Profitability by product line: what the financial statements don't tell you
Theory and practice
In previous posts we got to grips with the logic of the Break Even Point: now we’ll start to understand where the money is really made.
Many SMEs tell us: “We have a good overall margin… but we don't understand where it comes from.” “At year end there is a profit, but we don't know who is generating it and who is eroding it.”
All of this has a name: no analytical control by business line. And there is only one outcome: decisions made “on gut feeling” and strategies built on turnover, not on value.
What do margins by product line mean? Knowing the overall margin is not enough. You need to isolate the revenue and costs attributable to each product line, family or category.
A concrete example: If you sell three product families (A, B and C), you need to know:
- how much each one brings in (net revenue);
- how much it costs to produce or purchase (direct production cost);
- how many resources it absorbs (marketing, logistics, staff, customer service);
- what margin it generates after the allocation of indirect costs.
The dangers of “lumping everything together”
Overall financial statements can tell you that “everything is fine” while in reality: a high-margin line is funding a loss-making line; a flagship product has falling margins and you don’t know it; the sales force is rewarded on items that generate zero profit.
In short: you are rewarding turnover, not profit.
What do you need to calculate margins by product line properly? You need proper cost accounting, even in simplified form. Well-designed cost centres. A logical breakdown into areas (production, sales, after-sales…) linked to the product lines. Objective allocation of indirect costs (machine time, orders, service calls, staff…). Revenue tracked by category: many companies still lack this distinction. A readable dashboard showing revenue, direct costs, indirect costs and net margin by product line.
What changes with this analysis? You base strategy on value, not volume. You review pricing and discounts in a targeted way. You decide where to invest on the basis of hard data and bring the language of control into sales too.
When the sales force understands margin, it stops selling “at all costs” and starts generating profitability. Behind good turnover there may be products that absorb time, resources and overheads without really contributing to the company’s growth. Separating profitable lines from those that eat into margins makes it possible to make clearer choices and build far more effective sales strategies.
What to do, in practice. Set up cost centres and allocation rules, even if you do not yet have formal cost accounting. Produce clear, up-to-date, shareable margin reports. Train your team to read those numbers and use them to make decisions.
Only then can you know who is working for the margin and who is burning it.