For any business to remain open, supply customers, purchase supplies and materials, pay taxes, maintain employment, give to charitable causes, provide benefits, and so forth, that business must make a profit. Making a profit means that business makes enough revenue to cover all costs, including taxes, with some left over. This refers to Net Income or Net Income After Taxes (NIAT).
Gross profit or gross margin (GP /GM) is profit based solely on the costs of producing a product or service. Generally, GP is calculated after subtracting cost of goods sold (COGS) from gross revenue (total revenue minus sales discounts and sales returns).
Thus, Gross profit tells the firm if it is feasible to produce a product or service based solely on its revenue and the direct costs of producing that product or service. COGS does not include overhead. Overhead includes, but is not limited to, utilities, management, IT, Sales and Marketing, and a whole host of costs associated with running the entire business that cannot be directly attributed to a single product or service. These costs are generally “spread” over all the products / services.
In other words, there are activities and supplies directly associated with producing a product or service (COGS) and things that generate cost and are necessary to the firm but cannot easily be attributed to any single product or service (overhead).
In the table below (also attached are Practice Operations Product Profitability.xlxs downloadand Practice Operations Product Profitability.pdf files), analyze the data for the following: (NOTE: in the spreadsheet you can modify sales price and the costs for each area of the organization. It is highly suggested you do two things: first, use it to play with the data to better understand how to answer the questions below. Second, after every change or set of changes it is suggested you revert back to the original data. However, two copies of the spreadsheet are included in the workbook in case you make changes and cannot recover the original data.)
In Practice Operations (PO), what costs are directly associated with a product?
Which are the top 5 products, based on Gross Profit / Margin (GP or GM)?
The GP figure is calculated as follows: (Avg. Sales Price – Operating Costs)/Avg Sales Price
Example, Chiffon Dresses: (($50-$27.87)/$50)x100%=44.3%
Look at Hunting Pants (the most profitable product), Chiffon Dresses, and White Socks (the least profitable product). Obviously the higher the sales price and the lower the cost, the more profitable a product will be.
What are the major factors in each of these product’s profitability?
If we look at the product profitability solely as a function of sales price and operating cost, and if we assume the operation could take action accordingly, what aspects should the firm try in order to improve profitability?
Which action might be the most difficult?
What supply chain functions might be involved and how?
What operations functions might be involved and how?
What might the firm do about sales price? (Remember both how Bidding works in Practice Operations but also how it might work in real life)
What price would White Socks have to be to achieve break even gross profit (GP=0%)
What does the table tell us about profitability with respect to materials?
What does the table tell us about profitability with respect to operating cost?
Why is it important to have a Gross Margin that is as high as possible? (Hint: what does Gross Margin NOT include?)
If you have taken screenshots of your results after shipping products and/or examined your financial results you will see many of these costs appear
Where are holding costs of material captured in PO: COGS or overhead?
Where are holding costs of products captured in PO: COGS or overhead?
Why would a business have a target or minimum gross profit margin?
Why would a business still accept products with profit margins less than target or minimum desired gross profit margin?
