The Role of Product Costing in Gross Margin Analysis
When thinking about gross margin analysis, there tends to be significant focus on pricing, which is a sales and marketing focus. Equally important is the product costing aspect of gross margin, which tends to be more of an operational focus (e.g., manufacturing, purchasing, warehouse management, etc.). Not as glamorous, but critical to maximizing a business’s potential to achieve healthy, consistent, and predictable gross margins. In this post, we’re going to focus on three aspects of product costing that should be part of any business’s strategic planning process:
1. Move to Fully Absorbed Costing:
If not there already, businesses should focus on fully absorbing overhead, inbound freight, and any other product-related costs into their product cost. Fully absorbed product costs will greatly facilitate the analysis of contribution margins, supporting decisions about which products to promote and which products to discontinue.
2. Establish a Formal Cost Improvement Plan:
Every operational department should have a cost improvement goal that is tracked, reported, and rewarded. For rewarding, pick a percentage that can be used to fund an incentive pool for employees. For example, you could establish a system where 25 cents of every dollar saved goes to fund the incentive pool, making it affordable for the business.
3. Review and Manage Variance Analysis:
Once fully absorbed costing is established, there will be various variances, such as overhead absorption (volume vs. spend), purchase price variance, direct labor variance (efficiency vs. cost), and others.
These three aspects of product costing will unequivocally move the needle within any business, creating the information and motivation required to stabilize gross margins while potentially continuously improving them. If your organization needs any assistance with this type of cost accounting expertise, feel free to reach out. If you’d like to improve your gross margin analysis capabilities, see the link below.
Reach out with questions or if you need assistance building more robust planning tools.
