Financial Aspects of Marketing Management

CHAPTER 2
Financial Aspects of Marketing Management
TYPES OF COSTS
Variable Costs
Cost of Goods Sold Other Variable Costs
Sales Commissions
Fixed Costs
Programmed Costs Committed Costs
Variable/ Fixed Costs

Selling Expenses
Materials
Advertising
Rent
Salary
Labor
Discounts
Sales Promotion Sales Salaries
Administrative/ Clerical
Commissions/ Bonus
Overhead
Delivery
2013 Pearson Education, Inc. publishing as Prentice Hall
Slide 1-2
TYPES OF COSTS
Variable Costs
Are expenses that are uniform per unit of output within a relevant time period (budget year)
Fluctuate in direct proportion to the number of units produced

2013 Pearson Education, Inc. publishing as Prentice Hall Slide 1-3
TYPES OF COSTS
Variable Costs
Are divided into two categories:

Cost of Goods Sold
Materials, labor, and factory overhead tied directly to production
Other Variable Costs
Variable expenses not tied to production but with volume, such as sales commissions, discounts, etc.
TYPES OF COSTS
Fixed Costs
Are costs that do not fluctuate with output volume within a budget year On a per-unit basis, decrease as the number of units over which they are allocated increase Remain unchanged regardless of the number of units produced
TYPES OF COSTS
Fixed Costs
Are divided into two categories:

Programmed Costs
Those marketing costs that generate sales, such as advertising, sales promotion, salesforce salaries, etc.
Those costs that maintain the organization, such as rent, administrative/clerical salaries, etc.
Committed Costs
TYPES OF COSTS
Variable/Fixed Costs
Some costs have both a variable and fixed component. Example:

Fixed component: Salary
Selling Expenses
Variable component: Commissions or bonus
Slide 1-7
RELEVANT AND SUNK COSTS

Relevant Costs
Are expenditures that:

Are expected to occur in the future as a result of some marketing action Differ among marketing alternatives being considered
Include opportunity costs, the forgone benefits from an alternative not chosen
RELEVANT AND SUNK COSTS

Sunk Costs Are past expenditures for a given activity that are typically irrelevant in whole or in part to future decisions Are the opposite of relevant costs Include past R&D, test marketing, and advertising expenses Sunk cost fallacy: Recouping spent dollars by spending still more dollars in the future
MARGINS
Margin
Is the difference between the selling price and the cost of an offering Is expressed on a total volume or individual basis, dollar terms, or percentages
Consists of three types:

Gross Margin Trade Margin
Profit Margin
Slide 1-10
MARGINS
Gross Margin/Gross Profit
Is the difference between total sales revenue and total cost of goods sold Or on a per-unit basis, is the difference between unit selling price and unit cost of goods sold
Slide 1-11
MARGINS
Is expressed in dollars or percent:

Total Gross Margin
Net sales Cost of goods sold Gross profit margin
Dollar Amount
$100 -$40 $60
Percentage
100% -40% 60%
Unit Gross Margin

Unit sales price Unit cost of goods sold Unit gross profit margin $1.00 -$0.40 $0.60 100% -40% 60%
Slide 1-12
MARGINS
A decrease in gross margin can adversely affect profits and is due to:
Fluctuations in unit volume Changes in unit price or unit cost of goods sold Modification in the sales mix of the firms offerings
MARGINS
Trade Margin
Is the difference between unit sales price and unit cost at each level of a marketing channel (manufacturer wholesaler retailer) Is frequently referred to as a markup or mark-on by channel members, expressed as a percentage
MARGINS
Trade Margin Example: Selling Price = $20; Cost = $10; Margin = $10
Retailer Margin as a Percent of Cost Retailer Margin as a Percent of Selling Price
Differences in margin percentages show the importance of knowing the base (cost or selling price) Trade margin percents are usually based on selling price
MARGINS
Trade Margin Work backward from the consumer retail selling price through the marketing channel to arrive at the manufacturers products selling price
Marketing Channel Unit Cost of Goods Sold Unit Selling Price Gross Margin as a Percentage of Selling Price
Manufacturer Wholesaler Retailer Consumer
$2.00 $2.88 $3.60 $6.00
$2.88 $3.60 $6.00
30.6% 20.0% 40.0%
Slide 1-16
MARGINS
Net Profit Margin (Before Taxes) in an Income Statement
The remainder after cost of goods sold, other variable costs, and fixed costs have been subtracted from sales revenue
Dollar Amount
Net sales Cost of goods sold Gross profit margin Selling expenses Fixed expenses Net profit margin $100,000 -$30,000 $70,000 -$20,000 -$40,000 $10,000
Percentage
100% -30% 70% -20% -40% 10%
Slide 1-17
MARGINS
Net Profit Margin Dollars
Influences the working capital position of the organization by affecting its:

Ability to pay is costs of goods sold Ability to pay its selling/administrative costs Cash flow position
Slide 1-18
CONTRIBUTION ANALYSIS
Contribution
Is the difference between total sales revenue and total variable costs Or on a per-unit basis, is the difference between unit selling price and unit variable cost Is used to analyze the relationship between costs, prices, volume, and profit
Break-Even Analysis
Identifies the unit or dollar sales volume at which an organization neither makes a profit nor incurs a loss
Break-even is shown by this equation:
Total Revenue
Total Variable Costs
Total Fixed Costs
Slide 1-20
Break-Even Analysis
Break-even requires the following info:

An estimate of unit variable costs
An estimate of the relevant total dollar fixed costs to produce and market the offering unit The selling price for each offering unit
Slide 1-21
Break-Even Formula
Unit Break-Even Volume
Total Fixed Costs
=
Unit Selling Price
Unit Variable Costs
Denominator = Contribution per unit = Dollar amount that each unit sold contributes to the payment of fixed costs
Break-Even Analysis Unit Break-Even Volume Example: Unit Selling Price = $5; Unit Variable Costs = $2; Total Fixed Costs = $30,000 Unit Break-Even Volume
$30,000 $5 $2
10,000 units
Slide 1-23
Break-Even Analysis Dollar Break-Even Volume Example: Unit Selling Price = $5; Unit Variable Costs = $2; Total Fixed Costs = $30,000
Dollar Break-Even Volume Dollar Break-Even Volume Dollar Break-Even Volume
Unit Selling Price
=
=
$5
10,000 units
$50,000
Contribution Margin Formula
Unit Selling Price Contribution Margin
Unit Variable Costs
=
Unit Selling Price
Slide 1-25
Contribution Margin Example: Unit Selling Price = $5; Unit Variable Costs = $2
Contribution Margin
$5 $2 $5
Total Fixed Costs
Contribution Margin
60%
Dollar Break-Even Volume
$30,000
=
Contribution Margin
=
0.60
= $50,000
Slide 1-26
EXHIBIT 2.1: BREAK-EVEN ANALYSIS CHART
Slide 1-27
Sensitivity Analysis
Break-even points can change if there are changes in selling price, variable costs, and/or fixed costs
Unit Selling Price (P) Unit Variable Costs (UVC) Total Fixed Costs (FC) Contribution Per Unit CU = (P - UVC) Unit Break-Even Volume (FC / CU) Dollar Break-Even Volume (FC / CM*)
Scenario #1 Scenario #2 Scenario #3
$5.00 $4.00 $5.00
$2.00 $2.00 $1.50
$40,000 $30,000 $30,000
$3.00 $2.00 $3.50
13,333 units 15,000 units 8,571 units
$66,667 $60,000 $42,857
* Contribution margin (CM) = [(P UVC) P]

Break-Even Analysis: With Profit Goal
A modified break-even analysis is used to incorporate a profit goal
To incorporate a profit goal in the break-even formula, treat it as an additional fixed cost
Total Fixed Costs
Unit Volume to Achieve Profit Goal
Dollar Profit Goal
=
Contribution Per Unit
Break-Even Analysis: With Profit Goal Example: Unit Selling Price = $25; Unit Variable Costs = $10; Total Fixed Costs = $200,000; Profit Goal = $20,000
Unit Break-Even Volume with Profit Goal
$200,000 + $20,000 $25 $10
14,667 units
Slide 1-30
Break-Even Analysis: With Profit Goal A profit goal can be specified as a percentage of sales rather than as a dollar amount: Profit goal = 20% on sales
To incorporate a profit goal in the break-even formula, subtract the profit goal from the contribution per unit
Total Fixed Costs
Unit Volume to Achieve Profit Goal
=
Contribution Per Unit
Dollar Profit Goal

Slide 1-31
Break-Even Analysis: With Profit Goal
Example: Unit Selling Price (P) = $25; Unit Variable Costs (UVC) = $10; Total Fixed Costs (FC) = $200,000; Profit Goal = 20% of Unit Selling Price (P); Contribution per Unit (CU) = P- UVC
$200,000
[($25 $10) $5*]
20,000 units
* Dollar Profit Goal = (P Profit Goal Percent on Sales) = $25 20%; $25 .20 = $5
Multiple Product Break-Even Analysis
Break-even analysis can be extended to situations that involve multiple products and services
In these situations, the sales mix must be determined

The sales mix is the relative combination of products or services sold by a company
Unit Selling Price (P) Unit Variable Cost (UVC) Total Contribution Per Unit TCU = SM CU Total Marketing Fixed Cost (FC)
Model Economy Deluxe Total
Sales Mix (SM)
Contribution Per Unit CU = (P - UVC)
3 1 4
$500 $1,000
$300 $500
$200 $500
$600 $500 $1,100 $825,000
Weighted Average Contribution Per Unit
Total Contribution Per Unit
Total Sales Mix
= ($1,100 4) = $275 per unit = ($825,000 $275) = 3,000 units

Slide 1-34
Total Marketing Fixed Cost
Weighted Average Contribution Per Unit
Model Economy Deluxe Total
Sales Mix Sales Mix % (3:1) Model Unit Break-Even Volume (Total Unit B-E Volume of 3,000 units Sales Mix %) Unit Selling Price Weighted Average Unit Selling Price
3 1
75% 25%
2,250 750
$500 $1,000
100%
Economy
Sales Mix
3,000
Economy
Unit Selling Price (P)
$625
Deluxe
Sales Mix
Weighted Average Unit Selling Price
[(
)(
+
Deluxe
Unit Selling Price (P)
)]
Total
Sales Mix
= [(3 $500) + (1 $1,000)] 4 = $625 per unit

Dollar Break-Even Volume
= (3,000 units $625/unit) = $1,875,000

Slide 1-35
CONTRIBUTION ANALYSIS: MARKET SIZE

A manager can assess the feasibility of a venture by comparing the break-even volume with market size and market-capture percentage. Example: Market potential is 100,000 units and unit volume break-even point is 50,000 units. Therefore, a firms product or service needs a 50 percent market share to break even. Marketing implication: Can such a percentage can be achieved?
CONTRIBUTION ANALYSIS: PERFORMANCE MEASUREMENT

Product X (10,000 units) Product Y (20,000 units) Total (30,000 units)
Unit price Sales revenue Unit variable cost
$10.00 $100,000 $4.00 $40,000 $6.00 $60,000
$3.00 $16,000 $1.50 $30,000 $1.50 $30,000 $70,000 $40,000 $90,000 $160,000
Total variable cost

Unit contribution Total contribution
Fixed costs
Net profit
Which product is more profitable?
$45,000
$15,000
$10,000
$20,000
$55,000
$35,000
Which product is more profitable on a unit-contribution basis? Should Product X or Product Y be dropped? Why or why not? 2013 Pearson Education, Inc. publishing as Prentice Hall
Slide 1-37
CONTRIBUTION ANALYSIS: ASSESSMENT OF CANNIBALIZATION

Cannibalization occurs when a firm obtains sales revenue by diverting sales from one offering to another.
Brand X: Existing Opaque White Toothpaste Brand Y: New Gel Toothpaste $1.10 $0.40 $0.70
Unit price Unit variable cost Unit contribution

Why is this important?
$1.00 $0.20 $0.80
Which product has the higher unit contribution?
Slide 1-38
CONTRIBUTION ANALYSIS : ASSESSMENT OF CANNIBALIZATION

Cannibalization Effect
Brand X expected sales before Brand Y intro Brand Y expected sales Brand X: Existing Opaque White Toothpaste Brand Y: New Gel Toothpaste
1,000,000 1,000,000
Brand X units sales diverted to Brand Y Brand X per unit sales loss for each Brand Y unit sold
Brand Y per unit sales gain
500,000
$0.10 $0.70
How will the intro of Brand Y affect the total contribution dollars of Brand X?
Brand X total contribution lost? ($0.10/unit lost 500,000 cannibalized units from Brand X to Brand Y = $50,000) Brand Y total contribution gained? ($0.70 unit contribution 500,000 units of Brand Y = + $350,000) Financial effect of Brand Y intro? (Net contribution dollars = + $350,000 $50,000 = $300,000)
CONTRIBUTION ANALYSIS : ASSESSMENT OF CANNIBALIZATION

Product
Brand X: Existing Opaque White Toothpaste
Unit Volume 500,000
Unit Contribution $0.80
Contribution Dollars $400,000
Brand Y: New Gel Toothpaste
Cannibalized volume Incremental volume Subtotal
500,000 500,000 1,500,000
$0.70 $0.70
$350,000 $350,000 $1,100,000
Less: Original forecast volume for Brand Xexisting opaque white toothpaste 1,000,000
$0.80
$800,000
Total
+ 500,000
+ $300,000
Slide 1-40
LIQUIDITY AND WORKING CAPITAL

Liquidity
A firms ability to meet short-term financial obligations within a budget year
Working Capital
Current Assets Current Liabilities
Current Assets
Current Liabilities
Consists of cash, accounts receivable, prepaid expenses, inventory, etc.
Consists of short-term accounts payable, income taxes, etc.
Managers must be aware of the impact of marketing actions on working capital

OPERATING LEVERAGE
Operating leverage refers to the extent to which fixed costs and variable costs are used in the production and marketing of products and services
High Operating Leverage Low Operating Leverage
High total fixed costs relative to total variable costs Low total fixed costs relative to total variable costs
The higher the operating leverage, the faster total profits will rise or fall once sales volume rises or falls below break-even volume
EXHIBIT 2.2: EFFECT OF OPERATING LEVERAGE ON PROFIT

Base Case 10% Increase in Sales
High Fixed Cost Firm High Variable Cost Firm
10% Decrease in Sales

High Fixed Cost Firm High Variable Cost Firm
High Fixed Cost Firm
High Variable Cost Firm
Sales
Variable Costs
$100,000
$100,000
$110,000
$110,000
$90,000
$90,000
$20,000
$80,000
$22,000
$88,000
$18,000
$72,000
Fixed Costs
$80,000
$20,000
$80,000
$20,000
$80,000
$20,000
Profit
$0
$0
$8,000
$2,000
($8,000)
($2,000)
Slide 1-43
DISCOUNTED CASH FLOW

Discounted cash flows are future cash flows expressed in terms of their present value Incorporates the theory of the time value of money or present-value analysis Premise: A dollar received next year is worth less than a dollar received today because its future value is affected by risk, inflation, and opportunity cost
DISCOUNTED CASH FLOW
Net Cash Flow
Cash Inflows
Cash Outflows
Cost of Capital
The cost of earnings opportunities forgone by investing in a business with its attendant risk as opposed to investing in risk-free securities such as U.S. Treasury bills
The interest/discount rate is defined by the cost of capital

EXHIBIT 2.3: APPLICATION OF DISCOUNTED CASH FLOW ANALYSIS WITH A 15 PERCENT DISCOUNT FACTOR
Business A
Year Discount Factor Cash Flow Cumulative Cash Flow Discounted Cash Flow Cash Flow
Business B
Cumulative Cash Flow Discounted Cash Flow
0 1 2 3 4 5
1.000 0.870 0.756 0.658 0.572 0.497
($105,000) $25,000 $35,000 $50,000 $70,000 $90,000
($105,000) ($80,000) ($45,000) $5,000 $75,000 $165,000
($105,000) $21,750 $26,460 $32,900 $40,040 $44,730 $60,880
($105,000) $50,000 $55,000 $60,000 $65,000 $70,000
($105,000) ($55,000) $0 $60,000 $125,000 $195,000
($105,000) $43,500 $41,580 $39,480 $37,180 $34,790 $91,530
Totals
Which business has the larger cumulative cash flow? Why is this important? Which business has the faster payback? Why is this important?
Which business has the greater discounted cash flow? Why is this important?
CUSTOMER LIFETIME VALUE

Customer Lifetime Value (CLV)
The present value of future cash flows from a customer relationship
The CLV calculation requires this information:

$M
Sales Revenue
Variable Costs
Other Customer Acquisition Costs
)
Slide 1-47
Retention Rate Interest Rate
= (r ) = (i)

The customer lifetime value (CLV) formula is:
Customer Lifetime Value (CLV)
= $M
1 1+ir
Example: $M = $2,000; i = 10%; and r = 80%. CLV is:
CLV = $2,000 CLV = $6,666.67
1
1.0 + 0.1 0.8
Slide 1-48

Example: $M = $2,000; i = 10%; r = 80%; g (constant growth rate) = 6%. CLV is: CLV = $2,000 CLV = $8,333.33 Marketing affects the customer margin ($M), the retention rate (r), and the growth rate (g) but not the interest rate (i)
1.00 + 0.10 0.80 0.06

Some firms modify the customer lifetime value (CLV) formula to include the cost to acquire a customer (AC): Customer Lifetime Value (CLV)
$M
1 1+ir
AC
This CLV calculation requires insight into a firms customer relationships The firms customer database or industry norms are used to determine per-period margin ($M) and retention rate (r)
PRO FORMA INCOME STATEMENT

Displays projected revenues, budgeted expenses, and estimated net profit for an organization, product, or service during a specific planning period, usually a year Includes a sales forecast and a listing of variable and fixed costs that can be programmed or committed Reflects a marketers expectations (sales) given certain inputs (costs)
PRO FORMA INCOME STATEMENT CATEGORIES OR LINE ITEMS

Sales are the forecasted unit volume times unit selling price Cost of goods sold is the costs incurred in buying or producing offerings, which:
Are constant per unit within certain volume ranges Vary with total unit volume
Gross margin or gross profit is the remainder after cost of goods sold has been subtracted from sales
PRO FORMA INCOME STATEMENT CATEGORIES OR LINE ITEMS

Marketing expenses are the programmed expenses budgeted to produce sales General and administrative expenses (overhead) are the committed fixed costs for the planning period, which cannot be avoided if the organization is to operate
Net income before (income) taxes or net profit before taxes is the remainder after all costs have been subtracted from sales
EXHIBIT 2.4: PRO FORMA INCOME STATEMENT FOR THE 12-MONTH PERIOD ENDED DECEMBER 31, 2006
Sales Cost of goods sold Gross margin Marketing expenses Sales expenses Advertising expenses Freight or delivery expenses General and administrative expenses Administrative salaries Depreciation on buildings/equipment Interest expense Property taxes and insurance Other administrative expenses Net profit before (income) taxes
$1,000,000 $500,000 $500,000 $170,000 $90,000 $40,000 $120,000 $20,000 $5,000 $5,000 $5,000
$300,000
$155,000 $45,000
Slide 1-54

Financial Aspects of Marketing Management

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CHAPTER 2

Financial Aspects of Marketing Management

Variable/ Fixed Costs

Sales Promotion Sales Salaries

2013 Pearson Education, Inc. publishing as Prentice Hall

Fluctuate in direct proportion to the number of units produced

Are divided into two categories:

Materials, labor, and factory overhead tied directly to production

Other Variable Costs

Are divided into two categories:

Some costs have both a variable and fixed component. Example:

Variable component: Commissions or bonus

2013 Pearson Education, Inc. publishing as Prentice Hall

RELEVANT AND SUNK COSTS

Are expenditures that:

RELEVANT AND SUNK COSTS

Consists of three types:

2013 Pearson Education, Inc. publishing as Prentice Hall

Is expressed in dollars or percent:

Unit Gross Margin

2013 Pearson Education, Inc. publishing as Prentice Hall

Manufacturer Wholesaler Retailer Consumer

$2.00 $2.88 $3.60 $6.00

$2.88 $3.60 $6.00

30.6% 20.0% 40.0%

2013 Pearson Education, Inc. publishing as Prentice Hall

Influences the working capital position of the organization by affecting its:

2013 Pearson Education, Inc. publishing as Prentice Hall

Total Variable Costs

Total Fixed Costs

2013 Pearson Education, Inc. publishing as Prentice Hall

Break-even requires the following info:

2013 Pearson Education, Inc. publishing as Prentice Hall

Unit Break-Even Volume

Total Fixed Costs

Unit Variable Costs

Unit Break-Even Volume

2013 Pearson Education, Inc. publishing as Prentice Hall

Unit Selling Price

Unit Break-Even Volume

Unit Selling Price Contribution Margin

Unit Variable Costs

2013 Pearson Education, Inc. publishing as Prentice Hall

Dollar Break-Even Volume

EXHIBIT 2.1: BREAK-EVEN ANALYSIS CHART

2013 Pearson Education, Inc. publishing as Prentice Hall

Scenario #1 Scenario #2 Scenario #3

$5.00 $4.00 $5.00

$2.00 $2.00 $1.50

$40,000 $30,000 $30,000

$3.00 $2.00 $3.50

13,333 units 15,000 units 8,571 units

$66,667 $60,000 $42,857

* Contribution margin (CM) = [(P UVC) P]

A modified break-even analysis is used to incorporate a profit goal

Unit Volume to Achieve Profit Goal

Dollar Profit Goal

Unit Break-Even Volume with Profit Goal

$200,000 + $20,000 $25 $10

Unit Break-Even Volume with Profit Goal

2013 Pearson Education, Inc. publishing as Prentice Hall

Unit Volume to Achieve Profit Goal