Farah Choudhary - Ehsan Ul Haq
Farah Choudhary - Ehsan Ul Haq
Farah Choudhary - Ehsan Ul Haq
-EHSAN UL HAQ
OVERVIEW
In many companies product managers assume
the role of mini-CEOs.
PROFITABILITY ANALYSIS
CAPITAL BUDGETING
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SALES ANALYSIS
It is defined as “the gathering,
classifying, comparing and studying of
company sales data”
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MAJOR COMPONENTS OF SALES
ANALYSIS
How sales are defined?
In what units can sales be analyzed?
In what categories or classification can the
sales data be placed?
What are the appropriate standards against
which the sales can be compared?
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TOOLS FOR SALES ANALYSIS:
Sales-variance analysis
It measures the relative contribution of different factors to
a gap in sales performance.
Suppose the annual plan called for selling 4,000 units in
the 1st quarter at Rs. 1 per unit, for total revenue of
Rs.4000. At quarter’s end only 3,000 units were sold for
Rs. 0.80 per unit, for total revenue of Rs.2400. Now:
Variance due to price decline = (Rs.1.00-Rs.0.80 ) (3,000)
= Rs. 600 37.5%
Variance due to volume decline = (Rs.1.00)(4000-3000)
= Rs. 1000 62.5%
= Rs. 1600 100%
Almost 2/3rd of the variance is due to failure to achieve the volume
target 6
TOOL FOR SALES ANALYSIS:
Microsales Analysis
It looks at specific products, territories, and so forth that failed to
produce expected sales.
Suppose the company sells in three territories, and expected sales
were 1,500 units,500 units, and 2,000 units respectively. Actual
volumes were 1,400 units, 525 units, and 1,075 units, respectively.
Thus territory 1 showed a 7% shortfall in terms of expected sales;
territory 2, a 5% improvement over expectations; and territory 3,
a 46% short-fall.
Territory 3 is causing most of the trouble. Maybe territory
3’s sales rep is underperforming; a major competitor has entered
etc.
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ROADBLOCKS
1. Information systems are not designed by
product management in mind.
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STEPS FOR PROFITABILITY
ANALYSIS
STEP 1: Identifying Functional Expenses
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Conventional Product Profit
Accounting
This approach to computing profits is called
full-costing approach.
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 variance from budgets.
3. Contribution based system: Emphasis on
the cost the product manager can control. There is a
clear distinction between variable and fixed
cost. 14
Contribution Oriented System
2nd notion of profitability is called
contribution margin.
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Contribution Oriented System
Variable Costs:- They are those costs that
vary directly with total volume of sales
or production. Such costs normally
include materials and direct labour, etc.
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
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Subtotal $ 6,000 $ 440 $5,560
Total $ 10,100 3,900 6,200
Contribution Margin Statement
Product: New Call
Income Statements, December 31, 2005
(000’s)
Revenue (2M units@ $5) $10,000
Variable Costs
Direct Labor $2,500
Direct Supervision 500
Social Security 255
Sales force commission 200
Customer Service 240
Materials 5
Operational Overhead 200
Total variable costs 3,900
Contribution margin (61%) 6,100
Fixed Costs
Operational Overheads 640
Advertising 700
Promotions 200
Field sales 1,500
Product Management 25
Marketing Management 250
Product Development 150
Marketing Research 175
Customer Service 1,260
Testing 300
General & Administration 1,000
Total Fixed costs 6,200 18
Operation Profit (Loss) (100)
Contribution Margin Rate
Breakeven in units = Fixed Costs
Variable Margin per Unit
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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)
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Product Manager’s Responsibility
His primary responsibility is to make a
profit by generating revenues in excess of
variable costs that cover the fixed cost
attributable to his/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
Revenues 10,000
Variable Costs (Direct Labor, Supervision, Customer 3,900 3,900
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
Total Indirect Costs 1935
Operating profit (100) 25
Subtracting both programmed & standby direct
fixed costs, Newcall shows a ‘profit’ of $1.835 m.
Only after subtracting costs over which the
product manager has no control, the product
shows loss.
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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In Sum….
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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Strategic Framework For Control-
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 Of Variance Analysis: Product
Alpha
Item Planned Actual Variance
Revenues
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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. Re evaluating the projects after their
acceptance
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Evaluating the Cash Flows
Five major methods
1. 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 [A =A /(1+r) + A /(1+r) +…A /(1+r) ]
0 1 2
2
n
n
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