Decisions Regarding determination of Sales Mix.
A sales mix is the collection of all of the products and services a company offers. It considers each individual item a company sells, and the profit margin each product earns. While every product may have a different profit margin, the sales mix considers the profit margin of all of the items combined. By analyzing the sales mix, a company can determine which products should receive the most focus and priority, based on the earning capacity, demand, and the resources needed to produce a product.
The sales mix is a calculation that determines the proportion of each product a business sells relative to total sales. The sales mix is significant because some products or services may be more profitable than others, and if a company’s sales mix changes, its profits also change. Managing sales mix is a tool to maximize company profit.
Let’s imagine you own a food truck. Your menu includes four basic items: hamburgers, hot dogs, grilled cheese, and French fries. Last month you sold $10,000 from your food truck, netting $5,000. Overall you are earning a 50% profit. While you are excited about that profit margin, you think you could improve that if you look at each of your items separately, to determine what the cost of product is of each menu item.
Sales Mix Formula
To analyze the sales mix, you must understand the cost and contribution of each item. For instance, you need to know how much it costs to create a hamburger, and compare that to the sales price of your hamburgers. To evaluate this, let’s look at two formulas:
Sales Price – Cost of Materials = Profit
Profit / Sales Price = Profit Margin
Understanding Sales Mix
Analysts and investors use a company’s sales mix to determine the company’s prospects for overall growth and profitability. If profits are flat or declining, the company can de-emphasize or even stop selling a low-profit product and focus on increasing sales of a high-profit product or service.
Factoring in Profit Margin
Profit margin is defined as net income divided by sales, and this ratio is a useful tool to compare the relative profitability of two products with different retail sales prices. Assume, for example, XYZ Hardware generates net income of $15 on a lawnmower that sells for $300 and sells a $10 hammer that produces a $2 profit. The profit margin on the hammer is 20%, or $2 divided by $10 while the mower only generates a 5% profit margin, $15 divided by $300. Profit margin removes the sales price in dollars as a variable and allows the owner to compare products based on profit per sales dollar. If XYZ’s profits are slowing, the firm may shift the marketing and sales budget to promote the products that offer the highest profit margin.
Target Net Income
The sales mix can be used to plan business results and reach a target level of net income. Assume, for example, XYZ wants to earn $20,000 for the month by generating $200,000 in sales and decides to calculate different assumptions for the sales mix to determine the net income figure. As XYZ shifts the product mix toward products with a higher profit margin, the profit for every dollar sold increases along with net income.
Examples of Inventory Cost Issues
Sales mix also has an impact on the total inventory cost incurred, and this cost may change company profit by a significant amount. If, for example, XYZ decides to stock more lawn mowers to meet spring lawn demand, the firm will earn a lower profit margin than It would if it sold hammers and other products. In addition, stocking more lawn mowers requires more warehouse space, a larger cash investment in inventory, and the expense of moving mowers into the store and out to customer vehicles. Carrying larger, more expensive products generates higher inventory costs and requires a larger cash investment.