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Date: 17 Jul 2006


Mr Kuldip Kawatra
.

What is Marketing Finance?


Before we answer this question, let us answer a few other questions

What is the purpose of business? Without being modest, let us admit that sole purpose of
business is to earn PROFIT. And where does the profit come from? It comes from having
the customers and customers are earned by Marketing. Marketing, most simply defined, is
Getting into consumers mind.

Marketing is a capital intensive exercise. Starting from consumer survey (to know his needs and
preferences) to advertising campaigns and establishing distribution channels and so on, every
activity costs money. Thus, there is a financial perspective to almost every marketing
activity.

Earning and retaining customers is very fine. But what is the cost benefit analysis? Are
positive product-market results translating into positive financial results? Am I investing
more to increase my sales than the profits I expect to earn from increased sales? This cost
benefit analysis is vital before taking any marketing decision. Therefore, the interface
between Marketing & Finance is vital for any company.

Given a free hand, marketing department would splurge on marketing overdrive through
advertising campaigns, promotions, dealer appeasements, and so on. But at the end of it all,
have the profits grown? What are the financial consequences of marketing decisions? What
is the ROI on each penny invested on marketing? Have the marketing people dumped the
product in the market to paint a rosy picture of their performance before the CEO? A little
analysis of financial data of marketing department would lift up the veil. This is the role of
Marketing Finance.

Before going any further, let us revise fundamental s of Marketing.


As already said, Marketing most simply defined is getting into consumers mind. Finding
out what his needs are (needs could be physical, psychological, security, social, etc, etc; apparent or
dormant; etc) and then creating product or packaging the product to fulfil those needs is
Marketing. Take the classical real life case of repositioning an existing product to address
consumers need.

Whirlpool launched its washing machines in India in 1997 and became a raging success in next two years
against some well established competition, like, Videocon, Onida, and BPL through innovative marketing
strategy. However, come 2001 and consumer durables market got stagnated due to economic conditions. When
the markets stagnate, the only way to increase sales is by biting into the competitors share. It then becomes
dog eat dog world. Price discounts, promotions, gifts, etc, galore and competition becomes tougher with
passage of time. The story replayed as ever in washing machine market. However, Whirlpool, being an
International brand, follows some strict profitability norms, and therefore, could not match aggressive
discount war in the market and began to lose market share.

Page 1 of 57 - Marketing Finance (Ver 1.1)


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Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

In addition, a perception grew in the market that because of bigger agitator in Whirlpool washing machines, it
could take less clothes than other machines. Such perception led to waning consumer interest in the product.

Whirlpool then launched an in-depth study regarding consumers expectation from a washing machine. Study
revealed that while every machine was promising whiter than milk shirts and sarees, there was an
unfulfilled demand for machine which could wash heavy clothes like curtains, bed covers, etc. Whirlpool
decided to position their machine to fulfil this unfulfilled demand. They launched an ad campaign showing a
wild party scene in a house. People were frolicking and food was every where, on table clothes, curtains, etc.
Daughter was worried and asked her mother what she was going to do. The lady replies Mummy ka magic
chalega. And then she is seen washing all those heavy clothes in a whirlpool washing machine. Ad also
justified its capability saying that because its agitator is big and heavy, it can wash those clothes.

Whirlpool recaptured its lost market share and more within a very short time.

What we see from above marketing success story is that by proper insight into consumers
mind and little strategic marketing effort, whirlpool converted its perceived negative (heavy
agitator) into a positive attribute of the machine, and by repositioning the product,
succeeded in the market.

Coming to more specifics about marketing finance


Finance provides control points in a marketing exercise. Such control
points help in taking better marketing decisions .

Let us understand above statement.

Any company sets its goals. Those goals are then converted into targets for each
department/section/individual to achieve. Thereafter, plans are chalked out to achieve those
targets. These are the System Inputs.

System output is Performance in terms of achieving the set targets. Two questions are
important here. One Whether people are achieving their targets, Two If yes, then at what
cost? Are people maintaining profit levels while achieving their targets? As we will see in a
short while, it is quite possible that company loses out when people achieve their targets.

Take the case of sales team achieving their sales target. It is quite possible that they could
have dumped the product in the market/extracted orders from dealers on the promise of
extended credit period. Such dumping may lead to any or all of the following consequences:

(a) Sluggish take off from factory in subsequent months owing to glut in the
market due to dumping.

(b) Losses due to expiry of shelf life of perishable products. (Remember that
products which have tendency to quickly become obsolete due to technological upgrades,
like, mobile phones, computers, and other electronic gadgets or cyclic products, like fashion
clothes and accessories, also fall in the category of perishable goods, though theoretically
speaking they are not).

(c) Higher inventory levels and consequent increased working capital cost.

Page 2 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

(d) Higher receivables often translate into higher bad debts.

(e) If the company has No-Return policy, dealers are likely to sell those life
expired products to unsuspecting customers and soil the brand name of the
company.

Thus, while the sales team was able to demonstrate that target was achieved, did it boost the
profit level? On the contrary, it has negatively impacted the profit levels. Application of a
little marketing finance interface will be able to call the bluff by analysis of a few relevant
financial ratios.

Where all do the Marketing and Finance interface?


Product Related

New Product Launch Before launch of any new product, sales projections over
the entire product life cycle are done. There after, the variable cost projections are
done. Difference between the two gives the gross margin. From the gross margin,
marketing expenses over the life cycle of the product are extracted. That gives the
net margin. Those future earnings are then discounted to the present period to
calculate profitability of the product.

Compare the DCF of all the options and decide which product to opt for launch.

Product Mix Decisions Which product mix gives maximum contribution to the
company given the constraints of labour, material, production capacity and profit
margins? This calculation is done by finance department and communicated to the
marketing deptt to enable them to draw their marketing strategy to achieve the
desired product mix sales.

Whether to continue or drop a product? - A product could be incurring losses in


the market. Should product be dropped? This is not a purely marketing or even
finance decision which can be taken alone by either deptt without assistance of other.
There could be other forces at play, like use of some by-product which otherwise
may go waste. Or, this product could be pushing sales of some other profitable
product indirectly. There could be many more such reasons where marketing finance
interface will help in taking right decision.

Pricing Decisions Pricing decisions are again some thing that often necessitates
involvement of finance people. Production cost, variable cost, fixed cost, profit
margin under various conditions, etc are all calculations which need involvement of
finance people. But it is so only when price cuts are to be effected. During the price
rise, marketmens wisdom is better not adulterated. Take the interesting case of
Mercedes Benz Vs Toyota Lexus.

Toyota Lexus was launched in competition with Mercedes Benz. Lexus was priced tantalisingly lower
than Merc though with same features. Mercedes Benz defied the normal wisdom and instead of
responding with a price cut, increased the price of its car. Lexus, with a considerable price gap now,

Page 3 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

was thus pushed into a lower segment and niche segment again became Mercs propriety fiefdom.
Mercs sale increased despite price increase.

Product Modification Decisions Product modifications, like added features,


improved quality, etc, cost money. How much money? How much additional profit
is expected out of modification? Is the expected additional profit commensurate with
the risk of loss of investment?

Advertising Related

Advertising Effectiveness Evaluation of effectiveness of advertising helps in


proper channelising of the expenses. Which medium, which territory, which time of
the day, which advertisement, etc are giving the maximum sales growth?

Advertising is effective when there is Differentiation benefit available (Product can boast of a
benefit that others can not. Or it has taken the first movers advantage by a claim which may be
generic but not yet exploited by others, like use of clove oil by Promise toothpaste. This is called
USP-Unique Selling Proposition). If there are too many people advertising on same aspect of the
product (all washing soaps claim to wash the whitest), each one will probably be able to maintain its
existing share of pie. Any substantial shift of customer base can not be expected.

Evaluating ROI for various marketing alternatives. What is the sales


growth/profit growth for each rupee spent on marketing in a particular medium or
territory, etc.

Performance Evaluation Performance evaluation in financial terms of each


element of marketing, like, product, territory, dealer, salesmen, etc, is necessary for
corrective measures.

Outsourcing Decisions Decisions regarding outsourcing of marketing activities


are often influenced by Finance deptt. Outsourcing could be for product
manufacturing as is the case with most of the large manufacturers including giants
like Hindustan Lever. Or it could be for distribution. Company may decide to have
its own fleet of vehicles for distribution or decide to outsource the delivery of
product to various destinations. Or it could be combination of the two. Long distance
distribution could be outsourced and local distribution may be through companys
vehicles.

Service Level Decisions After Sales Service can be a big USP for any company.
Maruti and Tata score over every other automobile company on this count in car and
heavy vehicle segments respectively. (Maruti uses it in its advertising campaigns). But
service level decisions are complex. Prompt service means better customer
satisfaction and increased sales, but also large infrastructure which translates into
huge investments. Slow service means unsatisfied customers but lesser investments.
Cost benefit analysis will help to decide optimum level of service quality.

CAPEX Expansion of the distribution markets could be through company owned


showrooms/offices or through dealership/retailers etc. Similarly, distribution could

Page 4 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

be through company owned vehicles or be outsourced. Such decisions are taken in


consultation with Finance deptt based on capital availability with company vis a vis
profitability of investment.

Life Cycle Cost Marketing resource allocation at different stages of product life
cycle.

R&D expenses for assessing customer preferences/acceptance/needs, product


modifications, etc.

Brand Valuation Brand valuation is often required for mergers and acquisitions.

Marketing Finance
Marketing imposes high working capital requirement. Working capital has three basic
components: Receivables, Inventory and Liquidity ie cash.

Level of finished goods inventory at various end points, like, with C&F agents, stockists,
retailers, etc, affects sales volume. Low level of inventory would reduce visibility and
increase service time, and therefore affect sales adversely. However, higher inventory
increases working capital and costs associated with it.

Credit period is also used as a marketing strategy. Increased credit period is sometimes
offered to dealers as inducement for stocking the product. This again leads to higher
inventory levels. Higher inventory levels, apart from increased working capital
requirements, also increases various risks depending upon the nature of product. Products
with low shelf life, either due to frequent technological upgrades or perishable nature or
susceptibility to frequent changes in customer demands, like fashion goods, or with seasonal
demand like Air conditioners, heaters, cooler, etc, pose heightened risk.

Higher receivables again increase working capital requirement. Higher receivables also
increase risk of bad debts. Often discounts are offered for early payment to reduce the
receivables and the default risk.

Cash management is also vital. While idle cash carries a cost, inadequate cash may result in
opportunity loss.

All the three components of working capital would be dealt with in detail in subsequent
lectures.

Receivables Management
Health of receivables can be gauged by examining following four financial ratios

Annual Credit Sales


1. Account Receivables Turn Over Ratio =
Average Account receivables

Page 5 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

365
2. Collection Period in Days =
receivables Turn over Ratio
3. Account Receivables to total assets

4. Account Receivables to sales

Also, percentage of bad debts to sales can be used.

Problems:

Prob: Company A shows the following financial data. Analyse the sales deptt performance.

As On 31.12.2001 As on 31.12.2002

Sales 4,20,000 5,30,000


Total Assets 6,10,000 6,70,000
Account Receivables 60,000 1,00,000
Account Receivables as on 01 Jan 2001 were Rs 50,000.

Solution:

Average Account Receivables for year 2001 = 50000 + 60,000 = 55,000


2

Average Account Receivables for year 2002 = 60,000 + 1,00,000 = 80,000


2

Receivables Turnover Ratio for year 2001 = 4,20,000 = 7.63


55,000

Receivables Turnover Ratio for year 2002 = 5,30,000 = 6.625


80,000

Collection Period in Days in 2001 = 365 = 48


7.63

Collection Period in Days in 2002 = 365 = 55


6.625

Account Receivables to total assets in 2001 = 55,000 = 9%


6,10,000

Account Receivables to total assets in 2002 = 80,000 = 12%


6,70,000
Analysis

Against 26% growth in sales there is 66% rise in receivables. This is a sure sign of dumping.

Page 6 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Prob: Company B presents the following financial data: -

As On 31.12.2001 As on 31.12.2002 Effect

Sales 90000 120000 33%


Account Receivables 28000 31% 39000 43% 40%
Bad Debts 3000 3.33% 3500 2.91% 16%
When we analyse the performance in percentage terms, we see that against 33% increase in
sales, there is 40% increase in account receivables which gives the impression of dumping.
There is also an increase of Rs 500 in bad debts.

However, when the data is analysed in absolute terms, sales have grown by Rs 30,000.
Taking a profit percentage of measly 20%, profit growth is Rs 6,000. Increase in account
receivables is Rs 11,000. Even at a high capital cost of 20%, it means an increase of Rs
2,200 in working capital cost. Add to that additional bad debts of Rs 500 and total additional
cost is Rs 2,700 against additional income of Rs 6000. Thus, there is a net minimum gain of
Rs 3,300 due to this perceived dumping by Marketing Deptt and hence fully acceptable.

Inventory
In order to check the health of the inventory, we check two ratios

1. Inventory Turnover Ratio Cost of Sales


Avg Inventory
(Please note that it is Cost of Sales and not Sales because sales includes profit margin which has no bearing
on inventory)

2. Age of Inventory = . 365 .


Inv T/O Ratio

Prob: Company C gives following financial data of its performance


As On 31.12.2001 As on 31.12.2002

Finished Goods 11,000 17,000


Cost of Sales 73,000 85,000
As on Jan 01, 2001, finished goods were Rs 8,000.

Solution:

Avg inventory for year 2001 = 8000 + 11000 = 9500


2

Avg inventory for year 2002 = 11000+17000 = 14000


2

Inventory Turnover Ratio in 2001 73000 = 7.68


9500

Page 7 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Inventory Turnover Ratio in 2002 85000 = 6.07


14000

Age of Inventory in 2001 = 365 = 47.5 days


7.68

Age of Inventory in 2002 = 365 = 60 days


6.07

Thus, inventory turnover has gone up by from 47.5 days to 60 days which is an increase of
25%. This will lead to increase in working capital requirement. Also, some risk is associated
with higher age of inventory if it is low shelf life item, but not much if it is a standardised
product.

Page 8 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Date: 24 Jul 2006


Liquidity (Cash) Management

Prob: Company B reports the following info for the year ended on 31 Dec 2001: -
All figures in Rs
Net Income 7,50,000
Depreciation 30,000
Interest Payment 1,40,000
Sale of Fixed Assets 20,000
Payment of debt principal 3,00,000
Dividends 90,000
Capex 2,80,000
Find if companys liquidity position is satisfactory.

Solution:

The Key to solving this problem is to first find out the operating income and thereafter
deduct the expenses from it.

Operating Income/Profit
Net Income 7,50,000
Adjustments
Depreciation 30,000
Sale of Fixed Assets (20,000) 10,000
Total 7,60,000
Add Back Interest Payment 1,40,000
Total Operating Income 9,00,000
Liabilities
Interest Payment 1,40,000
Payment of Debt Principal 3,00,000
Dividend 90,000
Capital Expense 2,80,000
Total Liabilities 8,10,000

Cash Position after meeting the liabilities = 9,00,000 8,10,000 = Rs 90,000

Thus, company will be left with Rs 90,000 after meeting all its liabilities. Now it is hard to
say if this cash balance is adequate or not. One way to examine this is to check the historical
cash to sales ratio.

Page 9 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Cash holding of the company depends upon the nature of business, business model and
standing of the company in the market. A company like Reliance can get away with far less
percentage of cash holding than most other companies, as it can raise cash from banks and
market whenever required almost without any notice. Thus, adequacy of cash is a
completely subjective decision of the companys management.

ROSE or ROSHE Return on Share Holders Equity.

PAT
=
NW
28 40 400 200
PAT PBT SALES INVESTMENT
=
PBT SALES INVESTMENT NW
40 400 200 100
TAX MKTG ASSET T/O LEVERAGE
MGMT MGMT RATIO

Explanations
PAT Profit after Tax
NW Net Worth = Shareholders funds
PBT Profit Before Tax
Investment = Net Worth or Shareholders funds + Borrowed Funds.

PAT to PBT ratio is basically indicator of tax management efficiency indicator.


PBT to Sales ratio is the marketing departments efficiency indicator.
Sales to Investment ratio is indicator of efficiency of capital utilisation
Investment to NW ratio indicates the leverage. How much loan has been taken against the
shareholders funds.

40 400
PBT SALES
ROI =
SALES INVESTMENT
400 200

S C S
ROI =
S I

ROI = Rate of Margin Turnover of Capital

Thus, we see that ROI is dependent on two factors. One Rate of Margin or profit margin
on sales and Two Turnover of capital. Both these are independent factors and affect the
ROI independently.

Now, let us compare Kamath Restaurants and the Five Star Hotels.

In case of Kamath Restaurants, there is small investment. Business starts from early

Page 10 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

morning and continues whole day till late in the night. Customers visits are short and often
tables are shared by two or more unrelated customers. A single table could have been used
by 50 or even 100 people during the day. There is high turnover of customers but the bills
are small. Margins are also very small. The business basically runs on volume of customers.

A five star hotel requires huge investment. Business starts in the early afternoon. Becomes
dull again in late afternoon and picks up again in the night. Customers visits are leisurely.
One table is never shared by two different groups. A single table is rarely used by more than
4 groups in a day. But bills are considerably larger. Thus, a Five Star Hotel business runs on
very heavy margins but less customer volume and capital turnover.

Managing Account Rece ivables


It is business fact that most businesses run on credit.

If all the other factors are same, there are basically two ingredients of a business success
story

1. Price
2. Credit

While high amount of credit is sure to increase the sales, it will also increase the cost
through increased working capital requirement besides higher bad debts. On the other hand,
though low credit will save cost due to low working capital cost, it will affect the sales.
Thus, there is a need to optimise the credit.

But why indulge in credit sales at all?

Credit sales are a way of life in business world due to following reasons:

1. It started as an inducement to dealers by new entrants in the market against


established competition and has become a norm now. To be able to compete
successfully in the market and get more sales, it has become a necessity in bulk
sales.

2. To win over shelf or dealer space This is the strategy that was adopted by
Whirlpool in the initial years of launch in 1996-97 to gain penetration in the market.
Being a multinational company, it was cash rich and could afford large credit line.
But once the product gets established in the market and demand grows, credit lines
are squeezed. Credit strategies are different during launch and growth phase.

The companies/product which have good MARKET MUSCLE generally offer less or nil
discount. Market Muscle means A well differentiated and in-demand product. Product
demand is so good that shop keepers are forced by market dynamics to stock that product to
earn profit. Nirma had once achieved that status. Nokia Phones have achieved this status
now.

Page 11 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Elements of Credit Policy for Management of Account Receivables: -


1. Who to give credit? (Setting Credit Worthiness)
2. How much credit to be given to each? (Setting Credit Limit for each customer)
3. For how long to give credit? (Declaring stated credit duration policy)
4. Discounts for early payment of credit
5. Liberal credit to increase sales.

Checking Credit Worthiness

(a) By checking past records of old customers


(b) By obtaining Bank Reference for new customers. (This is not a very reliable
method since customer may have good relations with bank management).
(c) Check with other suppliers.
(d) Check from own old customers.
(e) From own sales people who have market intelligence through their friends
working for different companies.

Steps in Receivables Management

(a) Formulate a well defined billing cycle. Customer should be able to anticipate
when he is likely to get the bill. (Phone Bills and Credit Card Bills are always
payable by the same date). Customer arranges finances in advance for payment.
(b) Stamp the bill Pay By ____ clearly and prominently.
(c) Indicate late payment penalty even though it is rarely levied.
(d) Bill big customers immediately.
(e) Carry out age analysis of A/c Receivables customer-wise. This will make
customer credit rating easy.
(f) Start chasing customers for old dues payments.
(g) Go for Bill Discounting (Sell your dues to another company/bank for a discounted
price. The company pays the due amount immediately and collects the dues from customer.
In case of default by the customer, you will need to pay back the company).
(h) Dont allow credit to doubtful customers. At least, reduce the credit period.
(i) Ask customers to pay when due. (In many case marketmen fight shy of reminding the
customer to pay because they work with those customer on personal relations basis. So,
those customers are not defaulting on company but on the sales person) .

Page 12 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Problems:
Prob 1: Blake company provides following data:

Current Annual Credit Sales 80,000,000


Collection Period 2 Months
Terms Net 30 (Officialese for declaring credit period of 30
days)
Minimum Rate of Return 15% (Opportunity cost of Capital employed)
Proposal of Marketing Department Offer 2/10 Net 30 discount
(25% customers will take advantage. (Officialese for saying 2% discount for payment within 10
Collection period should decline to 1.5 days)
months)
Should the Marketing Department proposal be accepted? Why?

Solution:
Avg amount locked in credit sales before proposal = 2 months worth of sales
= Rs 80,000,000 x 2
12
= Rs 13,333,333
Avg amount in credit sales after the proposal = Rs 13,333,333 25%
= Rs 10,000,000
Amount released from credit = Rs 3,333,333
Working Capital Cost saved = Rs 3,333,333 x 15%
= 500,000
Cost of implementation of proposal = 2% of 25% of sales
= 2% x 20,000,000
= 400,000
Net Gain by implementing the proposal = 500,000 400,000
= 100,000

Prob 2: Long Corp gives following data:

Selling Price per Unit Rs 5/-


Variable Cost per Unit Rs 2/-
Fixed Cost per Unit Rs 2/-
Annual Credit Sales 6,00,000 units
Collection Period 1 month
Returns 24%

Page 13 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Proposal
Liberalise Credit Collection period 02 Months
Sales Increase Expected 20%
Bad Debt Increase Rs 90,000
Please assess if the credit period should be liberalised.

Solution:

Additional Earnings due to proposal


Increase in unit sales due to proposal = 20% x 6,00,000

= 120,000

Increase in contribution (Rs) due to proposal = 1,20,000 x Rs 3 (Contribution per unit for
additional units of sales)

= Rs 3,60,000

Cost of Implementing the Proposal


Additional Working Capital which will be locked up due to increase in credit sales

= Mfg cost of 2 months of additional sales


(remember, it is not sale price but production cost which
will be required to be invested by the company in credit
period)

= Additional Unit Sales x variable cost


6

= 1,20,000 units x Rs 2/- = Rs 40,000


6
Cost of additional working capital = Rs 40,000 x 24% = Rs 9,600

Additional Cost on existing receivables due to increase in credit period by one month

= 50,000 units x Rs 5 x 24%

= Rs 60,000

Additional Cost of Capital = Additional cost of existing receivable + Cost


of additional capital

= 60,000 + 9,600

= 69,600

Cost of bad debt = 90,000

Page 14 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Total cost of proposal = 1,59,600

Net Gain = 3,60,000 - 1,59,600

= 2,00,400

Page 15 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Date: 31 Jul 06
Prob 1: Ponds Ltd has annual sales of 10,000 units at Rs 300 per unit. The variable cost is
Rs 200/-. Fixed cost amounts to Rs 3,00,000/- per annum. The present credit period is one
month. The company is considering proposal to increase credit period to 2 months or 3
months and has made the following estimates: -

Credit Policy Existing Proposed


(01 month) (02 months) (03 months)
Increase in Sales -- 15% 30%
% of bad debt 01% 3% 5%
There will be increase in fixed cost by Rs 50,000/- if the sales increase beyond 25% of
present level. The company plans to earn pre-tax return of 20% on investment in account
receivables.

What should company do? Please advice.

Solution:

Credit Policy Existing Proposed


(01 month) (02 months) (03 months) (03 months)
(15% inc) (30% inc) (25% inc)
Sales 30,00,000 34,50,000 39,00,000 37,50,000
Number of Units 10,000 11,500 13,000 12,500
Variable cost @ Rs 200 20,00,000 23,00,000 26,00,000 25,00,000
Contribution/Gross Margin 10,00,000 11,50,000 13,00,000 12,50,000
Fixed Cost 3,00,000 3,00,000 3,50,000 3,00,000
Profit 7,00,000 8,50,000 9,50,000 9,50,000
Avg Account Receivable 2,50,000 5,75,000 9,75,000 9,37,500
(Sales/12 x months)
Investment in Receivables 23,00,000/12 26,00,000/6 29,50,000/4 28,00,000/4
=1,91,667 = 4,33,333 = 7,37,500 = 7,00,000
(a) Opportunity cost of 38,333 86,633 1,47,000 1,40,000
capital @ 20% of investment
(b) Bad Debts (1,3,5% of 30,000 1,03,500 1,95,000 1,77,500
sales)
Cost of option (a+b) 68,333 1,90,133 3,42,435 3,17,500
Net Gain from option = 7,00,000 8,50,000 9,50,000 9,50,000
profit cost of policy 68,333 1,90,133 3,42,435 3,17,500
= 6,31,667 = 6,59,867 = 6,07,515 = 6,32,500

From above analysis of profits, it is clear that increase in credit period from one month to
two months is beneficial to the company. However, any further increase in credit period is
counterproductive due to steep rise in opportunity cost of capital as well as on account of
bad debts.

Page 16 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Points to Ponder

1. If credit period is increased by one month, sale is increased by 15% only. Ideally, it
should have been to the extent of 20 or 25%.

2. For credit period increase by one month or two months, increase in bad debt rate
from one to 3 and 5 % is not acceptable.

Prob 2: Company D classifies its customers by risk ratings

Category Uncollectable Collection Credit Policy Increase in


Amount Period Annual Sales
A 1% 20 Days Unlimited Rs 5,00,000
B 4% 40 Days Restricted Rs 5,00,000
C 18 % 70 Days Restricted Rs 7,00,000

Given profit is average 20% of sales. Minimum rate of return on investment is 14%.
Recommend should the company relax credit policy.

Solution:

Category A B C
Incremental Gross Profit 5,00000 x 20% = 7,00,000 x 20% =
1,00,000 1,40,000
Investment in A/c Receivables (5,00,000 x 40)/365 (7,00,000 x 70)/365
(incremental) x 80% = 43,836 x 80% = 1,07,397
Bad Debts on increased sales 4% of 5,00,000 = 18% of 7,00,000 =
20,000 1,26,000
Opportunity Cost of Capital 14% of 43,836 = 14% of 1,07,397 =
invested @ 14% 6,137 15,036
Cost of Policy 20,000 + 6,137 = 1,26,000 + 15,036 =
26,137 141,036
Net Profit 1,00,000 - 26,137 = 1,40,000 - 141,036 =
73,863 (1,036)

Thus, it is seen that if restriction of credit policy is removed for B category of customers,
there is likelihood of increased profits of Rs 73,863 per annum. However, restriction on
credit policy is recommended to be continued for C category customers as any relaxation
is likely to lead to losses.

Page 17 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Date: 21 Aug 2006

CASE STUDY: AMPOULEAGENTS

In September 1991, Mr. Marwari, the Credit Controller of Ampouleagents, wrote to the
Sales Manager of the Company requesting him to stop the supply of Rs 1.5 lacs worth of
goods to M/s Pharmax Laboratories as many past dues from the party were yet to be
recovered.

Ampouleagents were suppliers of ampoules and vials for injectibles manufactured by the
pharmaceutical industry. It was a prosperous and growing company in a competitive
environment with its base and major market in Bombay. The Company was now having big
expansion plans with an eye on exports market. The Sales Manager and the Managing
Director kept reminding everyone that we must consolidate our base in India before
entering world market.

Pharmax Laboratories was a Delhi based pharmaceutical company which the Sales Manager
of Ampouleagents had recently converted into a customer after much wooing and persistent
efforts. This party represents a market worth about 15 Lacs per year and moreover the Sales
Manager felt that this would be the beginning to secure business from many more such
medium size pharmaceutical companies in Northern India.

The Credit Controller, Mr. Marwari, had consistently pointed out to the Sales Manager and
Managing Director that it is necessary to analyse the cost at which these new markets were
being pursued. In his most recent note he had written: In spite of my many suggestions to
the contrary, I find that we are getting ready to dispatch goods worth Rs 1.5 Lacs to
Pharmax Laboratories. I find that the party has an overtraded financing pattern and does not
deserve any more credit. Our outstandings from the party are now overdue by more than six
months. I am also attaching some relevant figures which I hope will prove my point.

Discussion Areas: 1) Is Mr. Marwari making a mountain out of a mole hill.


2) Evaluate credit worthiness of Pharmax Laboratories.

BALANCE SHEET OF PHARMAX LABORATORIES As on 31.12.1990

Liabilities Rs. Lacs Assets Rs. Lacs


Equity Capital 101.20 Net Fixed Assets 221.53
Reserves 43.20 Investment 22.10
Term Loans 70.63 Raw Material Inventory 46.69
Bank Borrowings 153.61 Work-in-progress 15.21
Deposits maturing in one year 26.89 Finished goods stocks 74.35
Sundry Creditors 75.53 Goods in transit 52.76
Other current Liabilities 122.48 Cash & Bank Balances 23.02
(including provisions) Sundry Debtors 81.48
Unsecured Advances 23.56

Page 18 of 57 - Marketing Finance (Ver 1.1)


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Other current Assets 32.84


(including advance tax)
Total 593.54 Total 593.54

Coarsened Income Statement for year ending 31.12.1990


(Rs.
Lacs)
Sales 666.30
Material Cost 239.17
Employee Costs 172.41
Selling & General Administration 150.57
Interest 35.34
Depreciation 9.97
Investment Allowance 0.96
Profit before Tax 57.88
Tax 34.73
Profit after Tax 23.15

Note: Company maintained dividend at 10% for 1990.

SALES TO AND COLLECTIONS FROM PHARMAX LABORATORIES


Sales Outstanding
Rs Lacs (Rs. Lacs as on 1st Sept. 91)
February 91 and before 0.74 0.18
March 91 0.36 0.36
April 91 0.22 0.22
May 91 0.64 0.64
June 91 -- --
July 91 2.85 2.85
(No sales or collection since
then up to Sept 91)
Total 4.81 4.25

Note: Up to July end 1991, Ampouleagents had registered total sales of Rs 57.9 lacs and
the outstanding as at July end stood at Rs. 18.19 lacs. It was normal practice of
Ampouleagents to give 45 days credit.

Financial Analysis -Ampouleagents

1 Sales up to Jul 57.90 Lakh


Pharmax Contribution to Sales 4.81 Lakh 8.3%
Growth Potential of Sales to Pharmax 15%
Outstanding of Ampouleagent 18.19 Lakh

Page 19 of 57 - Marketing Finance (Ver 1.1)


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Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Outstanding with Pharmax 4.25 Lakh 23% of total


Average Outstanding of Ampouleagent 2.2 Months*1
Outstanding with Pharmax 6 Months*2

Notes
57.9
1. Average monthly sales of Ampouleagent = 8.27
7

18.19
Average Outstanding = 2.2Months
8.27

2. Outstanding with Pharmax Lab

Total Outstanding = 4.25 Lakhs

4.81
Average Monthly Sales to Pharmax Lab = 0.687
7

4.25
Average Outstanding = 6 Months
0.687

Current Assets
2(a) Current Ratio =
Current Liabilities

350
= 0.92
378

Current Ratio should ideally be in the range of 1.33 to 1.5. Thus, current ratio
is unsatisfactory and indicates that the company is facing liquidity problems.

2(b) Another thing which is evident from the balance sheet is that 54% of the assets are
inventory which are the least liquid kind of assets. Thus, company has poor
inventory control.

2(c) Bank borrowing are short term loans which stand at 153 lakhs which is considered to
be quite high considering that Equity + Reserves are only 144 Lakhs.

3. Cash Position (Liquidity)

PAT 23 Lakh
Depreciation 10 Lakh
Total 33 Lakh
Less - Div Payment 10 Lakh
Term Loan Repayment 10 Lakh - (20 Lakh)

Balance Cash 13 Lakh

Page 20 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Considering that there are current liabilities worth 378 lakhs which are also to be satisfied,
companys liquidity position is very bad and company is likely to default on some payment
obligations.

This is what the financial analysis of the Pharmax Lab tells us which is all gloomy. Going
purely by the financial analysis, there is every reason to stop further supplies to Pharmax
Lab.

Now let us examine the issue from marketing perspective.

First some unwritten ground realities

Company is a North Indian Company. North Indian companies are traditionally slow
at paying debts. It is a universal truth.

Balance Sheet shows that Pharmax had an owing of Rs 75.53 Lakhs against its total
purchases of Rs 239.7 Lakhs.

75.53
Thus, Credit Payment period = 3.8Months 4Months
239.7

It is clear that company has a history of paying its dues in about 4 months. Major
part of Ampouleagents dues are of Jul vintage only (Rs 2.85 Lakhs) which as per Pharmax
payment philosophy are not due for payment yet (in Sep). Earlier months dues are just a
few thousand each.

Secondly, 90% of the marketing works on relationship management. Pharmax Lab


being a new customer, marketing people were shy of pushing the company too hard on
payment issue. Now, there is a need for marketing people to use their negotiation skills to
extract some payment from the company.

Company aspires to enter international market. International markets are far more
difficult than even North Indian markets. If the company is not careful, it will lose all its
money. So, if the company can not tackle the difficult clients in India, international trade
will be disastrous.

Pharmax Lab promises to be worth almost 15% of the total sales market of the
Ampouleagent which is considerably large pie to let go easily.

Marketing Deptt wants to use this big company as a mascot for approaching other
Pharma companies. Losing this client will be a serious set back for expansion plans in North
India.

If supplies are stopped, there is a risk that entire credit of Rs 4.25 lakh may sink.

Considering all the above points, it may be worthwhile to continue the supplies but
with a tactful thrust by Sales Deptt for recovery of dues.

Page 21 of 57 - Marketing Finance (Ver 1.1)


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Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

CASE STUDY
PRODUCT LINE PROFITABILITY ANALYSIS

MMF Ltd. decided to analyse its selling and distribution costs for products A, B, and C and
arrive at product-wise profit figures.

The income statement of the company for the past year is at follows:

Sales 5,20,000
Cost of sales 2,50,000
Gross profit on sales 2,70,000
Selling and distribution costs
Salesmens salaries 24,500
Salesmens commission 27,500
Sales office expenses 14,800
Advertising 65,000
Warehouse 4,500
Packing and shifting 5,600
Transportation & delivery 8,400
Credit and collections 4,100
Bad debts 9,400
1,63,810
General and administrative expense 41,250 2,05,060
Net Profit 64,940

Additional Information:
Product A Product B Product C

Sales 1,20,000 1,50,000 2,50,000


Cost of sales 55,000 70,000 1,25,000
Salesmens salaries 8,000 7,000 9,500
Salesmens commission 11,000 6,000 10,500
Advertising (%) 20 20 60
Warehouse space occupied 1/3 1/3 1/3
Invoice lines (packing and shifting) 1,500 2,500 3,000
Transportation and delivery 5,500 6,000 8,500
Average account receivable 15,000 35,000 50,000
Bad Debts 1.8% 1.5% 1.7%
Sales office expenses: Allocated in the same ratio as packing and shifting.
General and administrative expenses: Allocated on the basis of sales.
Required: A product-wise P & L Account.

Page 22 of 57 - Marketing Finance (Ver 1.1)


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Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Profit and Loss Statement


Basis for Allocation Total Prod A Prod B Prod C
Exp
Sales Direct 5,20,000 1,20,000 1,50,000 2,50,000
Cost of Sales Actuals 2,50,000 55,000 70,000 1,25,000
Gross Margin Calculated 2,70,000 65,000 80,000 1,25,000
Salesmen Salaries Actuals 24,500 8,000 7,000 9,500
Salesmen Commn Actuals 27,500 11,000 6,000 10,500
Sales Office Exp Invoice Lines 14800 3,171 5,286 6343
(15:25:30)
Advertising 1:1:3 65000 13,000 13,000 39,000
Warehousing 1/3:1/3:1/3 4,500 1,500 1,500 1,500
Pack & Shipping 15:25:30 5,600 1,200 2,000 2,400
Transport and 55:60:85 8,400 2,310 2,520 3,570
Delivery
Credit and A/c Outstandings 4,100 615 1,435 2,050
Collections 15:35:50
Bad Debts 216:225:425 9,410 2,345 2,422 4,613
Total 1,63,810 43,141 41,183 79,436
General Admin Sales 12:15:25 41,250 9,519 11,899 19,832
Total Costs 2,05,060 52,660 53,082 99,308
Net Profit 64,940 11,297 26,537 27,106

The Key to solving this question is to find the correct figures. In many cases, the
total that is given in summary of expenses in Exhibit II does not match with break-
up given in other two exhibit. Whenever such a situation occurs, use the detailed
break-up as ratio and distribute the expenditure given in same proportion.

Analysis

Analysis of above table indicates that Product B is most profitable since a profit of
Rs 26,537 is earned through a sale of Rs 1,50,000 which is 17.7% of sales. Product C which
is second most profitable gives a net profit of Rs 27,106, which though numerically
marginally higher than Product B profit, comes from a sale of Rs 250,000. Therefore, when
we consider the cost of funds on investment also, it might lag behind Product B.

The heads that have resulted in less than optimum profit for Products A and B are Salesmen
Salary and Commissions. Similarly, high advertisement expense has resulted in poor profit
margins for product C. However, it is hard to comment whether these excess expenditures
on salesmens salaries, commissions and advertising are unjustified. It is quite possible that
nature of product and market may have necessitated such expenses.

Page 23 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

CASE STUDY: COOL INDIA LTD.

Early in 1984, Mr. Lingnath, the General Manager of Cool India Ltd. called a meeting of the
Controller and the Far Eastern Zone Manager to discuss what action he should take with
regard to the Far Eastern Zone in which the company had been incurring losses from year to
year.

Cool India is one of the fast coming up companies in India in the field of Industrial
accessories. The technical nature of the product line requires substantial promotion effort by
the companys salesmen, besides the amount spent on advertising and promotion. In view of
the importance of effective marketing, right from the beginning, the Indian market has been
divided into 4 zones: Southern, North-Western, Mid Central, and Far Eastern and each zone
is placed under the charge of a Zonal Manager who is given complete freedom with regard
to operations and who is responsible for the entire range of marketing operations in his
territory, i.e., receiving goods from the companys plant, warehousing, sales promotion,
sales control, delivery and ROI of the division.

The companys manufacturing is located at Faridabad where from the stocks are supplied to
zonal warehouses as per requirements. The Zonal Managers are required to sell the product
at uniform prices in all the territories and maintain stocks in warehouses so as to ensure an
inventory turnover of at least 4 times. Likewise he should ensure that the receivables turn
every 30 days.

IN view of the rising price level, the market value today of the warehouse building is
considered equal to their original gross book value and the market value of warehouse
equipment and delivery truck is estimated to be one half of their original book value.

Mr. Lingnath observed that the Far Eastern Zone could not make any progress in
eliminating the losses and if that zone was to continue its operations, it would be a drain on
the resources generated by other divisions. The companys investment in the Far Eastern
division was producing a negative return of over 10% per year, a fact which greatly
disturbed Mr. Lingnath for reason that a losing division not only corrodes its own
investment but eats away other divisions profits also. He, therefore, asked the committee
whether, as a strategy, the company should attempt divestment in Far Eastern Zone reducing
the volume of operations OR seek expansion and sink possibly additional investment, so as
to salvage the zone. In any case, he said, the present state of affairs should not continue.

Page 24 of 57 - Marketing Finance (Ver 1.1)


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Exhibit II

Cool India Ltd.


Selling Statistics for year ending Dec.31, 1983

Southern North Mid Central Far Eastern


Zone Western Zone Zone
Zone
(Rs.) (Rs.) (Rs.) (Rs.)
No. of salesmen 36 20 32 15
Avg. sales per salesman 2,00,000 2,15,000 2,18,750 2,66,666
Avg. direct selling,
advertising & promotion
expenses for salesmen 13,000 14,600 13,800 18,300
Avg. no. of calls per customer
per month (according to
customer annual sales
volume)
Rs.
0-2,000 1 0.6 1 0.5
2,001 4,000 1.8 1.6 1 1.4
4,001 6,000 2.9 2.8 2.7 2
6001 8,000 5 4.3 4.1 3.2
over 8,001 5.2 5.2 5.1 5.1

Page 25 of 57 - Marketing Finance (Ver 1.1)


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Exhibit III

Cool India Ltd.

Delivery Expenses and Statistics for year ending December 31, 1983
Southern North Mid Far Eastern
Zone Western Central Zone
Zone Zone
(Rs.) (Rs.) (Rs.) (Rs.)
Truck Drivers 1,60,000 20000 30000 1,20,000
Drivers Assistant 54000 30000
Depreciation of 1,50,000 20,000 30,000 1,20,000
trucks(25%)
Gas, oil & supplies 56,000 24,000 26,000 49,000
Taxes, Insurance & 23,000 3,000 5,000 18,000
Licence
Repairs & 44,000 6,000 8,000 34,000
Maintenance
Freight out 2,28,000 3,30,000
Total 4,87,000 3,01,000 4,29,000 3,71,000
No. of trucks 15 2 3 12
Avg. annual miles 28,000 12,000 12,600 20,000
per truck
Avg. no. of daily 12 16 15 8
deliveries per truck
Avg. value of order 83.3 100 105 86.75
delivered

Page 26 of 57 - Marketing Finance (Ver 1.1)


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Exhibit IV

Cool India Ltd.


Warehouse Expenses for year ending December 31, 1983

Southern North Mid Central Far Eastern


Zone Western Zone Zone
Zone
(Rs.) (Rs.) (Rs.) (Rs.)
(square feet) (4,000) (3,300) (5,000) (4,000)
Variable expenses ( with
sales)
Salaries of storekeepers 80,000 51,000 99,000 83,000
and mineral handlers

Fixed Expenses
Depreciation of equipment 8,000 7,200 9,100 7,800
(10%)
Depreciation of 6,000 5,400 7,500 6,300
warehouse (2%)
Supervision 15,000 12,800 17,400 15,400
Clerical 10,000 6,300 12,600 10,000
Utilities 5,000 3,900 5,000 5,200
Taxes & Insurance 4,000 3,800 5,100 4,900
Repairs and maintenance 14,000 6,400 17,400 9,300
Supplies & Misc. 10,000 8,200 9,900 7,100
Total 1,52,000 1,05,000 1,83,000 1,50,000

Page 27 of 57 - Marketing Finance (Ver 1.1)


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Exhibit V

Cool India Ltd.


Warehouse Expenses for year ending December 31, 1983
Southern Zone Northern Zone Mid Central Zone Far Eastern Zone
Amount % of Amount % of Amount % of Amount % of
(Rs) sales (Rs) sales (Rs) sales (Rs) sales
Sales units 14,000 5,620 10,800 6,000
Market Share 10.5 10.1 11 8.7
Sales value 72,00,000 100 43,00,000 100 70,00,000 100 40,00,000 100
Cost of sales 46,80,000 65 30,10,000 70 50,40,000 72 32,00,000 80
26,20,000 35 12,90,000 30 19,60,000 28 8,00,000 20
Direct territory
Expenses:
Selling(Salaries only) 3,32,000 4.6 1,88,000 4.3 3,20,000 4.6 1,80,000 4.5
Delivery 4,87,000 6.7 3,01,000 7 4,29,000 6.1 3,71,000 9.3
Warehousing 1,52,000 2.1 1,05,000 2.5 1,83,000 2.6 1,50,000 3.7
Direct
Direct Advertising & Sales
1,37,000 1.9 1,05,000 2.5 1,20,000 1.7 95,000 2.4
promotion
Office (fixed) 90,000 1.2 72,000 1.6 83,000 1.2 70,000 1.8
11,98,000 16.5 7,71,000 17.9 11,35,000 16.2 8,66,000 21.7
Allocated selling & Admin 2,88,000 4 1,72,000 4 2,80,000 4 1,60,000 4
expenses of sales

Margin before allocated


selling & Administrative 13,22,000 18.5 5,19,000 12.1 8,25,000 11.8 66000 -1.7
expenses

P/L before income tax 10,34,000 14.5 3,47,000 8.1 5,45,000 7.8 2,26,000 -2.3

Page 28 of 57 - Marketing Finance (Ver 1.1)


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Solution:

Statistics for Far Eastern Region


Sales 40,00,000
Cost of Sales 32,00,000
Contribution/margin 8,00,000
Other Expenses 8,66,000
Net Loss 66,000
Add : Depreciation
Trucks 1,20,000
Equipment 7,800
Ware House 6,300 1,34,000
Operating Profit 68,000

We see that while the region is running into net loss, it is still generating gross profit. As a
policy, dont drop a product or region as long as operating profits are in positive. Since
Depreciation and Interest costs are fixed and beyond the control of manager. Asset sale may
entail heavy losses. It is normally worthwhile to continue the business and try to revive it by
improving the sales, operating efficiencies and cost management exercises.

Micro analysis of the financial data indicates that: -

1. Cost of sales = 80% of sales which is the highest among all the regions. High cost of
sales could be due to inappropriate product mix in the region. (Profit margins on all the
products of the same company are never the same. Profit margins are function of market forces. It is
responsibility of the management to employ more thrust on higher profit margin products and thus
change product mix to ensure higher margins even while sales do not improve). Second reason
for higher cost of sales could be due to higher transportation cost from Works in
Faridabad to Warehouses in Far Eastern Region since the distance is large compared
to other regions (Delivery expenses are for moving the items from warehouse to customers
premises. Prior to that there are transportation expenses involved in moving the items from Works to
warehouses which has been clubbed with cost of sales). This factor is beyond the control of
Regional Managers or even companys control unless company adopts differential
pricing norms for different regions. (Company currently has a policy of uniform pricing all
over India).

2. Far Eastern Region consists of seven north eastern states. Individual figures of sales
in each of states are not given. It may be necessary to check if sales in any states are
too low. It may be useful to strengthen distribution network in those states by
appointing distributors and C&F agents.

3. Delivery expenses in FE region are over 9% of sales compared to 6-7 % in other


regions. It is recognised that FE regions have hilly terrain and are less densely
populated and therefore delivery costs ought to be high there. However, figures
indicate sufficient scope for fine tuning delivery system which would result in
substantial savings in fuel and operating cost of trucks. If reorganisation of delivery
system can result in reduction of one truck and improve fuel efficiency marginally,

Page 29 of 57 - Marketing Finance (Ver 1.1)


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profits can improve by as much as Rs 35,000.

4. Possibility of outsourcing the delivery system was also examined. Two things were
highlighted during discussions. First, private distribution system in Far Eastern
Region is not much developed and therefore unlikely to be cost effective. Secondly,
cost of outsourcing is comparable in Western and Mid Central sectors with Southern
Sector which has its own delivery system. Therefore, worthwhile savings are
unlikely to be accrued by outsourcing.

5. Another high cost area is Warehousing. Following issues were highlighted: -

(a) The warehouse is too large to meet current requirements. For a sale of Rs 40
lakh, it has 4000 sqm area which is same as southern region with 80% more
sales. A smaller warehouse would save on capital cost. However, it could be
a long term investment to cater for growth of business.

(b) Despite handling 57% less stores, salaries of storekeepers and mineral
handlers is 4% higher than Southern Zone. Staff requires to be trimmed to
reduce expenses on salary head.

(c) Similarly, clerical and supervisory salary expenses are very high and need to
be curtailed.

What we have seen so far is control of expenses which in any case has a limit. Another way,
and that too more effective, is to increase sales.

Analysis of exhibit II reveals that there are only 15 salesmen and sale per salesman
is highest in the Far Eastern Region. It is clearly stated in case study that the technical
nature of the product line requires substantial promotion effort by the companys salesmen,
besides the amount spent on advertising and promotion. It seems that low number of
salesmen is affecting sales in the region, which is also borne out by facts that FE Zone has
lowest market share among all zones as well as lowest number of avg calls per customer.
Increasing number of salesmen is likely to increase the sales and any further increase in
sales is likely to have higher contribution.

On the whole, even though Far Eastern Region is incurring losses at present, there does not
seem to be any requirement to close the operations due to following reasons: -

1. Zone has positive operating profits and as a rule, operations should not be terminated
as long as operating profits are positive. (When there is net loss but contributions and
operating profits are positive, it means that though selling price is higher than variable cost, fixed
costs are very high leading to losses. Since fixed costs have already been taken care of, increased
sales will increase contribution and losses will be wiped out. However, when operating profits are
negative, it means that selling price is lower than even variable cost and any increase in sales will
increase the losses. Situation then is beyond redemption and it is prudent to close the operations).

2. There are enough prospects to improve the profitability of the zone, both by
controlling expenses and by increasing sales and altering product mix.

Page 30 of 57 - Marketing Finance (Ver 1.1)


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Prob: A company plans to supply its products to ultimate consumer through wholesaler,
retailer or directly. The objective is to maximise sales, earn better prices and better profits.
Based on following info, advice manager as to which distribution channel to adopt: -

Direct (I) Retailer (II) Wholesaler (III)


Unit Selling Price Rs 18 Rs 16 Rs 13
Estimated Unit sales 9,00,000 8,50,000 8,25,000
Selling and Distribution Cost per Rs 2.5 Rs 2 Rs 1.80
unit
Cost of Production Rs 3
Fixed Cost Rs 6,00,000

Please also explain which other factors you will consider.

Solution:

Direct (I) Retailer (II) Wholesaler (III)


Sales 1,62,00,000 1,36,00,000 1,07,25,000
Variable Cost @ 3 27,00,000 25,50,000 24,75,000
Selling and Distribution Cost 22,50,000 17,00,000 14,85,000
Operating Profit 1,12,50,000 93,50,000 67,65,000
Fixed Cost 6,00,000 6,00,000 6,00,000
Net Profit 1,06,50,000 87,50,000 61,65,000

Another way of solving the same problem is by calculating the unit contribution and then
finding profits.

Direct (I) Retailer (II) Wholesaler (III)


Per Unit Cost of Production 3 3 3
Per Unit Selling & Distribution Cost 2.5 2 1.80
Per Unit Variable cost 5.5 5 4.80
Per Unit Selling Price 18 16 13
Per Unit Contribution 12.50 11 8.20
Total Contribution 1,12,50,000 93,50,000 67,65,000
Less: Fixed Cost 6,00,000 6,00,000 6,00,000
Profits 1,06,50,000 87,50,000 61,65,000

Other factors which need to be considered while taking the decision are

1. Resources Available Having own selling and distribution network is capital as


well as manpower intensive exercise. S&D network would probably require more
resources as well time, energy, attention and manpower than required for production.
Thus, availability of resources is major criteria.

2. Nature of Products Nature of product plays very important part on intensity of

Page 31 of 57 - Marketing Finance (Ver 1.1)


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selling and distribution operations. The S&D chain of a product with limited shelf
life, like milk and newspaper, is far more vigorous, complex and sensitive to
administer than say Cars. Again, the mechanics of distribution of milk and
newspaper, which are purchased and consumed daily at fixed time of the day, are
far different from items which are consumed daily but purchased at little longer
intervals (and therefore occasionally at different times of day), (like soaps,
toothpaste and other personal care products). Having own distribution network
(without the help of that friendly neighbourhood Kiranawala) for such items is literally
impossible.

Page 32 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Date: 04 Sep 2006

MARKETING ROI

Marketing ROI is defined as relationship between marketing net profit and capital
employed/investment for marketing operations (it is expressed as percentage/ratio).

There are basically two kinds of investment in marketing: -

(a) Working Capital Investments in finished goods inventory and receivables.

(b) Investments in Fixed Assets for marketing purposes, like sales office,
delivery logistics (Trucks, vans, etc), office equipments, etc.

Let us see how is marketing ROI is different from business ROI.

SNo Total Mktg Deptt


1. Capital Employed in Fixed Assets 100 10
2. Working Capital Employed 100 60
Total 200 70
3. Sales 400 400
4. Cost of Sales (as pre transfer pricing) 300 350
5. Gross Margin/Profit 100 50
6. Operations Cost 40 23
7. Finance Charge/Interest/Opportunity Cost 20 7
8. Net Profit 40 20
9. ROI 40 = 20% 26
200 70 = 28.6%

Role of ROI in Sales Management


How is a Sales Managers performance evaluated?

It can be done by measuring his performance vis a vis target in terms of volume or value.
But what if he has achieved his target by giving huge discounts to dealers which affected the
profitability of marketing operations or increased bad debts enormously. So, achievement of
targets in terms of volume or value are not authentic measures of performance of a Sales
Manager.

To overcome such problems, profit targets are set for the sales managers. Now, if we have
to compare performance of two Sales Managers who have both achieved their respective
targets, what should be the basis?

Suppose there are two managers Mr A and Mr B who have both achieved equal sales.
How do we determine who is more efficient?

Page 33 of 57 - Marketing Finance (Ver 1.1)


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Manager A Manager B
Maintained low inventory levels and Maintained high inventory level to ensure
ensured customer satisfaction by better customer satisfaction but had to incur high
inventory review and forecasting and thus Working Capital costs.
incurred low working capital costs
Ensured quick receivables collection and Allowed longer credit period to push sales
kept working capital requirements and costs and thus blocked substantial amount of
low. working capital.

Now, despite the two managers being equal in terms of sales and profit generated, Manager
B has earned same profit as Manager A by much higher investment in marketing
operations. Thus, Manager A is more efficient than Manager B. Thus, even net profit is
not the correct measure for evaluating Marketing Managers performance.

Next method that is employed now a days is ROI concept. ROI deals with the question
How much profits for how much investment? What is the rate of return for each Rupee
invested in business? In marketing ROI, it means finding out the rate of return for each
Rupee invested in marketing activity.

Functions/Role of Sales Manager


There are three primary functions: -

1. Manage Product Mix (We have discussed about impact of product mix on profitability on
page 30. We will discuss this issue again and in greater detail with the help of a numerical problem a
little later).

2. Control Field Cost like travelling expenses, communication expenses, bonus,


commission, stationery expenses, office expenses, etc.

3. Sales Management Sales Management covers entire gamut of sales exercise. It


covers: -

(a) Recruit, Train and retain sales team.


(b) Allocate territories to sales people.
(c) Prepare route plans for sales people to ensure that entire territory is covered
on a regular basis.
(d) Allocate targets and quota for each salesman.
(e) Performance evaluation of sales people.
(f) Collect receivables.
(g) Manage finished goods inventory.
(h) Plan and launch sales promotion activities.

Page 34 of 57 - Marketing Finance (Ver 1.1)


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Net profit
Now ROI
Assets employed

Net profit Sales


ROI
Sales Assets employed

ROI Rate of profit Turn over ratio

Let us revisit the two managers whose performance we examined earlier. They both have
earned a profit of 10% on their sales of Rs 12 Lakh. But, while Manager A had an average
investment on inventory and receivables of Rs 3 Lakhs, Manager B had an average
investment of Rs 4 Lakh. Thus, turn over ratios for A and B were 4 and 3 respectively.

Now, ROI Rate of profit Turn over ratio


Manager A = 10% x 4 = 40%
Manager B = 10% x 3 = 30%

Thus, we see that despite achieving equal sales and having equal profit margin on products
sold, Manager A has performed better due to utilisation of lesser resources in terms of
working capital employed. The Return on Investment in his case is 40% against 30% of
Manager B.

Problems

Prob 1. Sales = Rs 10,00,000


Net Profit = Rs 80,000
Assets = Rs 5,00,000
Liabilities
Current = Rs 2,00,000
Capital = Rs 2,00,000
Retained Earnings = Rs 1,00,000 Rs 5,00,000

Total Investment = Capital + Retained Earnings


= 2,00,000 + 1,00,000 = Rs 3,00,000

80,000 10,00,000
ROI 26.67%
10,00,000 3,00,000

Prob 2. Profits = Rs 1,00,000


Sales = Rs 10,00,000
Assets = Rs 5,00,000

1,00,000 10,00,000
ROI 20%
10,00,000 5,00,000

Page 35 of 57 - Marketing Finance (Ver 1.1)


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Suppose that the Sales Manager was able to bring down the Working Capital invested to Rs
4,00,000 from 5 lakhs. What will be impact on ROI?

1,00,000 10,00,000
ROI 25%
10,00,000 4,00,000

Thus, we see that ROI has improved to 25% because of 20% reduction in
assets.

Prob 3: Sales 10,00,000


Factory Costs (7,00,000) 3,00,000
Direct Expenses
Salary & Fringe Benefits 1,10,000
Travel & Entertainment 28,000
Field Office 12,000 1,50,000
Operating Profit 1,50,000
Capital Employed
Receivables 2,10,000
Finished Goods Inventory 1,90,000 4,00,000

1,50,000 10,00,000
ROI 37.5%
10,00,000 4,00,000

Case I

Sales increase by 2,00,000


Rate of profit = 15%
Capital employed = 4,00,000

1,80,000 12,00,000
ROI 45%
12,00,000 4,00,000

Case II

Sales increase by 2,00,000


Rate of profit = 15%
Capital employed = 3,00,000

1,80,000 12,00,000
ROI 60%
12,00,000 3,00,000

Rate of profit is affected by following factors: -

(i) Sales Volume (Economies of scale)


(ii) Price
(iii) Product Mix

Page 36 of 57 - Marketing Finance (Ver 1.1)


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(iv) Field Expense


(v) Cost of goods sold
(vi) Marketing Expenses
(vii) Administrative Expenses

Problem (This problem will demonstrate how product mix impacts the profits.)

Given below is budgeted and achieved data of a company manufacturing three


products A, B and C.

SNo A B C Total
1. Gross Profit 40% 20% 30%
2. Budgeted Sales 500 200 300 1,000
3. Budgeted Gross Margin 500 x 40% 200 x 20% 300 x 30% 330
= (1) x (2) = 200 = 40 = 90
4. Actual Sales 100 500 400 1,000
(as budgeted)
5. Actual Gross Margin 40 100 120 260

What we see from above is that though the Actual Sales were same as budgeted, profits
have reduced from budgeted 330 to 260. That is because, the sales of higher profit product
Viz A were replaced by low profit B and C sales.

Other Effects of Dev iations from Budgeted Product Mix

Large deviations from budgeted product mix can lead to various other complications besides
affecting the profits. Production schedules are drawn on the basis of product mix estimates.
Purchase indents for raw material are raised accordingly. When product mix changes, and
there is sudden rise in demand for any product, entire production schedule gets upset. There
is shortage of raw material for that product and accordingly distress purchase of same at
much higher purchase cost and some times even extra transportation costs. On the other
hand, there is pile up of inventory of finished goods and raw material of other item
consuming space and capital. Panic sets in purchase, production departments and even in the
sales department because of uncertainty about delivery of orders. Thus, while there is loss of
profit on the sales front, there is loss at production and purchase end as well.

There are situations (especially in capital goods like large machinery, etc) where the
company keeps its schedule but customer fails to take the delivery and requests for delayed
supply. Typically what happens is that project gets delayed due to various reasons (almost
regularly in govt contracts) and then customer makes a request to delay the supply. Such
requests block the fund flow (orders are executed on the basis of small advance payment only). Large
capital invested in manufacturing the machine is blocked and incurs finance charges. At the
same time, there could be paucity of space to store the machine and overheads on
maintaining the machine is good condition till delivery. Sales Department is thus required to
not only obtain the order but also keep tab on progress of project to insure against such
eventualities.

Page 37 of 57 - Marketing Finance (Ver 1.1)


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Problem - Sales 10,00,000


Profits 1,50,000 15 %
Assets Employed 4,00,000 T/O Ratio = 2.5
ROI 37.5%

Proposal from Sales Department


Increase sales by 2,00,000 by going to new markets or selling through new distribution
channels. Because of extra efforts, profits (marginal) will be 10% on additional sales (not
15%). Marginal investment in receivables and finished goods inventory will be Rs 1,00,000.
Should the proposal be accepted.

ROI of additional investment proposal = Rate of Profit x Turn over ratio


=10% x 2,00,000 / 1,00,000 = 20%

Consolidated ROI after implementing the proposal =

1,70,000 12,00,000
ROI 34%
12,00,000 5,00,000

It is evident that the ROI is going down after the new investment. However, any decision
based on percentages and ratios alone should be avoided.

Purpose of business is to earn profits. Therefore, litmus test of any business proposal is
Will this proposal increase my NET profits? All the ratios have been designed to explore
this basic fact. In the present case, Even though the ROI has gone down, additional sales
have positive contribution and net profits have increased from Rs 1,50,000 to Rs 1,70,000.
And any proposal which increases the net profits should be acceptable (provided there is no
better proposal. And mind the word NET here. This word has a wide connotation and encompasses not only
monetary profits but other forms of profit as well. It does not cover only todays profits but also takes into
account its effect on tomorrows profits. It does not only take its effect on current business but also its effect on
groups other businesses).

Secondly, returns on investment in any new market are bound to be low in the beginning
(even negative in most cases). Returns improve over the time. So, there is every chance that ROI
in new market will match the existing market in due course.

Thus, on both the counts, proposal merits acceptance.

Evaluating a Sales Representative s Performance

1. Quantitative Parameters

(a) Sales Volume/Value


(b) Profit Generated/PV Ratio
(c) Field Expenses

Page 38 of 57 - Marketing Finance (Ver 1.1)


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(d) Calls made on clients


(e) Productive Calls Closure of sales achieved
(f) No of Orders
(g) Avg Value of orders Size of order affects profitability since there is a fixed
cost involved in processing the order. So, larger the order size, lesser per unit
fixed cost of order processing
(h) Market Share
(i) Cost to Sales ratio Product Mix achieved
(j) Receivables Management/Days outstanding
(k) Customer complaints
(l) New Customers

2. Qualitative Factors

(a) Product Knowledge


(b) Market Knowledge
(c) Reporting (daily, weekly, monthly)
(d) Market Information
(e) Customer Relationships
(f) Handling promotion material/product display

3. Personality Factors

(a) Attitude to work


(b) Motivation/Energy level
(c) Personal Hygiene
(d) Communication Skills

Page 39 of 57 - Marketing Finance (Ver 1.1)


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Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Problem : (From BK Chatterjee Book) Evaluate the performance of Salesmen A, B and C from the following data: -

SNo Criteria for Bonus Points Achievements


Evaluation A B C

Weightage

Norms

Weighted

Weighted

Weighted
Achieved

Achieved

Achieved
Score

Score

Score

Score

Score

Score
1. Market Share 30 25% 1 for every 5% deviation 35% 8 240 20% 5 150 40% 9 270
2. Value of Orders 15 10 L 1 for every 1 Lakh deviation 8L 4 60 11 L 7 105 9L 5 75
3. Avg Value per order 10 25 K 1 for every 5 K deviation 27 K 6 60 22 K 5 50 20 K 5 50
4. Sales Value 10 10L 1 for every 1 Lakh deviation 9L 5 50 10 L 6 60 13 L 9 90
5. PV Ratio 15 40% 1 for every 5% deviation 35% 5 75 30% 4 60 40% 6 90
6. Marketing ROI 20 20% 1 for every 5% deviation 27% 7 140 12% 4 80 30% 8 160
Total 635 505 735

Basic Score for achieving the norm 6 points

Max Score in any one discipline 12 Points

Analysis

1. A is an average performer, B is weak and C is star performer.

2. B has exceeded his target for value of targets. But he has obtained too many small orders. Also his product mix was poor
which led to his below avg performance. He is also poor in collection of receivables. He needs to be trained.

3. A has failed to achieve his target in terms of value of orders. His product mix is also inappropriate. Though his performance is
satisfactory, he needs training in these areas.

4. Though C is a Star performer, even he needs training in the field of sales closure and size of orders.

Page 40 of 57 - Marketing Finance (Ver 1.1)


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Date: 11 Sep 2006

RETURN ON PROMOTION INVESTMENT

Problem:

Modern Pharmaceuticals has five product lines. All advertisings expenses are first
divided into direct and indirect. Only directly allocable promotional expenses are traced for
each product. Contribution margin and sales for each product is given as follows.

Product 1 2 3 4 5

Expense
Sales 350 225 150 175 100
Contribution 40 50 60 30 45
Margin %

Expense
Advertising

Head
Sampling

Allocated
Detailing
(Direct)

(Direct)

on time

Total
basis

Product
1 4 10 14 28
2 6 3 5 14
3 3 4 16 23
4 5 5 5 15
5 7 8 5 20

Find, which product gives maximum return on promotional investment.

Solution:

Product
1 2 3 4 5
Expense
Sales 350 225 150 175 100
Contribution Margin 40% 50% 60% 30% 45%
Contribution Margin 140 112.5 90 52.5 45
in Rs
Contribution net of 140-28 = 112.5 14 90 23 = 52.5 15 45 20 =
Promo Expense 112 = 98.5 67 = 37.5 25

Page 41 of 57 - Marketing Finance (Ver 1.1)


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Expense Head

Contribution

Re of Promo
Allocated on

Sales per Re
Advertising

Margin per
time basis
Sampling

of promo
Detailing
(Direct)

(Direct)

Total
Product

1 4 10 14 28 350/28 = 12.5 112/28 = 4


2 6 3 5 14 225/14 = 16 98.5/14 = 7.03
3 3 4 16 23 150/23 = 6.5 67/23 = 2.91
4 5 5 5 15 175/15 = 11.66 37.5/15 = 2.5
5 7 8 5 20 100/20 = 5 25/20 = 1.25

From above figures it is evident that product 2 has highest sales per rupee of promotion
expense. Same product also has highest contribution margin per Re of promotion. While in
this case, same product tops both the tests, it may not always be the case. In case two ratios
are not in agreement, decision should be taken based on contribution margin per Re of
promotion which is the true measure of profitability and not stand alone Sales.

Another issue which attracts our attention here is about taking allocated costs into account
while calculating profitability of each product line. During the case study on Cool India Ltd
on page 30 it was stated that fixed costs and allocable expenses are be not to be considered
while taking decision, where as in the instant case we have taken allocated expenses in to
account. The reason is that we need to take all RELEVANT expenses into account while
taking any decisions. In the instant case, though Detailing Expenses are allocated expenses,
they are directly related to the product. These expenses can be saved if so desired, but at the
cost of losing sales. In case of Cool India case, fixed expenses were a legacy left behind by
earlier management, and allocated expenses were Head Office expenses which would have
continued even if operations of Far Eastern Region had been wound up. So, your decision to
wind up or otherwise had no bearing on HO expenses. Thus, to reiterate, while taking
management decisions, take all relevant expenses in to account no matter whether they are
fixed, variable, direct or allocated. A thumb rule that can be followed is that any expense
that will be affected by your decision is to be considered. An expense that will not be
affected by your decision is not to be considered.

Page 42 of 57 - Marketing Finance (Ver 1.1)


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CASE STUDY :COOKWELL EQUIPMENT LIMITED

The Cookwell Equipment Company Ltd sells two distinct lines of kitchenware, one to the
restaurants and one to retail stores. Restaurants sales are made to distributors and stores
sales through company salesmen.

The company has been successful and is operating at full capacity. However, its cash
position is very tight and therefore it will not be able to construct an additional plant to meet
the increasing demand for its products.

The company has rented for a two year period additional space adjacent to its present
factory. The rental expense is included in the allocated costs in Exhibit 1. This space is
adequate to permit a 20 percent sales expansion in either the restaurant line or the retail line.
Either line could absorb the added factory output without requiring any additional sales
effort.

The average price per unit in the restaurant line is Rs.20/- and in the retail line Rs.5/-. The
restaurant products are packed at the plant and the packing costs are included in the cost of
sales. The retail items are packed at the warehouse.

You are requested to review the data contained in Exhibit I and suggest the product line to
be expanded.

In the course of your examination of the companys income statement, you discover the
following additional information.

1. If the rented space is to be devoted to restaurant products, no additional trucks will


be required. However, present truck running time will have to be increased by 10%.
The additional 10% running time will require proportionate overtime payment to
truck drivers, at time and a half.

2. From the allocated selling and administrative expenses, you will find the following:

(a) Variable billing costs are estimated at 40 paise on invoice. The average value
of an invoice to restaurant customers is Rs.500/- and to retail customer
Rs.100/-

(b) Advertising includes counter displays for the retail line which amounts to one
percent of sales.

(c) Variable shipping salaries at the warehouses are equal to 80 paise per unit for
restaurant products and 5 paise per unit for retail products. Warehouse
packing costs (including cartons) amount to 4 paise per unit.

Page 43 of 57 - Marketing Finance (Ver 1.1)


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Exhibit - 1
COOKWELL EQUIPMENT LTD
Income Statement for the year ended December 31, 1990.
Restaurant Line Retail Line Total
Sales 1,800,000 1,700,000 3,500,000
Cost of Sales
Materials 400,000 320,000 720,000
Labour 300,000 240,000 540,000
Variable overheads 200,000 250,000 450,000
Fixed Overheads 270,000 210,000 480,000
Total 1,170,000 1,020,000 2,190,000
Gross Profit 630,000 680,000 310,000
(% of Sales) (35.0) (40.0) (37.4)
Less: Selling & Admn. Exp
Direct:
Salesman's Commission 0 136,000 136,000
Salesman's travel & Etainment 0 85,000 85,000
Truck depreciation 14,400 0 14,400
Insurance & Licences
Truck driver's salaries 65,000 0 65,000
Truck garage rental 3,600 0 3,600
Gasoline & other truck supplies 28,000 0 28,000
Commissions to distributors 180,000 0 180,000
Freights 6,000 62,000 68,000
Bad Debts 4,500 6,000 10,500
Total Direct 301,500 289,000 590,500
Allocated
Warehouse (basis of space) 40,000 80,000 120,000
Selling (sales) 48,000 32,000 80,000
Advertising (sales) 36,000 24,000 60,000
Administrative (sales) 54,000 36,000 90,000
Total Allocated 178,000 172,000 350,000
Total selling & admin 479,000 461,000 940,000
Profit before Income Taxes 150,000 219,000 369,000
(% of Sales) (8.4) (12.9) (10.9)

Capital employed
Variable:
Average monthly cash 72,000 48,000 120,000
Average monthly inventories 120,000 240,000 360,000
Average monthly receivable 162,000 184,000 346,000
Total 354,000 472,000 826,000
Fixed 1,144,000 1,372,000 2,516,000
Total 1,498,000 1,844,000 3,342,000
Return on capital (10.0%) (11.9%) (11.6%)

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Solution:

Restaurant Retail
Basis Line OR Line
Incremental Sales 20% of total sales 700,000 700,000
Units sale Sales/per unit cost 35,000 140,000
Cost of Sales Mat + Lab + Var
Exp (no Fixed O/H) 350,000 333,529
Gross Margin Sales - Cost of Sales 350,000 366,471
Going by Gross Margin, Retail Line seems to be preferable. However let us explore
further.

Selling and Admin Expenses


Sales Commission to
Salesmen same ratio as Orig 0 56,000
Travel and Entertainment
expenses of Salesmen same ratio as Orig 0 35,000
Truck Drivers Salary 15% of orig salary 9,750 0
Gasoline & Other Supplies 10% of origl exp 2,800
Distribution Commission same ratio as Orig 70,000
Freights same ratio as Orig 2,333 25,529
Bad Debt same ratio as Orig 1,750 2,470
Total Direct Expense 86,633 118,999

Indirect Costs
Advertising 1% of sales 0 7,000
Variable Shipping Exp 80p and 5p per unit 28,000 7,000
Invoice Cost @ 40p Working Note 3 560 2,800
Packing Cost @ 4p Working Note 4 0 5,600
Total allocable exp 28,560 22,400

Profits before allocable costs 263,367 247,472


Profits after allocable costs 234,807 225,072

Investments
Investment In same ratio 28,000 19,764
Monthly Cash In same ratio 46,666 93,333
Receivables In same ratio 63000 75764
Total Investment 137,666 188,861
ROI 1.71 1.19

Working Notes: -

1. Truck Drivers additional salary is @ 1.5 times. So for 10% extra running hours, they
will get 15% extra payment.

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2. Fuel expenses are proportionate to extra running.

3. Invoice Expense No of invoices x Cost of invoice

=. Sales x Cost of Invoice


Avg Invoice Amount

Restaurant Line 7,00,000 x 0.40 = 1400 x 0.40 = Rs 560


500

Retail Line 7,00,000 x 0.40 = 7000 x 0.40 = Rs 2,800


100

4. Packing Cost Only retail line products are packed in warehouse. So only that cost
is to be considered.
Packing cost = No of units x packing cost per unit
= Total Sales x packing cost per unit
Selling Price
= 7,00,000 x 0.04 = 1,40,000 x 0.04 = Rs 5,600
5

Page 46 of 57 - Marketing Finance (Ver 1.1)


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PRICING

(Refresh Pricing fundamentals from Philip Kotlers book)

Problem:
A company has maximum production capacity of 1,00,000 units. Its fixed cost is Rs
1,00,000 and variable cost is Rs 2/- per unit. Domestic demand is 50,000 units. It has
received export order for 30,000 units @ Rs 3 per unit. Should it accept the order?

Solution:

Unit production cost when export order is not available =

Fixed Cost Variable Cost 1,00,000 (2 50,000)


= Rs 4 / per unit
DomesticOrder 50,000

The export order is @ Rs 3 per unit which is Re 1/- less than the production cost for
domestic demand.

Yet, the order should be accepted on marginal costing basis. Since the fixed costs have
already been recovered from domestic demand of 50,000 units, and the capacity being
1,00,000, any incremental production will incur only variable cost of Rs 2/- per unit, thus
leaving a contribution of Re 1/- per unit. Therefore, the export order should be accepted.

Factors Which Influence Pricing


1. Cost Though Cost Plus or Mark-up pricing is almost out of fashion due to
intense competition, yet, cost plays an important role in pricing decisions. Lower the
cost, better the leverage in business decisions regarding pricing.
2. Differentiation
3. Market Characteristics
(a) Demand Vs Supply
(b) Growth
(c) Market Share
(d) Market Sophistication
(e) Competitors
(f) Importance to the customers
(g) Trade Practice
4. Exchange Rate Movements Exchange rate movement can increase or decrease
profits. In case of imports of raw material, adverse movement of exchange rate will
increase the material costs. Similarly, adverse movements after acceptance of export
order will squeeze the profit margins.

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5. Govt Regulations and incentives.


Problem:
The Delhi Mixie Co. manufactured and sold 1000 mixies @ Rs 800/- each. The cost
structure is as follows:
Material - Rs 200/-
Labour - Rs 100/-
Variable Overheads - Rs 50/-
Factory Cost - Rs 350/-
Fixed Overheads - Rs 200/-
Total Cost - Rs 550/-
Profit - Rs 250/-
Sales Price - Rs 800/-
Due to tough competition, the selling price for next year has to be brought down to Rs 750/-.
Assuming no change in cost structure, how many mixies need to be manufactured and sold
to ensure same level of profit.

Solution:
Old (Rs) New (Rs)
Selling Price 800 750
Variable Cost 350 350
Contribution 450 400
Fixed Cost 200 200
Profit 250 200
Total Profit 2,50,000 2,50,000
Total Unit Sales 1,000 1,250

Problem:
In a purely competitive market 10,000 mobiles phones can be manufactured and sold at a
certain price. It is estimated that 2000 mobile phones need to be manufactured and sold in a
monopoly situation to make same profit. Profit under each condition is targeted at
$ 2,00,000. Unit variable cost is $ 100 and total fixed cost is $ 37,000. Find the selling price
in each situation.

Solution:
Competition Monopoly
No of units sold 10,000 2,000
Profit 2,00,000 2,00,000
Profit per unit $20 $100
Variable Cost $100 $100
Fixed Cost $37,000 $37,000
Fixed Cost on per unit basis $3.70 $18.50
Total per unit Selling Price $123.70 $218.50

Page 48 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

BUDGETING
A budget is a plan that quantifies a companys goals in terms of specific and
operating objectives. Goals setting most often takes a bottom to top approach rather than the
opposite.

Goals are then broken into strategies, and plan of action is developed to use those strategies
in furtherance of the goals. In the course of development of plan of action, a host of factors
have to be considered, like,

(a) Various business environment factors


(i) Market Customer behaviour, demography, demand, etc.
(ii) Competition
(iii) Economy
(iv) Regulations
(v) Etc
(b) Product Life Cycle
(c) Companys Financial Status This is the starting point as every activity
costs money and budget is limited by financial capacity of the firm.

Companys Budget is broken into Departmental Budgets which are further broken into sub-
budgets and so on. Each department has its own budget which is part of the companys
budget. Marketing Department also has its budget. The Marketing Budget consists of
following sub-sub-budgets: -

(a) Sales Budget


(b) Advertising and Promotional Budget
(c) Market Research Budget
(d) Distribution Budget
(e) Logistics Budget covers transporting cost, and
(f) Warehousing Budget

Factors which influence Budgets

(a) Sales Budget

(i) Market Size/growth Market size and market growth gives a clue
about a realistic growth potential possible.

(ii) Competitive position

Page 49 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

(iii) Sales History Sales Budget has to be within realistic estimates of


previous sales growth record. If the sales in past were growing @
20%, expecting 50% growth would be nave.

(iv) Companys Financial Strength Even if growth is possible,


company should have financial strength to invest in plant, machinery,
infrastructure, distribution network, advertising, etc.

(v) Brand Strength

(b) Advertising and Promotion Budget

(i) Advertising Objectives Short term or long term growth, etc.

(ii) Media Costs

(iii) Market Situation Whether the market is booming or sluggish; how


is the demand for the product, etc

(iv) Competitive Spending/Share of Voice How much are the


competitors spending? We need to match our spending with at least
our close competitors.

(v) Advertising Creative Strategy Creative advertising may have higher


returns and therefore reduces advertising cost per Re of sale.

(vi) Consumer Behaviour Whether the consumers buy the product as


an impulse reaction or it is a deeply drawn decision. In case of
impulse decision products, advertising expenses are high due to need
for higher top of the mind recall requirements. Soft Drinks are
example of such products. In case of image oriented brands
sustained niche advertising is required.

(c) Market Research Budgets

(i) What methodology is being used for research Whether primary


data or secondary data, Group discussions or interviews, Face to face
interviews or telecalling, etc

(ii) Data Processing

(iii) Data Analysis

(iv) Project Report Preparation

However much care may have been taken while preparing budget, the outcome will rarely
match the plan. There will always be some variance, favourable or adverse. Whether
favourable or adverse, analysis of this variance can be neglected only at grave cost to the

Page 50 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

company. Variance analysis pin points the areas and persons whose performance was better
than expected though overall performance was below expectation and vice versa. Thus, we
know exactly where we underestimated and where we failed. Overall positive performance
may some times hide some grave danger signals. Variance analysis brings them out in to
open.

Problem:

A companys sales budget for 2004 was as follows

Product A: 8000 units @ Rs 5.50 per unit = Rs 44,000


Product B: 24,000 units @ Rs 7.50 per unit = Rs 1,80,000
Rs 2,24,000

Actual Performance

Product A: 6000 units @ Rs 6.00 per unit = Rs 36,000


Product B: 28000 units @ Rs 7.00 per unit = Rs 1,96,000
Rs 2,32,000

Variance = 2,32,000 2,24,000 = Rs 8,000 (F)

Sales Price Variance = Actual Volume (Actual Selling Price Planned Selling Price)

Product A = 6000 (6.00 5.50) = Rs 3000 (F)


Product B = 28,000 (7.00 7.50) = Rs 14,000 (A)

Net Sales Price Variance = Rs 11,000 (A)

Volume Variance = Planned Price (Actual Volume Planned Volume)

Product A = 5.50 (6,000 8,000) = Rs 11,000 (A)


Product B = 7.5 (28,000 24,000) = Rs 30,000 (F)

Net Volume Variance = Rs 19,000 (F)

Net Total Variance = Rs 11,000 (A) + Rs 19,000 (F) = Rs 8,000 (F)

Analysis

Price increase of Product A had negative impact on turnover of the company since the gain
from increase in price was only Rs 3000, while lost sales were Rs 11,000, leading to a
reduction in turnover by Rs 8,000.

Price reduction of Product B had positive impact on turnover of the company since losses
due to reduced price were Rs 14,000, while turnover increased by Rs 30,000, leading to a
net increase in turnover by Rs 16,000.

Page 51 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

On the whole, both products are highly price sensitive. Impact of price reduction on sales is
considerably high in both cases.

However, even this data is not adequate for business decision.

Turnover is NOT profit. Increased turn over is not necessarily increased profit.

In case of product A, while gains due to increased price ADD IN FULL to the profit of the
company, only a small percent of the sales loss will affect the profit. Let us assume that
production cost of product A was Rs 5.

Planned profit = 8,000 (5.5 5.00) = Rs 4,000


Actual Profit = 6,000 (6.00 5.00) = Rs 6,000

Thus, in this case, despite reduced sales, profits have increased by 50%.

Let us now see the state of Product B.

Suppose, cost of production of Product B is Rs 6.25

Planned profit = 24,000 (7.5 6.25) = Rs 30,000


Actual Profit = 28,000 (7.00 6.25) = Rs 21,000

Thus, in this case despite increased sales, profits have plummeted by Rs 9,000.

Problem:

Variance for selling expenditure for covering a territory are as follows

Standard Cost Rs 2,40,000


Standard Salesmen Days 2000 days
Standard cost per person per day Rs 120

Actual Cost Rs 2,38,000 Variance = Rs 2000 (F)


Actual Salesmen Days 1,700 Variance = 300 days (F)
Actual cost per person per day Rs 140 Variance = Rs 20 (A)

Solution

Variance due to Salesmen days = 120 (1700 2000) = Rs 36,000 (F)


Variance due to Salesmen cost = 1,700 (140 120) = Rs 34,000 (A)
Net Variance in Cost Rs 2,000 (F)

Page 52 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

Case Study
Following are a companys financial and marketing score boards

Financial Score Board


Performance Rs Millions Base Year 1 2 3 4 5
Sales Revenue 254 293 318 387 431 454
Cost of Goods Sold 135 152 167 201 224 236
Gross Contribution 119 141 151 186 207 218
Manufacturing O/H 48 58 63 82 90 95
Marketing and Sales 18 23 24 26 27 28
R&D 22 23 23 25 24 24
Admin O/H 15 15 15 16 16 16
Net Profit 16 22 26 37 50 55
Return on Sales % 6.3 7.5 8.2 9.6 11.6 12.1
Assets 141 162 167 194 205 206
Asset % of Sales 56 55 53 50 48 45
Return on Assets

Marketing Scorecard
Market Based Base Year 1 2 3 4 5
Performance
Market Growth units % 18.3 23.4 17.6 34.4 24 17.9
Sales Growth % 12.8 17.8 13.3 34.9 18.2 18.7
Market Share 20.3 19.1 18.4 17.1 16.3 14.9
Consumer Retention 88.2 87.1 85.0 82.2 80.9 80.0
New Customers 11.7 12.9 14.9 24.1 22.5 29.2
Dissatisfied Customers 13.6 14.3 16.1 17.3 18.9 19.6
Relative Product Quality 19 20 17 12 9 7
Relative Service Quality 0 0 -2 -3 -5 -8
Relative new product sales 8 8 7 5 1 4

Analysis of above data reveals that

1. Sales Revenue and Profits are constantly growing. However, market share is
constantly falling. This is indicative of boom in demand for the product in the
market. Companys growth is actually driven by general growth in the market. Even
then company has failed to take full advantage of the opportunities in the market and
increase its sales and profits further. If and when demand for the product falls,
company would be badly hit.

2. Expenditure on R&D is stagnant at about 24%. Considering as percentage of sales,


the expenditure on R&D has actually fallen. Thus, company is not future oriented. It
is not taking care of product life cycle. Same deduction can be drawn from the last

Page 53 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

row in marketing score board which shows constantly falling new product sales.
Company will be hard hit once the current product life cycle is on the wane.

3. Return on assets has grown from 11.3% to 26.7% which is almost 133% growth.
However, new investments in assets are low as the assets have grown from 141 to
206 only. Despite high growth in return on assets, company has failed to invest on
assets. Once again company is not investing for its future.

4. Companys product quality and service quality both are continuously declining over
the entire period. At the same time percentage of dissatisfied customers are
increasing. Customer retention is also dropping. Entire growth is being driven by
new customers. All the events are logical sequence. Company obviously has not
looked at its Balanced Score Card.

Page 54 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

BRAND VALUATION

A product becomes a brand after the company gives it a name or symbol or get-up.

Brand value is intangible and therefore, brand valuation exercise can not be very objective.
It is subjective in nature and at the best, a guess work.

Brand equity is the value built-up in a brand. It is measured based on how much a customer
is aware of the brand. The value of a company's brand equity can be calculated by
comparing the expected future revenue from the branded product with the expected future
revenue from an equivalent non-branded product. This calculation is at best an
approximation. An investment in brand equity is commonly claimed to work through the
creation of brand knowledge. This knowledge in turn consists of two aspects of a brand:
brand image and brand awareness. Brand image, in this context, consists of the mental
associations consumers make with the brand; Tata means honest business; Mercedes means
excellent car. Brand awareness is composed of the strength of the brand in consumers'
minds, for example their ability to recall the brand.

In order to create brand equity, often lot of investment is required (but not always). Equity can
not be measured in financial terms.

Fundamentals of building brand equity:

1. Perceived product quality

2. Name awareness

3. Brand loyalty

4. Brand association (Image), like Raymond suiting is associated with a warm and
caring complete man. Reid & Taylor tried to claim to be the best by slogan Bond
with the Best. But the icon of James Bond did not inspire much appeal in Indian
psyche. Thus, they have now changed the mascot to Amitabh Bachchan.

5. Other brand properties Gale mein Khich-khich Vicks, Dove one forth
moisturising cream.

Brand Equity is good for the company as well as good for the consumer.

Consumer Company
Customer is assured of certain minimum Adds value to the firm
level of quality and service from the
company keen to maintain its brand equity.
Companys concern about User Satisfaction Wins loyal customers
Easy purchase decision making. Customers confidence in brand
Information processing is easier when every Marketing programme is effective and
other company is making tall claims about productive.

Page 55 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

superiority of their product.


Leverage over trade. Pull strategy works
and there is no need to adopt Push
strategy. (For push and pull strategy, refer second
semester Marketing answer bank question 18 page
21).
Better product price/margins

How to measure brand equity?

It has been already pointed out in the beginning that brand equity is intangible and therefore
it is difficult to arrive at an exact figure. Thus, each stalwarts attempt to quantify brand
equity is only one of the many ways available to hazard a guess but none coming close to a
widely acceptable formula for measuring brand equity.

1. Young and Rubicams Brand Asset Valuation Young and Rubicam is one of the
largest advertising agency in the world and has been associated with over 450 brands
in 32 countries. As per Young and Rubicam, the brand is to be assessed on following
parameters on a scale of 1 to 5:

(a) Differentiation
(b) Relevance Emotional/rational connection
(c) Esteem Esteem = brand popularity x perceived quality.
(d) Knowledge.

How are the above parameters related?

Differentiation x Relevance = Brand Strength

Esteem x Knowledge = Brand Stature

2. Total Researchs Equitrend As per this firm, brand equity can be measured by
measuring brands performance on a 5 point scale for following attributes:

(a) Brand Saliency (uniqueness/differentiation)


(b) Perceived quality
(c) User satisfaction

Perceived Quality Perceived quality can be assessed based on

(i) Brand liking


(ii) Brand Trust
(iii) Willingness to recommend
(iv) Pride

Page 56 of 57 - Marketing Finance (Ver 1.1)


Jamnalal Bajaj Institute of Mgmt Studies
Mgmt study material created/ compiled by - Commander RK Singh rajeshsingh_r_k@rediffmail.com

3. Interbrand Model of Brand Assessment Criteria

(a) Business prospects of a brand


(b) Brand Market Environment
(c) Consumers Perception

Each of the three attributes are judged on a several parameter on a 5 point scale

(i) Leadership Gives economies of scale for production, advertisement,


etc.
(ii) Stability of Brand Like Lifebuoy, Sony, Lux have been around for
decades now.
(iii) International Status
(iv) Markets Growing/stable/declining, pricing structure/profitability,
etc
(v) Protection (legal) Like patent or license
(vi) Support Financial, human, system

If you have a strong brand, you may not involve in manufacturing the product. You can
outsource the production and only market it. Many companies around the globe are
following this strategy.

Some of the methods of brand valuation ar e:

Historical Cost Method The total cost incurred on building the brand ever since launch.
However, this is not the right method. Cost never determines the value. The first factor is
time value of money. Second issue is wastages in the process, third issue is the value
already recovered from investments. What we are looking for is residual value in the brand.
Take for instance Remington type writers. They enjoyed excellent brand valuation at one
time. But once computers started taking over, there was little brand value left. A case of
wastages is Signal toothpaste of Hindustan Lever. Despite investing lot of money in brand
promotion, product never got much market share. Thus, most of the investment was a waste.
Besides investment, there are a host of other factors that build the brand and probably they
are more important than money pumped into it.

Replacement Cost Method This method is good for theory only. It is impossible to find
the replacement cost (for re- building another brand with similar market).

Market Value This is a more realistic method. Ultimately value is what customer is
willing to pay. So, what does the consensus in the market among the prospective buyers
says?

Value by Potential Earnings This is another realistic method. It is possible to make an


approximation of the future earnings and discount them to todays value.

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