Marketing managers are often faced with a variety of strategies that they must decide on. Assuming that the final goals of marketing management are usually finance-based, evaluation of each alternative is needed so that the impact on the organisation’s financial performance and position can be made. It is in this sense that marketing decisions require, in our opinion, a certain amount of financial analysis. We make a special note here that we are not suggesting in any way that all
marketing decisions are made with a view to a financial objective. There must be alignment of any Marketing Strategies with the other Strategies (IT, HR, etc.) agreed by the board.
All of us forecast and record operating performance over a period of time (usually in periods of one year) by drawing up an income statement which is composed of the following elements:
All of these elements are very important and each one of them has a whole story to tell. Marketing decisions may have an impact one each and every one of these items. So, for example, look at a simple example of budgeting costs:
Here is your factory producing Loka Lola drinks.
If you produce one bottle per annum the cost of the rent imputed in that bottle will be 1,000,000 USD!!!! If you produce two bottles the cost goes down to 500,000 USD per bottle. If you produce 1,000,000 bottles the cost goes to 1 USD per bottle!! If you produce 10,000,000…..
But the sales force need a price upfront in order to go out and make deals with clients like Dc Monalds and Kurger Bing. To give them a price to sell you must estimate the costs, i.e. you need to budget or forecast the volume you are going to sell! Give them too high a price and they will make zero deals, give them too low a price and they make losses! So we need to make as precise estimates of many things as possible. We need to estimate the sales volume, the prices for the materials we need to produce this volume (the bigger the volume the more discounts we get on our purchases) the labour hours needed to go into this production and so on and so forth. Not an easy task!
For now, let us go back to the Income Statement and in particular the last figure, Net Profit Before Tax (PBT), which is usually the indicator for the operating strength of the organisation. It simply shows the net result of the efforts to sell after all the costs involved in the whole process are deducted. If the marketing manager’s goal is (as it usually is) the maintenance of a healthy PBT from year to year, then he/she needs to understand the relationship between the marketing activities and the income statement.
Let us start from the first item, income from sales. This is the product of two other items:
Unit selling price is after any discounts, allowances, returns etc. This means that we are talking about the actual price charged or to be charged to clients. The volume of sales is the number of items or quantity sold. To increase income from sales, either the unit price will have to increase or the volume of sales, or a combination of both. The decision to determine a level of price that will maximise income is not an easy one.
Sometimes an increase in price may lead to a disproportionate reduction in volume of sales thus reducing total income! Remember that if Price goes up, revenue goes up, but when Volume goes down revenue goes down.
Say price is now 100 and we sell 100,000 items – that gives revenue 10,000,000.
If we increase the price to 103 (i.e., 3% increase), but volume falls to 95,000, then the revenue will be 103 x 95,000 = 9,785,000.
So, unless there is a conscious strategy to want to do that, price should NOT be increased. This is an example of a product that is price elastic at that price. Knowledge of price elasticity is important in marketing.
Vice versa, a reduction in price may not lead to an increase in volume of sales to the extent expected!
And anyway, maximising income from sales does not necessarily mean maximising profits! This is because the increase in income may require a disproportionate increase in costs needed to generate that income! So questions relating to the income level and prices are trickier than initially thought and require the study of Price Elasticity of Demand. And marketing managers have to face these questions.
Most marketing managers base their calculations on sales forecasts. It is sales that are determined first and then everything else on the income statement is projected as a relation to sales.
But how is it that sales are being estimated? There are several methods. Let us consider some:
Surely there are no perfect methods at hand and in reality a combination of methods will probably be used. Whatever method or combination is used, it is important to adjust the results on the basis of knowledge and experience. Also important is to use at least one such method to forecast sales BEFORE the mathematical (often mechanical) exercise of break-even volumes based on costs and prices.
This article is the first part in our series on Finance for Marketing Managers. In our upcoming article, we will look more closely at the Cost of Sales, as this is an item that may be heavily impacted by Marketing decisions.
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