Financial Analysis: A Controller’s Guide, Second Edition

Chapter 13. Product and Service Profitability Analysis

Any product and service is initially priced to generate a profit. However, as time passes and both price points and costs change, companies tend to lose sight of the true profitability of their products. This chapter addresses how to evaluate profitability, both for products and services, as well as the circumstances under which unprofitable products should be cancelled.

Eliminating Unprofitable Products

Pareto analysis holds that 80 percent of the activity in a given situation is caused by 20 percent of the population. This rule is strongly applicable to the profitability of a company’s products, where 80 percent of the total profit is generated by 20 percent of the products. Of the remaining 80 percent of the product population, it is reasonable to assume that some make no profit at all. Consequently, financial analysis should encompass the regularly scheduled review of all company product offerings to determine which products should be withdrawn from the marketplace. This is a valuable analysis for the following reasons:

• Complexity. In general, too many products lead to an excessive degree of system complexity within a company in order to support those products.

• Excessive inventory. Each inventory item usually contains some unique parts, which require additional storage space in the warehouse, as well as a working capital investment in those parts, and the risk of eventual obsolescence. Further, the presence of unique parts in ...