How Do I Calculate Product Profitability?

Why Standard Accounting Reports Fail You

A typical income statement shows you total revenue, total cost, and blended gross margin. That tells you nothing about which products are driving the profit and which are destroying it. To make intelligent decisions — on pricing, product mix, customer selection, and capacity allocation — you need product-level profitability.

The Four Layers of Product Cost

Layer 1: Direct Material Cost

Bill of Materials (BoM) × actual material price. Key: use your real average purchase price, updated quarterly. Standard cost will drift away from reality.

Layer 2: Direct Labour Cost

Time study (minutes per unit) × labour rate per minute. Include social insurance, overtime premiums, and idle time allocation. If your workers are paid for 8 hours but producing 6 hours of output, the idle 2 hours must be allocated somewhere.

Layer 3: Variable Overhead

Energy, consumables, and machine maintenance attributable to production volume. Allocate by machine hours or production run time.

Layer 4: Fixed Overhead Absorption

Factory rent, depreciation, supervisory salaries, QC costs. Choose a cost driver (machine hours works best for most manufacturers) and absorb at a predetermined rate. Review the rate quarterly.

Contribution Margin vs. Fully-Loaded Margin

Run both analyses. Contribution margin (revenue minus variable costs only) tells you which products to prioritise when capacity is constrained. Fully-loaded margin tells you which products cover their fair share of fixed costs.

The Output: A Profitability Matrix

Rank every product by fully-loaded gross margin %. You will typically find three groups:

• Stars (top 30%): Protect, invest, scale.
• Acceptable (middle 40%): Improve or rebalance.
• Loss-makers (bottom 30%): Reprice, renegotiate, or exit.

This analysis is the starting point of every ReachOut Consultancy manufacturing engagement — because you cannot fix what you cannot see.