Where do you make your profit? Margin calculation: purchase-, production- and sales result.

It is generally easy to know how much profit your business has made. This information has been summarized in your profit and loss statement (P&L).

But do you also know the margin of your different products? These are the building blocks of your profit.

 

And what exactly is THE margin? Your margin is a sum of different operational sub-results. By looking at your margin this way, you can identify causes and responsibilities that allow you to make adjustments where necessary.

The three main sub-results that determine your margin are the purchase result, production result, and sales result.
 

Your margin calculation

But how do you know to what extent your purchasing process, production process, and sales process contribute to your margin? The method to obtain these insights is by comparing actuals to standards.

Actuals are realized figures on which the responsible manager has influence. By comparing these realized figures to standards (usually based on the budget), you are able to assess the delivered performance as positive or negative.

This not only explains where your profit comes from, but also enables you to answer the question, "Did we purchase, produce, and sell better than expected?"

Margin = purchase result + production result + sales result

Your purchase result

For each sub-result, it is important to only include elements in the analysis over which the responsible manager actually has influence.

The purchase result shows how well your buyers have purchased. In this regard, the buyers primarily have influence over the purchase price they can negotiate. In many cases, it is the production unit or MRP system that determines the quantity to be purchased, making it unfair to hold the buyer accountable for increased or decreased purchase quantities.

The formula for the purchase result is as follows:

Actual purchased quantity x (Standard price - Actual price paid).

The actual purchased quantity is not compared to the planned quantity because of aforementioned reason. The purchase result shows whether the purchase has badly affected the margin (if negative result) or contributes to a positive margin (thus purchased at a cheaper price compared to the standard price).

Your production result

The same applies for production result. Only factors over which responsible managers have influence are taken into account. Efficiency is therefore key.

To achieve a positive production result, you must produce more efficiently than budgeted. If efficiency is lower, the production result is negative. To know this, the actual production cost is compared to the standard cost. This budgeted amount reflects how much the production was expected to cost (material costs, variable production costs, and fixed production costs).

The production result consists of the production revenue reduced by the production cost, where:

Production revenue = actual production x standard cost price;
Production cost = sum of transformation costs and actual materials used at standard cost price.

Other factors on which production managers have no influence should not affect the production result, this to create a reliable picture. Examples of these include differences in purchase price, changing sales volumes or sales mix, costs of over- and undercapacity, etc.

A positive production result indicates that you produced at a lower cost (= more efficient) than expected, which created margin. Conversely, a negative production result indicates higher production costs than expected (inefficiency), which reduced your margin.

Your sales result

By subtracting the standard cost of goods sold and the standard sales overhead from the actual revenue, you obtain the commercial result.

This enables the company to evaluate the sales department based on parameters they actually influence, which are three factors:

• Sales volume;
• Sales mix;
• Sales price.

The extent to which sales volume, mix and price are responsible for deviation in sales margin compared to the budget is analyzed through a variance analysis.
A positive sales result shows that you have created additional value through your sales. A negative sales result leads to a decrease in the margin that you have created with your purchase and production results.

Conclusion

By calculating your purchasing, production, and sales results, you can determine where you have created or lost value (=margin). Do your salespeople deserve praise, or did they sell the wrong combination of products, in too small quantities, at the wrong price? Did production go as planned, or do you need to take a closer look at your operational efficiency? Did your buyers make good purchases, or was the profit lost from the beginning due to high purchase prices?

Would you like to have these insights for your business? This is perfectly possible through reporting in Power BI. It allows you to assess risks on time and recognize trends and opportunities.

Do you also want to monitor actual situation in your organization and make well-informed decisions on time? Contact us for more information.

 

Matthieu Cloquet - 28 juni 2021