Profitability is a measure of how a product or business generates profit or financial gain and involves an assessment of revenue and costs. This article outlines the steps to assessing product profitability using a Profit and Loss Statement.
A “Profit and Loss (P&L) Statement” or “Income Statement” shows the revenue and expenses for a product during a particular period. It’s common to create a P&L statement at the beginning of a project to estimate revenue and expenses and justify the investment decision, and the P&L is usually updated periodically during the product life cycle. The P&L statement is typically calculated for one or more years or quarters. At a high level, the P&L shows revenue, expenses, and profit. An example P&L statement is shown below for a three-year period.
Product revenue is calculated by multiplying the units sold by the Average Selling Price (ASP). COGS, or Cost of Goods Sold, is similarly calculated by multiplying the units sold by the cost per unit. The first measure of product profitability is gross profit, or the profit left after COGS is subtracted from revenue.
Operating expenses are the expenses not directly related to producing or manufacturing the product. These include Sales and Marketing, Research and Development, and General and Administrative. This leads to the second measure of profitability of the product, net profit, the income left after paying all costs associated with the product.
Gross profit and net profit are sometimes expressed as a percentage of revenue as gross (profit) margin and net (profit) margin:
Gross Margin = (Gross Profit / Revenue) x 100%
Net Margin = (Operating Income / Revenue) x 100%
Read more about assessing profitability and other key product management topics in my book, Mastering Product Management: A Step-By-Step Guide, available now in paperback and eBook.