Direct profit is calculated by subtracting direct costs from sales, but it becomes more difficult when multiple products are involved. An analyst is needed to determine how costs are shared between different product lines, and some costs cannot be easily split.
The definition of direct profit is money from sales, subtracted from direct costs. This is one of the best ways to find out if a particular product is profitable, especially in a company that manufactures or sells multiple products. However, when multiple products are involved, it will be more difficult to determine the profitability of those products individually.
When a company produces only one product, it may not be difficult to determine what the direct profit is. For example, a company that mines coal will know what its direct profit is because everything the company has, apparently, is dedicated to that one operation. Therefore, all costs incurred by the business are used in the formula to determine direct profit.
In cases where there are multiple products manufactured in the same facility or area, determining direct profits becomes a little more difficult. For example, if one line in a food factory produces bread and the other snack cakes, then there are some costs that will be shared between the two lines. Determining how it breaks down is the job of an analyst.
To continue this example, if the factory purchases flour and it is used universally by both the bread and cake lines, a usage analysis should be performed. This will determine the amount of flour used for the loaf of bread and the snack. Then, once the total number of units produced is determined, there is a good indication of how much flour each line uses. Therefore, the results can be factored into a direct earnings report.
Determining the employee cost for these lines isn’t that difficult either, provided there is adequate record keeping. Dependents can be used exclusively on one line or the other, further simplifying the process. If not, it’s important to determine how many hours an employee spent on one line versus the other. With proper documentation, this is easily achieved.
However, there are other fixed costs, such as building payments, utilities, and the like, that can’t be easily split. For example, it would be difficult to account for costs associated with heating or cooling an employee’s work area. One could look at the square footage required for both operations and then split the costs between the two based on that, but that wouldn’t be a true reflection of direct profit because some areas may need to be heated or cooled more than others. In these situations, determining profit completely accurately can be next to impossible.
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