When designing and delivering a product, the ultimate goal is to be able to sell it for more than it cost you to make it. If you sell something for less than the cost of making it, you will have no profit to show. In the case of a for-profit company, this is usually not the objective. So how can principles of finance be applied to your product design?
As you design to prepare a product to market, it is important that you understand the principles of finance. There are a lot of principles of finance, some apply to product design and some don’t. For this specific guide, we’ll focus on five principles of finance that are general in application.
What are those five principles?
- Cash Flow Matters
- Time Value of Money
- Principles of Risk and Return
- Market Prices is Key
- Conflicts of Interest Cause Problems
Cash Flow Matters
First, we’ll define cash flow. Cash flow is simply the cash flowing that flows in and out of the company. For example, if you spend $100 per month to run your business and make $200 per month from the business, you have a positive cash-flow of $100 per month. Obviously this is a very simple example to show a very simple principle
If you are a new company, understand that you will likely have negative cash flow for a while until you start selling your product, and even then it may be a little before you become profitable. Being profitable means that you are making more money than you are spending and that you have a positive cash flow. If you are a new company without any products in the market, there are basic things you need to understand about cash flow so that you can properly plan your design.
- How much money it will cost you to bring your product to market. This includes every aspect of the design process, including time and physical cost of goods unless you’re selling a SaaS or software product, which generally doesn’t have a physical cost but only a labor cost. Remember that this cost must be incurred before you start selling the product. You will need money (cash) on hand, and that will be your startup cost.
- How much you can sell? and at what price and at any time? This will help you determine when you will be able to start making profits.
In general, for startups, it takes a long time to make a profit because everything is being done from scratch.
These two principles are also important for existing companies that bring a new product or design to market, but the existing company often uses positive cash flow from other products to fund a new product. So, although it may take a while to reach positive cash flow on a new product, the company as a whole may have a positive cash flow overall.
Cash flow is perhaps the most important finance principle to understand while designing a new product. Without understanding this, you could run out of money and not be able to get the product to market or generate a positive cash flow.
Time Value of Money
The time value of money simply means that your employees cost something. You might not take into account someone’s time into the cost of designing a product, but there is a fact that “no one works for free”. There should be a monetary figure put on the people working on the product design, not just the physical cost of the product.
When you look at time as money, you have to keep in mind all the different people who touch the product. This can include engineering, product design, product marketing, finance, journalism, analyst relations, etc. The cost of all these salaries as a function of their time working specifically on that product should be taken into account through the design process.
For example, you don’t want to think that a product costs you $100 to produce and actually sell it for $105 because $100 only includes the cost of actually producing the product. You also need to look at the cost of these jobs split out around how many they’re expected to sell, and take that into account when you look at COGS, or cost of goods sold.
Principles of Risk and Return
The higher the risk, the higher the probability of return. This means that if you are launching a product that costs you a lot to make, you have the potential to make more money from it. This is great, but the key word is potential because there is a greater risk of losing more if the product does not work well.
Think of this in the terms of investments. If you invest 1 dollar and it doubles, you will earn 1 dollar; But if you invest $100 and double it, you will win $100. I’m sure you’ve heard the phrase “making money takes money”. This is the basis of this principle.
It is important to understand that you may need more capital up front to take on greater risk and potentially get a greater return.
Market Price is Key
This is a very simple but important finance principle: Market prices are right in general. If you’re putting a product on the market, you can generally price it similarly to other products in the market, plus or minus a bit depending on the features. However, if you are introducing a new category to the market, you will need to do market research to determine what the price should be.
The market will tell you what the favorable price, and you have to follow this principle. Although you may think that your product is worth much more, the market determines the price, and your job is to ensure that the design cost provides enough profit at the market price.
Conflicts of Interest Cause Problems
A conflict of interest occurs when people have conflicting end goals, whether personal or for the corporate, and allow this to interfere with financial decisions. This isn’t a huge concern when it comes to product design, but I think it’s very important to bring up. All product owners and designers need to work toward a common goal to help the company as a whole make money from the product. You can’t focus on what you want for yourself, but instead what’s best for the company’s success. It is important that the entire team is on the same page and that you are be able to guide the ship to ensure everyone buys.
Conclusion
As a product designer, you often have great and creative ideas, but producing the cost (including time and labor) and selling price must be taken into account. As we’ve discussed, understanding market prices in general will help you ensure that you’re on the right track with your pricing and cost.
Understanding these principles will help ensure the success of your product from design to sale. If you work for a for-profit company, you don’t want to design a product that you can’t sell for more than it costs you to make. These basic principles of finance will help your product become a profitable success.
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