cost in your other calculations. Just use a consistent approach across all the product lines you wish to compare.