Chapter 2
Financial Aspects of
Marketing Management

Costs
Fixed
Costs
Variable
Costs
2-2

Expenses that are uniform per unit of output within a relevant time period
As volume increases, total variable costs increase
2-3

THERE ARE TWO CATEGORIES OF
VARIABLE COSTS
1. Cost of Goods Sold
2. Other Variable Costs
2-4

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
2-5

Expenses not directly tied to production but vary directly with volume
Examples include:
 Sales commissions, discounts, and delivery expenses
2-6

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
2-7

THERE ARE TWO CATEGORIES OF
FIXED COSTS
1. Programmed costs
2. Committed costs
2-8

Result from attempts to generate sales volume
Examples include:
 Advertising, sales promotion, and sales salaries
2-9

Costs required to maintain the organization
Examples include nonmarketing expenditures, such as:
 rent, administrative cost, and clerical salaries
2-10

2-11

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
2-12

The direct opposite of relevant costs.
Past expenditures for a given activity
Typically irrelevant in whole or in part to future decisions
Examples of sunk costs:
Past marketing research and development expenditures
Last year’s advertising expense
2-13

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.
2-14

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
2-15

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
2-16

Total Gross Margin Dollar Amount Percentage
Net Sales
Cost of Goods Sold
Gross Profit Margin
$100
- 40
$ 60
100%
- 40
60%
Unit Gross Margin
Unit Sales Price
Unit Cost of Goods Sold
$1.00
- 0.40
Unit Gross Profit Margin $0.60
100%
- 40
60%
2-17

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 %
2-18

Unit Cost of
Goods Sold
Unit
Selling Price
Gross Margin as a % of
Selling Price
Manufacturer
$2.00
Wholesaler
$2.88
Retailer
Consumer
$3.60
$6.00
$2.88
$3.60
$6.00
30.6%
20.0%
40.0%
2-19

Dollar Amount Percentage
Net Sales $ 100,000
Cost of Goods Sold - 30,000
Gross Profit Margin $ 70,000
100%
- 30
70%
Selling Expenses - 20,000
Fixed Expenses - 40,000
Net Profit Margin $ 10,000
- 20
- 40
10%
2-20

Kellogg’s Cereal Margins at a Price of $2.72 per box
Kellogg’s Direct Unit Manufacturing Cost
Grain $.18
Other Ingredients .23
Packaging
Labor
.31
.18
Mfg. Overheads
Cost of Goods Sold
.34
$1.24
–––––––
54.4% Gross Margin
($2.72 - $1.24)/$2.72
Promotions (excluding Advertising) + .20
Total Unit Variable Cost
Manufacturer Contribution to Fixed Cost
$1.44
and Profit $1.28
––-
47% Contribution Margin
($2.72-$1.44)/$2.72
Kellogg’s Selling Price to Grocery Store $2.72
Grocery Store Margin .68
––-
20% Trade Margin
($3.40 - $2.72)/$3.40
Grocery Store Selling Price $3.40

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
2-22

Break-even point is the unit or dollar sales at which an organization neither makes a profit nor a loss.
At the organization’s break-even sales volume:
Total Revenue = Total Cost
2-23

Dollars
Total Revenue
LOSS
BE Point
Total Cost
PROFIT
Variable Cost
Fixed Cost
0 Unit Volume
2-24

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

Sensitivity Analysis
Profit Impact
Market Size
Performance Measurement
Assessment of Cannibalization
2-26

Refers to a company’s ability to meet short-term financial obligations
Very important for a company’s day-today operations
A key factor is Working Capital = Current
Assets minus Current Liabilities
2-27

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.
2-28

Discounted cash flows are future cash flows expressed in terms of their present value
Incorporates the time value of money
Based on the premise that a dollar received tomorrow is worth less than a dollar today
Useful in determining a business’s net cash flows
2-29

The discount rate can be expressed as follows:
Discount factor = ___1___
(1 + r) n
Where the r in the denominator is the interest rate and n is the number of years
2-30

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.
2-31

Example
Suppose you were to collect $1 million in 5 years. If the discount rate used were 10%, the present value of the $1 million would be:
1
PV = ———— X $1,000,000 = $620,921.32
(1 + 0.10)
5
2-32

A pro forma income statement is a projected income statement
Includes:
Projected Revenues
Budgeted Expenses
Estimated Net Profit
2-33

Pro Forma Income Statement – Example
Sales
Cost of goods sold
Gross margin
Marketing expenses
Sales expenses
Advertising expenses
Freight or delivery expenses
$170,000
90,000
40,000
General and administrative expenses
Administrative salaries $120,000
Depreciation on buildings and equipment 20,000
Interest expense 5,000
Property taxes and insurance
Other administrative expenses
5,000
5,000
Net profit before (income) tax
$1,000,000
500,000
500,000
300,000
155,000
$45,000

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
2-35

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
2-36