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Difference Profit Margin for Segment and Company

Anonymous A

Hi,

I was just wondering if I understood the concept of margins on a company level and on a segment level correctly and it would be nice if you could tell me if my understanding is correct or if I made a mistake somewhere:

For the net profit margin of a specific product (segment) I would make this calculation:

(Revenue Product A - Variable Costs Product A - Fixed Costs directly associated with the production of this product (here is where I am not quite sure?)) / Revenue Product A

And for the whole company I would just calculate the overall revenue and substract all costs and divide this by revenues.

2 things I am not 100% sure about:

1) Do I substract fixed costs like wages for employees and deprecitation of machines (assuming they are specifically used for the production of product A) to calculate the profit margin for a product?

2) What about overhead costs like rent which is not directly associated with a specific product if I produce more than one product. I assume that I have to substract them for the overall company profit, but do I have to incorporate them on a product level as well?

EDIT: What about things like CEO salaries? I would assume they can be irgnored on a product level but have to be substracted on a company profit margin level

(edited)

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Vlad replied on 03/13/2018
McKinsey / Accenture / Got all BIG3 offers / More than 300 real MBB cases / Harvard Business School

Hi,

First of all, in cases, you either do the calculations on the product level or on the company level. You rarely jump from one to another.

On a product level, usually, you compare your unit economics with the competitors and there may be 2 options:

1) You calculate contribution margin per product which is price minus all variable costs of sales per this product. The difference between the contribution margin and gross margin is that fixed overhead costs are not included in the contribution margin.

  • Price per unit
  • Variable Costs per unit
  • CM = Price per unit - variable costs per unit

But sometimes in the cases, they may still call it gross margin fro simplicity. You can calculate as a % as well

2) You compare net margin per product:

  • Cost per product that already includes variable costs and fixed costs allocation
  • Price of product
  • Net Margin = Price per product - Cost per product

Best

(edited)

Currently non-active expert
Expert
replied on 03/13/2018

Hey anonymous,

First of all, let me tell you that you are entering at such a deep level of detail that you will very hardly find in any interview - cost allocation (methods).

Second, if you want to be really precise and accurate to find the real margin per product, you will need to allocate all the company operating costs to the different products (btw, this also applies to other dimension discussions, such as, per channel or per geography). In order to do it, there are several methods of allocation for all those indirect costs you are referring (rent, CEO paycheck, etc), but you will not need to know them nor to apply them in any interview - except if you are applying to be a finance controller (I know them pretty well because that was my role before consulting :D).

Third, at a company level it's much easier: it's exactly as you said.

Best

Bruno

Francesco replied on 03/13/2018
Ex BCG | MBB Specialist | #1 Expert for coaching sessions (1400+) and recommendation rate (100%)

Hi Anonymous,

to answer your questions:

1) Do I subtract fixed costs like wages for employees and depreciation of machines (assuming they are specifically used for the production of product A) to calculate the profit margin for a product?

Yes. To calculate the gross profit margin you should subtract from revenues all costs directly related to its production/distribution.

2) What about overhead costs like rent which is not directly associated with a specific product if I produce more than one product. I assume that I have to subtract them for the overall company profit, but do I have to incorporate them on a product level as well?

Costs not directly related to a segment will not be subtracted by the gross margin (revenues – costs related to the segment), but will be subtracted to calculate the operating margin of the segment (revenues – costs related to the segment – other fixed costs, divided as for a specific allocation). A possible allocation could refer to the revenues generated by each division, and consider the general overhead costs allocated proportionally to that. It is rare to have to compute operating margin for a specific segment though.

3) What about things like CEO salaries? I would assume they can be ignored on a product level but have to be subtracted on a company profit margin level

The answer is the same as for point 2

Best,
Francesco

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