1. Chapter 2
Financial Aspects of
Marketing Management

2. In this chapter, you will learn about…
Variable and Fixed Costs
Relevant and Sunk Costs
Margins
Gross Margin
Trade Margin
Net Profit Margin (Before Taxes)
Contribution Analysis
Break-even Analysis
Sensitivity Analysis
Contribution Analysis and Profit Impact

3. In this chapter, you will learn about…
Contribution Analysis (contd.)
Contribution Analysis and Market Size
Contribution Analysis and Performance Measurement
Assessment of Cannibalization
Liquidity
Operating Leverage
Discounted Cash Flow
Preparing a pro forma Income Statement

4. Types of Cost
Costs
Fixed
Variable Costs

5. Variable Costs are…
Expenses that are uniform per unit of output within a relevant time period
As volume increases, total variable costs increase

6. THERE ARE TWO CATEGORIES OF
VARIABLE COSTS
Cost of Goods Sold
Other Variable Costs

7. Variable Costs – Cost of Goods Sold
For Manufacturer or Provider of Service
Covers materials, labor and factory overhead applied directly to production
For Reseller (Wholesaler or Retailer)
Covers primarily the cost of merchandise

8. Other Variable Costs
Expenses not directly tied to production but vary directly with volume
Examples include:
Sales commissions, discounts, and delivery expenses

9. Fixed Costs
Expenses that do not fluctuate with output volume within a relevant time period
They become progressively smaller per unit of output as volume increases
No matter how large volume becomes, the absolute size of fixed costs remains unchanged

10. THERE ARE TWO CATEGORIES OF
FIXED COSTS
Programmed costs
Committed costs

11. Fixed Costs – Programmed Costs
Result from attempts to generate sales volume
Examples include:
Advertising, sales promotion, and sales salaries

12. Fixed Costs – Committed Costs
Costs required to maintain the organization
Examples include nonmarketing expenditures, such as:
rent, administrative cost, and clerical salaries

13. Relevant and
Sunk Costs

14. Relevant Costs are…
Future expenditures unique to the decision alternatives under consideration.
Expected to occur in the future as a result of some marketing action
Differ among marketing alternatives being considered
In general, opportunity costs are considered relevant costs

15. Sunk Costs are… The direct opposite of relevant costs.
Past expenditures for a given activity
Typically irrelevant in whole or in part to future decisions
Examples of sunk costs:
Past marketing research and development expenditures
Last year’s advertising expense

16. Sunk Cost Fallacy
When marketing managers attempt to incorporate sunk costs into future decisions, they often fall prey to the Sunk Cost Fallacy – that is, they attempt to recoup spent dollars by spending even more dollars in the future.
Example: Continuing to advertise a failing product heavily in an attempt to recover what has already been spent on it.

17. Margins
The difference between the selling price and the “cost” of a product or service
Margins are expressed in both dollar terms or as percentages on:
a total volume basis, or
an individual unit basis

18. Gross Margin or Gross Profit
On a total volume basis:
The difference between total sales revenue and total cost of goods sold
On a per-unit basis:
The difference between unit selling price and unit cost of goods sold

19. Gross Margin Total Gross Margin Dollar Amount Percentage Net Sales
$100
100%
Cost of Goods Sold
- 40
- 40
Gross Profit Margin
$ 60
60%
Unit Gross Margin
Unit Sales Price
$1.00
100%
Unit Cost of Goods Sold
- 0.40
- 40
Unit Gross Profit Margin
$0.60
60%

20. Trade Margin (Markup)
Suppose a retailer purchases an item for $10 and sells it at $20.
Retailer Margin as a percentage of cost is:
($10 / $10) x 100 = 100 %
Retailer Margin as a percentage of selling price is:
($10 / $20) x 100 = 50 %

21. Gross Margin as a % of Selling Price
Trade Margin
Unit Cost of Goods Sold
Unit
Selling Price
Gross Margin as a % of Selling Price
Manufacturer
$2.00
$2.88
30.6%
Wholesaler
$3.60
20.0%
Retailer
$6.00
40.0%
Consumer

22. Net Profit Margin (before taxes)
Dollar Amount
Percentage
Net Sales
$ 100,000
100%
Cost of Goods Sold
- 30,000
- 30
Selling Expenses
- 20,000
- 20
Fixed Expenses
- 40,000
- 40
Gross Profit Margin
$ 70,000
70%
Net Profit Margin
$ 10,000
10%

23. Kellogg’s Cereal Margins at a Price of $2.72 per box
Kellogg’s Direct Unit Manufacturing Cost
Grain $.18
Other Ingredients .23
Packaging .31
Labor .18
Mfg. Overheads .34
Cost of Goods Sold $1.24 ––––––– 54.4% Gross Margin
($ $1.24)/$2.72
Promotions (excluding Advertising)
Total Unit Variable Cost $1.44
Manufacturer Contribution to Fixed Cost
and Profit $1.28 ––- 47% Contribution Margin
($2.72-$1.44)/$2.72
Kellogg’s Selling Price to Grocery Store $2.72
Grocery Store Margin ––- 20% Trade Margin
($ $2.72)/$3.40
Grocery Store Selling Price $3.40

24. Contribution Analysis
Contribution is…
The difference between total sales revenue and total variable costs
OR on a per-unit basis
The difference between unit selling price and unit variable cost

25. Break-Even Analysis
Break-even point is the unit or dollar sales at which an organization neither makes a profit nor a loss.
At the organization’s break-even sales volume:
Total Revenue = Total Cost

26. Break-even Analysis Chart
Unit Volume
Dollars
Total Revenue
BE Point
Total Cost
Variable Cost
LOSS
PROFIT
Fixed Cost

27. Break-even Analysis Example Fixed Costs = $50,000 Price per unit = $5
Variable Cost = $3
Contribution = $5 - $3 = $2
Breakeven Volume = $50,000  $2
= 25,000 units
Breakeven Dollars = 25,000 x $5
= $125,000

28. Applications of Contribution Analysis
Sensitivity Analysis
Profit Impact
Market Size
Performance Measurement
Assessment of Cannibalization

29. Liquidity
Refers to a company’s ability to meet short-term financial obligations
Very important for a company’s day-to-day operations
A key factor is Working Capital = Current Assets minus Current Liabilities

30. Operating Leverage
Extent to which fixed costs and variable costs are used in the production and marketing of products and services.
Firms with high total fixed costs relative to total variable costs are defined as having high operating leverage.
Higher operating leverage results in a faster increase in profit once sales exceed break-even volume. The same happens with losses when sales fall below break-even volume.

31. Discounted Cash Flow
Discounted cash flows are future cash flows expressed in terms of their present value
Incorporates the time value of money
Based on the premise that a dollar received tomorrow is worth less than a dollar today
Useful in determining a business’s net cash flows

32. Discounted Cash Flow Discount factor = ___1___ (1 + r)n
The discount rate can be expressed as follows:
Discount factor = ___1___
(1 + r)n
Where the r in the denominator
is the interest rate and n is the number of years

33. The interest or discount rate is often defined as…
The opportunity cost of capital, which is the cost of earnings opportunities forgone by investing in a business with its attendant risk as opposed to investing in risk-free securities.

34. Discounted Cash Flow Example
Suppose you were to collect $1 million in 5 years. If the discount rate used were 10%, the present value of the $1 million would be: 1
PV = ———— X $1,000,000 = $620,921.32
( )5

35. Preparing a pro forma Income Statement
A pro forma income statement is a projected income statement
Includes:
Projected Revenues
Budgeted Expenses
Estimated Net Profit

36. Pro Forma Income Statement – Example
Sales $1,000,000
Cost of goods sold ,000
Gross margin ,000
Marketing expenses
Sales expenses $170,000
Advertising expenses ,000
Freight or delivery expenses , ,000
General and administrative expenses
Administrative salaries $120,000
Depreciation on buildings and equipment ,000
Interest expense ,000
Property taxes and insurance ,000
Other administrative expenses , ,000
Net profit before (income) tax $45,000

37. Preparing a pro forma Income Statement
Sales – forecasted unit volume times selling price
Cost of goods sold – costs incurred in buying or producing products and services
Gross margin – represents the remainder after cost of goods sold has been subtracted from sales

38. Preparing a pro forma Income Statement
Marketing Expenses – programmed expenses to be spent on increasing sales
General & Administrative Expenses – fixed costs (often referred to as overheads)
Net Income before Taxes – sales revenues minus all costs