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Mohamed
Mohamed

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How To Conduct a Profitability Analysis Of Sales And What It Is

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Hello! In this article we will talk about the analysis of profitability of sales.

Today you will learn:

  • What is return on sales?
  • How to analyze the dynamics of sales profitability;
  • What methods of factor analysis exist;
  • What are the models for the analysis of the profitability ratio.

What is return on sales

Profitability is a familiar concept to everyone. Everyone understands that this is an economic indicator that reflects the performance of a business.

Profit and profitability of the organization are interrelated concepts, one reflects the other. In fact, it is. But this definition does not give us an idea about the purpose of the tool, so let's take a closer look at the concept of "profitability".

Profitability is a financial indicator of the activity of an organization or its individual divisions, reflecting the degree of efficiency in the allocation of resources in an organization.

Thus, profitability reflects the amount of profit that you will receive from a unit of investment. For example, this month you allocated 50,000 rubles to the marketing department, and received 60,000. Accordingly, the return on investment will be (60-50) / 50 \u003d 0.2 or 20%.

The profitability of product sales is a parameter of the efficiency of the sales department. It shows how much profit is included in the cost unit, so the profitability of sales is often called the rate of return
.

Why analyze profitability of sales

First, profitability, as mentioned above, allows us to assess the rationality of resource allocation. That is, you'll see which distribution channels perform best without cutting staff costs or increasing the impact of sales promotion tools .

Secondly, the return on sales reflects the share of profit that each unit of production brings. This allows you to evaluate each commodity item in the product portfolio, eliminate unprofitable goods and support promising ones.

Thirdly, the analysis of the profitability of product sales gives an idea of ​​the market development trends, to see the structure of sales.

However, if you decide to determine the effectiveness of investing in something using the profitability ratio, then you will not receive reliable data. For this purpose, it is necessary to evaluate a wider range of performance indicators
.

Fourth, on the basis of the profitability indicator, it is possible to optimize the pricing policy of the enterprise. But here you need to be careful, because the price directly affects the volume of sales. Estimate the elasticity of demand.

Influence of factors on profitability

Before we move on to the practical part, I would like to identify the factors that have a positive and negative impact on our ratio.

Positive Factors

Sales revenue growth outpaces cost growth .

Everyone understands that the excess of revenue over costs is a good sign. But not everyone knows what events can cause this phenomenon.

Consider them:

  • Price increase provided there is no decrease in sales volume;
  • Growth in sales volume;
  • Reducing inventory in the warehouse;
  • Expansion or narrowing of the range (elimination of unprofitable products).

The decrease in costs occurs faster than the decrease in revenue .

In the event that you narrow down production, eliminate unprofitable goods from the product portfolio, both your revenue and costs will fall. If revenue decreases at a slower rate, then profitability will increase.

The reasons for the decline in revenue at a slower rate than the fall in costs are:

  • Price increase. However, it is necessary to carry out changes in pricing policy very carefully, having previously estimated the elasticity of demand;
  • No decrease in sales volume with a reduction in the range. This is achievable only if you work competently with the product portfolio. To do this, you need to evaluate the value of the product for the consumer that you want to withdraw from the product portfolio. To do this, calculate how many consumers you will lose when reducing the range.
  • Range reduction.

Revenue is up and costs are down .

The most favorable option of all.

It can be achieved with:

  • Rising prices (in this case, there should not be a strong reduction in sales volume);
  • Optimization of the company's product portfolio. It can be either a reduction or an expansion of the range.

Negative Factors

Costs are rising faster than revenue .

This means that you are working "in the red", which is unacceptable.

The reasons for the operation of the enterprise at a loss can be:

  • Inflation led to an increase in costs, while prices were not indexed;
  • Too much price cuts
  • Liquidation of products from the assortment, which led to the departure of a segment of consumers;
  • Introduction to the assortment of an unprofitable product;

Revenue falls faster than costs .

A negative phenomenon for the organization, which may arise under the influence of the following reasons:

  • Price reduction;
  • Liquidation of a product resulting in a decrease in sales;
  • Adding a failed product.

Here we have listed the internal factors that affect the profitability of sales. You can change them, so you need to know them. However, there are also external factors.

These include:

  • The economic situation in the country (inflation, depreciation of the ruble, unemployment and others);
  • Political and legal regulation of business (laws, state support);
  • Development of technologies in your field;
  • Trends in social development (fashion for something, cultural characteristics, etc.).

We cannot influence these factors, but we can minimize their negative impact and take advantage of the positive ones.

Factor analysis of profitability

As you know, the cost of goods consists of the following elements: fixed and variable costs, profit.

Accordingly, a decrease in costs will entail an increase in profits with the price unchanged. An increase in sales will also lead to an increase in the efficiency indicator (we do not change the price).

Thus, costs and quantities sold are key factors influencing the rate of return. Factor analysis allows us to see the degree of influence of these factors.

Factor analysis is carried out after calculating the rate of return for the current and base (previous) period. The reason for conducting factor analysis can be both a decrease and an increase in the indicator.

Consider the methodology for assessing the impact of each of the following factors:

  • Sales income;
  • Production cost;
  • Business expenses;
  • administrative costs.

The impact of income on the profitability ratio is determined by the following formula:

Rv \u003d ((Here-SB -KRB-URB) / Here) - (VB-SB-KRB-URB) / WB , where:

Here is the revenue for the current period;

SB - cost for the current period;

KRB - selling expenses for the current period;

BDS - administrative expenses for the base period (previous);

WB - revenue for the base period (previous);

KRB - selling expenses for the base period.

Let's take an example. It will allow you to calculate the influence of other factors, so for them we will only give calculation formulas.

The table shows the results of the organization's activities for two periods .

May

  • Income - 10000
  • Cost price - 5000
  • Administrative costs - 2000
  • Selling expenses - 1000

June

  • Income - 12000
  • Cost price - 5500
  • Administrative costs - 1500
  • Selling expenses - 1000

R=((12000-5500-1000-2000)/12000)-((10000-5500-1000-2000)/10000)=0.29-0.15=0, fourteen

Thus, due to the growth in profits in the reporting period, profitability increased by 14%, that is, in other words, for each ruble of investments in the current period, we will receive 14 kopecks more than we received in the base one.

The formula for calculating the degree of influence of the cost on the level of the rate of return:

Rc \u003d ((Here-SBot -CRB-URB) / Here) - (Here-SB-CRB-URB) / Here , where:

Cbot - the cost of goods for the reporting period.

Formula for assessing the significance of management costs:

Rur \u003d ((Vot-SB -KRB-URot) / Here) - (Vot-SB-KRB-URB) / Here , where:

URot - administrative expenses for the previous period;

Formula for calculating the degree of influence of commercial costs:

Rk \u003d ((Here-SB -KRO-URB) / Here) - (Here-SB-CRB-URB) / Here , where:

KRo - selling expenses for the previous period.

And finally, the formula for the cumulative influence of factors:

Rob \u003d Rv + Rs + Rur + Rk.

If the influence is negative, then the operation of addition changes to the operation of subtraction.

The value for further work is the calculation of each factor individually. This allows you to identify β€œweak spots” and take measures to eliminate them. Total factor analysis is needed to determine the cumulative effect and has little to no practical value.

profitability ratio

Let's proceed directly to the calculation of the profitability of sales.

The most commonly used three methods for determining the profitability of sales. They differ in numerators, the denominator in the expression is always revenue or sales in monetary terms.

In addition, profitability can be calculated both for the entire organization and for individual structural units. As for the profitability of sales, it is advisable to calculate it for each distribution channel or for each outlet.

At the same time, it is worth considering the fact that profitability shows only the efficiency of resource use and does not reflect the efficiency of the entire company.

The first method for calculating profitability allows you to determine what percentage of revenue is profit: P \u003d (Profit / Revenue) * 100%.

Also, the rate of return is determined by the gross profit of the organization.

Gross profit, in turn, is revenue minus cost of sales. Formula: P \u003d (Gross profit / Revenue) * 100%.

The third formula will allow you to calculate the operating margin of sales. This indicator will allow you to determine what rate of return is contained in each ruble of revenue before tax.

Operating return on sales = (Profit before tax/Revenue)* 100%.
The last two methods are designed to determine the effectiveness of the sales department without taking into account the cost or tax deductions.

It is important to understand that a drop in the profitability of sales means a decrease in the competitiveness of the product and the demand for it. Having received such results, the entrepreneur needs to urgently conduct a factor analysis in order to identify "weak points" in the company's activities.

Only after that you can proceed to the development of measures to increase the profitability of sales. These include: optimization of the assortment, sales promotion, changes in pricing policy, improvement of product quality, and more.

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