A customer profitability analysis compares what was earned from a given customer versus what was spent. Such analyses are important to improving your bottom line and to ensuring that sales efforts are aimed in the right direction. To perform a customer profitability analysis, you will need to select a client to analyze, assemble sales data for that customer for a set period of time and collect data on all expenditures associated with those sales. You will need to include not only hard costs such as materials and product production costs, but also soft costs such as customer service and account management time. You will then compare those numbers to see exactly how profitable the relationship has been.
To begin a customer profitability analysis, choose a client and determine a time period to analyze. This might be one or more specific transactions; a calendar period, such as a year; or the life of the relationship. Gather all sales data from the time period you select. This data can most accurately be pulled from past invoices or from your accounting system.
The next step is to assemble cost data for the same time period. The stronger your project management process is, the easier this step will be. You'll need to assemble invoices or costs for all physical goods or parts as well as time on machinery. You'll also need to assemble costs for time worked by employees, warehousing costs and cost of carrying capital if you did not receive an advance payment. Some businesses apply a value add formula to labor, which assumes that those costs would have been incurred regardless of whether the work was performed and so charges labor at a lower than actual rate.
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Complete your customer profitability analysis by subtracting the total costs from the total sales. If this number is negative, you lost money. If it is positive, you made money. To find out the profitability rate, divide the profit number by the total sales number. Compare the resulting number against the rates of other customers and against your goals for this customer.
Keep in mind that you should set the level of acceptable profitability for each customer. In some cases, this might be a set percentage across all customers. In others, it may vary by customer or vary based on your business' situation. For example, you might be willing to take on a new client at a low rate of profit as long as the potential to increase profitability exists. If over time, however, you find the profitability is not increasing, you may wish to let the customer go, or at least stop actively soliciting his business.
Similarly, when your business is new, you might be willing to accept low rates of return in order to build a customer base and keep your business afloat. As you become self-sustaining, however, you might find that customers with low profitability rates are better replaced with other clients who are more profitable. A customer profitability analysis can help you make these decisions.