Tool Box
Issue No. 24 - August/September 2005
Are your products really profitable?
by Craig Stubing
The term “information is power” is particularly true for manufacturing businesses who need all the information they can get to remain profitable in today’s competitive environment. Unfortunately, a main source of financial information relied upon by manufacturers for decision making is the Profit and Loss Statement.
I say unfortunately because the Profit and Loss Statement provides very little useful information for management.
Businesses that manufacture a range of products may be losing money on up to 40% of these products and yet their Profit and Loss Statement provides no information on those loss-making products. Indeed the Profit and Loss Statement often covers up poor performing products by reporting a net profit result which includes profitable products subsidizing unprofitable products.
Management of manufacturing businesses need to know which products sold to which customers are profitable/unprofitable. To do this they should have a product costing system in place. The best product costing systems are “stand alone” which mean they are separate from accounting systems and based on estimated operating costs and production quantities over the next 12 months. Product costing systems should accurately allocate all costs (including overhead costs) to products in order to assess the net profit margin made on a product.
There are two methods of product costing
- Traditional Costing method
- Activity Based Costing method
The Traditional Costing method is suitable for manufacturing organisations that have a turnover under $3 million p.a. Over this turnover threshold the accuracy of the Traditional Costing method becomes less reliable and the Activity Based Costing method should be used.
The Traditional Costing method has the following attributes:
- Easy to implement
- The allocation of overheads is based on a single
- measure such as direct la...
