Question

12-A2 Customer Profitability

The following table gives sales, product cost, and cost-to-serve data for a company that makes three product lines: A, B, and C. The company has two customer types.

	PRODUCT A	PRODUCT B	PRODUCT C
Sales	$5,000	$6,000	$25,000
Cost of Sales	4,500	4,800	15,000
	Customer Type 1	Customer Type 2	Customer Type 3
Product A Sales	$500	$4,500	$5,000
Product B Sales	1,000	5,000	6,000
Product C Sales	13,000	12,000	25,000
Manager Visits	4	16	20

The cost to serve all customers is $12,000 and is allocated to customer types based on the number of manager visits to customer locations for pre- and post-sales support.
1. Determine the gross profit margin percentage of sales for each product. Which product is the most profitable?
2. Determine the gross profit margin and the gross profit margin percentage of sales for each customer type.
3. Determine the cost-to-serve percentage of sales for each customer type.

4. Determine the operating income and operating income percentage of sales for each customer type.

5. Which customer is the most profitable based the following profitability measures:

a. Grossmargin

b. Gross margin percentage of sales

c. Operating income

d. Operating income percentage of sales

Answer 1

Assumption: Cost of sales (product cost) does not include Cost to serve.

Customer Type 3 is a printing mistake as two customer types are mentioned in the question.

1.

Gross profit margin percentage of sales for each product

Product	A	B	C
Sales (a)	5,000	6,000	25,000
Product cost (b)	4,500	4,800	15,000
Gross Profit ((a-b)=c)	500	1,200	10,000
Gross Profit margin percentage of sales (Gross Profit*100/Sales)=(c*100/a)	10%	20%	40%

Product C is most profitable as per the Gross Profit margin percentage of sales.

2.

Gross profit margin and gross profit margin percentage of sales for each customer type.

Customer Type	Type 1	Type 2
Gross Profit Product A(10% of sales from Part 1)	50	450
Gross Profit Product B(20% of sales from Part 1)	200	1,000
Gross Profit Product C(40% of sales from Part 1)	5,200	4,800
Total Gross Profit (A+B+C)	5,450	6,250
Total Sales(A+B+C)	500+1,000+13,000 =14.500	4,500+5,000+12,000 =21,500
Gross Profit margin percentage of sales (Gross Profit*100/Total Sales)	5,450*100/14,500 =37.58%	6,250*100/21,500 =29.07%

3.

Cost to serve percentage of sales for each customer type

Customer Type	Type 1	Type 2
Manager Visits	4	16
Cost to serve (Total cost to serve* manager visit for customer type/Total manager visits)	12,000*4/20 =2,400	12000*16/20 =9,600
Total Sales customer wise (from Part 2)	14,500	21,500
Cost to serve percentage of sales	2,400*100/14,500 =16.55%	9,600*100/21,500 =44.65%

4.

Operating income and operating income percentage of sales for each customer type

Customer Type	Type 1	Type 2
Gross Profit (a)	5,450	6,250
Cost to serve (b)	2,400	9,600
Operating Income/(loss) (a-b)	3,050	(3,350)
Operating income percentage of sales (Operating income*100/ Total Sales from Part 2)	3,050*100/14,500 =21.03%	(3,350)*100/21500 =(15.58%)

5.

Most profitable customer as per following profitability measures:

a. Gross Margin:- Customer Type 2 as per part 2 (Gross profit $6,250)

b. Gross Margin percentage of sales:- Customer Type 1 as per part 2 (Gross profit percentage of sales 37.58%)

c. Operating income:- Customer Type 1 as per part 4 (Operating income $3,050)

d. Operating income percentage of sales:- Customer Type 1 as per part 4 (Operating income percentage of sales 21.03%)