Product Launch and Evaluation
7.10 FINANCIAL EVALUATION
This consists of two parts: first the collection and control of the costs of launching, and second the recalculation of financial predictions to include the new information on sales revenue and costs from the launch.
A launch is always expensive. Costs can run away as people try to solve problems in production and marketing, while sales may grow more slowly than predicted. In small companies with inadequate working capital, this is where the company's outgoings exceed the limits to which the bank has agreed and the bank may place the company in receivership. But even with larger companies it may cause the product to be withdrawn before it has had time to develop a position in the market.
The short-run profitability can be determined, that is the payback time for the development and launch costs. If the launch has been a success the payback time may have been reached already, but in all cases the predicted time for payback will have become more accurate than the pre-launch predictions. If the launch is not going as predicted, an estimation of the additional working capital, additional capital expenditure and additional production and marketing costs is required, together with another calculation of the payback time to determine how much further it will be extended into the future.
Balancing the further expenditure, the payback time and the financial condition of the company are crucial at this time. When deciding to remove the product from the market altogether or to continue at reduced or full expenditure, up-to-date and accurate financial information is critical to the decisions.
The long-term financial analysis, carried out in the product commercialisation stage, can now be refined. The difference between the predicted pessimistic, most likely and optimistic cash flows will have become closer, the costs are becoming stabilised, the initial sales growth is history and the competitive reactions are apparent. With this information, the costs and sales revenues in future years can be estimated with some confidence.
Market predictions based on the earlier data and on the actual sales are made, using techniques such as time series analysis and moving averages. There are also predictions from the buyers' surveys, and from the company staff as a result of their experience in the launch. Comparing all these predictions is a good basis for forecasting the pessimistic, most likely and optimistic sales potentials for the next five years with their associated probabilities of achievement. The net present value, or the return on investment, can be calculated using discounted cash flows.
Very simple examples of payback time analysis and net present values are shown in Tables 7.2 and 7.3.
There are two predictions in Table 7.2, one made before the launch and one two months after the launch, to show how predictions need to be updated when actual sales and costs are available. The payback period is defined as the length of time required to recover the cost of the project. This is useful to control the cash flows but it is not helpful in choosing the project in the first place, as a project with long-term profits could be dropped.
To take into account the timing of the investment, costs and profits, discounted cash flows are used as in Table 7.3. Timing has a direct bearing on the profitability of the project. The objective of discounted cash flows (DCF) is to relate cash flows arising from the project to a common base year, normally the present; hence the name 'net present value’ (NPV). For a project, the discounted investments are subtracted from the discounted earnings to give the present value of the project as shown in Table 7.3.
Table 7.2 Predicted payback period for new product ‘A’
Table 7.3 Predicted cash flows and present value for new product ‘B’
The computation uses present value factors, which are calculated for various rates of return.
Present value = future value/(1+i)n where i is the interest rate and n the number of years; 1/(1+i)n is known as the discount factor.
In Table 7.3, 12% was used and the factors calculated using this gave a positive net present value, showing the project returned more than 12%. The actual DCF rate of return can be calculated by finding the rate where the earnings and the investment cash flows are equal, i.e. profits will just pay back the capital and the interest over the life of the project.
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