FINANCE AND BUSINESS

CASE ESSENTIALS FOR

PRODUCT MANAGERS

VIKAS BATRA

DEC 2015

WHY FINANCIAL

INTELLIGENCE MATTERS?

Enables you to manage business effectively

• Measure, Track and Improve Business Performance

• Assess financial health of suppliers, partners & customers

Likelihood of Bonus/Salary Hike

Readiness for Greater Responsibility

OUTLINE

Key Financial Statements and Key Concepts

Business Case, Example

Building Financial Intelligence of your team

Summary

KEY FINANCIAL

STATEMENTS

Income Statement

• Profit or loss generated over a period of time

Balance Sheet

• Snapshot of the organization’s financial position at a

specific point in time.

• Assets, liabilities and equity

Cash Flow Statement

• Cash generated (Inflow) and cash used (Outflow) over a

period of time

INCOME STATEMENT

Single Step

INCOME STATEMENT

Multi-Step

Product Design, Manufacturing…

Business Operations …

Financing, One-time transactions…

INCOME STATEMENT

Internal Multi-Step Formats

Assess effectiveness

Target effectiveness

Concepts

Assumptions on Allocations

Accrual Based Accounting.

BALANCE SHEET

Snapshot of organization’s financial position at a specific point in

time.

Assets = Liabilities + Shareholder's Equity

Simple View

BALANCE

SHEET

Detailed View

DEPRECIATION

Depreciation Allocating a portion of cost of an asset on Income

Statement

CASH FLOW

STATEMENT

Cash generated (Inflow) and cash used (Outflow) over a period of

time

Generally Prepared by Indirect Method

FINANCIAL

STATEMENT

Don’t Tell you Everything

Non-financial Health

Customer Satisfaction

Competitive Environment

BUSINESS

CASE/COST

BENEFIT

ANALYSIS

BUSINESS CASE

Weigh Benefits vs. Costs

Tied to a decision

Should we invest in an opportunity or not ?

BUSINESS CASE -

STEPS

• Identify all new revenues

• Identify all costs to incurred to realize revenue. Identify any

cost savings

• Map out the timeline for expected revenues and costs

• Assess impact to bottom line

• Capture unquantifiable benefits and costs

• Strategic fit with high-level organizational strategies, Win

new business opportunity, Customer goodwill etc.

ASSESSING THE

IMPACT

• Return On Investment (ROI)

• Breakeven Analysis

• Net Present Value (NPV)

• Sensitivity and Scenario Analysis

RETURN ON

INVESTMENT (ROI)

• Benefit (Return) received for every dollar invested

• E.g. 4% => $4 earned for every $100 invested

• Calculation

• Net return = Total benefits – Total costs

• ROI = Net return ÷ Cost of investment

Definition of “Return” and “Cost” vary by context.

BREAKEVEN

ANALYSIS

Product units must be sold in order to recover investment

Are the Sales Volume at assumed price point realistic?

Calculation

• Contribution margin per unit = Selling price per unit –

variable cost per unit

• Breakeven volume = Total Investment ÷ Contribution

margin per unit

EXAMPLEMetric 2016

Units Sold 1500

Selling Price/Unit ($) 1,000$

Revenue ($) Units X Selling PriceUnit 1,500,000$

Cost of Goods Sold/Unit ($) Variable Cost/Unit (550)$

Total Cost of Goods Sold ($) Units X COGS/Unit (825,000)$

Contribution Margin/Unit($) Price/Unit - Variable Cost/Unit 450$

Contribution Margin($) 675,000$

Contribution Margin (%) Cont. Margin / Revenue 45%

Fixed Cost - Product

R&D Cost ($) (300,000)$

Purchase of Assets ($) (60,000)$

Fixed Cost - Allocations

Selling, General & Administrative Costs($) (225,000)$

Operating Income/(Loss) ( $) Revenue - Costs 90,000$

Operating Margin/(Loss) (%) Operating Income / Revenue 6.0%

Non-Operating Income/Loss

Tax Expense ($) 35% (31,500)$

Net Income (After Taxes) 58,500$

Return on Investment (ROI) Net Income / (R&D + Assests) 16%Breakeven Point (Units) simple Fixed Costs / (Cont. Margin/Unit) 800

NET PRESENT VALUE

Time value of money : A dollar you receive five years from now is worth less than a dollar

you receive today

• Dollar today can be invested, Inflation…

Present Value

Reduce the value of the dollar at rate every year (Discount Rate)

EXAMPLE

Today Year 1 Year 2 Year 3 …. Year T

$100 10% 100* ( 1 + 0.1)

100 * 1.1

110.00$ 110* (1 + 0.1)

100 * (1 + 0.1) * (1+ 0.1)

121.00$ 121 * ( 1 + 0.1)

100 * (1 + 0.1) * (1+0.1) * (1+ 0.1)

133.10$

… $100* ( 1 + 0.1) ^ T

Value with Interest $100 110.00$ 121.00$ 133.10$

Interest at 10% Interest Rate

Today Year 1 Year 2 Year 3 Year T

Actual Value 100.00$ 110.00$ 121.00$ 133.10$

110/ ( 1 + 0.1) 121 / ( (1+0.1) * (1+.1)) 133.1 / ( (1+0.1) (1+.1) (1+r) )

110/1.1

Present Value 100.00$ 100.00$ 100.00$

Actual CashFlow $C0 $ C1 $ C2 $ C3 $C T

…

Present Value Cash Flow$ C0 C1 / ( 1 + r) C2 /( 1 + r) ( 1 + r) C3/ ( 1+r) (1 +r ) (1+r) $ C T / (1+r)^T

Present Value at 10% Discount Rate

NET PRESENT VALUE

(NPV)

Time value of money : A dollar you receive five years from now is worth less than a dollar

you receive today

• Dollar today can be invested, Inflation…

Present Value

Reduce the value of the dollar at rate every year (Discount Rate)

NPV Calculation:

• Start with Incremental Cash Flows for every year,

• Discount Cash Flows for each year to their respective Present Values.

• Add them to get Net Present Value (NPV)

NPV positive and no other investment => Invest.

NPV close to zero or marginally positive => Judgement call

EXAMPLE

Metric 2015 2016 2017 2018 2019 Total

Units Sold 0 1500 3000 2000 1000 7500

Selling Price/Unit ($) 1,000$ 1,000$ 1,000$ 1,000$

Revenue ($) Units X Selling PriceUnit -$ 1,500,000$ 3,000,000$ 2,000,000$ 1,000,000$ 7,500,000$

Cost of Goods Sold/Unit ($) Variable Cost/Unit (550)$ (550)$ (550)$ (550)$

Total Cost of Goods Sold ($) Units X COGS/Unit -$ (825,000)$ (1,650,000)$ (1,100,000)$ (550,000)$ (4,125,000)$

Contribution Margin/Unit($) Price/Unit - Variable Cost/Unit -$ 450$ 450$ 450$ 450$

Contribution Margin($) -$ 675,000$ 1,350,000$ 900,000$ 450,000$ 3,375,000$

Contribution Margin (%) Cont. Margin / Revenue NA 45% 45% 45% 45% 45%

Fixed Cost - Product

R&D Cost ($) (500,000)$ (300,000)$ (50,000)$ (50,000)$ (50,000)$ (950,000)$

Purchase of Assets ($) (300,000)$ (300,000)$

Depriciation of the Asset($) 5 Year Fixed (60,000)$ (60,000)$ (60,000)$ (60,000)$ (60,000)$ (300,000)$

Fixed Cost - Allocations

Selling, General & Administrative Costs($) -$ (225,000)$ (450,000)$ (300,000)$ (100,000)$ (1,075,000)$

Operating Income/(Loss) ( $) Revenue - Costs (560,000)$ 90,000$ 790,000$ 490,000$ 240,000$ 1,050,000$

Operating Margin/(Loss) (%) Operating Income / Revenue 6.0% 26.3% 24.5% 24.0% 14.0%

Non-Operating Income/Loss

Tax Expense ($) 35% -$ (31,500)$ (276,500)$ (171,500)$ (84,000)$ (563,500)$

Net Income (After Taxes) (560,000)$ 58,500$ 513,500$ 318,500$ 156,000$ 486,500$

EXAMPLE

CASH FLOW STATEMENT 2015 2016 2017 2018 2019 Total

Net Income (560,000)$ 58,500$ 513,500$ 318,500$ 156,000$ 486,500$

Depreciation Adjustment 60,000$ 60,000$ 60,000$ 60,000$ 60,000$ 300,000$

Total Cash Inflow (Sources) Net Income + Dep Adj. (500,000)$ 118,500$ 573,500$ 378,500$ 216,000$ 786,500$

Purchase of Assets.. (300,000)$ -$ -$ -$ -$ (300,000)$

Others…(Inventory, Accounts Receivable etc.) -$ -$ -$ -$ -$ -$

Total Cash Outflow(Uses) (300,000)$ -$ -$ -$ -$ (300,000)$

Net Cash Flow (Inflow - Outflow) Cash Inflow - Cash Outflow (800,000)$ 118,500$ 573,500$ 378,500$ 216,000$ 486,500$

Discounted Net Cash Flow(10%) Present Value of Cash Flow (800,000)$ 107,727$ 473,967$ 284,373$ 147,531$ 213,598$

Net Present Value (NPV) Sum of PV of Cash Flows 213,598$

SENSITIVITY AND

SCENARIO ANALYSIS

Sensitivity

• Change in NPV with variation of an input

• 10% decrease in price/unit => 19.5% NPV decrease

• 10% increase in R&D Cost => 2.3% NPV decrease

Scenario

• Analysis for certain set of inputs

• Most-Likely, Best-Case, Worst-Case Scenario

BUSINESS CASE -

SUMMARY

Business Case is as good as the assumptions made

Business Case tell only part of the story. Do not ignore non-

quantifiable items

Does not replace Influencing Effort

When comparing across business cases, watch for

consistency

Tracking and adjusting Business Case, as you go along is

important

• Sensitivity Analysis can identify areas

IMPROVING TEAM

FINANCIAL

INTELLIGENCE

Benefits

• Make Smarter Decisions

• Understand logic behind goals set by senior management

• Effective Management

Steps

• Informal training sessions

• Regular “numbers/metrics” meetings

• Targets in Performance Objectives

• Buy In from leaders

REFERENCES

• http://www.accountingcoach.com/

• Your Company’s Finance Department

• Internet Search

SUMMARY

• Financial Intelligence Matters

• Don’t be scared by jargon

• Work with your Finance/ CFO Controller

• Financial Statements: Don’t have to memorize all terms/

ratios.

• Understand metrics organization tracks/aims

• Understand impact of your decisions to metrics

• Use metrics to drive team behavior and effectiveness

Finance is simple, based on common sense

FINANCE AND BUSINESS

CASE ESSENTIALS FOR

PRODUCT MANAGERS

VIKAS BATRA

DEC 2015

THANK YOU

BACK UP

CONCEPTS

Accrual based Accounting : Income and expenses are reported

on Income Statement when they are incurred, regardless of when

cash is received or paid.

Allocations are apportionments of costs to different buckets or

departments within a company

Depreciation Allocating a portion of cost of an asset on Income

Statement

ASSESSING

FINANCIALS

• Ratio analysis.

• A financial ratio is two key numbers from an organization’s

financial statements expressed in relation to each other.

• There are numerous kinds of financial ratios:

• Profitability ratios

• Operating ratios (including liquidity ratios and efficiency

ratios)

• Leverage ratios

INTERNAL RATE OF

RETURN

IRR is the Discount Rate at which the NPV of an investment

equals zero

If IRR > Expected Rate of Return then, make the investment.