When costs change or there is reason to change the selling price of a product or service, it can be useful to perform a margin impact analysis to understand the effect of the change on your cash flow. A margin impact analysis compares the existing state of profit margins with a future state after specific anticipated changes have occurred. Depending upon the outcome of this analysis and taking into account other costs related to doing business, a decision such as cutting costs or increasing prices could be warranted.
Calculate the current profit margin by subtracting the current total cost from the current selling price and dividing by the current selling price. Multiply that by 100. The result will be the current percentage of profit.
Calculate the new profit margin by subtracting the new total cost from the current selling price and dividing by the current selling price. Multiply that by 100. The result will be the new percentage of profit given the changes in costs.
Subtract the new profit margin from the old profit margin. The difference represents the margin impact of the projected change in costs.
Make sure to only include direct costs for the product or service. Direct costs are the costs that can be directly attributed to a specific sale. Do not include indirect costs in your cost calculation. An example of an indirect cost is building rent. The gross profit remaining from the product sales would be used to pay for indirect costs and activities.
- "Financial Statement Analysis"; John J. Wild, et. al.; 2007
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