Potential Pitfalls of Not Actively Utilizing Gross Margin Analysis
To date, we’ve focused on how to utilize gross margin to improve business profitability and cash flow. Today, we’re diving into some pitfalls and potential solutions for a few of the more common issues.
- **Inaccurate Costing**: In an earlier post, we discussed fully absorbed product costing. If product costing is inaccurate, then pricing decisions will be impacted. To prevent this issue, ensure your accounting systems are tracking direct and indirect costs associated with each product, and that variances are actively monitored and corrected. ️
- **Overlooking Supplier Costs**: Supplier costs need to be proactively managed to offset other potential supply chain issues, such as recent freight expense increases. Additionally, good vendor relationships can help margins when you need to give price concessions to customers. For example, a client with a Vendor Central relationship with Amazon had to adjust pricing down slightly to gain Amazon’s assurance of purchasing to their forecast. They worked with their vendor to reduce product costs, making the entire arrangement cost-neutral.
- **Lack of Product Line Analysis**: Being able to segment revenue by some kind of Line of Business or Product Hierarchy structure is imperative. Not having these systems in place can lead to poor decision-making regarding what’s truly adding to the bottom line. Businesses need to regularly perform product line profitability analysis. Focus on promoting and expanding profitable lines while discontinuing or improving less profitable ones.
These are, in our opinion, some of the more detrimental pitfalls relating to weak gross margin analysis. Addressing these pitfalls will lead to improved gross margin. Additionally, we cannot overemphasize the importance of having a high-quality product hierarchy, which will become a significant marketing differentiator as any business matures.
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Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy. Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.