Financial Aspects of Marketing Management: Variable and Fixed Costs

10/8/2021
CHAPTER 2 Financial Aspects of

Marketing Management
© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-1
AFTER READING THIS CHAPTER

YOU SHOULD BE ABLE TO:
1. Define accounting and financial

concepts useful in marketing
management.
2. Describe how pro forma income

statements are prepared.
VARIABLE AND
FIXED COSTS
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TYPES OF COSTS
Variable/
Variable Fixed Fixed
Costs Costs Costs
Other
Cost of Programmed Committed Selling
Variable
Goods Sold Costs Costs Expenses
Costs
Sales
Materials Advertising Rent Salary
Commissions
Sales Administrative/ Commissions/

Labor Discounts
Promotion Clerical Bonus
Sales
Overhead Delivery
Salaries
TYPES OF COSTS
Variable Costs
Expenses that are uniform per unit of output

within a relevant time period
− Fluctuate in direct proportion to the number of
units produced
TYPES OF COSTS
Variable Costs
Are divided into two categories:
Cost of Materials, labor, and factory overhead

Goods Sold tied directly to production
Other Variable expenses are not tied to

Variable production but with volume, such as
Costs
sales commissions, discounts, etc.
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TYPES OF COSTS
Fixed Costs
Costs that are fixed and do not fluctuate with

output volume within a budget year
− Remain unchanged regardless of the number of
units produced
− On a per-unit basis, decrease as the number of units
produced increases
TYPES OF COSTS
Fixed Costs
Divided into two categories:
Marketing costs that generate sales,

Programmed
Costs
such as advertising, sales promotion,
salesforce salaries, etc.
Committed Costs that maintain the firm, such as

Costs rent, administrative/clerical salaries, etc.
TYPES OF COSTS
Variable/Fixed Costs
Some costs have both a variable and fixed

component.
• Fixed component: Salary

Selling
Expenses • Variable component: Commissions
or bonus
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RELEVANT AND
SUNK COSTS
RELEVANT AND SUNK COSTS
Relevant Costs
Expenditures that are expected to occur in

the future as a result of some marketing
action
− Differ among marketing alternatives being
considered
− Include opportunity cost
Sunk Costs
Past expenditures for a given activity that

are irrelevant for future decisions
− The opposite of relevant costs
− Include past R&D, test mkt., and adv. expenses
− Sunk cost fallacy is recouping spent dollars by
spending still more dollars in the future
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Sunk Costs
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MARGINS
MARGINS
Margin
• Is the difference between the selling price and

the ―cost‖ of an offering
• Is expressed on a total volume or individual

basis, dollar terms, or percentages
• Consists of three types:
Gross Margin Trade Margin Profit Margin
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MARGINS
Gross Margin/Gross Profit
• Is the difference between total sales revenue

and total COGS
• On a per-unit basis, is the difference between

unit selling price and unit COGS
MARGINS
Is expressed in dollars or percent:
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%
MARGINS
• A decrease in gross margin can adversely

affect profits
• Gross margin can change due to:
− Changes in unit price or unit COGS
− Fluctuations in unit volume
− Modification in the sales mix of the firm’s offerings
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MARGINS
Trade Margin
• Is the difference between unit sales price and

unit cost at each level of a marketing channel
• Known as a markup or mark-on by channel

members and expressed as a percentage
MARGINS
Trade Margin
Example: Selling Price = $20; Cost = $10; Margin = $10
Retailer Margin as a Retailer Margin as a

Percent of Cost Percent of Selling Price
• Know the base (cost or selling price) for calculating margin

• Trade margin percentage is usually based on selling price
MARGINS
Trade Margin
Work backward from the retail selling price through the

marketing channel to arrive at the manufacturer‘s
product‘s selling price
Gross Margin
Marketing Unit Cost of Unit Selling as a Percentage
Channel Goods Sold Price 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
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MARGINS
Net Profit Margin (Before Taxes) in an Income Statement
The remainder after COGS, other variable costs, and fixed

costs have been subtracted from sales revenue
Dollar Amount Percentage
Net sales $100,000 100%

Cost of goods sold -$30,000 -30%
Gross profit margin $70,000 70%
Selling expenses -$20,000 -20%
Fixed expenses -$40,000 -40%
Net profit margin $10,000 10%
MARGINS
Net Profit Margin Dollars
• Can influence the working capital position

• Working capital directly affects:
− The ability to pay COGS
− The ability to pay its selling/administrative costs
− Cash flow position
CONTRIBUTION ANALYSIS
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Contribution
Total sales revenue minus total variable costs

− On a per-unit basis, unit selling price minus unit VC
− Used to analyze the relationship between costs,
prices, volume, and profit
Break-Even Analysis
• Identifies the unit or dollar sales volume at

which a firm has neither profit nor loss
• Break-even is shown by this equation:
Total Total Total

Revenue = Variable Costs + Fixed Costs
Break-Even Analysis
Requires the following information:

− An estimate of unit VC
− An estimate of total dollar FC
− The selling price per unit
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Break-Even Formula
Total
Fixed Costs
Unit
Break-Even =
Volume
Unit Unit
Selling Price – Variable Costs
Denominator = Contribution per unit
= Dollar amount that each unit

sold ―contributes‖ to the
payment of fixed costs
Break-Even Analysis
Example of Unit Break-Even Volume:

Unit Selling Price = $5; Unit VC = $2; Total FC = $30,000
Unit $30,000
Break-Even =
Volume $5 – $2
Unit
Break-Even = 10,000 units
Volume
Break-Even Analysis
Example of Dollar Break-Even Volume:

Unit Selling Price = $5; Unit VC = $2; Total FC = $30,000
Dollar Unit
Unit
Break-Even = Selling Price × Break-Even
Volume Volume
= $5 × 10,000 units
= $50,000
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Contribution Margin Formula
Unit Unit
Selling Price – Variable Costs
Contribution
Margin =
Unit
Selling Price
Contribution Margin
Example: Unit Selling Price = $5; Unit VC = $2
Contribution $5 – $2 Contribution
Margin = ; Margin = 60%
$5
Total
Dollar Fixed Costs $30,000
Break-Even = = = $50,000
Volume Contribution 0.60
Margin
EXHIBIT 2.1: BREAK-EVEN ANALYSIS

CHART
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Sensitivity analysis is a technique used to determine how

different values of an independent variable will impact a
particular dependent variable under a given set of
assumptions
Unit Unit Dollar

Unit Variable Total Contribution Break-Even Break-Even
Selling Price Costs Fixed Costs Per Unit Volume Volume
(P) (UVC) (FC) CU = (P - UVC) (FC / CU) (FC / CM*)
Scenario #1 $5.00 $2.00 $40,000 $3.00 13,333 units $66,667
Scenario #2 $4.00 $2.00 $30,000 $2.00 15,000 units $60,000
Scenario #3 $5.00 $1.50 $30,000 $3.50 8,571 units $42,857
* Contribution margin (CM) = [(P – UVC) ÷ P]

Break-Even Analysis: With Profit Goal
• A modified break-even analysis is used to

incorporate a profit goal
• To incorporate a ‗profit goal‘ in the break-even
formula, treat it as an additional fixed cost
Total Dollar Profit

Fixed Costs + Goal
Unit Volume
to Achieve =
Profit Goal Contribution
Per Unit
Break-Even Analysis: With Profit Goal
Example: Unit Selling Price = $25; Unit VC = $10; Total FC =

$200,000; Profit Goal = $20,000
Unit Break-Even Volume $200,000 + $20,000

with Profit Goal =
$25 – $10
Unit Break-Even Volume

with Profit Goal = 14,667 units
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Break-Even Analysis: With a % of Profit Goal
• A profit goal can be specified as a % of sales rather than

as a dollar amount: Profit goal = 20% on sales
• To incorporate a profit goal in the break-even formula,

subtract the profit goal from the contribution per unit
Total
Fixed Costs
Unit Volume
to Achieve =
Profit Goal Contribution Dollar
Per Unit – Profit Goal
Break-Even Analysis: With a % of Profit Goal
Example:
Unit Selling Price (P) = $25; Unit VC (UVC) = $10
Total FC (FC) = $200,000; Profit Goal = 20% of P
Contribution per Unit = P- UVC
Unit
$200,000
Break-Even
Volume with = = 20,000 units
Profit Goal
[($25 – $10) – $5*]
* Dollar Profit Goal = (P × Profit Goal Percent on Sales) = $25 × 20%; $25 × .20 = $5
Multiple Product Break-Even Analysis
Break-even analysis can be extended to

situations that involve multiple products
− Determine the sales mix which is the relative
combination of products sold by a company
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Total
Unit Unit Contribution Total
Sales Selling Variable Contribution Per Unit Marketing
Mix Price – Cost = Per Unit TCU = Fixed Cost
Model (SM) (P) (UVC) CU = (P - UVC) SM × CU (FC)
Economy 3 $500 $300 $200 $600
Deluxe 1 $1,000 $500 $500 $500
Total 4 $1,100 $825,000
Weighted Average Total Total

Contribution = Contribution ÷ Sales = ($1,100 ÷ 4) = $275 per unit
Per Unit Per Unit Mix
Unit Total Weighted Average

Break-Even = Marketing ÷ Contribution = ($825,000 ÷ $275) = 3,000 units
Volume Fixed Cost Per Unit

Sales Model Unit Break-Even Volume Unit
Sales Weighted Average
Mix % (Total Unit B-E Volume of Selling
Model Mix Unit Selling Price
(3:1) 3,000 units × Sales Mix %) Price
Economy 3 75% 2,250 $500

Deluxe 1 25% 750 $1,000
Total 4 100% 3,000 $625
Economy Economy Deluxe Deluxe
[( )( )]
Total
Weighted Average
Unit Selling Price = Sales × Unit Selling + Sales
× Unit Selling
÷ Sales
Mix Price (P) Mix Price (P) Mix
Weighted Average
Unit Selling Price = [(3 × $500) + (1 × $1,000)] ÷ 4 = $625 per unit
Dollar Unit
Weighted Average
Break-Even = Break-Even ×
Unit Selling Price = (3,000 units × $625/unit) = $1,875,000
Volume Volume
CONTRIBUTION ANALYSIS:
PERFORMANCE MEASUREMENT
Product X Product Y Total
(10,000 units) (20,000 units) (30,000 units)
Unit price $10.00 $3.00
Sales revenue $100,000 $60,000 $160,000
Unit variable cost $4.00 $1.50
Total variable cost $40,000 $30,000 $70,000
Unit contribution $6.00 $1.50
Total contribution $60,000 $30,000 $90,000
Fixed costs $45,000 $10,000 $55,000
Net profit $15,000 $20,000 $35,000

• Which product is more profitable?
• Which product is more profitable on a unit-contribution basis?
• Should Product X or Product Y be dropped? Why or why not?
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CONTRIBUTION ANALYSIS :
ASSESSMENT OF CANNIBALIZATION
CONTRIBUTION ANALYSIS:
Cannibalization occurs when a firm obtains sales
revenue by diverting sales from one offering to
another.
Brand X: Brand Y:
Existing Opaque New Gel
White Toothpaste Toothpaste
Unit price $1.00 $1.10
Unit variable cost ‒$0.20 ‒$0.40
Unit contribution $0.80 $0.70
• Which product has the higher unit contribution?

• Why is this important?
Brand X: Brand Y:
Existing Opaque New Gel
Cannibalization Effect White Toothpaste Toothpaste
Brand X expected sales before Brand Y intro 1,000,000

Brand Y expected sales 1,000,000
Brand X units sales diverted to Brand Y – 500,000
Brand X per unit sales loss for each
Brand Y unit sold
– $0.10
Brand Y per unit sales gain $0.70
How will the intro of Brand Y affect the total contribution dollars of Brand X?
• Brand X total contribution lost? ($0.10/unit lost × 500,000 cannibalized units
from Brand X to Brand Y = – $50,000)
• Brand Y total contribution gained? ($0.70 unit contribution × 500,000 units of
Brand Y =+ $350,000)
• Financial effect of Brand Y intro? (Net contribution dollars = + $350,000 – $50,000 = $300,000)
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Unit Unit Contribution

Product
Volume Contribution Dollars
Brand X: Existing Opaque

White Toothpaste 500,000 $0.80 $400,000
Brand Y: New Gel Toothpaste
Cannibalized volume 500,000 $0.70 $350,000

Incremental volume 500,000 $0.70 $350,000
Subtotal 1,500,000 $1,100,000
Less: Original forecast volume
for Brand X—existing opaque
white toothpaste – 1,000,000 $0.80 – $800,000
Total + 500,000 + $300,000
LIQUIDITY AND WORKING CAPITAL
A firm‘s ability to meet ST financial

Liquidity
obligations within a budget year
Current Current
NWC = Assets – Liabilities
Current Consists of cash, A/R, prepaid expenses,

Assets inventory, etc.
Current
Liabilities Consists of S-T A/P, accruals, etc.
Managers must be aware of the impact of marketing

actions on NWC
OPERATING LEVERAGE
Operating leverage refers to the extent to which a

firm uses operating FC and operating VC
High
OL High total FC relative to total VC
Low Low total FC relative to total VC

OL
• The higher the OL, the faster the total profit will rise or fall
once sales volume rises or falls below break-even volume
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EXHIBIT 2.2: EFFECT OF OPERATING

LEVERAGE ON PROFIT
10% Increase 10% Decrease
Base Case
in Sales in Sales
High Fixed High Variable High Fixed High Variable High Fixed High Variable
Cost Firm Cost Firm Cost Firm Cost Firm Cost Firm Cost Firm
Sales $100,000 $100,000 $110,000 $110,000 $90,000 $90,000
Variable
$20,000 $80,000 $22,000 $88,000 $18,000 $72,000
Costs
Fixed
$80,000 $20,000 $80,000 $20,000 $80,000 $20,000
Costs
Profit $0 $0 $8,000 $2,000 ($8,000) ($2,000)

Profit of firms with higher fixed cost are more sensitive to sales.
DISCOUNTED CASH FLOW
Discounted Cash Flows are future CFs are

expressed in today’s CFs
− Incorporates the theory of TVM or PV analysis
− Premise: A dollar today is worth more than a dollar
tomorrow
DISCOUNTED CASH FLOW
Net Cash Cash Cash

= –
Flow Inflows Outflows
The interest/discount rate is defined by the

‗Opportunity Cost of Capital‘
The cost of earnings opportunities

The
forgone by investing in a business
Opportunity
with its attendant risk as opposed
Cost of
to investing in risk-free securities
Capital
such as Treasury bills
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EXHIBIT 2.3: APPLICATION OF DISCOUNTED CASH FLOW

ANALYSIS WITH A 15 PERCENT DISCOUNT FACTOR
Business A Business B
Discount Cash Cumulative Discounted Cash Cumulative Discounted
Year
Factor Flow Cash Flow Cash Flow Flow Cash Flow Cash Flow
0 1.000 ($105,000) ($105,000) ($105,000) ($105,000) ($105,000) ($105,000)
1 0.870 $25,000 ($80,000) $21,750 $50,000 ($55,000) $43,500
2 0.756 $35,000 ($45,000) $26,460 $55,000 $0 $41,580
3 0.658 $50,000 $5,000 $32,900 $60,000 $60,000 $39,480
4 0.572 $70,000 $75,000 $40,040 $65,000 $125,000 $37,180
5 0.497 $90,000 $165,000 $44,730 $70,000 $195,000 $34,790
Totals $60,880 $91,530
 Which business has the larger cumulative cash flow? Why is this important?
 Which business has the faster payback? Why is this important?
 Which business has the greater discounted cash flow? Why is this important?
CHAPTER 2: FINANCIAL ASPECTS OF

MARKETING MANAGEMENT
CUSTOMER
LIFETIME VALUE
CUSTOMER LIFETIME VALUE
The NPV of the stream of future

CLV profits expected over the customer‘s
lifetime purchases
The CLV calculation requires this information:
$M =
Sales
Revenue – ( Variable
Costs + Other Customer
Acquisition Costs )
• $M=Cash margin per customer
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The CLV formula is:
1
(CLV) = $M ×
1+i–r
• (i) = Interest rate used for discounting future CFs
• (r)= Retention rate, per-period probability that the customer will be retained
Example: $M = $2,000; i = 10%; and r = 80%. CLV is:

1
CLV = $2,000 ×
1.0 + 0.1 – 0.8
CLV = $6,666.67
Example: $M = $2,000; i = 10%; r = 80%;

g (constant growth rate) = 6%. CLV is:
1
CLV = $2,000 ×
1.00 + 0.10 – 0.80 – 0.06
CLV = $8,333.33
Marketing affects the customer margin ($M),

the retention rate (r), and the growth rate (g)
but not the interest rate (i)
Some firms modify the customer lifetime value (CLV)

formula to include the cost to acquire a customer (AC):
Customer
Lifetime 1
Value = $M × – AC
(CLV)
1+i–r
• This CLV calculation requires insight into a firm‘s

customer relationships
• The firm‘s customer database or industry norms are used
to determine per-period margin ($M) and retention rate (r)
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CHAPTER 2: FINANCIAL ASPECTS OF

MARKETING MANAGEMENT
PREPARING A
PRO FORMA
INCOME STATEMENT
PRO FORMA INCOME STATEMENT
Pro forma income statement is a projected

income statement showing projected revenues,
expenses, and net profit for a firm during a
specific planning period
− Includes a sales forecast, VC and FC
− Reflects a marketer’s expectations (sales) given certain
inputs (costs)

CATEGORIES OR LINE ITEMS
• Sales are the forecasted unit volume times unit

selling price
• COGS is the costs incurred in buying or producing
offerings, which:
− Are constant per unit within certain volume ranges
− Vary with total unit volume
• Gross margin or gross profit is the remainder after

COGS has been subtracted from sales
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CATEGORIES OR LINE ITEMS
• Marketing expenses are the programmed expenses

budgeted to produce sales
• General and administrative expenses (overhead)

are the committed FC for the planning period, which
cannot be avoided if the organization is to operate
• NI before taxes or net profit before taxes is the

remainder after all costs have been subtracted from
sales
EXHIBIT 2.4: PRO FORMA INCOME STATEMENT FOR

THE 12-MONTH PERIOD ENDED DECEMBER 31, 2006
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/equipment $20,000
Interest expense $5,000
Property taxes and insurance $5,000
Other administrative expenses $5,000 $155,000
Net profit before (income) taxes $45,000
All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without the prior written
permission of the publisher. Printed in the United States of America.
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10/8/2021

CHAPTER 2 Financial Aspects of

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-1

AFTER READING THIS CHAPTER

1. Define accounting and financial

2. Describe how pro forma income

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-2

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-3

Sales Administrative/ Commissions/

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-4

Expenses that are uniform per unit of output

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-5

Are divided into two categories:

Cost of Materials, labor, and factory overhead

Other Variable expenses are not tied to

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-6

Costs that are fixed and do not fluctuate with

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-7

Divided into two categories:

Marketing costs that generate sales,

Committed Costs that maintain the firm, such as

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-8

Some costs have both a variable and fixed

• Fixed component: Salary

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-9

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-10

RELEVANT AND SUNK COSTS

Expenditures that are expected to occur in

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-11

RELEVANT AND SUNK COSTS

Past expenditures for a given activity that

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-12

RELEVANT AND SUNK COSTS

Biman pilot denied entry in Qatar for not carrying

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-13

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-14

• Is the difference between the selling price and

• Is expressed on a total volume or individual

• Consists of three types:

Gross Margin Trade Margin Profit Margin

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-15

Gross Margin/Gross Profit

• Is the difference between total sales revenue

• On a per-unit basis, is the difference between

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-16

Gross Margin/Gross Profit

Is expressed in dollars or percent:

Total Gross Margin Dollar Amount Percentage

Unit Gross Margin

Gross Margin/Gross Profit

• A decrease in gross margin can adversely

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-18

• Is the difference between unit sales price and

• Known as a markup or mark-on by channel

© 2020 Pearson Education, Inc. publishing as Prentice Hall Slide 2-19

Example: Selling Price = $20; Cost = $10; Margin = $10

Retailer Margin as a Retailer Margin as a

• Know the base (cost or selling price) for calculating margin

Work backward from the retail selling price through the

Wholesaler $2.88 $3.60 20.0%

Retailer $3.60 $6.00 40.0%

Net Profit Margin (Before Taxes) in an Income Statement

The remainder after COGS, other variable costs, and fixed