Margin Analysis

Financial analysis is a key skill for any great Product Manager, yet it is one of the least discussed, taught, or blogged about. Maybe it’s because finances are not sexy or “the accounting team will handle it.” If you are CEO of your product, you had better have a handle on your products’ finances. As one of my bosses once said: “my management criteria begins and ends with ‘what will get me fired today?,’ and if the CEO asks me ‘what is the financial performance of my product?’ and I can’t answer it, that would be very bad.” Let’s make sure you don’t get fired.

If you’re in PM, you should already have a good high level understanding of P&L, markup, gross margin, COGS, and understand how to read a income statement, balance sheet, and cash flow statement. If you don’t, read the links above, and go buy a book called Finance for the Non-Financial Manager (Amazon, B&N). It will teach you all of the above, which should be 90% of what you need to know to get by and the rest will learn by necessity through your role, and it would be too specific for a book to teach anyway. The great thing about that 90% is that financial skills are highly transferable and you will take them with you to your next role.

Gross margin is a very interesting and important metric for your product. Wikipedia defines GM as:

Gross Margin

GM allows you to express your profit as percentage of your revenue. That is very important, because often your CFO will have a GM target for the company, and you will (and should) have a GM target for your product. GM is great because it sits between your cost and your price and allows you to model changes to both and understand the different outcomes.

To help you model your cost, price, and GM, here is a modeling tool you can download and play with.

ExcelUnified Margin Analysis Tool (20 Kb)

This calculator allows you to play with 3 scenarios:

  • Known Cost, Known Price Target, Unknown GM
  • Known Cost, Known GM Target, Unknown Price
  • Known GM Target, Known Price Target, Unknown Cost

In the first scenario, you know your COGS, and you know what price you want to hit – but what GM does that give you? Plug in the numbers and the calculator will model it for you. In the second scenario, you know your cost, and you know what GM you need, but what price do you have to charge to hit it? In the third scenario, you know what GM you want, and you know what price you want to charge based on the competition, but you need to find out how much in cost you can spend on the product. The last scenario is one you would use to help inform engineering before the product is developed, because there is no point in investing resources trying to build a product that can’t exceed $500 in cost if engineering takes one look at it and says it will cost $2000 to build.

Note that this tool is skewed towards my current role, which in consumer electronics hardware is focused on shiping boxes, so the mode of thinking is “unit based.” Also, if you have transcended cost plus pricing and are doing truly market based pricing, you would not need to rely on a tool like this to help you set a price, but you should still be checking your market based price against your cost to see if your GM is where you expect it to be. Also, we sell through 2-tiered distribution, so I’ve included the ability to model your price to distribution, distribution’s price to the dealer, and the dealer’s price to the buyer (“MSRP”).

What other tools are invaluable to your day-to-day? Send them to me and I will post them.

Previous Post Next Post

7 Comments

  • Reply Tom Grant April 8, 2008 at 11:43 am

    It’s probably worth noting that product groups in some companies see financial analysis as attractive as a big brimming bowl of Ebola virus. P&L and other sorts of indicators imply all sorts of nasty questions about the real success of the product.

    I’m not defending this behavior, which I think is indefensible. But I’m just saying, it exists.

  • Reply Joprotus July 11, 2008 at 8:53 am

    Hi, it’s a very informative article.

    I’ve been trying to download the excel file but it’s not there. How can I have a copy?

    Thanks,
    Joprotus

  • Reply Sami July 14, 2008 at 11:53 am

    The attached EXCELL file is missing

  • Reply Rabia March 29, 2009 at 1:37 pm

    Informative article, indeed.

    and about the first comment, P&L and other indicators “only” do not indicate the real success of the product. It doesn’t make their importance any less though. As much focus businesses need to put on non-financial indicators, we just cannot forget about financial ones as well.

  • Reply Bill July 14, 2010 at 9:46 am

    Just a quick clarification, there are several books with the same title you recommend “Finance for the Non-Financial Manager”. Who is the author of the version you’re recommending and what year was it published?

    Thanks!
    Regards,
    Bill
    whsarmstrong@gmail.com

  • Reply Mark July 28, 2010 at 4:21 am

    Thanks, Very helpful. Difficult to find anything on the subject on pricing that is simple and understandable.

    Regards,

    Mark

  • Reply Paul Young April 25, 2011 at 11:44 pm

    To those who are having trouble with the Excel file … it works for me… drop me an email (see about page) if you can’t get it and I’ll email it to you.

    @Bill – the book I have is an earlier edition of this one at Amazon: http://www.amazon.com/Finance-Non-Financial-Managers-Briefcase-Books/dp/0071413774/ref=sr_1_1?s=books&ie=UTF8&qid=1303796561&sr=1-1

    Best of luck all!

  • Leave a Reply