Product profitability is an indicator that demonstrates the economic benefit from product manufacturing and sales. It characterizes the overall efficiency of an enterprise, including its capital, workforce, fixed assets, and working capital. It’s often called a synonym for profitability. Profitability is one of the key performance indicators for any business, including farming operations. By analyzing it, you can determine the company’s current financial state, evaluate its development prospects, see your position among competitors, and forecast return on investment. Today, we’ll explain how to calculate the profitability indicator and improve it.
How to Calculate Product Profitability?
Profitability is a very broad category that encompasses all areas of enterprise activity. However, we are specifically interested in product profitability, which characterizes the profit from goods sales.
Why Determine Product Sales Profitability?
The main reason is to determine the current financial state of the enterprise. It’s advisable to compare product sales profitability with the average indicator for certain types of goods or with competitors’ performance. This helps determine how effectively production, logistics, and commercial processes are organized in a specific farming operation.
Product sales profitability is also worth calculating in these scenarios:
- Creating financial plans for a year or other time interval. Knowing approximate production volumes and profitability, you can forecast the absolute profit amount. This allows planning new equipment purchases and production expansion for the next period.
- Attracting investments. If a farmer wants to implement a specific business plan and intends to attract external financing, they need to provide the investor with key performance indicators of their farm, including profitability.
- Pricing. One of the most popular methods for calculating sales price is adding the industry’s average profitability to the cost. Profitability calculation also helps determine if there’s an urgent need to increase prices.
- Business analysis. By breaking down key indicators in the profitability formula into individual components, you can determine which ones positively and negatively affect the farm’s profitability level. This enables making appropriate management decisions to improve the situation.
- Business sale. One method of determining business value is based on its profitability and target investment payback period. Calculating profitability will make it clear what amount can be obtained from a prospective deal.
Read also: Farm Enterprise: What It Is, Types, How to Name and Register
Product Profitability: Formula
The product profitability level is determined as the ratio of net result obtained from product sales to the efforts spent on its production and sale. In the context of an agricultural enterprise, this will be the ratio of net profit to cost. The product profitability coefficient formula looks like this:
Profitability = Net profit before taxes and interest/Cost of production and sales × 100%
Net profit can be determined as the difference between sales amount and cost. The latter includes all expenses that can be attributed to a specific unit of goods:
- purchase of fuel and lubricants;
- labor costs;
- purchase of seed and consumable materials;
- repair of machinery and equipment;
- storage and transportation of products;
- utility bills payment;
- equipment depreciation, etc.
The final formula for sold products profitability will be individual for each farm. Its composition depends on the type of enterprise activity, production process specifics, business model, and other factors. But it’s also important to understand which costs are not included in the cost price. These include:
- payment of taxes and interest for financial services;
- professional service fees – consulting, legal, audit, accounting, marketing, etc.;
- general expenses – for business trips, events, office maintenance;
- maintenance costs of general business assets that cannot be attributed to specific production processes, such as the director’s car;
- warranty returns, penalties, fines, late fees;
- decrease in asset value from damage not related to normal depreciation.
To learn how to determine product profitability most accurately, you can refer to UAS 16 for a complete list of such expenses. High detailing of profitability calculation components is very important for analytics. It allows evaluating how each indicator affects farm profitability and what can be done to improve the situation.
Product Profitability: Example
The agricultural enterprise Shepetivka-Agro-Plus LLC sells wheat, rye, corn, sunflower seeds, and sunflower meal. The following indicators are used in calculating net profitability of sold products:
| Product | Sales amount, thousand UAH | Product cost, thousand UAH |
| Wheat | 350 | 230 |
| Rye | 800 | 670 |
| Corn | 150 | 90 |
| Sunflower seeds | 350 | 300 |
| Sunflower meal | 90 | 40 |
To get product profitability indicators, first calculate net profit for each product type by subtracting cost from sales amount. Then it needs to be divided by cost. Average product profitability is calculated similarly – for this, you need to total sales amount and cost for all product types and perform the above mathematical operations. We’ll enter the calculation results in the table:
| Product | Sales amount, thousand UAH | Product cost, thousand UAH | Net profit, thousand UAH | Profitability |
| Wheat | 350 | 230 | 120 | 52,2% |
| Rye | 800 | 670 | 130 | 19,4% |
| Corn | 150 | 90 | 60 | 66,7% |
| Sunflower seeds | 350 | 300 | 50 | 16,7% |
| Sunflower meal | 90 | 40 | 50 | 125% |
| Total | 1740 | 1330 | 410 | 30,8% |
The overall product profitability of the enterprise is 30.8%. The lowest profitability is in sunflower seeds and rye sales. This is a reason for detailed analysis of production processes and finding ways to increase their efficiency. Sunflower meal has the highest profitability. However, it’s important to understand that this is a by-product of production, so scaling its production is quite difficult. Corn is in second place. Having a high profitability indicator, the farm can expand its planting area to get more profit.
If additional investments are needed for this, you can use the WEAGRO online service to purchase agricultural machinery, equipment, seed material, and more in installments. Our online service allows you to buy goods today and pay for them within 180 days from the agreement signing. This solution allows farmers to expand production volumes without withdrawing their own funds from current processes.
Profitability of Specific Product Type
Individual product profitability is calculated using the standard formula:
Product profitability = Net profit from unit sales/Cost of production and sales per unit × 100%
However, in this case, it’s very important to pay attention to the cost indicator. While income for a specific product type can be determined by simply summing the value of each sold unit, costs will be more complicated.
Current Ukrainian Accounting Standards (Standards) don’t provide a definitive answer on how to attribute general production costs to specific product types. Therefore, when calculating sold products profitability, they may be distributed proportionally to:
- sales revenue;
- production costs;
- time expenses;
- employee wages;
- normal production capacity calculated over several past periods.
With low mechanization levels, time expenses and labor costs are usually used; with high automation – revenue, production costs, and normal capacity. This helps avoid artificial lowering or inflation of profitability indicators during uneven production volumes, inconsistent demand, or significant price differences for individual goods.
Ways to Increase Product Profitability
The priority direction for improving enterprise performance indicators is intensive development. This means increasing the degree of labor mechanization and automation to reduce resource and labor costs. It positively affects product profitability in the long term and makes the enterprise more competitive.
Read also: Working Capital: What It Is, Types, How to Calculate
Ways to increase profitability also include:
- Reducing costs by choosing alternative suppliers with lower prices for similar goods.
- Increasing sales prices in conditions where the market has low sensitivity to product cost, for example during product shortages or strong sales seasonality.
- Developing new management strategy. Changing enterprise management policy can increase sold products profitability by reducing wasted time and materials.
- Creating new marketing strategy. A strong brand sells its products at higher prices compared to competitors without facing negative consumer reaction.
- Increasing enterprise operation volumes. Some cost components grow disproportionately – general production costs increase more slowly than those that can be attributed to specific product types. Therefore, the larger the production volume, the better profitability indicator can be achieved.
The online service WEAGRO will help you find a quick solution for increasing investments in agricultural business expansion. Our service allows you to get agricultural equipment and materials in installments in the shortest time, without personally visiting financial institutions. All you need is to choose a supplier, submit an application, and conclude a purchase contract after installment approval.
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