Financial Analysis for

Product Management
-Rohan M. Thomas
-Nikunj Barnwal
 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.

2
 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.

3. 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.

3
 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.

4
 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?
5
 Roadblocks
 Information systems are not
designed by product management in
mind.
 Financial and accounting personnel
have quite different mindsets and
perspective than marketing
personnel.
 Lack of internal marketing on the
part of product management.
6
 Profitability Analysis
Product: New Call
Income Statements, December 31, 2005
(000’s)
Revenue (2M units@ $5) $10,000
Less: Direct Labor 2,500
Direct Supervision 500
Social Security 255
Materials 5
Operational Overhead 840
Expenses From Operations 4,100
Operating or gross margin 5,900
Less: 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 1,000
Total Expenses 6,000
7
Operation Profit (100)
 Strength &Weakness of conventional
Product Profit Accounting
Strength: 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.

8
Alternative Accounting System

We can classify accounting systems into 3

groups:
 Financial or custodial: Useful for external
constituents who may care only about the overall
financial performance of the company.
 Performance based: Looks at today's performance
based on budget.
 Contribution based system: Emphasis on the
cost the product manager can control. There is a clear
distinction between variable and fixed cost.

9
 Contribution Oriented System
Category Total Cost Variable Fixed

Operating expenses($000)
Direct Labor $2500 2500
Direct Supervision 500 500
Social Security 255 255
Materials 5 5
Operational overhead 840 200 640
Subtotal: $ 4,100 3,460 640
Non operating expenses
Advertising $ 700 700
Promotion 200 200
Field Sales 1,700 200 1,500
Product management 25 25
Marketing Management 250 250
Marketing research 175 175
Customer Service 1,500 240 1,260
Testing 300 300
General & administration 1,000 1,000
Subtotal $ 6,000 $ 440 $5,560 10
Total $ 10,100 3,900 6,200
 Contribution Margin Rate
Breakeven in units = Fixed Costs
Variable Margin per Unit
Breakeven in dollars = Fixed Costs
Variable Margin Rate
Safety factor = (Current Sales Volume – Break
Even Volume)/Current Volume

11
 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
12
• 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
13
 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)
14
• 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)

15
 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.
16
 Income Statement: Direct vs. Indirect Fixed Costs
(Pg 454)

Revenues 10,000
Variable Costs (Direct Labor, Supervision, 3,900 3,900
Customer Service, Materials, Operations Overhead
etc.)
Contribution Margin 6,100
Fixed Costs-
Programmed Direct (Advertising, Promotion, Field 3,025 3,075
Sales, Product Mgmt, Mktng Research etc.)
Standby Direct (Operations Overhead, Testing, 1,240 1,835
General & Administrative)
Programmed Indirect (Advertising, Mktng Mgmt, 1,235
Product Development etc.)
Standby Indirect (General & Administrative) 700 1935
(100) 17
• 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.

18
• 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.
19
 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
20
 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) 21
 Price-Quantity Decomposition
S => Share, M => Total Market Size,
Q => Quantity sold in units,
C => Contribution margin per unit
Price/Cost Variance =>
(Ca - Cp)* Qa = (0.1773 – 0.2000)* 22,000,000 =
-500,000
Volume Variance =>
(Qa - Qp)* Cp = (22,000,000 – 20,000,000)* 0.20 =
400,000
Sum of the variances => -100,000
22
 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

23
 Summary of the analysis
Planned Profit Contribution $4,000,000
Volume Variance
Share Variance ($600,000)
Market Size Variance 1,000,000
400,000
Price/Cost Variance (500,000)
Actual profit contribution $3,900,000

24
 Capital Budgeting
• Deals with prioritizing several aspects to
projects within a firm.
• Five discrete steps
1. Generating Investment proposals
2. Estimating Cash Flows for the proposals
3. Evaluating the Cash Flows
4. Selecting projects based on an acceptance
criterion
5. Reevaluating the projects after their
acceptance

25
3. Evaluating the Cash Flows
Five major methods
• Average Rate of Return (Avg Annual Profit)/ Avg
Investment per year
• Payback (No. of years to recover the initial investment) Initial
Investment/Annual Cash Flows
• Internal Rate of Return [A =A /(1+r) + A /(1+r) +…
0 1 2
2

An/(1+r)n] (n- last period when the cash flows can be expected)
• Present Value NPV= ∑A /(1+k) t
t

• Economic Value added After-tax operating

income – (Investments in assets* Weighted Average
Cost of Capital)

26
27