financial analysis for product management_nikunj_rohan
TRANSCRIPT
Financial Analysis for Product Management
-Rohan M. Thomas-Nikunj Barnwal
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Overview
• Product Managers have the complete profit and loss responsibility for their product.
• To be a part of firms overall decision making, product manager must understand the financial implication of their decision.
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Two kinds of information are important to marketing decision
making:1. The product manager is to have the profit and
loss responsibility or set short & long term objective, he or she must have a good understanding of how profits are computed.
2. Understanding of financial performance is relevant if there is a product line or many product variant because it analyzes the performance of different product variant.
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Sales Analysis
• Defined as “the gathering, classifying, comparing and studying of company sales data”
• Sales analysis is a powerful tool in the hands of a product manager.
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Major component of sales analysis
1. How sales are defined?2. In what units can sales be
analyzed?3. In what categories or classification
can the sales data be placed?4. What are the appropriate
standards against which the sales can be compared?
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Roadblocks
1. Information systems are not designed by product management in mind.
2. Financial and accounting personnel have quite different mindsets and perspective than marketing personnel.
3. Lack of internal marketing on the part of product management.
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Profitability AnalysisProduct: New Call
Income Statements, December 31, 2005(000’s)
Revenue (2M units@ $5) $10,000Less: Direct Labor 2,500 Direct Supervision 500 Social Security 255 Materials 5 Operational Overhead 840Expenses From Operations 4,100Operating or gross margin 5,900Less: Advertising $ 700 Promotions 200 Field sales 1,700 Product Management 25 Marketing Management 250 Product Development 150 Marketing Management 175 Customer Service 1,500 Testing 300 General & Administration 1,000Total Expenses 6,000
Operation Profit (100)
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Strength &Weakness of conventional Product Profit
AccountingStrength: All cost of the operation are covered
by the product.
Weakness: At first glance, it appears the company
would be $100,000 more profitable by eliminating
the product new call?It is difficult to use full-costing approach to
obtain answers for straightforward questions.
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Alternative Accounting System
We can classify accounting systems into 3 groups:
1. Financial or custodial: Useful for external constituents who may care only about the overall financial performance of the company.
2. Performance based: Looks at today's performance based on budget.
3. Contribution based system: Emphasis on the cost the product manager can control. There is a clear distinction between variable and fixed cost.
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Contribution Oriented System
Category Total Cost Variable Fixed
Operating expenses($000)Direct Labor $2500 2500Direct Supervision 500 500Social Security 255 255Materials 5 5Operational overhead 840 200 640Subtotal: $ 4,100 3,460 640Non operating expensesAdvertising $ 700 700Promotion 200 200Field Sales 1,700 200 1,500Product management 25 25Marketing Management 250 250Marketing research 175 175Customer Service 1,500 240 1,260 Testing 300 300General & administration 1,000 1,000Subtotal $ 6,000 $ 440 $5,560Total $ 10,100 3,900 6,200
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Contribution Margin Rate
Breakeven in units = Fixed Costs Variable Margin per
UnitBreakeven in dollars = Fixed Costs
Variable Margin Rate
Safety factor = (Current Sales Volume – Break Even Volume)/Current Volume
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Break-Even Analysis
• Break-even analyses => Short term oriented
• Example of a new product…• What if some fixed cost undergo
incremental change?Re 1/0.33 = Rs 3
• Target profit breakeven = (Target + Fixed Cost)/Contribution Rate
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• Businesses which are more fixed cost-intensive, suffer when sales drop.– Example of Airline Industry (why price-war?)
• Products characterized by different variable margin rates have different strategic problems.– Variable costs are high and CMR is
low=> price needs to be kept high to make profitability high
– Fixed costs are high and Variable costs are low => price needs to be kept high to serve the Fixed costs
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Fixed Costs
• Programmed Direct Fixed Costs- Controlled by managers and are usually expended for a specific planning period. (Eg. Advertising)
• Programmed Indirect Fixed Costs- Controlled by management but cover several products. (Eg. Corporate Umbrella Advertising)
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• Standby Direct Fixed Costs- Don’t change significantly without a major change in operations, Generally not controlled by Product Manager in the short run. (Eg. A facility dedicated to a specific project)
• Standby Indirect Fixed Costs- Corporate Overheads (Eg. CEO’s Salary)
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Product Manager’s Responsibility
• Is his primary responsibility to make a profit by generating revenues in excess of variable costs that cover the fixed cost attributable to her product?
• In other words, the product manager should be responsible for making a profit based on costs that would exist only if the product existed.
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Income Statement: Direct vs. Indirect Fixed Costs
(Pg 454)
Revenues 10,000
Variable Costs (Direct Labor, Supervision, Customer Service, Materials, Operations Overhead etc.)
3,900 3,900
Contribution Margin 6,100
Fixed Costs-
Programmed Direct (Advertising, Promotion, Field Sales, Product Mgmt, Mktng Research etc.)
3,025 3,075
Standby Direct (Operations Overhead, Testing, General & Administrative)
1,240 1,835
Programmed Indirect (Advertising, Mktng Mgmt, Product Development etc.)
1,235
Standby Indirect (General & Administrative) 700 1935
(100)
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• In fact despite showing loss, the Company will be worse off dropping this money-losing product, as it is generating $1.835 m which is covering indirect fixed costs.
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• Full Costing Statement- Top Management & External Constituents.
• Contribution Margin Statement- Easy to read and shows quickly the money going to cover the fixed costs, but doesn’t differentiate between Indirect and Direct fixed costs.
• Statement breaking down Fixed Costs- Most relevant for Product Management as it clearly states how the product is performing.
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Variance Analysis
• Variance- A discrepancy between a planned figure/objective and the actual outcome
• Used for control• Major benefit => Identification of
potential problem areas, not diagnosing the causes of the problems
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An Example
Item Planned Actual Variance
Revenues
Sales (Rs) 20,000,000
22,000,000
2,000,000
Price per lb. ($) 0.5000 0.4773 0.2270
Revenues ($) 10,000,000
10,500,000
500,000
Total Mkt (lbs.) 40,000,000
50,000,000
10,000,000
Share of Mkt 50% 44% 6%
Costs
Variable cost per lb. ($)
30 30 --
Contribution per lb. ($)
0.2000 0.1773 0.0227
Total ($) 4,000,000
3,900,000
(100,000)
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Price-Quantity Decomposition
S => Share, M => Total Market Size, Q => Quantity sold in units, C => Contribution margin per unitPrice/Cost Variance =>(Ca - Cp)* Qa = (0.1773 – 0.2000)* 22,000,000 = -500,000Volume Variance =>(Qa - Qp)* Cp = (22,000,000 – 20,000,000)*
0.20 = 400,000Sum of the variances => -100,000
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Penetration-Market Size Decomposition
• Variance in contribution due to market share => (Sa - Sp)* Ma* Cp
(0.44 – 0.50)* 50,000,000* 0.2 = -600,000
• Offset by the gain from the increased size of the market =>(Ma - Mp)* Sp* Cp
(50,000,000 – 40,000,000)* 0.5* 0.2 = 1,000,000
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Summary of the analysis
Planned Profit Contribution $4,000,000
Volume VarianceShare Variance ($600,000)Market Size Variance 1,000,000
400,000Price/Cost Variance
(500,000)Actual profit contribution
$3,900,000
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Capital Budgeting• Deals with prioritizing several
aspects to projects within a firm.• Five discrete steps
1. Generating Investment proposals2. Estimating Cash Flows for the
proposals3. Evaluating the Cash Flows4. Selecting projects based on an
acceptance criterion5. Reevaluating the projects after their
acceptance
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3. Evaluating the Cash Flows
Five major methods1. Average Rate of Return (Avg Annual
Profit)/ Avg Investment per year
2. Payback (No. of years to recover the initial investment) Initial Investment/Annual Cash Flows
3. Internal Rate of Return [A0=A1/(1+r) + A2/(1+r)2 +…An/(1+r)n] (n- last period when the cash flows can be expected)
4. Present Value NPV= ∑At/(1+k)t
5. Economic Value added After-tax operating income – (Investments in assets* Weighted Average Cost of Capital)
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