Customer profitability analysis compares a customer’s earnings and expenses to determine profitability. To perform the analysis, collect sales and cost data, subtract costs from sales, and compare profitability rates with other customers and goals. Set an acceptable level of profitability for each client and replace low-profitability customers with more profitable ones.
A customer profitability analysis compares what a given customer earned versus what they spent. Such analyzes are important for improving bottom line and ensuring that sales efforts are headed in the right direction. To perform a customer profitability analysis, you will need to select a customer to analyze, assemble sales data for that customer over a specific period of time, and collect data on all expenses associated with those sales. You will need to include not only high costs such as materials and product manufacturing costs, but also minor costs such as customer service and account management time. Then you’ll compare those numbers to see exactly how profitable the relationship was.
To begin a customer profitability analysis, choose a customer and determine a time period to analyze. This could be one or more specific transactions; a calendar period, such as a year; or the life of the relationship. Collect all sales data for the selected period. This data can be more accurately extracted from past invoices or the user’s accounting system.
The next step is to assemble cost data for the same time period. The stronger the project management process, the easier this step will be. You will need to assemble invoices or costs for all physical goods or parts as well as times on machinery. You will also need to combine employee time costs, storage costs and capital transportation costs if you have not received an upfront payment. Some companies apply a value-added formula to the work, which assumes that these costs would have been incurred whether or not the work was done, and then charge for the work at a lower rate than the actual rate.
Complete your customer profitability analysis by subtracting total costs from total sales. If this number is negative, you have lost money. If it’s positive, you’ve made money. To find out the profitability rate, divide the profit number by the total number of sales. Compare the resulting number with the rates of other customers and with your goals for this customer.
Keep in mind that you need to set the acceptable level of profitability for each client. In some cases, this may be a fixed percentage for all customers. In others, it may vary by customer or vary by business situation. For example, you may be willing to take on a new client with a low profit rate as long as the potential exists to increase profitability. If over time, however, you find that profitability doesn’t increase, you may want to let the customer go, or at least stop actively soliciting their business.
Similarly, when your business is new, you may be willing to accept low rates of return in order to build a customer base and keep your business afloat. As you become self-reliant, you may find that customers with low profitability rates are better replaced with other customers who are more profitable. A customer profitability analysis can help you make these decisions.
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