When you are 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 are selling something for less than the cost to make, you will not have a profit to show. In the case of a for-profit company, this is usually not the goal. So, how can the principles of finance apply to your product design?
As you are designing and preparing to deliver a product to market, it is important to understand the principals of finance. There are tons of principles of finance, and some apply to product design and some do not. For this specific guide, we are going to focus on Five Principles of Finance that are general in application.
What are those five principles?
First, we are going to define cash flow. Cash flow is very simply the cash flowing into and out of the business. For example, if you are spending $100 a month to run your business and making $200 a month from the business, you have a positive cash follow of $100 a month. Obviously, that is a very simple example, but it is really a very simple principle. However, it is a key one to understand as you go through the product design phase.
If you are a new company, you have to understand that you will likely have a negative cash flow for a while until you start to sell the product, and even then it may be a bit before you become profitable. Being profitable means you are making more money than you are spending and have a positive cash flow. If you are a new company without any products in market, there are basic things you need to understand about cash flow so you can properly plan for your design.
How much money it is going to cost you to bring your product to market. This includes every aspect of the design process, including time and the physical cost of goods unless you are selling a SaaS or software product, which generally does not have a physical cost but just a labor cost. Remember that this cost will need to be incurred before you start selling the product. You will need to have the cash on hand, and it will be your start-up cost.
How many you can sell, for what price and over what time. This will help you determine when you will be able to start making a profit.
Generally, for start-up companies, it takes a long time to turn a profit because everything is being done from scratch.
These two principles are also important for existing companies bringing a new product or design to market, but an existing company can often use positive cash flow from other products to fund a new product. Therefore, while you still might take a bit of time to reach a positive cash flow on a new product, the company as a whole might have a positive cash flow overall.
Cash flow is probably the most important finance principle to understand as you are designing a new product. Without understanding this, you could run out of money and never be able to get the product to market or achieve a positive cash flow.
Time value of money simply means that your people cost something. You might not take into account someone’s time in the cost of designing a product, but no one works for free. There needs to be a monetary figure put on the people working to design the product, not just the physical cost of the product.
As you look at time as money, you have yo consider all of the different people who are touching the product. That can include engineering, product design, product marketing, finance, press and analyst relations, etc. The cost of all of these salaries as a function of their time working specifically on this product must be taken into account through the design process.
For example, you don’t want to think the product costs you $100 to physically produce and sell it for $105 because the $100 only includes the cost to physically produce the product. You also need to look at the cost of these functions split out over how many you are expected to sell, and take that into account when you look at the COGS, or cost of goods sold.
The bigger the risk, the bigger the potential for return. That means if you are putting out a product that costs 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 bigger risk of losing more if the product does not do well.
Think about this in terms of investments. If you invest $1 and it doubles, you will make $1; but if you invest $100 and it doubles, then you make $100. I am sure you have heard the expression, "It takes money to make money." That is the basis of this principle.
What is important to understand is that you may need more up-front capital to take a bigger risk and potentially get a bigger return.
This is a very simple but important finance principle: Market prices are generally right. If you are bringing a product to market, you can generally price it similarly to other products in market, plus or minus a little depending on the features. However, if you are bringing a new category to market, you will need to conduct market research to determine what the pricing should be.
The market will tell you what the price should be, and you need to follow along with this principle. Even though you may think that your product is worth a ton more, the market determines the price, and it’s your job to ensure your design cost provides enough profit at the market price.
A conflict of interest occurs when people have conflicting end goals, whether personal or for the company, and they let this interfere with financial decisions. This is not a big concern when it comes to product design, but I do think it’s important enough to bring up. All product owners and designers need to be working toward a common goal to help the company as a whole make money on the product. You cannot be focused on what you want for yourself, but instead what is best for the company's success. It is important that the whole team is on the same page and that you are able to guide the ship to ensure buy-in from everyone.
As a product designer, you often have awesome and creative ideas, but the cost to produce (inclusive of time and labor) and the price to sell must be taken into consideration. As we discussed, understanding market prices will generally help you ensure that you are on track with your pricing and cost.
Understanding these principles will help ensure your product is a success from design to sale. If you are working for a for-profit company, you don’t want to design a product that you cannot sell for more than it cost you to make. These basic principles of finance will help your product be a profitable success.