Financial Aspects of

Marketing Management
Chapter 2
by Subbu Sivaramakrishnan
University of Manitoba
In this chapter, you will
learn about
1. Variable and Fixed Costs
2. Relevant and Sunk Costs
3. Margins
Gross Margin
Trade Margin
Net Profit Margin (Before Taxes)
4. Contribution Analysis
Break-even Analysis
Sensitivity Analysis
Contribution Analysis and Profit
Impact
In this chapter, you will
learn about
4. Contribution Analysis (contd.)
Contribution Analysis and Market
Size
Contribution Analysis and
Performance Measurement
Assessment of Cannibalization
5. Liquidity
6. Operating Leverage
7. Discounted Cash Flow
8. Preparing a pro forma Income
Statement
Costs
Fixed
Costs
Variable
Costs
Types of Cost
Expenses that are uniform per unit of
output within a relevant time period
As volume increases, total variable
costs increase
Variable Costs are
THERE ARE TWO CATEGORIES OF
VARIABLE COSTS
1. Cost of Goods Sold
2. Other Variable Costs
For Manufacturer or Provider of
Service
Covers materials, labor and
factory overhead applied directly
to production
For Reseller (Wholesaler or Retailer)
Covers primarily the cost of
merchandise
Variable Costs Cost of
Good Sold
Other Variable Costs
Expenses not directly tied to
production but vary directly with
volume
Examples include:
Sales commissions, discounts,
and delivery expenses
Expenses that do not fluctuate with
output volume within a relevant
time period
They become progressively smaller
per unit of output as volume
increases
No matter how large volume
becomes, the absolute size of fixed
costs remains unchanged
Fixed Costs
THERE ARE TWO CATEGORIES OF
FIXED COSTS
1. Programmed costs
2. Committed costs

Result from attempts to generate sales
volume
Examples include:
Advertising, sales promotion, and
sales salaries
Fixed Costs Programmed
Costs
Costs required to maintain the
organization
Examples include nonmarketing
expenditures such as:
rent, administrative cost, and
clerical salaries
Fixed Costs Committed
Costs
Relevant and
Sunk Costs
Future expenditures unique to the
decision alternatives under consideration.
Expected to occur in the future as
a result of some marketing action
Differ among marketing
alternatives being considered
In general, opportunity costs are
considered relevant costs
Relevant Costs are
The direct opposite of relevant costs.
Past expenditures for a given
activity
Typically irrelevant in whole or in
part to future decisions
Examples of sunk costs:
Past marketing research and
development expenditures
Last years advertising expense
Sunk Costs are
When marketing managers attempt to
incorporate sunk costs into future
decisions, they often fall prey to the
Sunk Cost Fallacy that is, they
attempt to recoup spent dollars by
spending even more dollars in the future.
Example: Continuing to advertise a failing
product heavily in an attempt to recover
what has already been spent on it.
Sunk Cost Fallacy
Margins
The difference between the
selling price and the cost of a
product or service
Margins are expressed in both
dollar terms or as percentages on:
a total volume basis, or
an individual unit basis
Gross Margin or Gross Profit
On a total volume basis:
The difference between total sales
revenue and total cost of goods
sold
On a per-unit basis:
The difference between unit selling
price and unit cost of goods sold
Gross Margin
Total Gross Margin Dollar Amount Percentage
Net Sales $100 100%
Cost of Goods Sold
- 40
- 40
Gross Profit Margin $ 60 60%
Unit Gross Margin
Unit Sales Price $1.00 100%
Unit Cost of Goods Sold
- 0.40
- 40
Unit Gross Profit Margin $0.60 60%
Trade Margin (Markup)
Suppose a retailer purchases an item for
$10 and sells it at $20.
Retailer Margin as a percentage of cost is:

($10 / $10) x 100 = 100 %


Retailer Margin as a percentage of selling
price is:

($10 / $20) x 100 = 50 %
Trade Margin
Unit Cost of
Goods Sold
Unit
Selling Price
Gross Margin
as a % of
Selling Price
Manufacturer $2.00 $2.88 30.6%
Wholesaler $2.88 $3.60 20.0%
Retailer $3.60 $6.00 40.0%
Consumer $6.00
Net Profit Margin
(before taxes)
Dollar Amount Percentage
Net Sales $ 100,000 100%
Cost of Goods Sold - 30,000 - 30
Selling Expenses - 20,000 - 20
Fixed Expenses - 40,000 - 40
Gross Profit Margin $ 70,000 70%
Net Profit Margin $ 10,000 10%
Kelloggs Cereal Margins at a Price
of $2.72 per box
Kelloggs Direct Unit Manufacturing Cost
Grain $.18
Other Ingredients .23
Packaging .31
Labor .18
Mfg. Overheads .34
Cost of Goods Sold $1.24 54.4% Gross Margin
($2.72 - $1.24)/$2.72
Promotions (excluding Advertising + .20
Total Unit Variable Cost $1.44
Manufacturer Contribution to Fixed Cost
and Profit $1.28 - 47% Contribution Margin
($2.72-$1.44)/$2.72
Kelloggs Selling Price to Grocery Store $2.72
Grocery Store Margin .68 - 20% Trade Margin
($3.40 - $2.72)/$3.40
Grocery Store Selling Price $3.40
Contribution Analysis
Contribution is
The difference between total sales
revenue and total variable costs
OR on a per-unit basis
The difference between unit selling price
and unit variable cost
Break-even point is the unit or dollar
sales at which an organization neither
makes a profit nor a loss.
At the organizations break-even sales
volume:
Total Revenue = Total Cost
Break-Even Analysis
LOSS
PROFIT
Total Revenue
Fixed Cost
BE Point
Total Cost
Variable Cost
Unit Volume
Dollars
0
Break-even Analysis Chart
Break-even Analysis
Example
Fixed Costs = $50,000
Price per unit = $5
Variable Cost = $3
Contribution = $5 - $3 = $2
Breakeven Volume = $50,000 $2
= 25,000 units
Breakeven Dollars = 25,000 x $5
= $125,000
Applications of
Contribution Analysis
Sensitivity Analysis
Profit Impact
Market Size
Performance Measurement
Assessment of Cannibalization
Liquidity
Refers to a companys ability to meet
short-term financial obligations
Very important for a companys day-to-
day operations
A key factor is Working Capital = Current
Assets minus Current Liabilities
Operating Leverage
Extent to which fixed costs and variable
costs are used in the production and
marketing of products and services.
Firms with high total fixed costs relative
to total variable costs are defined as
having high operating leverage.
Higher operating leverage results in a
faster increase in profit once sales
exceed break-even volume. The same
happens with losses when sales fall
below break-even volume.
Discounted Cash Flow
Discounted cash flows are future cash
flows expressed in terms of their
present value
Incorporates the time value of money
Based on the premise that a dollar
received tomorrow is worth less than a
dollar today
Useful in determining a businesss net
cash flows
The interest or discount rate is
often defined as

The opportunity cost of capital,
which is the cost of earnings
opportunities forgone by investing in
a business with its attendant risk as
opposed to investing in risk-free
securities.
Preparing a pro forma
Income Statement
A pro forma income statement is a
projected income statement
Includes:
Projected Revenues
Budgeted Expenses
Estimated Net Profit
Pro Forma Income Statement Example
Sales $1,000,000
Cost of goods sold 500,000
Gross margin 500,000
Marketing expenses
Sales expenses $170,000
Advertising expenses 90,000
Freight or delivery expenses 40,000 300,000
General and administrative expenses
Administrative salaries $120,000
Depreciation on buildings and equipment 20,000
Interest expense 5,000
Property taxes and insurance 5,000
Other administrative expenses 5,000 155,000
Net profit before (income) tax $45,000
Preparing a pro forma
Income Statement
Sales forecasted unit volume
times selling price
Cost of goods sold costs incurred
in buying or producing products
and services
Gross margin represents the
remainder after cost of goods sold
has been subtracted from sales
Marketing Expenses programmed
expenses to be spent on increasing
sales
General & Administrative Expenses
fixed costs (often referred to as
overheads)
Net Income before Taxes sales
revenues minus all costs
Preparing a pro forma
Income Statement