Ask a sales manager which products are most profitable and you'll hear about gross margin percentages. Ask a CFO the same question and you'll get a different answer—one that considers full costs, capacity constraints, strategic value, and customer lifetime economics.
The difference matters. Products with high gross margins might consume disproportionate overhead, require excessive inventory investment, or cannibalize more profitable offerings. Products with lower margins might utilize excess capacity, attract customers who buy high-margin products, or generate predictable recurring revenue.
Experienced CFOs evaluate product profitability through multiple lenses, understanding that simple gross margin calculations miss critical factors affecting true profitability and strategic value. For manufacturing business owners making decisions about which products to emphasize, price, or discontinue, understanding how CFOs analyze profitability leads to better decisions.
Here's how experienced CFOs evaluate product profitability in manufacturing businesses.
Most manufacturers start with gross margin: revenue minus cost of goods sold, divided by revenue. It's simple, readily available from accounting systems, and not wrong—just incomplete.
Gross margin tells you:
Gross margin doesn't tell you:
CFOs use gross margin as a starting point, then layer additional analysis to understand true profitability.
Understanding margin analysis in manufacturing provides context for why multiple perspectives matter.
The first refinement CFOs apply is contribution margin analysis—distinguishing between fixed and variable costs.
Contribution margin = Revenue - Variable Costs
Variable costs change with volume: direct materials, direct labor (if truly variable), sales commissions, shipping, and other costs that increase with each unit produced.
Fixed costs remain constant within relevant ranges: facility rent, salaried employees, equipment depreciation, insurance.
Why this matters:
A product with 30% gross margin but 50% contribution margin contributes significantly toward covering fixed costs and generating profit. Once fixed costs are covered, incremental units are highly profitable.
Conversely, a product with 40% gross margin but only 25% contribution margin (because of high allocated overhead) may not actually contribute as much as it appears.
Example:
Product A:
Product B:
Both show identical 20% gross margin, but Product A contributes $50 per unit toward fixed costs while Product B contributes only $30.
Understanding gross profit vs. contribution margin reveals why CFOs value both perspectives.
Traditional overhead allocation assigns costs based on simple metrics like labor hours or revenue. A product using 10% of labor hours gets 10% of overhead.
This creates distortion when products consume overhead resources disproportionately to allocation bases.
Activity-Based Costing allocates overhead based on actual resource consumption through cost drivers:
Traditional allocation:
ABC allocation:
The result: Product A might get $600K overhead allocation under ABC vs. $400K traditional—revealing it's less profitable than traditional costing suggests.
Common cost drivers CFOs use:
CFOs don't necessarily implement full ABC systems (they're complex), but they use ABC thinking to understand which products consume disproportionate overhead resources.
Understanding how to determine COGS in manufacturing includes considering more sophisticated cost allocation approaches.
Profitability changes dramatically depending on whether you're operating below or at capacity.
Below capacity:
When you have excess capacity, incremental product contribution matters most. Any product with positive contribution margin (revenue exceeds variable costs) is worth producing because it:
At or above capacity:
When capacity is constrained, CFOs evaluate products based on contribution per constraining factor:
Example - Constraint is machine hours:
Product A:
Product B:
Product B is more profitable despite lower absolute contribution because it generates more contribution per scarce machine hour.
CFOs identify the true constraint (machine capacity, labor availability, material supply, cash) and optimize product mix to maximize contribution per unit of constraint.
Understanding capacity planning for manufacturers helps integrate profitability analysis with capacity decisions.
Some products aren't profitable themselves but attract customers who buy profitable products later.
CFOs evaluate:
Loss leaders: Products sold at low or negative margin to attract customers who then buy high-margin products
Razors and blades: Initial products (razors) sold cheaply; recurring products (blades) generate ongoing profit
Ecosystem products: Products that lock customers into broader product families or platforms
Gateway products: Entry-level products that upsell to premium offerings
Example:
Product Entry:
But analysis shows:
CFOs would classify Entry as highly profitable when considering full customer lifetime economics, even though stand-alone profitability is modest.
Understanding strategies for profit includes recognizing when short-term losses create long-term value.
Products differ in working capital intensity:
High working capital products:
Low working capital products:
CFOs calculate return on working capital invested:
Product A:
Product B:
Product A generates better returns despite lower absolute profit because it requires less working capital investment.
This matters especially for cash-constrained manufacturers where working capital is a limiting factor.
Understanding effective cash flow strategies every manufacturer needs includes managing product working capital requirements.
Some products justify keeping despite marginal profitability for strategic reasons:
Market presence: Products that maintain market position in key segments even if marginally profitable
Competitive blocking: Products that prevent competitors from gaining foothold
Capacity utilization: Products that keep facilities running and workforce employed during slow periods
Technology development: Products that develop capabilities valuable for future opportunities
Customer relationships: Products that strengthen relationships with strategic customers
Brand portfolio: Products that round out brand positioning
CFOs quantify strategic value when possible (e.g., "this product prevents 20% share loss in key segment") and make explicit trade-offs between financial returns and strategic value.
The key: strategic justifications should be specific, measurable, and time-limited. "We need this for strategic reasons" without specifics is weak rationale for poor profitability.
Experienced CFOs evaluate products through systematic framework:
Calculate multiple margin measures:
Compare to benchmarks:
Identify disproportionate overhead drivers:
Calculate true cost:
Determine limiting factor:
Optimize contribution per constraint:
Quantify strategic benefits:
Set time horizons:
Evaluate overall mix:
Understanding financial KPIs includes product-level profitability metrics that CFOs monitor.
After analysis, CFOs recommend specific actions:
Strong margins, efficient constraint use, low overhead, positive working capital economics. Actions: Increase sales focus, expand capacity, invest in improvements, optimize pricing.
Poor current profitability but strategic value or fixable issues. Actions: Reduce costs, increase pricing, improve utilization, reduce overhead.
Mature, declining volume, still profitable but limited growth. Actions: Maintain production, minimize investment, maximize cash, prepare exit.
Persistently unprofitable, minimal strategic value, consumes valuable resources. Actions: Discontinue, sell/license, fulfill commitments then exit, redeploy resources.
Understanding how to conduct pricing and margin analysis complements profitability evaluation.
CFOs make sophisticated analysis practical:
Start with 80/20 analysis: Focus deep analysis on products representing 80% of revenue or margin.
Use existing data: Work with available ERP and accounting data before building complex systems.
Pilot ABC thinking: Apply ABC logic to specific questions without full system implementation.
Create product scorecards: Simple dashboards showing key metrics for each product.
Review quarterly: Systematic reviews keep profitability front of mind.
Involve cross-functional teams: Finance analyzes, but operations, sales, and product management provide context and implement actions.
Working with a fractional CFO or financial controller experienced in product profitability analysis accelerates implementation.
Experienced CFOs evaluate product profitability through multiple lenses: contribution margin analysis, activity-based costing thinking, capacity constraint optimization, customer lifetime value, working capital efficiency, and strategic value.
This multi-dimensional approach reveals insights simple gross margin analysis misses: which products truly drive profitability, which consume disproportionate resources, which optimize constrained capacity, and which provide strategic value justifying modest financial returns.
For manufacturing business owners, adopting CFO-level profitability analysis improves decisions about:
Start with contribution margin analysis to distinguish fixed from variable costs. Layer in ABC thinking to understand overhead consumption. Consider capacity constraints and working capital requirements. Evaluate strategic value explicitly. Then make informed decisions backed by comprehensive profitability analysis rather than simple gross margin percentages.
The investment in sophisticated profitability analysis returns multiples through better resource allocation, improved pricing, optimized product mix, and strategic clarity about which products actually drive business value.