For companies that sell more than one product, it is helpful to calculate how much each individual product contributes to the overall company's sales and profits. To do that, we calculate the margin mix for all of the company's products.
First, calculate gross profits and gross margins for each product
To demonstrate how this calculation works, let's work through a simple example. First, we'll need the sales price and cost of each product. We should exclude costs that are not a direct result of the production of our products. The following table shows our products, their sales prices, and their costs to produce.
Sales Price |
Costs of Goods Sold | |
---|---|---|
Product A |
$25 |
$12 |
Product B |
$10 |
$4 |
Product C |
$50 |
$40 |
Product D |
$15 |
$3 |
With this data, we'll calculate the gross profit and gross margin we earn from the sale of each product. Gross profit is just the difference between the sales price and the cost to produce the product. Gross margin is a percentage calculated by dividing the gross profit by the sales price. Doing this for each product, we can see how much profit we earn from the sale of each individual product in both dollar and percentage terms.
Gross Profit |
Gross Margin | |
---|---|---|
Product A |
$13 |
52% |
Product B |
$6 |
60% |
Product C |
$10 |
20% |
Product D |
$12 |
80% |
At this point, we can already begin to learn about our margin mix, even though we have a few more steps to go before we are finished. We can already see that Product D produces the highest percentage profit in gross margin terms and the second highest profit in dollar terms per unit sold, even though its sales price is the second lowest of our products.
Product C, on the other hand, is by far our most expensive product, but it is the lowest earning in percentage terms and second lowest in dollar terms.
Because Product C requires so much expense to produce relative to the profits it generates, it is our most inefficient product. Product D, conversely, is very efficient with its extremely low costs and high profit margins.
Next, we have to look at the overall sales
With this understanding of our gross profit and gross margins, we can now expand our analysis to include actual sales numbers. Gross profit only matters if the product sells, after all.
This table summarizes our sales from the last quarter.
Unit Sales |
% of Total Unit Sales | |
---|---|---|
Product A |
60 |
27% |
Product B |
43 |
20% |
Product C |
100 |
45% |
Product D |
17 |
8% |
With this data now in hand, our understanding of our sales mix changes a bit from our review of the gross profit and gross margin. Product C was our least efficient product, but it is also our best-selling product by a wide margin. Product D, our most efficient product, is our least popular seller. Products A and B are both decent sellers, far outpacing product D but remaining well below Product C's volume.
The final step in calculating our margin mix is to combine the gross profit and gross margin data and our sales mix data into a single metric. We do this by multiplying each product's gross profit by its percentage of unit sales. Each products percentage contribution to this metric is its margin mix.
Gross Profit |
% of Total Unit Sales |
% of Sales x Gross Profit |
Margin Mix | |
---|---|---|---|---|
Product A |
$13 |
27% |
3.55 |
35% |
Product B |
$6 |
20% |
1.17 |
12% |
Product C |
$10 |
45% |
4.55 |
45% |
Product D |
$12 |
8% |
0.93 |
9% |
This final step confirms much of what we've already learned, but also brings a new insight to light. First, we already knew that Product C was a very important product because of its high sales volume. That volume more than makes up for its tight gross margins and high costs of goods sold.
Likewise, the margin mix confirms what we already learned about Product D. Despite its great margins, it doesn't have nearly enough sales volume to have a big impact on this business.
With this final step now complete, we can for the first time see that Product A is a much more important product to us that Product B. Product A and B had relatively similar gross profit margins and unit sales. Compared to the extreme differences between Products C and D, Products A and B flew under our radar until this point in the analysis. But now we can clearly see that Product A is our second most important product. The combination of its higher sales price and decent sales volume gives it the advantage over Product B's low sales price.
The beauty of this margin mix analysis is in how it reveals new and useful insight as we move through the process. At each step in this example we learned important information about each of our products. As a manager or investor, this kind of understanding is a critical consideration in developing plans for company strategy, expansion possibilities, and product development.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at knowledgecenter@fool.com. Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Comments