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Financial Analysis Control Tool Image of data charts and money

Financial Analysis Control Tool

Audio Version — 5:15

Financial Analysis Control Tool Explained

The fourth tool for measuring the annual control plan is the financial analysis control tool. This analysis tool looks at the relationship between the expense-to-sales analysis (ratio) and the overall financial framework to analyze where and how the company is making or losing money concerning marketing activities. In other words, it’s an analysis tool used to determine the efficiency of how a firm is using its assets to generate revenue. 

Companies efficient at generating revenue from their assets have a high asset turnover ratio. Whereas the opposite is true for firms that are not efficiently using their assets to generate sales, they have a low asset ratio.

Marketing managers and executives use the financial analysis tool to measure the return rate on their net worth.

The return on net worth is the product of two ratios: its return on assets and its financial leverage. The critical factors in determining the rate of return on net worth include:

    • Profit margin (net profits / net sales)
    • Asset turnover (net sales / total assets)
    • Return on assets (net profits / total assets)
    • Financial leverage (total assets / net worth)

There are two ways a company can improve the return on its net worth. They can:

  1. Increase its ratio of net profits to assets.
  2. Increase the ratio of assets to net worth.

Let’s take a look at an example of the financial analysis tool at work.

Financial Analysis Example

I will use a utility company for the financial analysis example. Utility companies strive to have an asset turnover ratio between 0.25 and 0.5. The higher the asset ratio, the more efficient the firm is in generating revenue or sales from assets. As a side note, utility and manufacturing firms often have a more extensive asset base, which results in a lower asset turnover. On the other hand, retail businesses tend to have small asset bases with a higher sales volume that lends itself to a high asset turnover ratio.

Taking a look at the diagram below — the Financial Model of Return on Net Wort — we can see that the asset turnover for our utility company is 0.5, which is within a normal range for a utility company. However, its profit margin is low at 3.2%, whereas the average profit margin for a utility firm hovers around 9%.

 

Financial Model of Return on Net Worth Formula Diagram

Financial Model of Return on Net Worth graphic chart

 

How to Improve Rate of Return on Net Worth

 

Before I discuss improving performance concerning the low-profit margin and average asset turnover in the utility company example, let’s address how the firm could improve its rate of return on net worth. I’ll examine the net worth first since the rate of return on net worth relates to the firm’s profit margin and asset turnover and the return on assets and financial leverage.

It’s important to note that the return on assets is the product of the profit margin and asset turnover ratio. The rate of return on net worth is the product of the return on assets and financial leverage. See the formula and calculation below for more information.

 If our rate of return of net worth is 2% in our example, then for a utility company, it appears low. To improve its return on net worth, the utility company must do one of two things in this scenario. They must increase their ratio of net profits to assets or increase the proportion of assets to net worth. To achieve their goal, they should analyze their asset composition to determine if it can improve its asset management. Some assets may include:

    • cash
    • accounts receivable
    • inventory
    • plant and equipment

As discussed above, the return on assets is the product of the profit margin and asset turnover ratios. Because the asset turnover, in our example, appears to be in the normal range for utility companies, but the profit margin is low, the marketing executive can improve performance by increasing the:

    1. Profit margin by increasing sales or cutting costs.
    2. Asset turnover by increasing sales or reducing assets (inventory and receivables) held against a certain level of sales.

Financial Analysis Calculations

There are several calculations for arriving at the Rate of Return on Net Worth in the diagram below. Use the Financial Model of Return on Net Worth above as a model for using the formulas below.

Financial Analysis Calculations

 

 

Summary

The financial analysis control tool is simple to use when calculating if a firm efficiently uses its assets to generate sales. A high asset ratio indicates that the company is financially efficient, and a low asset ratio indicates the opposite. The tool helps guide marketing executives who want to improve financial performance concerning sales for their companies. Two ways executives can improve performance. First, they can increase the profit margin by increasing sales through marketing programs or cutting costs to produce the product. Second, they can increase the asset turnover increasing sales volume or reducing assets such as inventory and receivables held against a certain level of sales.

futuristic image of analytics graph for marketing expense to sales analysis article

Marketing Expense-to-Sales Analysis

Audio Version — 5:03

Marketing Expense-To-Sales Analysis Explained

The marketing expense-to-sales analysis is one of four tools in the marketing annual control plan. As discussed in the article, The Marketing Control Process for your Business, the analysis is partly responsible for ensuring that a company reaches its financial goals. The ratio helps monitor marketing expenses, ensuring that a firm does not overspend on marketing to achieve its sales goals.

Many business leaders and marketing advisors tie marketing spending to industry benchmarks. However, the expense-to-sales analysis tool is a marketing control analysis tool and not a benchmarking tool because marketing drives sales and sales do not drive marketing spending.

When determining if a company is overspending on marketing to achieve its sales goal, the key metric to measure is the marketing expense-to-sales ratio. Other metrics a company uses and that make up the marketing to sales metric are:

    • Salesforce-to-sales ratio
    • Advertising-to-sales ratio
    • Sales promotion-to-sales ratio
    • Marketing research-to-sales ratio
    • Sales administration-to-sales ratio
Practical Application Question

Can you think of other possible sales ratios that a company may use to calculate the expense-to-sales ratio?

Marketing Expense-To-Sales Analysis Scenario Example

We’ll take a look at an example of how the marketing sales-to-expense analysis may impact marketing decision-makers.

A fictional manufacturing company’s marketing sales-to-expense ratio is 40 percent. That is, the firm’s marketing expenses are 40 percent of its sales revenue. Five other metrics make up the total marketing expense-to-sales ratio. The ratios are:

    • Salesforce to sales (20 percent)
    • advertising to sales (6 percent)
    • sales promotion to sales (9 percent)
    • marketing research to sales (1 percent)
    • sales administration to sales (4 percent)

A benchmark for each ratio helps marketers monitor fluctuations in expenses. If expenses fall outside of the “normal” range in any of the sales ratios, there could be cause for concern. For example, if costs are rising, the firm may still have good control over expenses, and the occurrence is considered an anomaly or one-off event. On the other hand, the marketing team may have lost control over the expense, and further investigation into its cause is warranted.

To better monitor expense ratios, marketing managers need to monitor each ratios expenses using a control chart. For example, let’s explore the advertising-to-sales ratio for our manufacturing company example.

marketing expense to sales analysis advertising expense chart

 

The advertising-to-sales ratio, as noted in the manufacturing company example earlier, is 6 percent. Taking a look at the control chart for this ratio, we observe expenses fluctuate between the upper limit and lower limits, with an observation that expenses steadily increased beginning in the 8th period. Marketing managers should have noted the unusual pattern and rise in expenses. An investigation into the costs should have occurred before the 14th period when expenses rose beyond the upper limit.

 

Practical Application Question

Can you identify possible reasons why the advertising-to-sales expense ratio may be increasing?

 

Marketing-to-Sales Expense Calculation/Formula

The marketing-to-sales expense ratio, along with the other ratios, is relatively simple to calculate. To calculate, divide the total marketing spending by the total sales revenue and multiply the results by 100 to get a percentage. Exclude any revenue that is not associated with the sales activity. These revenues may include royalty earnings or interest and savings. The same calculation method applies to sales-to-advertising spending and the rest of the marketing expense-to-sales ratio components.

marketing expense to sales ratio formula

 

Example Calculation

For example, if a company’s marketing expense for a particular product is $40,000 and the company generates a total of $100,000 in sales revenue, the marketing expense-to-sales revenue is 40%.

 

Marketing to Sales Ratio: $40,000 / $100,000 (sales revenue) = .4 x 100 = 40%.

 

Summary

Using the marketing-to-expense sales ratio provides marketing managers with financial insights into how their marketing budgets perform in relation to the sales revenue. With lower ratios, the company has a higher profit-earning potential. However, marketers need to monitor the ratios using a control chart with upper and lower limits to ensure that marketing expenses do not get out of control. At the first sign of heightened costs, marketers need to investigate the causes in the rise of marketing spend.

The better the financial data supplied, the better the analysis and ability to decide a marketing campaigns’ effectiveness.

Market Share Analysis Header Image of Man review metrics and data

Market Share Analysis – Annual Plan Control

Audio Version — 6:41

Is Your Company or Product Leading or Trailing the Competition?

The market share analysis is another tool used as part of the marketing annual plan control and closely related to the sales analysis tool. Market share indicates how your company is doing in terms of unit or revenue sales compared to your competition. However, market share is perhaps the most overused and misused marketing metric. 

Experienced marketers downplay the role of market share or ignore it outright as their processes and ways of measuring success have evolved, making market share analysis irrelevant. However, if the metric is used correctly, in context, and for the right purpose — as with all metrics — then market share is a useful tool for short-term use.

Overall Market Share Analysis

Illustrated pie chart - hand drawn.There are several ways of calculating market share. The most common metric is the overall (or total) market share analysis. The overall market share is the percentage of a market in terms of either unit sales or sales revenue. In other words, it’s the company’s total units sold or revenue generated in comparison to the market’s competitors. 

Understanding the total market share helps marketing managers determine their total market growth or decline and helps them gain insights into trends for how customers make competitor selections. 

Organic sales growth (or the total market growth) costs a company less and is more profitable than the firm seeking to achieve growth by capturing competitor shares. However, losses in market share may signal long-term problems that require the firm to make strategic adjustments to its marketing plan. A company with a market share below a predetermined level may not be profitable, thus not a viable business. Also, firms can use shifts in their product market shares as leading indicators of future opportunities or potential competitive challenges. If a product’s market share dips below a specified level, marketers need to look at various scenarios to determine the cause for a drop in sales. Conversely, suppose sales surge, and the firm gains market share. In that case, this could indicate a problem with the competition or other potential scenarios that require closer analysis.

How Overall Market Share is Calculated

Calculating market share is a relatively simple process. However, gathering competitive data may prove arduous without the proper primary or third-party research data. Assuming that you have this data, market share is calculated in two ways, as mentioned earlier: unit sales and sales revenue.

Unit Market Share is the units sold by a firm as a percentage of total market sales. The formula for unit market share is:

Unit Market Share Formula

 

Revenue Market Share reflects the price of sold goods. The formula for calculating revenue market share is:

revenue market share formula

 

Relative Market Share Analysis — A Better Metric

sketch art of percent signUnlike total market share, which examines the whole market, relative market share analysis measures a firm’s market share related to its largest market competitor. Tracking relative market share over time gives you a benchmark and better understanding of what’s happening between you and your largest competitor. Relative market share allows marketing managers to compare relative market positions across different product markets.

A company or product tied for the lead with its largest competitor in the same market has a relative market share of 100-percent. Anything more than 100-percent indicates a market leader, and less than 100-percent shows the firm behind the market leader. The relative market share can help a company better understand its position or product position in the marketplace with more meaning than the total market share.

Relative market share calculation is similar to total market share. Calculated the metric by either the brand’s product units sold or revenue generated. The formula for the relative market share calculation is:

Relative Market Share Formula - Market Share Analysis

 

Market Share Analysis Challenges and Assumptions

Market Share Analysis Assumption Illustration of two men with question mark.While market share, precisely relative market share, is an excellent metric to measure your firm’s or brand’s leadership or lack of in a given market against competitors. It is not without challenges. Conclusions from market share analysis come with several assumptions. 

First, the assumption that external forces affect all companies in the same manner is often without merit. For example, the U.S surgeon general’s notice the harmful effects smoking has on the body depressed total cigarette sales but did not affect all companies equally.

The assumption that a firm’s performance should be judged against all firms’ average performance is not always correct. The best way to evaluate a company’s performance is against that of its closest competitor. 

The assumption that if a new firm enters the industry, then all existing firm’s market share may drop. A decline in market share does not necessarily mean that the company is performing worse than other companies. Share loss depends on what degree the new firm enters the company’s specific markets.

The assumption that a market share decline is deliberately engineered to improve profits. For example, marketing managers may drop unprofitable customers or products to reduce costs by driving up profits.

The final assumption is that market share can fluctuate for many minor reasons. For example, market share is affected by changes in promotional strategies because a massive promotional sale on a given date affects market share. It may also be affected by social and cultural phenomena like a sales spike for Ocean Spray Cran-Raspberry drink when a video went viral, showcasing a man skateboarding and consuming the beverage.

Summary

Market share is undoubtedly a critical metric to measure. However, marketing managers must throw caution to the wind when using the metric. In other words, marketing managers must use the metric correctly, in context, and for the right reason for it to be a useful analytical tool to guide marketing performance. While overall market share provides a high-level view of where the organization or organization’s product falls compared to the competition in the same market, relative market share is a better indicator of whether a firm or product is leading or lagging behind its closest competitor.

futuristic image of man using technology for sales analysis article

Sales Analysis – Annual Plan Control

Audio Version — 3:52

Sales Analysis

In the article titled The Marketing Control Process for your Business – Explained, I outline what marketing controls are: 

“Marketing control is a process where company management or executives analyze and assess their marketing activities and programs.”

Hand-drawn graph for sales analysis post - Allen StaffordThe marketing control process includes four types of marketing control, they are,

  • Annual plan control
  • Profitability control
  • Efficiency control 
  • Strategic control 

This post focuses on the sales analysis part of the annual control plan. The other three types of measuring tools that fall under the annual control plan include,

  • Marketing share analysis,
  • Marketing expense-to-sales analysis,
  • Financial analysis.

The sales analysis measures and evaluates the firm’s actual sales as it relates to its sales goals. The two types of analysis tools used are the sales-variance analysis and the micro-sales analysis.

Sales-Variance Analysis

A sales-variance analysis is a metric that measures the relative contribution of different internal and external factors to a discrepancy in sales performance. The ability to calculate and identify sales variance is an essential metric to understand so that the firm may address issues in expected sales deficiencies.  

Sales-Variance Example

Suppose a manufacturer planned on selling 2,000 units of Product A in the fourth quarter at $2.50 per unit. The expected total revenue is $5,000. At the end of the fourth quarter, 1,700 Product “A” units sold at $1.95 per unit for total revenue of $3,315. The following calculation shows the price decline in performance versus the price decline due to a volume decreasing. 

Sales-Variance Example Calculation

Variance due to price decline:($2.50 - $1.95) (1,700 units) = $93555.5%
Variance due to volume decline:($2.50) (2,000 - 1,700) = $75044.5%
$1,685100%

Metrics Analysis

Notice that almost half of the variance is due to a failure to achieve the volume target. The manufacturer needs to examine why sales failed to reach their expected sales volume. Possible reasons may include poor sales performance, lack of sales staff to cover a region, inferior quality product, or weak or no sales promotion activity. 

Micro-Sales Analysis

pie chart for micro-sales analysis articleThe micro-sales analysis examines specific products, sales regions or territories, and other measurable factors that underperformed the expected sales goals. For example, imagine that the manufacturer in our case above sells Product A into three regions. They set their sales goals for region one at 900 units, region two at 400 units, and region three at 700 units for the fourth quarter. However, the actual sales volumes were 800 units for region one, 498 units for region two, and 325 units for region three. Thus, the sales manager notices a 12% sales reduction for region one, a 22% increase in region two, and a dramatic 73% drop in region three sales.

From the data, the sales manager may come to several possibilities. They may conclude that the salesperson in region three is performing poorly, a new competitor entered the market in that region, or the product is priced too high for the market. Other possibilities may come into play as well.

Summary

The sales analysis is just one tool for managing marketing programs. When used to analyze sales volumes, marketers can learn if internal or external factors are to blame for sales volume deficiencies or surpluses. The data collected can help marketers make adjustments to existing marketing programs and incorporate them into new programs in new markets.