Generating Effective Gross Margin Analysis

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How to generate effective gross margin analysis for product-based companies

Produced ByChase Morrison, Partner

Agenda

• Review the questions a GM bridge must answer• Go over variance calculations• Review model architecture• Review the requirements for GM bridge• Review implementation of each variance category• Take a look at approach used to calculate variances• Display a GM bridge schedule• Display basic dashboard schedule• Wrap Up


What questions should a GM bridge answer?

• Is our pricing strategy working as planned?• What is the GM impact of new products?• How are volume differences within a product family or

group impacting GM%?• Are assumptions regarding standard costs (or prices)

correct?• How is volume vs. price vs. mix impacting total GM

profits?• Which products/families are having the greatest impact

to GM?• What actions will have the greatest “bang for the buck”?


GM Bridge Variances

Though this isn’t the only way to produce a GM Bridge, our bridge will be split into three components:

Price Variance (ASP and cost) -- The price variances reflect the differences between the planned or historical ASP/standard cost and the actual. There is a separate calculation for both.

Volume Variance (ASP and cost) – The volume variances also affect both revenue and cost by comparing the planned/historical units to the actual.

Mix Variance – GM variances generally contain a mix component. Mix variance generally occurs when there are material volume differences between products that also have different gross margins.


Sales & Cost Price VariancesPurpose: Quantifies the impact of differences between planned

prices and the actual prices incurred.Applicability: Applies to both average selling prices (ASP) and

standard costs to compute both ASP variances and cost variances.

Indications: Sales price variances – differences between planned prices and actual invoice price indicates inconsistencies between marketing price assumptions and implemented pricing policies. Cost price variance – Should be minimal given that standard costing is under business’ complete control. Differences may indicate operational changes effected to standard costing.

Calculation: ASP Variance = (ASP Actual – ASP Plan) * Actual VolumeCost Var. = (Unit Cost Plan – Unit Cost Act) * Act Volume


Sales & Cost Volume Variances

Purpose: Quantifies the impact of differences between planned and actual shipment volumes. Only used at a product level.

Applicability: Applies to both average selling prices (ASP) and standard costs to compute both sales-related and cost related volume variances.

Indications: Sales volume variances – differences between planned volume and actual volume indicates inconsistencies between plan shipments vs. actual shipments. Cost volume variance – Should be minimal given that standard costing is under business’ complete control. Differences are the same as with the above. Material variances are indicative of variances between planned and actual shipment volume.

Calculation: Sales Volume Variance = (Units Actual – Units Plan) * Plan Unit ASPCost Volume Var. = (Units Plan – Units Actual) * Plan Unit Cost


Final Volume & Mix Variances

Purpose: Segregates the net sales and cost volume variances into final volume and mix variances (i.e., Sales + Cost Volume Variances = Final Volume + Mix Variances)

Applicability: Adding the product level volume variances will not correctly allocate the GM variance due to GM% differences between products; the mix variance quantifies the impact of volume changes between products. (For example, a business may achieve a unit shipped target, as well as the dollar revenue target; but if that achievement was based on under delivering a high GM% product by over delivering on a low GM% product, that would produce an unfavorable mix variance. )

Indications: Mix variance – If positive, indicates that the volume mix of products is biased toward higher GM% products, with the inverse being true if negative. Final volume variance – Variance coincides with volume variance at a summary level (e.g., family, product line, total, etc.) at per unit GM $s.


Final Volume & Mix Variances (Continued)

Calculation: Both variances are computed at a summary level (e.g. family, product line, etc.), as follows:Final Volume Var. = Actual UnitsSUMMARY * Average Per Unit Plan GM$SUMMARY - Σ Planned GM$SUMMARY

Mix Variance = Σ Expected GM $s1 – Computed GM $s2

1 Σ Expected GM $s = (Unit Plan GM$sProduct 1 * Actual UnitsProduct 1) + (Unit Plan GM$sProduct 2 * Actual UnitsProduct

2) + (Unit Plan GM$sProduct N * Actual UnitsProduct N)2 Computed GM $s = Summary Planned Per Unit GM$ * Actual Units For Total Product Category


Why bother with mix variance?

• Mix variance pertains to volume variances within a product group (or type, product line, family, etc.)

• Mix is important if products are categorized into a group and there is a need to bridge GM variance at group level

• If there are no groups, then there is no mix variance• If using groups, adding up the individual product price and

volume variances will not bridge the computed group variance.

• Will review in more detail in spreadsheet discussion


Workbook Model Requirements

• Separate sales, cost of goods and gross margin on to individual worksheets

• Create a set of three worksheets for each category to be analyzed (e.g. plan, actual, prior year, forecast, etc.)

• Structure each worksheet the same (e.g., planned revenue, cost of goods, gross profit for Product A is referenced at row 10 on each worksheet)

• The gross margin worksheet is function of sales & cost of goods worksheets

• Per unit prices on actual worksheets should be a function of sales|cost of goods divided by units shipped

• Similar products should be grouped together to reflect • Add an Adj./Other section for misc. adjustments, if needed


Plan Worksheet StructureRevenue Plan Worksheet (Name: Pln_RV)• Reflects planned revenue $s invoiced by month• Revenue plan $ = ASP X Units• Per unit metric is ASP• Considerations: Include free goods, warranty

replacements, returns, etc.

Cost of Goods Plan Worksheet (Name: Pln_CG)• Reflects planned cost of goods shipped• COGs plan $ = Per Unit Stnd Cost X Units• Per unit metric is unit standard cost• Plan standard costs should be reconciled to final

costs basis

Gross Margin Plan Worksheet (Name: Pln_GM)• GM plan $ = Revenue Plan – COGs Plan• Added GM% in place of units• Per unit metric is Per Unit GM $s


Actual Worksheet StructureRevenue Actual Worksheet (Name: Act_RV)• Reflects actual revenue $s invoiced by month• ASP $ = Revenue / Units• Per unit metric is ASP• Considerations: Consistent handling of free

goods, warranty replacements, returns, etc.

Cost of Goods Actual Worksheet (Name: Act_CG)• Reflects actual cost of goods shipped• Per Unit Stnd Cost $ = Act Cost of Goods / Units• Per unit metric is unit standard cost• Plan to actual per unit standard costs variance

should be minimal to nonexistent

Gross Margin Act Worksheet (Name: Act_GM)• GM plan $ = Revenue Plan – COGs Plan• Added GM% in place of units• Per unit metric is Per Unit GM $s


Requirements for Margin Bridge

• Want the user to be able to select comparison period

• Want to include a graphical bridge to display variances

• Want to have simple dashboard to help users identify any persistent trends

• Want simple macro to print dashboard for all products, families and total business


1Q Gross Margin Summary -- $683K Unfavorable

• Summarizes 1Q variance (e.g., Jan. Through Mar.)

• Note family subtotals• Need to parse $683K

variance into price, volume & mix variances, by product family

• Total Variance = Actual - Plan


Sales & Cost Price Variances

• Sales Price Variance( Actual Unit Sales Price –

Plan Unit Sales Price)* Actual Units

Shipped

• Cost Price Variance( Plan Unit Cost –

Actual Unit Cost)* Actual Units

Shipped


Product-Level Volume Variances

• Sales Volume Var.( Actual Sales Volume –

Plan Sales Volume)* Planned ASP

• Cost Volume Var.( Plan Sales Volume –

Actual Sales Volume)* Planned Unit Cost1

1 Or standard cost


Final Volume & Mix Variance

• Final Volume Var.Actual UnitsSUMMARY * Avg Unit Plan GM$SUMMARY – Planned GM$SUMMARY

• Mix VarianceΣ Expected GM $s1 – Computed GM $ s1

1 At actual volume








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Generating Effective Gross Margin Analysis