Finance and Business Case Essentials for Product Managers
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The document discusses key financial concepts and tools that are important for product managers to understand, including: - Three key financial statements: the income statement, balance sheet, and cash flow statement. - How to evaluate business cases and opportunities using metrics like return on investment, breakeven analysis, net present value, and sensitivity analysis. - The importance of building financial intelligence within one's team to make smarter decisions and effectively manage business performance. Regular training, meetings, and performance targets can help improve a team's financial literacy.
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Finance and Business Case Essentials for Product Managers
- 1. FINANCE AND BUSINESS CASE ESSENTIALS FOR PRODUCT MANAGERS VIKAS BATRA DEC 2015
- 2. WHY FINANCIAL INTELLIGENCE MATTERS? Enables you to manage business effectively • Measure, Track and Improve Business Performance • Assess financial health of suppliers, partners & customers Likelihood of Bonus/Salary Hike Readiness for Greater Responsibility
- 3. OUTLINE Key Financial Statements and Key Concepts Business Case, Example Building Financial Intelligence of your team Summary
- 4. KEY FINANCIAL STATEMENTS Income Statement • Profit or loss generated over a period of time Balance Sheet • Snapshot of the organization’s financial position at a specific point in time. • Assets, liabilities and equity Cash Flow Statement • Cash generated (Inflow) and cash used (Outflow) over a period of time
- 6. INCOME STATEMENT Multi-Step Product Design, Manufacturing… Business Operations … Financing, One-time transactions…
- 7. INCOME STATEMENT Internal Multi-Step Formats Assess effectiveness Target effectiveness Concepts Assumptions on Allocations Accrual Based Accounting.
- 8. BALANCE SHEET Snapshot of organization’s financial position at a specific point in time. Assets = Liabilities + Shareholder's Equity Simple View
- 10. DEPRECIATION Depreciation Allocating a portion of cost of an asset on Income Statement
- 11. CASH FLOW STATEMENT Cash generated (Inflow) and cash used (Outflow) over a period of time Generally Prepared by Indirect Method
- 12. FINANCIAL STATEMENT Don’t Tell you Everything Non-financial Health Customer Satisfaction Competitive Environment
- 14. BUSINESS CASE Weigh Benefits vs. Costs Tied to a decision Should we invest in an opportunity or not ?
- 15. BUSINESS CASE - STEPS • Identify all new revenues • Identify all costs to incurred to realize revenue. Identify any cost savings • Map out the timeline for expected revenues and costs • Assess impact to bottom line • Capture unquantifiable benefits and costs • Strategic fit with high-level organizational strategies, Win new business opportunity, Customer goodwill etc.
- 16. ASSESSING THE IMPACT • Return On Investment (ROI) • Breakeven Analysis • Net Present Value (NPV) • Sensitivity and Scenario Analysis
- 17. RETURN ON INVESTMENT (ROI) • Benefit (Return) received for every dollar invested • E.g. 4% => $4 earned for every $100 invested • Calculation • Net return = Total benefits – Total costs • ROI = Net return ÷ Cost of investment Definition of “Return” and “Cost” vary by context.
- 18. BREAKEVEN ANALYSIS Product units must be sold in order to recover investment Are the Sales Volume at assumed price point realistic? Calculation • Contribution margin per unit = Selling price per unit – variable cost per unit • Breakeven volume = Total Investment ÷ Contribution margin per unit
- 19. EXAMPLE Metric 2016 Units Sold 1500 Selling Price/Unit ($) 1,000$ Revenue ($) Units X Selling PriceUnit 1,500,000$ Cost of Goods Sold/Unit ($) Variable Cost/Unit (550)$ Total Cost of Goods Sold ($) Units X COGS/Unit (825,000)$ Contribution Margin/Unit($) Price/Unit - Variable Cost/Unit 450$ Contribution Margin($) 675,000$ Contribution Margin (%) Cont. Margin / Revenue 45% Fixed Cost - Product R&D Cost ($) (300,000)$ Purchase of Assets ($) (60,000)$ Fixed Cost - Allocations Selling, General & Administrative Costs($) (225,000)$ Operating Income/(Loss) ( $) Revenue - Costs 90,000$ Operating Margin/(Loss) (%) Operating Income / Revenue 6.0% Non-Operating Income/Loss Tax Expense ($) 35% (31,500)$ Net Income (After Taxes) 58,500$ Return on Investment (ROI) Net Income / (R&D + Assests) 16% Breakeven Point (Units) simple Fixed Costs / (Cont. Margin/Unit) 800
- 20. NET PRESENT VALUE Time value of money : A dollar you receive five years from now is worth less than a dollar you receive today • Dollar today can be invested, Inflation… Present Value Reduce the value of the dollar at rate every year (Discount Rate)
- 21. EXAMPLE Today Year 1 Year 2 Year 3 …. Year T $100 10% 100* ( 1 + 0.1) 100 * 1.1 110.00$ 110* (1 + 0.1) 100 * (1 + 0.1) * (1+ 0.1) 121.00$ 121 * ( 1 + 0.1) 100 * (1 + 0.1) * (1+0.1) * (1+ 0.1) 133.10$ … $100* ( 1 + 0.1) ^ T Value with Interest $100 110.00$ 121.00$ 133.10$ Interest at 10% Interest Rate Today Year 1 Year 2 Year 3 Year T Actual Value 100.00$ 110.00$ 121.00$ 133.10$ 110/ ( 1 + 0.1) 121 / ( (1+0.1) * (1+.1)) 133.1 / ( (1+0.1) (1+.1) (1+r) ) 110/1.1 Present Value 100.00$ 100.00$ 100.00$ Actual CashFlow $C0 $ C1 $ C2 $ C3 $C T … Present Value Cash Flow$ C0 C1 / ( 1 + r) C2 /( 1 + r) ( 1 + r) C3/ ( 1+r) (1 +r ) (1+r) $ C T / (1+r)^T Present Value at 10% Discount Rate
- 22. NET PRESENT VALUE (NPV) Time value of money : A dollar you receive five years from now is worth less than a dollar you receive today • Dollar today can be invested, Inflation… Present Value Reduce the value of the dollar at rate every year (Discount Rate) NPV Calculation: • Start with Incremental Cash Flows for every year, • Discount Cash Flows for each year to their respective Present Values. • Add them to get Net Present Value (NPV) NPV positive and no other investment => Invest. NPV close to zero or marginally positive => Judgement call
- 23. EXAMPLE Metric 2015 2016 2017 2018 2019 Total Units Sold 0 1500 3000 2000 1000 7500 Selling Price/Unit ($) 1,000$ 1,000$ 1,000$ 1,000$ Revenue ($) Units X Selling PriceUnit -$ 1,500,000$ 3,000,000$ 2,000,000$ 1,000,000$ 7,500,000$ Cost of Goods Sold/Unit ($) Variable Cost/Unit (550)$ (550)$ (550)$ (550)$ Total Cost of Goods Sold ($) Units X COGS/Unit -$ (825,000)$ (1,650,000)$ (1,100,000)$ (550,000)$ (4,125,000)$ Contribution Margin/Unit($) Price/Unit - Variable Cost/Unit -$ 450$ 450$ 450$ 450$ Contribution Margin($) -$ 675,000$ 1,350,000$ 900,000$ 450,000$ 3,375,000$ Contribution Margin (%) Cont. Margin / Revenue NA 45% 45% 45% 45% 45% Fixed Cost - Product R&D Cost ($) (500,000)$ (300,000)$ (50,000)$ (50,000)$ (50,000)$ (950,000)$ Purchase of Assets ($) (300,000)$ (300,000)$ Depriciation of the Asset($) 5 Year Fixed (60,000)$ (60,000)$ (60,000)$ (60,000)$ (60,000)$ (300,000)$ Fixed Cost - Allocations Selling, General & Administrative Costs($) -$ (225,000)$ (450,000)$ (300,000)$ (100,000)$ (1,075,000)$ Operating Income/(Loss) ( $) Revenue - Costs (560,000)$ 90,000$ 790,000$ 490,000$ 240,000$ 1,050,000$ Operating Margin/(Loss) (%) Operating Income / Revenue 6.0% 26.3% 24.5% 24.0% 14.0% Non-Operating Income/Loss Tax Expense ($) 35% -$ (31,500)$ (276,500)$ (171,500)$ (84,000)$ (563,500)$ Net Income (After Taxes) (560,000)$ 58,500$ 513,500$ 318,500$ 156,000$ 486,500$
- 24. EXAMPLE CASH FLOW STATEMENT 2015 2016 2017 2018 2019 Total Net Income (560,000)$ 58,500$ 513,500$ 318,500$ 156,000$ 486,500$ Depreciation Adjustment 60,000$ 60,000$ 60,000$ 60,000$ 60,000$ 300,000$ Total Cash Inflow (Sources) Net Income + Dep Adj. (500,000)$ 118,500$ 573,500$ 378,500$ 216,000$ 786,500$ Purchase of Assets.. (300,000)$ -$ -$ -$ -$ (300,000)$ Others…(Inventory, Accounts Receivable etc.) -$ -$ -$ -$ -$ -$ Total Cash Outflow(Uses) (300,000)$ -$ -$ -$ -$ (300,000)$ Net Cash Flow (Inflow - Outflow) Cash Inflow - Cash Outflow (800,000)$ 118,500$ 573,500$ 378,500$ 216,000$ 486,500$ Discounted Net Cash Flow(10%) Present Value of Cash Flow (800,000)$ 107,727$ 473,967$ 284,373$ 147,531$ 213,598$ Net Present Value (NPV) Sum of PV of Cash Flows 213,598$
- 25. SENSITIVITY AND SCENARIO ANALYSIS Sensitivity • Change in NPV with variation of an input • 10% decrease in price/unit => 19.5% NPV decrease • 10% increase in R&D Cost => 2.3% NPV decrease Scenario • Analysis for certain set of inputs • Most-Likely, Best-Case, Worst-Case Scenario
- 26. BUSINESS CASE - SUMMARY Business Case is as good as the assumptions made Business Case tell only part of the story. Do not ignore non- quantifiable items Does not replace Influencing Effort When comparing across business cases, watch for consistency Tracking and adjusting Business Case, as you go along is important • Sensitivity Analysis can identify areas
- 27. IMPROVING TEAM FINANCIAL INTELLIGENCE Benefits • Make Smarter Decisions • Understand logic behind goals set by senior management • Effective Management Steps • Informal training sessions • Regular “numbers/metrics” meetings • Targets in Performance Objectives • Buy In from leaders
- 28. REFERENCES • http://www.accountingcoach.com/ • Your Company’s Finance Department • Internet Search
- 29. SUMMARY • Financial Intelligence Matters • Don’t be scared by jargon • Work with your Finance/ CFO Controller • Financial Statements: Don’t have to memorize all terms/ ratios. • Understand metrics organization tracks/aims • Understand impact of your decisions to metrics • Use metrics to drive team behavior and effectiveness Finance is simple, based on common sense
- 30. FINANCE AND BUSINESS CASE ESSENTIALS FOR PRODUCT MANAGERS VIKAS BATRA DEC 2015
- 31. THANK YOU
- 32. BACK UP
- 33. CONCEPTS Accrual based Accounting : Income and expenses are reported on Income Statement when they are incurred, regardless of when cash is received or paid. Allocations are apportionments of costs to different buckets or departments within a company Depreciation Allocating a portion of cost of an asset on Income Statement
- 34. ASSESSING FINANCIALS • Ratio analysis. • A financial ratio is two key numbers from an organization’s financial statements expressed in relation to each other. • There are numerous kinds of financial ratios: • Profitability ratios • Operating ratios (including liquidity ratios and efficiency ratios) • Leverage ratios
- 35. INTERNAL RATE OF RETURN IRR is the Discount Rate at which the NPV of an investment equals zero If IRR > Expected Rate of Return then, make the investment.
Editor's Notes
- Objective of business to make money. You can help your organization make money and spend it wisely by reducing costs, increasing revenues, or both. Generally the authority to make decisions that have material impact financials come at a certain level. If you are aspiring to get to that position then demonstrating financial intelligence in your current role will improve you readiness to get into role. If you are scared of Finance you are not the only one. Math is mostly limited to adding subtracting and dividing. There is trig or calculus or any other topic in mathematics that may have found challenging in your high school days. Or any of topics in mathematics Finance has a lot jargon that makes is look scary. While in reality, behind the jargon, it is very simple and based on common sense. Cover some of the basic concepts. Don’t let jargon scare you. No one knows all the terms. Ask the definition or look it up.
- Offer three different perspectives on the organization’s financial performance Also called P&L, or Earning Statement or Statement of Operations. The balance sheet "balances" your organization’s assets and liabilities. Promises and agreements made with customers are balanced against promises and agreements made with vendors, lenders, and stockholders. Like a bank statement, it tells how much cash was on hand at the beginning of the period, and how much was on hand at the end of the period. It then describes how the organization spent its cash.
- The title always shows time interval. The problem with this is that we cannot see what is core business and what is non core. Re arrange the items. Create Ratios..
- Gross Profit measure The Product Design/Manufacturing etc. tied to the product. Operations : Marketing, Administrative. Etc.. Top Line and Bottom Line. Create Ratios.. Idea is to get view on different aspects of the business
- Reflect that state certain part of business.. You can use them to set goals, measure effectiveness of the certain parts of business. Allocation: Example of allocating cost of product management in COGS or not .. May impact the decision on the product. accrual accounting records revenues and expenses in the same time period based on their causal relationships. This enables managers to measure the business’s performance without including mistimed transactions that distort the reported figures. accrual accounting. Income and expenses are booked when they’re incurred, regardless of when payment from customers has actually been received or suppliers’ invoices have actually been paid. e.g. inventory, Accounts receivable, accounts payable. So what happens to inventory you bought.
- Balance sheet data is most helpful when you compare it with information from a previous year.
- Account Receivable and Inventory show up here due to accrual based accounting on P&L Balance sheet data is most helpful when you compare it with information from a previous year. What is happening the cash ? Goodwill,
- Why Cash Flow: Cash is a reality check. Cash doesn’t equal profit. Cash connects with everything else. company's income statement as our starting point. We then make adjustments to that figure to arrive at the cash amount. If all of a company's revenues were cash sales (no credit sales), and if the company paid out cash for all of its expenses, then net income would equal the cash from operating activities. However, since some of the revenues and expenses on the income statement were not cash transactions, we must include depreciation, gain or losses on sales of assets, and the changes in current assets and current liabilities. financial models are based upon cash flow The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
- Accrual: Example of Product Development Cost How you allocate costs has big ramifications. Bias isn’t inherently wrong; everyone just needs to understand the assumptions. It’s important that the rationale underlying the allocations is transparent to decision makers. Aspects of nonfinancial health—such as safety, employee engagement, and organizational decisiveness. Customer attitudes—including satisfaction with a company and its products, complaints, and intent to buy again from a business. Competitors’ actions—for example, the emergence of rivals from unexpected regions around the globe and small, seemingly harmless upstarts.
- Whether the Benefits Outweigh the Costs. Developing a new product, buying capital equipment, acquiring a provider, adding staff members etc..
- Cost/benefit analysis helps you figure out whether—over a given time frame—the benefits of a new investment will outweigh the associated costs. Identify the costs that would be incurred by the investment —up-front costs as well as later costs. Identify the new revenues the investment would produce New revenues could come from more customers or increased purchases from existing customers. Identify any cost savings to be gained. Cost savings might come from more efficient processes that require less time, or more accurate processes that reduce the number of errors or lost customers. (Because they can come from a variety of sources, cost savings can be harder to spot.) Identify impact on the bottom line. Determine how the new revenues and the costs associated with them will affect profit. Map out the timeline for expected costs and anticipated revenues. Figure out when you expect the costs to be incurred and in what increments. Determine when you expect to receive the benefits (additional revenues, cost savings) and in what increments. Evaluate unquantifiable benefits and costs. Examples include an increase in customer goodwill, a good strategic fit between the investment and high-level organizational strategies, and the ability to take on a new business opportunity.
- you should always weigh the relative merits of each investment against the consequences of not proceeding with the investment—the status quo. Don’t assume the cost of doing nothing is always high. Often, even when a new investment could generate significant benefits, the cost of doing nothing can be relatively low—making the status quo a worthwhile alternative to consider.
- ROI analysis has several advantages: It’s easy to convey to upper management. It reminds everyone that wise expenditures pay off financially. It adopts a long-term perspective. It helps you compare different investment options e.g. bonds The conventional way of calculating ROI has some limitations. For one thing, it doesn’t provide an accurate economic picture. That’s because it ignores the time value of money—the notion that any money received now is worth more than it would be worth in the future. Also, ROI reflects the rate of return over the life of the investment, not the annual rate of return. This is a problem because you can’t analyze it in terms of annual costs and thus easily compare it with other annual returns.
- team can make smarter decisions if they know something about the financial implications For instance, your employees would understand that they have different goals for this quarter not because some executive randomly picked those goals—but because the company’s financial situation has changed. If employees know the reason for changes in goals, they’ll likely be willing to adapt to the new situation. If they don’t understand the reason, they may wonder if management really knows what it’s doing. Sponsoring a one-time workshop or handing out an instruction booklet won’t be enough. Three strategies—applied on a regular basis—can help you build your people’s financial intelligence: Informal training sessions Regular “numbers” meetings Support from leaders
- because you might have a better way of allocating or making those estimates, than the accounting group does.
- Accrual: Example of Product Development Cost How you allocate costs has big ramifications. Bias isn’t inherently wrong; everyone just needs to understand the assumptions. It’s important that the rationale underlying the allocations is transparent to decision makers. Aspects of nonfinancial health—such as safety, employee engagement, and organizational decisiveness. Customer attitudes—including satisfaction with a company and its products, complaints, and intent to buy again from a business. Competitors’ actions—for example, the emergence of rivals from unexpected regions around the globe and small, seemingly harmless upstarts.
- In many instances, companies will set a hurdle rate—a minimum rate of return that all investments are required to achieve.