Revenue and Cost

Marketing Finance Independence` ``` `Finance Functions

The purpose of financial accounting is to summarize financial activity of the business in the profit and loss statement, balance sheet and cash flow statement. Accounting records and bookkeeping are the basis of your businesss financial accounting. Financial accounting dictates the amounts you owe to suppliers, what customers owe you, operating costs, payroll costs and available cash. You can use financial accounting to analyze significant aspects of your business, such as monthly sales or the reasons for high expenses in one month. Sound financial records demonstrate financial controls and oversight that reduce the risk of fraud and theft, something that investors like to see.Financial accounting helps you formulate your future course of action or strategy and measure the success of this strategy with the financial information produced from another period.Marketing FunctionsGathering and Analysing Market InformationMarketing PlanningProduct Designing and DevelopmentStandardisation and GradingPackaging and LabellingBrandingCustomer Support Service Pricing of Products. PromotionPhysical DistributionTransportationStorage or WarehousingAdvertisingMarketing Finance InterdependenceTheKeyfunctionsofabusinessare:Operations-involvesorganisingtheproductionofgoodsandservices EmploymentRelations-responsiblefororganisingthebusiness'shumanresources-thepeoplewhoworkinthebusiness.Marketing-thelinkbetweenthebusinessanditscustomers.AccountingandFinance-responsibleforprovidingthefinancialresourcesnecessarytorunthebusiness.Thebusinessfunctionsareinterdependentandworktogethertoachievetheobjectivesofthebusiness.

Conceptual Framework of Financial PerformanceFinancial performance depends on revenue and cost.Revenue is provided from sales of merchandise by retailers, sales of products and sale of services.Companies generate three types of costs including discretionary, engineered and committed costs.Various costs fall into one of these three categories based on the cause and effect relationships involved.These three cost concepts are summarized in next slides.* Cause and effect relationship A relationship in which one event makes another event happen.

Discretionary CostA discretionary cost is a cost or capital expenditure that can be curtailed or even eliminated in the short term without having an immediate impact on the short-term profitability of a business.Management may reduce discretionary costs when there are cash flow difficulties, or when it wants to present enhanced short-term earnings in the financial statements. However, a prolonged period of reduction in discretionary costs gradually reduces the quality of a company's product pipeline, reduces awareness by customers, increases machine downtime, and may also decrease product quality and increase employee turnover. Thus, discretionary costs are actually only discretionary in the short-term, not the long-term.Many activities are viewed as beneficial to an organization, even though the benefits obtained or value added by performing these activities cannot be defined precisely , either before or after the activity is completed.The costs of the inputs, or resources required to perform such activities are referred to as discretionary costs. These costs are discretionary in the sense that management must choose the desired level of the activity based on intuition or experience .

Examples includes employee training, advertising, sales promotion, legal advice, Employee training Equipment maintenance, Quality control, Research and development, Building Maintenance etc.

Engineered costsEngineered costs result from activities with reasonably well defined cause and effect relationships between inputs and outputs and costs and benefits.Engineers can specify precisely how many parts (inputs) are required to generate a specific output.Engineered cost are committed at the design stage of a product like direct material and direct labour. Once the design is final, engineered cost are strictly proportional to the output volume. Managers will focus mostly on efficiency or productivity. Characteristics of Engineered cost1. Inputs can be measured in Monetary terms.2. Outputs can be measured in physical terms.3. The optimal amount of input required to produce one unit of output can be established.Engineered cost is basically a manufacturing cost, warehousing cost, distribution cost.In an engineered expense center, the Quantity multiplied by the standard cost or each unit produced represents what the finished products have the cost. When these cost is compared to actual cost , the difference between the two represents the efficiency of the organization unit being measured. E.g. Direct Material cost per unit, Direct labor per unit, Manufacturing ohs per unit etc.

Committed costsCommitted costs refers to the costs associated with establishing and maintaining the readiness to conduct business. It has been committed by Management The benefits obtained from these expenditures are represented by the company's infrastructure. A committed cost is an investment that a business entity has already made and cannot recover by any means, as well as obligations already made that the business cannot get out of it. You should be aware of which costs are committed costs when you are reviewing company expenditures for possible cutbacks or asset sales. Committed cost will continue even if an organization shuts down for a short timeFor example, if a company buys a machine for $40,000 and also issues a purchase order to pay for a maintenance contract for $2,000 in each of the next three years, all $46,000 is a committed cost, because the company has already bought the machine, and has a legal obligation to pay for the maintenance. A multi-year property lease agreement is also a committed cost for the full term of the lease, since it is extremely difficult to terminate a lease agreement.There is usually a long-term legal agreement associated with a committed cost. If not, it is much easier to negotiate the termination of an expense. Examples 1. the costs associated with the purchase of a franchise, a patent, copy rights.2. The cost of facilities and top management- These cost can not be eliminated without exposing an organizations overall health and existence.

Marketing ROIIt is different from Corporate ROI. because marketing is not the same kind of investmentIt is basically a relationship between Net Marketing Margin (NMM) and Investment in Marketing Operation.Here manufacturing and marketing department are two different profit center so performance measurement will be separate.So amount of total costs and revenue have to be kept differently.Instead of money that is 'tied' up in plants and inventories (often considered capital expenditure or CAPEX), marketing funds are typically 'risked.' Marketing spending is typically expensed in the current period (operational expenditure or OPEX). The idea of measuring the markets response in terms of sales and profits is not new, but terms such as marketing ROI and ROMI are used more frequently now than in past periods. Usually, marketing spending will be deemed as justified if the ROMI is positive. The purpose of ROMI is to measure the degree to which spending on marketing contributes to profits. Marketers are under more and more pressure to show a return on their activities.

ConstructionReturn on Marketing Investment (ROMI) =[Incremental Revenue Attributable to Marketing ($) X Contribution Margin (%) Marketing Spending ($)] /Marketing Spending ($)

A necessary step in calculating ROMI is the estimation of the incremental sales attributable to marketing. These incremental sales can be 'total' sales attributable to marketing or 'marginal.'

Short termThe first, short-term ROMI, is also used as a simple index measuring the dollars of revenue (or market share, contribution margin or other desired outputs) for every dollar of marketing spend.For example, if a company spends $100,000 on a direct mail advertising and it delivers $500,000 in incremental revenue, then the ROMI factor is 5.0. If the incremental contribution margin for that $500,000 revenue is 60%, then the margin ROMI (the incremental margin for $100,000 of marketing spent is $300,000 (= $500,000 x 60%). Of which, the $100,000 spent on direct mail advertising will be subtracted and the difference will be divided by the same $100,000 . Every dollar expended in direct mail advertising translates an additional $2 on the company's bottomline.COSTVOLUME PROFIT ANALYSISCVP ANALYSISCost Volume profit analysis means any analysis to study the effect or impact on cost and profit of changes in volume, and vice versa. It helps to ascertain the financial performance at a given level of sales.It helps to know the break even level for an organization where total revenue equalize the total cost.

ChangeImpact/EffectIn fixed cost: a) Increase

b) DecreaseBE units- IncreaseCont/Sales ratio- SameMOS DecreaseThe reverse of aboveIn variable cost a) Increase

b) DecreaseBE units- IncreaseCont/Sales ratio- decreaseMOS DecreaseThe reverse of above

In sale price: a) Increase

b) Decrease

In sales Unit a) Increase b) decrease

BE units- decreaseCont/Sales ratio- IncreaseMOS IncreaseProfit - IncreaseThe reverse of above

Margin of Safety and profit IncreaseMargin of Safety and profit decrease

Assumptions;Fixed cost remain static & marginal costs are completely variable at all levels of output.Selling prices are constant at all sales volume.Factor prices (raw material, Labor etc) are constant at all sales volume .Efficiency and productivity remain unchanged. In a multi product situation ,there is constant sales mix at all level of sales.Turnover level is only relevant factor affecting cost & revenueELEMENTS-MARGINAL COST EQUATION CONTRIBUTION MARGIN .PROFIT /VOLUME RATIO .BREAK EVEN POINT .MARGIN OF SAFETY.MARGINAL COST EQUATIONSALES=VARIABLE COSTS +FIXED EXPENSES+P/LORS-V=F+P/LCONTRIBUTION MARGIN-CONTRIBUTION =SELLING PRICE MARGINAL COSTORC=F+P/LORC-F=P/L

PROFIT /VOLUME RATIO;P/V= CONTRIBUTION x 100SalesOR P/V ratio =CHANGE IN PROFITS OR CONTRIBUTION x 100CHANGE IN SALES;Break Even Point

Break even point(in units)= Fixed cost Contribution per unitBreak even point(in Amt)= Fixed cost P/V ratio

VALUE OF SALES TO EARN DESIRED AMOUNT OF PROFIT ;Calculations of sales for desired profit Required sales = Fixed cost+ Desired profit P/V ratioRequired sales (units)= Fixed cost + Desired profit Contribution per unit

MARGIN OF SAFETY ;margin of safety(Rs) = Actual Sales - Sales at B.E.P Or = Profit p/v ratioMargin of safety (units)=Actual sales(units)- B.E.P. (units)Or = Profit Contribution per unit

Assignment 1ABC Ltd has provided the following informationSales @ Rs. 5 per unit.- 20000 unitsVariable cost p.u.-Rs.3Fixed Cost Rs.8000Calculate PV Ratio and Break even sales.Assignment 2Following data is given by XYZ Ltd.Sales @ Rs 10 pu -100000 UnitsVariable cost per unit Rs.6 Fixed cost 300000Calculate Margin of safety.Assignment 3A company producing a single product sells it at Rs.50pu . Unit variable cost is Rs.35 and fixed cost is Rs.1200000.Find out Break Even Sales and P/V ratio.New break even sales if variable cost increase by Rs.3 pu without increase in selling price.Volume of sales required to earn a profit of Rs.2.4 lakhAssignment 4 Ridewell Cogcle Ltd purchases 20000 bells per annum from an outside supplier at Rs.5 each. The Management feels that these be manufactured and not purchased. A machine costing Rs. 50000 will be required to manufacture the item within the factory. The machine has an annual capacity of 30000 units and life of 5 years. The following additional information is availableMaterial cost per bell will be Rs. 2.00Labor cost per bell will be Rs. 1.00Variable overheads 100% of labor costYou are required to advise whetherI. The company should continue to purchase the bells from the outside supplier or should make them in the factoryII the company should accept an order to supply 5000 bells to the market at a selling price of Rs. 4.50 per unit ?

Assignment 5A company has annual Fixed cost of Rs. 1400000. In 2004 sales amounted to Rs. 6000000 as compared with Rs. 4500000 in 2003 and profit in 2004 was Rs. 420000 higher than in 2003. a) At what level of sales does the company break even ?b) Determine profit or loss on a present sales volume of Rs. 8000000c) If there is reduction in selling price in 2005 by 10% and the company desires to earn the same profit as in 2004, what would be the required sales volume ?

Assignment 6Material cost 120 Labour Cost 30 Overhead is 12Selling price 270 Fixed cost 14 lakhsSales 40.5 lakhs.During forthcoming year direct workers will be entitled a rise in 10% Material cost will rise by 7.5% and overhead by 5% Fixed cost will rise by 3%Find New sales price in the forthcoming year if current P/V ratio is to be maintained.Number of units that would require to be sold during the forthcoming year to have the same amount of profit in the current year without increasing the selling price.Assignment 7The following data refer to a single product , the techwhiz, made by the Markdata Computer company:Sales Price = Rs.5595Materials cost (Including Purchased components) = Rs. 899Direct labour cost = rs. 233Facilities Cost = ( for a highly automated plant mainly includes rent, insurance , taxes and Depreciation) = 2352000 per year.

RequiredWhat is the unit contribution marginWhat is the BEP in units and AmountWhat is the desired level of sales unit if the company plans to increase Fixed cost by 5% and to achieve a desired before Tax profit of Rs. 200000If the companys income Tax rate is 22 percent what unit sales are necessary to achieve an after tax profit of Rs. 150000Concept of Return on InvestmentROI = Net Profit X 100 Capital EmployedFurther Decomposed it is the multiplication of Net Profit Ratio and Capital turnover RatioNPR is NP/SalesCTR is Sales/Capital Employed Capital Turnover Ratio indicates the efficiency of the organization with which the capital employed is being utilized. A high capital turnover ratio indicates the capability of the organization to achieve maximum sales with minimum amount of capital employed. Higher the capital turnover ratio better will be the situation.

ParticularTotal Non- MarketingmarketingremarksCapital EmployedFixed Asset100901010% represents automobiles ,warehouse, office equipment by MKTGWorking Capital1004060Total20013070Sales400320400320 is the transfer price of goods from Manufacturing to Marketing.a- Marginal Cost300270350350 includes 320 and another 30 are variable marketing exp.Contribution1005050- Fixed Cost Operational401822- Financial Charges20137Total603129Net Profit401921NMM is 21.ROI20%15%30%

Assignment 1

Fixed asset 100 Working Capital 100Sales 400 Variable cost of sales 300Fixed Cost Operation 40Fixed cost Finance Charges 20Calculate ROI, Contribution to Sales Ratio and Capital Turnover Ratio, Margin of safetyAssignment 3A company has a margin of safety at 20% and a profit of Rs.4 lakhs. If its contribution to sales is 0.4 calculate its current sales and fixed cost.

Assignment 4Profit /Volume ratio of a company is 50%, while its margin of safety is 40%. If sales volume of the company is Rs. 50 Lacs, find out its break even point and net profit.

Multi Product Sales MixA manufacturer may have more than one product and also their sales.The relative proportion of each product sold in the aggregate sales is termed as sales mixA change in the mix of products sold usually affects the weighted average P/V Ratio and hence the BEPSo when the product have different P/V Ratios changes in the sales mix will affect the BEP.AssignmentThree products X Y and Z have their sales at 100000, 60000, 40000 respectively. Their variable costs are 80000, 42000, 24000 respectively. Fixed cost for the firm is 27000 find out the break even sales for the firm.If Rs.40000 sales of the product X could be shifted equally to product Y and Z then what will be the new profit and new BEP sales for the firm. Impact of selling price, Fixed Cost and Variable cost on BEP.An increase in selling price increases the amount of contribution resulting in improvement in P/V Ratio and vice versa.The increase or decrease in fixed cost does not affect the P/V ratio even though it may increase or decrease the total profit.Increase in variable cost per unit will reduce the contribution and result to decrease in P/V Ratio and vice versa.The increase in P/V Ratio means lower break-even point and higher margin of safety and vice versa.Make an analysis of the below mentioned assignment.Selling price per unit Present Rs.50 Proposed Rs.40Variable Cost per unit Present Rs.30 and Proposed Rs.30Fixed Cost p.a. Rs.60000 in both arrangements.Production units 10000 units in both the cases.Calculate P/V Ratio Break Even Point and Margin of safety and comment on the situations of lowering selling price per unit in the light of previous slides discussion.Assignment A company wants to buy a new machine to replace one which is having a frequent break down. It received offers for two models M1 and M2.Further details of these two models are given below. Installed capacity in units for M1 10000 and for M2 10000Fixed overhead p.a. for M1 Rs. 240000 and for M2 Rs. 100000Estimated profit at the above capacity M1 Rs 160000 and M2 Rs.100000.The product manufactured using this type of machine M1 or M2 is sold at Rs.100 per unit.You are required to find out the Break Even level of sales for each model.The level of sales at which both the models will earn the profit of Rs. 200000AssignmentThe following figures relate to a company manufacturing a varied range of product.

Total SalesTotal CostYear ended 31st March 200522,23,00019,83,600Year ended 31st March 200624,51,00021,43,200Assuming stability in price with variable cost carefully controlled to reflect predetermined relationship and an unvarying figure cost calculate the followingP/V Ratio, Fixed Cost,Fixed Cost % to Sales, Break even point and margin of safety for the year ended 2005 and 2006.AssignmentXYZ Ltd has to decide between launching one or two similar new products. It does not have the production capacity to launch both the product. Fixed Cost for the company is Rs.20000 p.a. Product A can be sold at Rs.400 per item and product B at Rs.350 per item. The variable unit cost are Rs.240 for Product A and Rs.200 for product B. The likely demand for both the products are given by the following probability distribution. Calculate the Break-even point for both the product and estimate the profitability of these two products.Likely DemandProbability of AProbability of B1000.10.32000.30.43000.40.25000.20.1Total1.01.0Practical application of Linear Programming techniqueAllocation of scares resources : Limited resources to be allocated to various products.Product mix problems Capacity utilization optimization so that profit can be maximized.Determinations in joint product profitability In case of product involving joint cost where one or more of the joint products may be processed further. LP may help determine the profitability of further processing.Cost volume profit analysis for Multi product cost volume profit analysis.

To formulate the LPP1. Objective Functions : The objective functions of each problem is a mathematical representation of the objective in terms of a measurable quantity such as profit, cost, revenue etc.It should be an optimization function either to maximize or to minimize.2. Constraint functions : There are always certain limitations on the use of limited resources like labour, machine, raw material etc. Such constraints must be expressed as linear equalities or inequalities in terms of decision variables.The solution of an LP model must satisfy these constraints.3. Non Negativity condition- X and Y being the no. of units produced , cannot have negative values. Thus both of them can assume values only greater than or equal to zero. It expressed as x > 0 and y > 0.Guidelines for formulationsExpress objective function in words.Define the objective function whether to maximize or minimize.Express them in mathematical terms.Express it as a linear function of decision variables multiplied by their profit or cost considerations. Define decision Variables: Express each constraints in wordsFormulate the constraints imposed by the resource availability and express them in linear equality or inequality in terms of decision variables defined.. A store has requested a manufacturer to produce pants and sports jackets.For materials, the manufacturer has 750 m2 of cotton textile and 1,000 m2 of polyester. Every pair of pants (1 unit) needs 1 m2 of cotton and 2 m2 of polyester. Every jacket needs 1.5 m2 of cotton and 1 m2 of polyester.The price of the pants is fixed at $50 and the jacket, $40.What is the number of pants and jackets that the manufacturer must give to the stores so that these items obtain a maximum sale?

AssignmentA firm is engaged in producing two products. A and B. Each unit of product A requires 2 kg of raw material and 4 labour hours for processing, where as each unit of B requires 3kg of raw materials and 3 labour hours for the same type. Every week, the firm has an availability of 60 kg of raw material and 96 labour hours. One unit of product A sold yields Rs.40 and one unit of product B sold gives Rs.35 as profit. Formulate this as an Linear Programming Problem to determine as to how many units of each of the products should be produced per week so that the firm can earn maximum profit.Practice ProblemA small manufacturer making two products A and BTwo resources R1 and R2 are required to make these products.Each unit of Product A requires 1 unit of R1 and 3 units of R2.Each unit of Product B requires 1 unit of R1 and 2 units of R2.The manufacturer has 5 units of R1 and 12 units of R2 available.The manufacture also makes a profit of Rs. 6 per unit of Product A sold and Rs. 5 per unit of product B sold.Formulate this as an Linear Programming Problem to determine as to how many units of each of the products should be produced so that the firm can earn maximum profit.