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Handout 16 Product Cost Analysis / Financial Viability Analyzing the financial viability of the proposed product involves calculating the expected revenue the product will generate (through interest and fee income, commissions, etc) to the costs incurred from delivering the product – both direct and indirect. Below is a rough break-even analysis what kind of sales volume the product would need to generate to cover a certain percentage of the institution’s fixed cost. The purpose of this financial analysis is to allow the institution to refine the product terms and features before it has been launched to make sure it can be sustained. Using the worksheet provided below, develop rough cost projections for your product. By repeating the sensitivity analysis, you can use this information to refine the price and terms of the proposed product. Worksheet 11: Estimating Break-Even A. Fixed Costs to be covered by the Product1 1. Direct staff expenses (e.g.: program managers, loan officers) 2. Indirect staff expense (e.g. President, accounting, legal) 3. MIS or other capacity upgrades 4. Marketing materials TOTAL COSTS TO COVER = 1 + 2 + 3 + 4 B. Marginal Contribution per Product 1. Average loan size or savings balance 2. Average term 3. Average repayment periods per loan 4. Average “spread” (price – cost of capital) 1 Deciding what portion of the fixed costs of operations your product will cover is a strategic one. There are no rules set in stone, but most common methods include estimating what proportion of staff efforts will be dedicated to this product or service, since salaries are one of the most significant expenses for microfinance institutions and prorating indirect costs by that percentage. © ACCION International This material is not to be used or reproduced without the express written consent of ACCION International. Handout 16 Break-Even Sales Volume = Total Fixed Costs of Design & Pilot Marginal Contribution per loan* * Marginal contribution equals financial margin times recovery rate (which 1 – delinquency rate). The financial margin per loan is a function of: average loan size average loan term average number of repayment periods per loan average net interest rate (price – weighted average cost of capital) The exact formula will depend on the method of interest rate calculations the MFI uses. MARGINAL CONTRIBUTION PER LOAN = method of interest rate calculations used by your institution, for example: FLAT: loan term (months) X monthly interest rate X principal amount DECLINING BALANCE: Payment = ______interest rate X Payment____ (1 – 1/(1+int rate)/# of periods) In order to understand the implications of the product on the organizational financial goals seriously consider the following points: 1. Compare break even sales volume with total potential market size. Is it realistic that your organization can capture enough of the potential market demand to reach the break-even sales volume? 2. If yes, how long do you think it would take your organization to reach break-even? 3. Do you have other sources of revenue to cover the costs of development in the interim? 4. How sustainable are these sources in case the product does not do as well as expected? If the financial projections indicate that the current product design might not be viable, you can conduct a “sensitivity analysis” to see if changing the terms (i.e, increasing interest rate or average loan term) impacts the break even time. © ACCION International This material is not to be used or reproduced without the express written consent of ACCION International. Handout 16 Finalizing the prototype design will involve balancing cost and profitability considerations with customer service, competitive strategy, and risk. This exercise will help you establish return goals for the pilot test or at least what information you need to gather to calculate more accurate financial projections. © ACCION International This material is not to be used or reproduced without the express written consent of ACCION International.