2 finance's link to marketing

8/8/2019 2 finance's link to marketing

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Describe the effectof marketing to

finance and vice-versa.


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Marketing managers are accountable for

the impact of their actions on profit andcash flow.


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RELEVANT ACCOUNTING& FINANCE CONCEPTS

Variable and Fixed Cost Relevant and Sunk Cost

Margins

Contribution Analysis Liquidity

Operating Leverage

Discounted Cash Flow Customer LifetimeValue Analysis


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VARIABLE & FIXED COSTS

VARIABLE COSTS are expenses that areuniform per unit of output within a relevanttime period yet total variable costs fluctuatein direct proportion to the output volume ofunits produced. In other words, as volumeincreases, total variable costs increase.

The two (2) types are those tied to product

(cost of goods sold) and those not tied toproduct costs (e.g. commissions, discountsand delivery expenses)


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VARIABLE & FIXED COSTS

FIXED COSTS are expenses that do notfluctuate with output volume within arelevant time period but becomeprogressively smaller per unit of output asvolume increase.

The two (2) types are programmed costs(costs that happened in attempting to

generate sales volume) and committed costs(costs required to maintain the organizationlike rent and administrative expenses)


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RELEVANT & SUNK COSTS

RELEVANT COSTS are expenditures that (1)are expected to occur in the future as aresult of some marketing actions and (2)

differ among marketing alternatives beingconsidered.

To expound, if we decided to add a new

product to our offering, we have to considerthe cost to manufacture and to market


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RELEVANT & SUNK COSTS

SUNK COSTS are the direct opposite ofrelevant costs. Sunk costs are pastexpenditures for a given activity and are

typically irrelevant in whole or in part tofuture decisions.

In marketing context, sunk costs include past

research and development expenditures andlast years advertising expense.


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MARGINS

MARGINS refers to the differencebetween the selling price and thecost of a product and service.

Common types of margins are: [1]Gross margins, [2] Trade Margins and

[3] Net Profit Margins (before taxes)


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MARGINS

GROSS MARGINS is the difference betweentotal sales revenue and total cost of goodssold. This may be expressed in dollar termsor as a percentage

Gross margins is a useful tool because itimplicitly includes unit selling price, unitcost and unit volume.

A decrease in gross margin is an immediateconcern because it has direct impact onprofits, providing that other expendituresremain unchanged.


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MARGINS

60%0.60Unit gross profit margin

(40)(0.40)Unit cost of goods sold

100%1.00Unit sales price

Unit Gross Margins

60%60Gross Profit Margin(40)(40)Cost of Goods Sold

100%100Net Sales

PercentageMonetaryAmount

Total Gross Margins


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MARGINS

TRADE MARGINS is the differencebetween unit sales price and unit costat each level of a channel marketing

(manufacturer-wholesaler-retailer). A trade margin is frequently referred

to as a markup or mark-on by channelmembers and it is often expressed as apercentage.


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Consider the following example Aretailer purchases an item for $10 andsells it at a price of $20 that is, a $10

margin. What is the retailers marginpercentage as percentage of cost?

As percentage of selling price?

MARGINS

100%

50%


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MARGINS

What if a wholesaler purchases an itemfor $2 and seeks to have 30% marginbased on selling price. What would be

the selling price? ($2.86, 2/0.70)


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MARGINS

What if a manufacturer suggests aretail list price of $6 on an item forultimate resale to the customer. The

item will be sold through retailerswhose policy is to obtain 40% marginbased on selling price. For what pricemust the manufacturer sell the item tothe retailer? .4x6=2.4, 6-2.4, $3.60


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NET PROFIT MARGIN (before taxes)

NET PROFIT MARGIN is the remainderafter cost of goods sold, other variablecosts, and fixed costs have been

subtracted from sales revenues.


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NET PROFIT MARGIN (before taxes)

What is effect of NET PROFIT MARGINSto WORKING CAPITAL and CASH FLOWPOSITION?


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CONTRIBUTION ANALYSIS

CONTRIBUTION is the difference betweentotal sales revenue and total variable costs,or, on a per-unit basis, the difference

between unit selling price and unit variablecost.

CONTRIBUTION ANALYSIS is particularly

useful in assessing relationships among costs,prices, and volumes of products and serviceswith respect to profit.


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BREAKEVEN ANALYSIS is one of thesimplest applications of contributionanalysis. This identifies the unit or dollar

sales volume at which an organizationneither makes a profit nor incurs loss.Stated in equation form:

TOTAL REVENUE = TOTAL VARIABLE COSTS + TOTAL FIXED COSTS


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UNIT SELLING PRICE UNIT VARIABLE COSTS

TOTAL FIXED COSTSUNITBREAKEVEN

VOLUME


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A manufacturer plans to sell a product for$5.00. The unit variable costs are $2.00,and total fixed costs assigned to the

product are $30,000. How many unitsmust be sold to break-even? How muchsales must be generated to break-even?

10,000 units and $50,000


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What would break-even volume be if fixed costswere increased to $40,000 (with everythingremaining constant)? 13,333

What would be break-even volume be if sellingprice were dropped from $5.00 to $4.00? 15,000

What would break-even volume be variable cost

were reduced to $1.50, selling price remained at$5.00 and fixed costs were $30,000? 8,571


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CONTRIBUTION ANALYSIS AND PROFIT IMPACT

UNIT SELLING PRICE UNIT VARIABLE COSTS

TOTAL FIXED COSTS + PROFIT GOAL

UNIT

VOLUME TOACHIEVEPROFIT

GOAL


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Suppose a firm has a fixed costs of$20,000 budgeted for a product or service,the unit selling is $25 and the variable

costs are $10. How many units must besold to achieve a profit goal of $20,000.

14,667 units



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How would you handle if profit goal isexpress in terms of 20% profit on sales?

20,000 units



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UNIT SELLING PRICE UNIT VARIABLE COSTS UNIT PROFIT GOAL

TOTAL FIXED COSTS

UNIT

VOLUME TOACHIEVEPROFIT

GOAL


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What is the significance of break-even tomarket size? Give an insight.

CONTRIBUTION ANALYSIS AND MARKET SIZE


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CONTRIBUTION ANALYSISAND PERFORMANCE MEASUREMENT

35,00020,00015,000NET PROFIT

55,00010,00045,000FIXED COSTS90,00030,00060,000T-CONTRIBUTION

1.506U-CONTRIBUTION

70,00030,00040,000TOTAL VC

1.504UNIT VC

160,00060,000100,000SALES REVENUES

310UNIT PRICE

30,00020,00010,000VOLUME

TOTALPRODUCT YPRODUCT X

Would it be a

good decision todiscontinueProduct X? Why?Why not?


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CANNIBALIZATION is the process by whichone product or service sold by a firm gainsa portion of its revenue by diverting sales

from another product or service also soldby the firm

CONTRIBUTION ANALYSISAND CANNIBALIZATION


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IF YOU OWN A COMPANY THAT HAS THISSITUATION, WHAT CAN YOU SAY?(GIVE YOUR INSIGHTS)

0.700.80UNITCONTRIBUTION

(0.40)(0.20)UNIT VARIABLECOSTS

1.101.00UNIT SELLING

PRICE

NEW GELTOOTHPASTEEXISTINGOPAQUE WHITETOOTHPASTE


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LIQUIDITY

LIQUIDITY refers to the firms ability tomeet short-term obligations.

A key measure of a firms liquidity

position is WORKING CAPITAL. WORKING CAPITAL formula is given by?


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WORKING CAPITAL Refers to a firms short-term assets (such as

inventory) and liabilities (such as money owedto suppliers)

Must be managed to ensure that the firm has

sufficient resources to continue its operations

and avoid costly interruptions (this involves a

number of activities related to the firmsrecipts and disbursement of cash)


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LIQUIDITY

Why should a marketing manager beaware of a firms working capitalsituation?


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Some questions about WC

1) How much cash and inventory should we

keep on hand?2) Should we sell on credit? If so, what

terms will we offer, and to whom will we

extend them?3) How will we obtain any needed short-

term financing? Will we purchase on

credit or will we borrow money in theshort term and pay in cash? If weborrow, how and where we should do it?


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OPERATING LEVERAGE

OPERATING LEVERAGE refers to the extent towhich fixed costs and variable costs are usedin the production and marketing of productsand services.

Firms that have high total fixed costsrelative to variable costs are defined ashaving a high operating leverage (e.g.airlines and heavy equipmentmanufacturers)


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OPERATING LEVERAGE

The higher the firms operatingleverage, the faster its total profitswill increase once sales exceed break-

even volume.


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OPERATING LEVERAGE

(2,000)(8,000)2,0008,00000PROFIT

20,00080,00020,00080,00020,00080,000

F-COSTS

72,00018,00088,00022,00080,00020,000V-COSTS

90,00090,000110,000110,000100,000100,000

SALES

HIGH VCFIRM

HIGH FCFIRM

HIGH VCFIRM

HIGH FCFIRM

HIGH VCFIRM

HIGH FCFIRM

10% DECREASE

IN SALES

10% INCREASE

IN SALES

BASE CASE

GIVE EXAMPLES OFFIRMS THAT HASHIGH OPERATINGLEVERAGE?


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DISCOUNTED CASH FLOW

DISCOUNTED CASH FLOW incorporatesthe theory of time value of money, orpresent-value analysis. The idea

behind the present value of money isthat a unit of money received nextyear is not equivalent to a unit ofmoney received today because the useof money has a value reflected by risk,inflation and opportunity cost.


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CUSTOMER LIFETIME VALUE

CUSTOMER LIFETIME VALUE (CLV) is thepresent value of future cash flows arisingfrom a customer relationship.

The CLV calculation requires three pieces of

information (M), the per-period cash margin/ customer

(r), per-period probability that the customer will

be retained (i), interest rate used for discounting future cashflow


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1 + i - r

1(M)CUSTOMER

LIFETIME VALUE


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To illustrate, consider a credit cardcompany. It has a card-member with anannual margin of $2,000. The typicalretention rate for card members is 80%. Theapplicable interest rate to discount futurecash flow is 10%. What is the CLV?

What happens to CLV if the credit cardcompany launched a retention program thatled to a 12.50% increase in retention rate?

$ 6,666.67

$ 10,000.00


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Profit is areward for the

appreciationgiven by the

customer

- MATSUSHITA KONOSUKE

2 finance's link to marketing

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