Question

Critically analyse how an accounting system may assist managers in identifying and selecting an appropriate entry market for a new product. You answer should pay particular attention to the roles of reverse income analysis in supporting such decisions.

Answer 1

An accounting system assists managers with following information:

• Costs associated with a particular product (product costing)
• Clearly identify the behaviour of costs (whether fixed or variable)
• Classify the costs between direct and indirect
• Identify hidden costs

When planning for launching a new product, a firm intends to know upfront:

• What all costs need to be incurred to bring the product into the market?
• What should be the desired profit margin?
• What will be the demand at different price points?
• What should be the right price point for the new product?

An accounting system assists managers in identifying and selecting an appropriate entry market for new product in the following manner:

• Based on past experience and entire manufacturing process, an accounting system helps manager identify and budget (or account) for all the costs that will go towards bringing the product into market
• Helps manager to figure out the expected cost structure: what proportion of cost will be fixed and variable?
• Helps manager to figure out direct and indirect costs
• Enables manager to perform reverse income statement analysis
  • All the operating costs are piled up
  • All the long term (capital) costs are piled up, such as research & development costs, initial investment, any other capital cost that are required to make the product perform
  • An amortisation or depreciation schedule is worked out for the capital costs
  • On top of the total costs, a profit margin is added to figure out what quantum of revenue will enable the company generate the kind of profits envisaged.
  • Thus a target revenue is calculated in a reverse manner and hence it's called reverse income statement.
  • In order to achieve the target revenue, a manger then tries to figure out the quantum of sales (volumes) that need to be generated.
  • Market assessment gives an idea of demand at different price points. Managers use this to find out what should be the right price point for the new product.
• Thus on the basis of target revenue and costs, manager then start identifying which markets will be able to absorb the price points and which markets will enable them to have the kind of cost structure they have in mind. For example, there is no point launching a product at a price of $ 1,000 / unit in a city where average monthly per capita income is $ 800.
• Similarly, in a place where tax structure is high, probably a company will not be able to generate the kind of margins it require unless costs are cut.

Thus, a good accounting system can assist managers in identifying the best market to enter for a new product.