Is it? Really?
It can be surprising how many people and companies do not consider this point before embarking on the development phase of a product and then their marketing campaigns. Too many times new products have been created but make a loss because the financial analysis elements of selling the products were not considered.
Picture the situation: Your number one customer loves the new product and wants to order many units. Only then do you realise that the margin being made on the product is unacceptable. What do you do?
- Sell the product at the agreed price and maintain the relationship with the customer but make less profit or even a loss on each sale?
- Go back to the customer and admit that you made a mistake with the pricing and risk damaging the relationship?
Neither of these are an enviable position to be in.
How Can This Situation Be Avoided?
Simple. Carry out some financial analysis before presenting the product to the customer.
If you are already aware of the bottom price that you can sell at you will be in a much stronger negotiation position.
What must be considered in a financial analysis to calculate an accurate profit margin?
- Target profit margin
- Product cost (inc materials and labour)
- Marketing costs
- Admin costs
- Distribution costs
- Customer specific costs
- Exchange rates – these can have a massive impact on your bottom line either positively or negatively.
Having an analysis file pre-populated with the key financial costs can save time in deciding if the selling price is reasonable, and more importantly, if you cannot reach the target profit margin are you a) willing to accept this or b) is there anything you can do recoup some of the lost margin?
Most of the cost elements of a financial analysis are driven by using budgets prepared previously and only the product costs, exchange rate and selling prices will change. However, a well-designed template will allow the user to make changes as necessary. Different customers may have different supply terms and discounts which need adding to the analysis. It is quite possible to sell the same product at the same price to two different customers but make a loss with one customer.
I once carried out a financial analysis for an eBay seller selling dummy clips. The seller was receiving lots of orders because their price was much lower than other sellers, yet they couldn’t understand why these sales weren’t translating into a positive cash flow.
After speaking with them and understanding the cost of the items to make the clips (bought in bulk) and the various financial charges imposed by eBay and PayPal it soon became apparent that the other sellers’ prices were much higher because that was the minimum needed to make an acceptable profit. I created a file that the seller could use to change their pricing to see the end profit margin. The result meant that they needed to increase their selling prices substantially just to break even.
Thankfully the seller realised something wasn’t right early in the process and avoided a financial loss by increasing their prices. This situation could have been avoided from the outset if they had taken more time with their financial analysis and considered all the various cost elements of their product.
The root cause of this problem was the seller not realising that even though they weren’t buying the various elements of the clips individually, the bulk purchases make a large hole in the cash flow when they need paying for. They were also not aware of how eBay and PayPal calculated their fees.