Solving the Inventory Costing Puzzle: How Manufacturers Can Cut Unprofitable Product Lines to Boost Overall Margins

This scene might sound familiar for manufacturers: your shop floor hums with activity, order books are full, and revenue charts show a steady upward trend. Yet, despite this apparent success, the bottom line feels…sluggish. The profit margins you expect seem to be perpetually out of reach.

You're working harder than ever, but the financial rewards don't seem to match the effort. You're not gaining ground where it truly counts: profitability. The gap impacts your ability to invest in new technology, reward your dedicated team, and secure the long-term future of your business.

Manufacturers might battle with robust sales figures that don't translate into healthy bottom lines. You might be wondering why, despite the constant activity, your financial performance isn't where it should be. The truth is that a steady stream of revenue could be masking a critical issue: certain product lines might be silently eroding your overall profitability, acting like hidden anchors dragging down your potential.

Inventory Costing as Your Profitability Compass

Escaping this profitability mirage involves a granular understanding of your costs. This is where advanced inventory costing can help. 

Think of it as more than just tracking expenses; it's about illuminating the true financial contribution (or detriment) of each individual product line.

Basic costing methods just lump expenses together. A robust inventory costing system meticulously traces and allocates costs directly to the specific jobs or product lines that incur them. It looks at the nuances of direct materials, direct labor, and overhead, assigning these costs with far greater accuracy. 

This detailed approach transforms raw financial data into actionable intelligence, revealing the true cost drivers associated with every part you produce. With this clarity, you can finally make informed decisions about where to focus your energy and resources for maximum profitability.

Identify and Address Unprofitable Lines

Gaining this crucial insight isn't theoretical. Here are steps your manufacturing business can take:

• Implement or refine your inventory costing system. If your current system is basic or non-existent, invest in a more sophisticated approach. You could try activity-based costing (ABC), which allocates overhead based on the specific activities that drive those costs. Ensure your system can accurately track direct materials and direct labor at the individual job or product line level.
• Pursue comprehensive cost allocation. Ensure that all relevant costs, both fixed and variable, are logically allocated to each product line. Be wary of overly simplistic allocation methods (like allocating all overhead based solely on direct labor hours) that can significantly distort the true cost picture. Consider the resources each product line truly consumes.
  

• Calculate true product line profitability. This goes beyond simply looking at revenue. You should subtract all associated costs: direct materials, direct labor, and the accurately allocated overhead. The formula is straightforward, but the underlying data accuracy is crucial:
• Product Line Profit = (Revenue - Direct Materials - Direct Labor - Allocated Overhead)
• Identify and analyze underperforming lines: With accurate profitability data in hand, you can now identify product lines that consistently deliver low or negative margins. Don't just look at the numbers; look into why these lines are underperforming. Are material costs exceptionally high? Are the production processes inefficient? Is the sales volume low? Are there pricing issues in the market?
  
• Cut or pivot: If you choose to discontinue an unprofitable product line, carefully consider the potential impact on existing customers and whether resources can be effectively reallocated. In some cases, you can salvage a line by exploring options to reduce costs, like negotiating better supplier prices or streamlining production.
• Monitor and iterate: Continuously monitor the profitability of your product portfolio. Market conditions change, costs fluctuate, and production processes evolve. Regularly review your inventory costing data and adapt your strategies as needed.

Reaping the Rewards of Clarity

There’s an immediate sense of relief that comes from a clear and accurate understanding of your profitability. No more second-guessing which products are truly contributing to your bottom line. 

Discontinuing or streamlining unprofitable lines immediately frees up valuable resources–raw materials, labor hours, and production capacity. By eliminating the drain of unprofitable products, you'll likely see an immediate improvement in your cash flow. Your team can concentrate its efforts on producing and selling products that generate healthy profits.

And the most immediate impact will be a tangible increase in your overall profit margins as the drag of unprofitable products is removed.

Instead of constantly battling to maintain margins, you'll be proactively shaping a more profitable future. You'll move from reacting to financial symptoms to addressing the root causes of profitability challenges. This shift, powered by the insights gained from advanced inventory costing, will build a resilient and thriving manufacturing operation, well-positioned for long-term success.

If you're a Twin Cities-area manufacturer looking for help with inventory costing systems and identifying opportunities to boost margins, our dedicated Manufacturing team at Redpath and Company is here to help.