For manufacturers, knowing which products are profitable is essential for strategic decision-making and long-term success. While total revenue can provide a sense of overall product performance, profitability analysis can deliver a clearer picture of which products contribute the most (and the least) to your bottom line. Unless you track the costs of manufacturing each product, you're missing an opportunity to maximize your profitability by fine-tuning your production, marketing and pricing strategies.

Crunch the numbers

Determining product-specific costs requires significant work. You'll need to calculate the direct labor, material and other costs associated with each product and come up with a reasonable method of allocating indirect costs among your products. Indirect costs can include overhead (rent, insurance and administrative expenses) and executive compensation.

Once this is done, you can calculate the actual costs and profit margin of each product. With this information, you can make strategic decisions about pricing products and focus your resources on manufacturing and marketing the products with the highest profit margins.

Bear in mind that your results may surprise you. For example, you may discover that a product you thought was profitable is losing money. In some cases, it might make sense to discontinue the product — but not always. It depends on the product's contribution margin, which is calculated by subtracting a product's variable costs from its revenue.

If a product's contribution margin is positive, then it's contributing to the company's overall profitability by helping to cover the company's fixed costs. Because those costs would be incurred regardless of whether the product is produced, eliminating it would likely hurt profits rather than help them.

Identify new opportunities

If your manufacturing company isn't tracking and analyzing product-specific cost information, you're essentially operating blind. Only by examining profit margins on a product-by-product basis can you ensure everything you're producing is contributing to your bottom line and focus on the products that will boost your company's performance the most.

Detailed cost information can also help you evaluate new business opportunities. Familiarity with your company's costs can help you determine whether a particular opportunity — a contract manufacturing job, for example — would be worth your while.

Execute your plan

Once you've analyzed your products' profitability, take action. Focus on scaling high-margin products, optimizing costs and possibly discontinuing unprofitable product lines. Regularly reviewing your product portfolio ensures you're making informed financial decisions. Enterprise resource planning systems and other software solutions can help automate the process.

If you need help analyzing your products' profitability and making strategic financial decisions, contact us. We can help provide valuable insights tailored to your manufacturing business.