Margins & Profitability.

Financial Return23rd January

Chapter 3

Chapter 10

Lecture Objectives

• To explain financial reporting principles• To explain “margins”• To define the main financial metrics

important for marketing

• Managers are requesting more accountability from marketers

• Accounting v. marketing – marketing has fewer standardised techniques for measuring performance

Measuring Marketing Performance

Chapter 3 at a glance

Margins and Profits

• Margins• Average price per unit• Variable and Fixed Costs• Breakeven analysis and Contribution analysis

Chapter 10 at a glance

Marketing and finance

• Net profit and return on sales (ROS)• Return on investment (ROI)• Project metrics: Payback, Net Present Value(NPV). • Return on marketing investment (ROMI)

• Annual Plan control looks at the objectives of the annual marketing plan. Evaluates these against results achieved & takes action

• Financial or Expense control considers the financial parameters and objectives in the annual marketing plan.

• Strategic control ensures the organization maximises opportunities

3 types of control

Key Metrics (in red & bold)

Margins and Profits

• Margins : Unit Margin. Percentage (%) Margin• Average price per unit• Variable and Fixed Costs• Breakeven analysis and contribution analysis:

Contribution per unit. Contribution Margin. Breakeven revenue. Breakeven quantity.

LW2MM01 UNIT MARGIN

Definition

“Unit Prices LESS Unit Cost”

Construction

UNIT MARGIN= SELLING PRICE PER UNIT - COST PER UNIT (in relevant currency)

EXAMPLE 135 pence per litre (95 Octane petrol) - 130 pence per litre= 5 pence per litre

LW2MM02 % MARGIN

Definition

“Unit Margin as a % of Unit Price”

LW2MM02 % MARGIN

Definition

“Unit Margin as a % of Unit Price”

Construction

% MARGIN = UNIT MARGIN (currency)SELLING PRICE per UNIT

EXAMPLEUnit Margin per litre £0.05 % Margin = 3.7%Selling Price per litre £1.35

LW2MM03 AVERAGE SELLING PRICE

Definition

“The average selling price of each unit sold in a period”

Construction

AVERAGE PRICE PER UNIT= TOTAL REVENUE/TOTAL UNIT SALES

EXAMPLE

SALES VALUE IN A PERIOD £156M AVERAGE PRICE £15,600

UNIT SALES IN SAME PERIOD 10,000

LW2MM04 FIXED AND VARIABLE COSTS

Definition

“Fixed costs are those which do not vary with volume (output)”

“ Variable costs are those which (do) vary with volume (output) ”

LW2MM05 CONTRIBUTION PER UNIT

Definition

“Unit Price LESS unit Variable Cost

Construction

LW2MM06 CONTRIBUTION MARGIN

Definition

“Contribution per unit divided by unit price”

Construction

Contribution Margin (%)= Contribution per unit (eg £)

Selling Price per unit (eg £)

LW2MM07 BREAKEVEN SALES LEVEL

Definitions

“Breakeven is that level of sales where sales value equals total cost of sales”

BREAKEVEN QUANTITY

“ Breakeven (unit sales) equals Fixed Cost divided by Contribution per unit”

BREAKEVEN REVENUE

“Breakeven revenue is Fixed Cost divided by the percentage Contribution Margin ”

Fixed costs

Units Sold

Mo

ney

(£)

Determining the break even point

Total variable costs

Fixed costs

Total revenue

Units Sold

Mo

ney

(£)

Determining the break even point

Total cost

Total variable costs

Fixed costs

Break even point

Total revenue

Units Sold

Mo

ney

(£)

Determining the break even point

Losses

Total cost

Total variable costs

Profits

Chapter 10

Marketing and finance

• Net profit and return on sales (ROS)• Return on investment (ROI)• Project metrics: Payback, Net Present Value(NPV). • Return on marketing investment (ROMI)

LW2MM07 NET PROFIT

Definition

“Sales Revenue Less Total Costs”

Construction

Net Profit = Sales Revenue less Total Costs(Total costs will include a share of Corporate

Overheads)

LW2MM08 RETURN ON SALES (ROS)

Definition

“Net Profit as a % of sales revenue”

Construction

Net Profit = Sales Revenue – Total Cost

Return on Sales (%) = Net Profit Sales Revenue

LW2MM09 RETURN ON INVESTMENT (ROI)

Definition

“The financial benefit accruing from prior financial investments, expressed as a percentage of the investment”

Construction

Net Profit = Sales Revenue – Total Cost

Return on Investment (%) = Net Profit Investment

Return on Investment (ROI)

• Also known as Accounting Rate of Return (ARR)

• Average annual profit after depreciation but before interest to capital invested.

ROI example

Initial outlay for a computing system is £110,000. Annual cash flows over five years will be £24,400 p.a. The scrap value estimated at end will be £10,000. Depreciation on straight line basis. What is the ARR?

Investment £110,000Scrap value £10,000Life (years) 5Annual cash flows £24,400Annual Depreciation £20,000Average Annual Profit £4,400ARR is (£4400/£110000) 4.00%Average Investment (initial + scrap/2) £60,000Or ARR using average investment is 7.33%

Payback Period Method

• Estimates the time taken by a project’s net cash flow to recover the initial investment.

• Favours projects which can recoup their cost quickly.

YearCash Flow

Cum. Cash Flow

Cash Flow

Cum. Cash Flow

Cash Flow

Cum. Cash Flow

£ £ £ £ £ £0 Initial investment -21000 -21000 -210001 Net cash inflow 3000 3000 5000 5000 8000 80002 Net cash inflow 14000 17000 15000 20000 6000 140003 Net cash inflow 4000 21000 1000 21000 7000 210004 Net cash inflow 500 6000 10000

Payback reached at end of year 3 3 3

Project J Project L Project R

Time Value of Money

• To make sensible investment decisions appraisal method should also make a logical allowance for the projected timing of the costs and benefits.

• Interest earned on interest already paid is called compounding.

• Concept involves going from today’s value, or present value (PV) to future value (FV).

Net Present Value (NPV)

• The value of a stream of future cash flows after accounting for the time value for money

• Why? To summarise the value of cash flows over multiple periods

LW2MM10 RETURN ON MARKETING INVESTMENT (ROMI)

Definition

“The contribution attributable to marketing investments, expressed as a percentage of the marketing monies invested or put at risk”

ConstructionROMI (%) = Incremental Revenue*Contribution Margin (%) LESS Marketing

Exp.

Marketing Expenditure

Marketing Profitability Analysis

• Step 1: Identify functional expenses• Step 2: Assign functional expenses to

marketing entities• Step 3: Prepare a profit-and-loss

statement for each marketing entity

Profit-and-Loss Statements for Channels