Part 2- Product life-cycle price optimization in a nutshell

Hi all!

Apropos Part 1, I have few questions! Did you get the answers after sorting out my riddles? If not, don’t bother. I have excels here which will sort out all anomalies. This time I'm doing price optimization and in the next sequel, will demonstrate production optimization. Coming to serious business, there are few options for every business-

Plan A: Focus on earning profits. This involves maximizing revenue while minimizing costs.

Plan B: Aim to sustain operations but be prepared to shut down if necessary. Consider cost-cutting measures and efficiency improvements.

Plan C: Propose a new strategy to mitigate losses. Evaluate innovative approaches to turn things around. Plan C, which focuses on innovative strategies to mitigate losses and improve overall performance, is indeed inclusive within Plans A and B. By combining elements from both approaches, you can create a comprehensive strategy that optimizes revenue, minimizes costs, and enhances operational efficiency. Remember to adapt these plans based on your specific business context and market dynamics. Where ever you find MC=MR, it’s Plan C. We have examples of appraisals where it’s: Exact BEP Units; Above BEP Units; Below BEP Units; and Fixed units (1,000). Diligently recorded the results and pasted them into the worksheet for analysis. Having accurate data is crucial for making informed decisions.

To start with, I have meticulously formatted all necessary financial statements and started appraising them to find out the optimal price which can tally the balance sheet which you already have had seen in Part 1 and also to mitigate losses. I have devised a technique which is intriguing and this will minimize losses and maximize profits by reducing costs or prices only through few adjustments to Sales Mark-up. It is called as MC=MR=Profit Maximization.

Let’s delve into the concept of profit maximization using the MC=MR approach.

In economics, MC (Marginal Cost) represents the additional cost incurred by producing one more unit of a product, while MR (Marginal Revenue) is the additional revenue generated from selling one more unit. The goal of profit maximization is to find the output level where MC equals MR.

The condition for profit maximization is: MC=MR

When MC is greater than MR, producing more units would decrease overall profit. Conversely, when MR exceeds MC, increasing production would lead to higher profits.

However, my proposal deals with:

How to set BEP Units?

Reset Sales markup to 0% -> Clear working capital or don't-> Make Units as 0 or1000 or whatever you like depending upon your research-> Use Goal Seek objective cell as PBT or PAT cell -> Set it to 0 -> By changing variable cell as Sales Markup. Use Trunc() or Round() wherever necessary. View/Download Excel

Selling Above BEP Units- It’s fascinating how the drawings can appear positive for sales units above the Break-Even Point (BEP) units, indicating a lucrative bank balance. However, once the balance sheet is tallied, the drawings reveal the true magnitude of marginal revenue generated associated with the ₹20 sales price. I am happy with the results but when I suppressed MR and MC through a linear program ‘MR-MC=0’ in B24:U24 cells, it’s astonishing that Drawings propelled from -5,78,041/- to 24,86,136/- when the balance sheet is tallied. It’s fascinating to see the impact of suppressing MR and MC through the linear program ‘MR-MC=0’! The significant fall in drawings before and after tallying the balance sheet highlights the trade-off between immediate cash flow and price fluctuations. Indeed, selling at a lower price during challenging times can attract customers and benefit distributors.   View/Download Excel

In this scenario we sold 50,000 additional units over BEP Units and after implying MC-MR=0, the prices fell half for the whole bunch. In laymen terms, if your BEP Units are 10,000 and if 20/- is the selling price plus if you can plan an additional 10,000 Units, not only the additional units, but you'll also be able to sell the whole bunch of 20,000 Units at a price lower than 20/- and still retain nominal profits. This is a boon to consumers and an unprecedented strategy. Yes indeed! The MC=MR approach assumes an optimal output level where marginal cost equals marginal revenue. However, my programming highlights an alternative strategy—one that doesn’t require an optimal output but price (Solver is not able to output both). By adjusting prices for the entire batch of 20,000 units, you can still maintain nominal profits even at a lower selling price. Besides, MC=MR is propelled by many economic and forecasting factors, whilst this technique is purely analytical. 

Selling Below BEP Units: Indeed, the MC=MR approach often leads to optimal decisions. By equating Marginal Cost (MC) with Marginal Revenue (MR), businesses can find the sweet spot where profit is maximized just like in this case. But there is a catch here, the prices will hike in this scenario! Let’s see this example where I manufactured and sold 20,000 units below the BEP units. If our selling price is 20/-, then the company incurred losses consistently and the bank balance is negative. After tallying the balance sheet, the bank negative balance reduced to 25,52,645/- from -2,45,912/- but accounting loss persists. If we mitigate this by solving MC=MR, the prices rose to an average 51/- per unit from 20/-, losses converted to profits and drawings capacity rose. Which is not surprising to basic learners as well. View/Download Excel 

Selling Exactly At BEP Units: I broke-even when PBT=0. So, taxes added to losses but actual PBT remained 0 at 20/- price. The interplay between different financial metrics highlights the complexity of your business decisions. It’s remarkable how tallying the balance sheet can transform a slightly negative bank balance (-4,58,040.24/-) at the Break-Even Point (BEP) into a positive one (+24,06,118.00/-). Indeed, as the saying goes, “Cash is King”.  View/Download Excel

 (I'm leaving this as an assignment for you guys to try TR=TC and find out the results yourselves)

Selling Fixed at 10,000 Units:

Optimal Price Determination:

Use of Solver or optimization software to find the price that balances the company’s balance sheet. This involves considering costs, revenue, and profit margins.

Or, you can ensure that the chosen price aligns with market demand and competitive dynamics manually. View/Download Excel where I have worked on 10,000 units which is below the annual BEP units. Both Manual & Solver versions covered here.

Let’s delve into the details:

Competitor’s Price: Assuming the competitor sells their product at 20 per unit.

Company’s Costs: Considering the 5 Million predetermined costs related to Property, Plant, and Equipment (PPE).

Creditor Obligations: The company would owe creditors an amount of -66,70,210.96/-.

Working Capital Optimization: After Tallying the Balance sheet through adjustments to annual working capital requirement, the company’s repayment burden reduces to -38,86,064/-. It’s concerning that the company’s Profit After Tax (PAT) remains consistently negative, a loss of 3,39,060.55. This is the limitation we have if the price is 20/- and to address this there is no technique apart from using annual BEP units.

However, it’s impressive how Solver applied the predefined MC=MR equation to reduce losses.

MC=MR Equation: Before applying this, Costs are greater than Revenues.

By equating Marginal Cost (MC) to Marginal Revenue (MR), we found an optimal price point.

When costs exceed revenues, Solver adjusts prices upward to increase marginal revenue to set-off against marginal cost.

Resulting Profit: However there is a catch here. I have left the results plus TR-TC=0 results. During MC=MR, the results pasted is negative. However, after setting price and equating TR=TC, the negatives become positives with a price hike. 

The positive impact on profit demonstrates the effectiveness of this strategy.

Remember to monitor these adjustments over time and adapt as needed.  View/Download Excel

 

Author’s Note:

While the calculations of corporate taxes are accurate, I haven’t factored in carryforward losses, deferred tax assets (DTA) arising from them, or negative current taxes. Therefore, I’ve used the break-even point (BEP) based on profit before tax (PBT). Even with tax clerical errors, the philosophies outlined have proven to be true, and there’s no need to panic. The videos demonstrate the procedure, and the Excel files attached may have minor variations in numbers from videos, but those differences will precisely correspond to the tax amounts.

 Taxable income is PBT+ Disallowed expenses - Allowed expenses – Capital allowance. Under various sections of IT acts, there is 100% relief on Interest on loan and debentures. Also, loan commission & debenture issue costs are covered with 100% relief. Thus, no need to include them into the calculations.

2.      Similarly, no deferred taxes rose from them apart from carrying amounts of PPE & its capital allowance tax base. Used, Grant depreciation & WDV to calculate DTL.

3.       Did not set up Carryforward losses in this model but included settings like the current tax become 0 if tax expense is negative suggesting no need to pay taxes.

4.       Users can plan taxes as per their compliances and the philosophies will not vary.

5.       For best results, use optimization software like Frontline Solver for example.

6.       Drawings means what the investors took or might draw in the future. A negative balance might indicate how much the company still owes to investors. It’s simply the sum of bank closing balance + working capital repaid. For unknown reasons the closing balance can be higher even after funding capital. So, use an optimization software to balance it to zero. It’s ideal that Banks have some funds so that it can re-invest into working capital. All I’m writing about is the efficacy of MC-MR=0 equation which can metamorphose huge negative balance to a smaller one.

  It’s evident that you’ve carefully considered various aspects related to taxable income, tax relief, deferred taxes, and carryforward losses. Your attention to detail and thoughtful approach will undoubtedly contribute to effective financial planning here. Remember that each business context may have unique considerations, but my guidelines serve as a valuable starting point to optimization and budgeting. If you have any further questions or need assistance, feel free to reach out—I’m here to help! 😊

 The sad part is the content might not be appealing despite robust tech because no one can produce my content in the Hollywood. However, I tried my best here.  

Copyrighted to ©Yasaswi Gomes

 

Disclaimer: The analysis, techniques, and philosophies presented here are provided for informational purposes only. No claims or guarantees are made regarding their accuracy or applicability to specific situations. Always consult with a qualified professional for personalized advice tailored to your unique circumstances. Any misuse or unauthorized use of copyrighted material is not endorsed. Additionally, while constructive feedback is appreciated, criticism is not tolerated from any profession on this unprecedented publication.

 

 Note: All modifications have been completed, and in the next step, I plan to review them with a tax accountant to set up carryforward losses. If that’s not possible, we’ll still explore additional strategies.