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MARKETING ARITHMETIC
When you finish this appendix you should
• Know what should be included in a marketing plan for
a typical organisation.
• Understand how the marketing plan is developed in a
logical and iterative manner.
• Be able to relate this process to a particular situation of
a product or service.
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Mar keting Arithmetic
701
Marketing students must become familiar with the essentials of the language of business.
Businesspeople commonly use accounting terms when talking about costs, prices and
profit, and using accounting data is a practical tool in analysing marketing problems.
T H E P R O F I T A N D L O S S S TAT E M E N T
A profit and loss statement is a simple summary of the financial results of a company’s
operations over a specified period of time. Some students may feel that the profit and loss
statement is complex but, as will soon be seen, this really is not true. The main purpose of
the profit and loss statement is to determine the net profit figure and to present data to support
that figure.
PROFIT AND LOSS STATEMENT
A simple summary of the
financial results of a company’s
operations over a specified
period of time
Figure 1
A profit and loss
statement
SMITH COMPANY
Profit and Loss Statement
For the Year Ended June 30, 199X
Gross sales . . . . . . . . . . . . . . . . .
Less: Returns and allowances
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold:
Beginning inventory at cost . . . . . . . . . . . . . . . . . . . . . .
Purchases at invoiced cost . . . . . . . . . . . . . . $310 000
Less: Purchase discounts . . . . . . . . . . . . . . . $40 000
Cost of goods available for sale .
Less: Ending inventory at cost .
$80 000
. . . . . . . .
290 000
. . . . . . . . . . . . . . . . . . . . . . . . . .
370 000
70 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total selling expense . . . . . . . . . . . . . . . . . . . . . . . .
Administrative expense
Office salaries . . . . . . . . . . . . . . . . . . . . . . . . . 30 000
Office supplies . . . . . . . . . . . . . . . . . . . . . . . . 10 000
Miscellaneous administrative expense . . . . . . . 5000
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
45 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net profit from operation .
300 000
200 000
100 000
. . . . . . . . .
Total administrative expense . . . . . . . . . . . . . . . . . . . . . . . .
General expense:
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . 10 000
Miscellaneous general expense . . . . . . . . . . . . . 5000
Total expenses .
$500 000
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross profit (gross margin) . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Selling expenses:
Sales salaries . . . . . . . . . . . . . . . . . . . . . . . . . . 60 000
Advertising expense . . . . . . . . . . . . . . . . . . . . 20 000
Delivery expense . . . . . . . . . . . . . . . . . . . . . . 20 000
Total general expense
. . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
Purchases at net cost . . . . . . . . . . . . . . . . . . . . . . 270 000
Plus inward freight . . . . . . . . . . . . . . . . . . . . . . . 20 000
Net cost of delivered purchases . . . . . . . . . . . . . . . . .
Cost of goods sold .
$540 000
40 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
160 000
$40 000
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Appendix D
A profit and loss statement for a wholesale or retail business is presented in Figure 1.
A complete and detailed statement is shown here so that the framework throughout the
discussion will be seen, but the amount of detail on a profit and loss statement is not
standardised. Many companies use financial statements with much less detail than here,
emphasising clarity and readability rather than detail. To understand a profit and loss
statement, however, one must know all of its components.
The main components of a profit and loss statement are sales, which come from the
sale of goods and services; costs, which come from the making and selling process; and
the balance, called profit or loss, which is just the difference between sales and costs.
Other items on a profit and loss statement are there only to provide supporting details.
There is no single time period that all profit and loss statements cover. Rather, statements are prepared to satisfy the needs of a particular business. This may be at the end
of each day or at the end of each week. Usually, however, a profit and loss statement
summarises results for one month, three months, six months or a full year. Since the time
period does vary, this information is included in the heading of the statement.
MANAGEMENT USES OF PROFIT
AND LOSS STATEMENTS
Before providing a more detailed discussion of the components of a profit and loss statement, consider some of the uses for such a statement. Figure 1 shows how it presents
much information in a clear and concise manner. With this information a manager can
easily find the relationship of net sales to the cost of goods sold, the gross profit,
expenses and net profit. Opening and closing inventory figures are available, as is the
amount spent during the period for the purchase of goods for resale. Total expenses are
listed to make it easier to compare these with previous statements and to help to control
these expenses.
All of this information is important to a company’s managers. Assume that a particular company prepares monthly profit and loss statements. A series of these statements is
a valuable tool for directing and controlling the business. By comparing results from one
month to the next, managers can uncover unfavourable trends in the sales, costs or profit
areas of the business and can then take any necessary action.
COMPONENTS OF A PROFIT AND
LOSS STATEMENT
Refer to Figure 1 and attempt to analyse it in order to obtain first-hand knowledge of the
components of the profit and loss statement.
As a first step, take all of the items that have dollar amounts extended to the third, or
right-hand, column. Using these items only, the profit and loss statement looks like this:
Gross sales . . . . . . . . . . . . . . . .
Less: Returns and allowances
Net sales . . . . . . . . . . . . . .
Less: Cost of goods sold .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$540 000
40 000
500 000
300 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
200 000
160 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$40 000
Gross profit . . . . . . . .
Less: Total expenses
Net profit (loss) .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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703
Is this a complete profit and loss statement? The answer is yes. This skeleton statement
differs from Figure 1 only in supporting detail; all the basic components are included. In
fact, the only items that must be listed to have a complete profit and loss statement are:
GROSS SALES
Net sales . . .
Less: Costs .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net profit (loss) .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$500 000
460 000
$40 000
These three items are the essentials of a profit and loss statement; all other subdivisions or details are just useful additions.
Now consider the meaning of the terms in the skeleton statement. The first item is
sales. The term gross sales is the total amount charged to all customers during some time
period. It is certain, however, that there will be some customer dissatisfaction or errors in
ordering and shipping goods. This results in returns and allowances, which reduce gross
sales.
A return occurs when a customer sends back purchased products. The company either
refunds the purchase price or allows the customer credit on other purchases.
An allowance occurs when a customer is not satisfied with a purchase for some reason. The company gives a price reduction on the original invoice (bill), but the customer
keeps the goods and services.
These refunds and price reductions must be considered when the company calculates
its net sales figure for the period. What is of interest is the revenue the company manages to retain. This is net sales—the actual sales dollars the company receives. Therefore
all reductions, refunds, cancellations and so on, made because of returns and allowances,
are deducted from the original total (gross sales) to get net sales. This is shown below:
The total amount charged
to all customers during
same period
RETURN
When a customer sends
back purchased products
ALLOWANCE
When a customer is not
satisfied with a purchase for
some reason
NET SALES
The actual sales dollars
the company receives
COST OF GOODS SOLD
The total value (at cost) of
Gross sales . . . . . . . . . . . . . . . .
Less: Returns and allowances
Net sales
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$540 000
40 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$500 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
the sales during the period
GROSS PROFIT
The money left to cover
The next item in the profit and loss statement—cost of goods sold (or cost of sales)—
is the total value (at cost) of the sales during the period. This calculation will be discussed
later. Meanwhile, note that after obtaining the cost of goods sold figure it is subtracted
from the net sales figure to get the gross profit.
Gross profit (or gross margin) is the money left to cover the expenses of selling the
products and operating the business. Companies hope that a profit will be left after
subtracting these expenses.
Selling expense is commonly the major expense below the gross profit. Note that in
Figure 1 expenses are all the remaining costs that are subtracted from the gross profit to
get the net profit. The expenses in this case are the selling, administrative and general
expenses.
Net profit is what the company earned from its operations during a particular period.
It is the amount left after the cost of goods sold and the expenses are subtracted from net
sales. Net sales and net profit are not the same. Many companies have large sales but no
profits—or they may even have losses! This is why it is important to understand and
control costs.
the expenses of selling the
products and operating
the business
EXPENSES
All the remaining costs that
are subtracted from the gross
profit to get the net profit
NET PROFIT
What the company earned
from its operations during
a particular period
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Appendix D
D E TA I L E D A N A LY S I S
COST OF GOODS SOLD FOR A WHOLESALE
OR RETAIL COMPANY
In Figure 1 it can be seen that beginning (or opening) and ending (or closing) inventory,
purchases, discounts received and freight inward are all necessary in calculating costs
of goods sold. If the cost of goods sold section is separated from the profit and loss
statement, it looks like this:
Cost of goods sold:
Beginning inventory at cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases (at invoiced cost). . . . . . . . . . . . . . . . . . . . . . . . . . . $310 000
Less: Discounts received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 000
. . . . . . . .
$80 000
Net cost of delivered purchases .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
290 000
Cost of goods available for sale .
Less: Ending inventory at cost .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases at net cost .
Plus: Freight inward .
Cost of goods sold .
DISCOUNT
A reduction of the original
invoice amount for some
business reason
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$270 000
20 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$370 000
70 000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$300 000
The inventory figures merely show the cost of goods on hand at the beginning and
end of the period the statement covers. These figures may be obtained by a physical
count of the goods on hand on these dates or they may be estimated by ‘perpetual inventory’ records that show the inventory balance at any given time. The methods used in
determining the inventory should be as accurate as possible because these figures affect
the calculated cost of goods sold during the period, and net profit.
The net cost of delivered purchases must include freight charges and discounts received
since these items affect the money actually spent to buy goods and bring them to the
place of business. A discount is a reduction of the original invoice amount for some business reason; for example, a cash discount may be given for prompt payment of the
amount due. The total of such discounts is subtracted from the original invoice cost of
purchases to obtain the net cost of purchases. To this figure are added the freight charges
for bringing the goods to the place of business. This gives the net cost of delivered
purchases. When the net cost of delivered purchases is added to the beginning inventory
at cost, the total cost of goods available for sale during the period is obtained. The ending inventory at cost is subtracted from the cost of the goods available for sale to obtain
the cost of goods sold.
One important point should be noted about cost of goods sold. The way the value of
inventory is calculated varies from one company to another and can cause significant differences in the cost of goods sold and the profit and loss statement. (See any introductory accounting textbook to learn how the various inventory valuation methods operate.)
COST OF GOODS SOLD FOR A
MANUFACTURING COMPANY
Figure 1 shows the way in which the manager of a wholesale or retail business arrives at
his or her cost of goods sold. Such a business purchases finished products and resells
them. In a manufacturing company, the ‘purchases’ section of this profit and loss
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Mar keting Arithmetic
705
statement is replaced by a section called ‘cost of production’. This section includes purchases of raw materials and parts, direct and indirect labour costs, and factory overhead
charges (such as heat, light and power) that are necessary to produce finished products.
The cost of production is added to the beginning finished products inventory to arrive at
the cost of products available for sale. Often, a separate cost of production statement is
prepared and only the total cost of production is shown in the profit and loss statement.
See Figure 2 for an illustration of the cost of goods sold section of a profit and loss
statement for a manufacturing company.
Figure 2
Cost of goods sold:
Finished products inventory (beginning) . . . . . . . . . . . . . . . . . . $20 000
Cost of production (Schedule 1). . . . . . . . . . . . . . . . . . . . . . . . 100 000
Total cost of finished goods available for sale: . . . . . . . . . . . . . . 120 000
Less: Finished products inventory (ending). . . . . . . . . . . . . . . . 30 000
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $90 000
Schedule 1, Schedule of cost of production
Beginning work in process inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 000
Raw materials
Beginning raw materials inventory . . . . . . . . . . . . . . . . . . . . . . . 10 000
Net cost of delivered purchases . . . . . . . . . . . . . . . . . . . . . . . . . 80 000
Total cost of materials available for use . . . . . . . . . . . . . . . . . . . . 90 000
Less: Ending raw materials inventory . . . . . . . . . . . . . . . . . . . . 15 000
Cost of materials placed in production . . . . . . . . . . . . . . . . . 75 000
Direct labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 000
Manufacturing expenses
Indirect labour . . . . . . . . . . . . . . . . . . . . . . . $4000
Maintenance and repairs . . . . . . . . . . . . . . . . . 3000
Factory supplies . . . . . . . . . . . . . . . . . . . . . . . 1000
Heat, light, and power. . . . . . . . . . . . . . . . . . . 2000
Total manufacturing expenses . . . . . . . . . . . . . . . . . . . . . . . 10 000
Total manufacturing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 000
Total work in process during period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 000
Less: Ending work in process inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 000
Cost of production. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100 000
EXPENSES
Expenses go below the gross profit line. They usually include the costs of selling and the
costs of administering the business, but not the cost of goods sold—either purchased or
produced.
There is no ‘right’ method for classifying the expense accounts or arranging them
on the profit and loss statement. They can just as easily be arranged alphabetically or
according to amount, with the largest placed at the top and so on down the line. In a
business of any size, however, it is clearer to group the expenses in some way and to use
subtotals by group for analysis and control purposes, as was done in Figure 1.
Cost of goods sold
section of a profit and
loss statement for a
manufacturing company
▼
706
Appendix D
STATEMENT SUMMARY
The statement presented in Figure 1 contains all the major categories in a profit and loss
statement, together with a normal amount of supporting detail. Further detail can be
added to the statement under any of the major categories without changing the nature
of the statement. The amount of detail is usually determined by how the statement will
be used. A shareholder may be given a summarised profit and loss statement, while a
statement prepared for internal company use may have a lot of detail.
C A L C U L AT I N G T H E
I N V E N T O RY T U R N O V E R R AT E
INVENTORY
TURNOVER RATE
A measure of the number
of times the average
inventory is sold during
a year
A detailed profit and loss statement can provide the data needed to compute the inventory turnover rate, which is a measure of the number of times the average inventory is
sold during a year. Note that the inventory turnover rate is related to the turnover during
a year and not the length of time covered by a particular profit and loss statement.
The inventory turnover rate is a very important measure because it shows how rapidly
the company’s inventory is moving. Some businesses typically have slower turnover than
others, although a drop in turnover in a particular business can be worrying. It may
mean that the company’s assortment of products is no longer as attractive as it was, or
that the company will need more working capital to handle the same volume of sales.
Most businesses pay a lot of attention to the inventory turnover rate and try to achieve
faster turnover (and lower inventory costs).
Three similar methods can be used to calculate the inventory turnover rate. Which
method is used depends on the data available. These three methods, which usually give
approximately the same results, are shown below.*
(1)
Cost of goods sold
Average inventory at cost
(2)
Net sales
Average inventory at selling price
(3)
Sales in units
Average inventory in units
Calculating the inventory turnover rate will be illustrated only for formula (1) since
all approaches are similar. The only difference is that the cost figures used in formula
(1) are changed to a selling price or numerical count basis in formulae (2) and (3). (Note:
regardless of the method used, both the numerator and denominator of the formula must
be in the same terms.)
If the inventory level varies greatly during the year, detailed information about the
inventory level at different times is required to calculate the average inventory. If it
remains at about the same level during the year, however, it is easy to get an estimate. For
example, using formula (1), the average inventory at cost is calculated by adding the
* Differences occur because of varied mark-ups and non-homogeneous product assortments. In an
assortment of tyres, for example, those with low mark-ups might have sold much better than
those with high mark-ups. With formula (3), however, all tyres would be treated equally.
beginning and ending inventories at cost and dividing by 2. This average inventory
figure is then divided into the cost of goods sold (in cost terms) to obtain the inventory
turnover rate.
For example, suppose that the cost of goods sold for one year was $1 000 000, beginning inventory was $250 000 and ending inventory $150 000. Adding the two inventory
figures and dividing by 2, an average inventory of $200 000 is obtained. Next, the cost of
goods sold is divided by the average inventory ($1 000 000 divided by $200 000) and
results in an inventory turnover rate of 5.
The inventory turnover rate is covered further in Chapter 18.
O P E R AT I N G R AT I O S
Many businesspeople use the profit and loss statement to calculate operating ratios—
the ratio of items on the profit and loss statement to net sales—and compare these ratios
from one time period to another. They can also compare their own operating ratios with
those of competitors; such competitive data are often available through trade associations. Each company may report its results to the trade association, which then distributes summary results to its members. These ratios help managers to control their
operations. If some expense ratios are rising, for example, those particular costs are
singled out for special attention.
Operating ratios are calculated by dividing net sales into the various profit and loss
statement items that appear below the net sales level in the profit and loss statement. Net
sales is used as the denominator in the operating ratio because it shows the sales the
company actually obtained.
The relationship of operating ratios to the profit and loss statement becomes clear
if another column is included to the right of the dollar figures in a profit and loss
statement. This column contains percentage figures using net sales as 100 per cent. This
approach can be seen below:
Gross sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $540 000
Less: Returns and allowances . . . . . . . . . . . . . . . . . . . . . . . . . 40 000
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $500 000 . . . . . . . . . 100%
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 000 . . . . . . . . . . 60%
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $200 000 . . . . . . . . . . 40%
Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 000 . . . . . . . . . . 32%
Net profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40 000 . . . . . . . . . . . 8%
The 40 per cent ratio of gross profit to net sales in the above example shows that 40
per cent of the net sales dollar is available to cover sales expenses and the administration
of the business, and to provide a profit. Note that the ratio of expenses to sales added to
the ratio of net profit to sales equals the 40 per cent gross profit ratio. The net profit ratio
of 8 per cent shows that 8 per cent of the net sales dollar is left for profit.
The value of percentage ratios should be obvious. The percentages are easily calculated and much easier to compare than large dollar figures.
Note that because these profit and loss statement categories are interrelated, only a
few pieces of information are needed to estimate the others. In this case, for example,
knowing the gross profit percentage and net profit percentage makes it possible to calcu-
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Mar keting Arithmetic
707
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708
Appendix D
late the expense and cost of goods sold percentages. Further, knowing just one dollar
amount and the percentages allows one to calculate all the other dollar amounts.
MARK-UPS
MARK-UP
The dollar amount added to
the cost of goods sold
to obtain the selling price
A mark-up is the dollar amount added to the cost of goods sold to obtain the selling
price. The mark-up is usually similar to the company’s gross profit because the mark-up
amount added onto the unit cost of a product by a retailer or wholesaler is expected to
cover the selling and administrative expenses, and to provide a profit.
The mark-up approach to pricing is discussed in Chapter 18, so it will not be
discussed here at length, but a simple example illustrates the concept. If a retailer buys an
article that costs $1 when delivered to the store, the retailer must sell it for more than
this cost in order to make a profit. Therefore, 50 cents might be added onto the cost of
the article to cover selling and other costs and, it is hoped, to provide a profit. That
50 cents is the mark-up.
The 50 cents is also the gross profit from that item if it is sold. Note, however, that
it is not the net profit: the selling expenses may amount to 35 cents, 45 cents or even
55 cents. In other words, there is no guarantee that the mark-up will cover costs. Further,
there is no guarantee that customers will buy at the marked-up price. This may require
mark-downs, which are discussed later in this appendix.
MARK-UP CONVERSIONS
Often, it is convenient to use mark-ups as percentages rather than focusing on the actual
dollar amounts. However, mark-ups can be calculated as a percentage of cost or selling
price. For consistency, mark-up (per cent) will mean percentage of selling price unless
stated otherwise. Therefore the 50-cent mark-up on the $1.50 selling price is a mark-up of
331⁄3 per cent. On the other hand, the 50-cent mark-up is a 50 per cent mark-up on cost.
Some retailers and wholesalers use mark-up conversion tables or spreadsheets to convert from cost to selling price easily, depending on the mark-up on selling price that they
want. To see the interrelationship, look at the two formulae below. They can be used to
convert either type of mark-up to the other.
(4)
(5)
Per cent mark-up
on selling price
=
Per cent mark-up
on cost
=
Per cent mark-up on cost
100% + Per cent mark-up on cost
Per cent mark-up on selling price
100% - Per cent mark-up on selling price
In the previous example there was a cost of $1, a mark-up of 50 cents and a selling
price of $1.50. The mark-up on selling price was 33 ⁄3 per cent, and on cost it was
50 per cent. Substituting these percentage figures—in formulae (4) and (5)—will show
how conversion from one basis to the other can be made. Assuming that the mark-up on
selling price is known and needs to be converted to mark-up on cost, using formula (5),
one gets:
1
Per cent mark-up on cost
=
331⁄3%
=
100% - 33 ⁄3%
1
331⁄3%
662⁄3%
=
50%
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Mar keting Arithmetic
709
On the other hand, converting per cent mark-up on cost to mark-up on selling price is
as follows:
Per cent mark-up on selling price
50%
=
100% + 50
=
50%
= 331⁄3%
150%
It is important to recognise that only the percentage figures change while the money
amounts of cost, mark-up and selling price remain the same. Note, too, that when selling
price is the base for the calculation (100 per cent), then the cost percentage plus the
mark-up percentage equal 100 per cent. However, when the cost of the product is used
as the base figure (100 per cent), the selling price percentage must be greater than 100 per
cent by the mark-up on cost.
M A R K - D O W N R AT I O S
The ratios discussed above were concerned with figures on the profit and loss statement.
Another important ratio, the mark-down ratio, is a method used by many retailers to
measure the efficiency of various departments and their whole business. Note, however,
that it is not directly related to the profit and loss statement, but it requires special
calculations.
A mark-down is a retail price reduction that is required because customers will not
buy some item at the originally marked-up price. This refusal to buy may be due to a
variety of reasons, such as soiling, style changes, fading, damage caused by handling, or
an original price that was too high. To sell these products quickly, the retailer offers them
at a lower price.
Mark-downs are generally considered to be due to ‘business errors’, perhaps because of
poor buying, original mark-ups that are too high and other reasons. (Note, however, that
some retailers use mark-downs as a way of doing business rather than a way to correct
errors. For example, a store that buys out overstocked fashions from other retailers may
start by marking each item with a high price, and then reduce the price each week until
it sells.) Regardless of the reason, mark-downs are important to managers who want to
measure the effectiveness of their operations.
Mark-downs are similar to allowances because price reductions are made. Therefore,
in calculating a mark-down ratio, mark-downs and allowances are usually added together
and then divided by net sales. The mark-down ratio is calculated as follows:
Mark-down %
=
$ Mark-downs + $ Allowances
x 100
$ Net sales
The 100 is multiplied by the fraction to eliminate decimal points.
Returns are not included when calculating the mark-down ratio, as they are treated as
consumer errors rather than business errors.
Retailers who use mark-down ratios usually keep a record of the amount of markdowns and allowances in each department, and then divide the total by the net sales in
each department. Over a period of time, these ratios give management one measure of
the efficiency of buyers and salespeople in various departments.
It should be stressed again that the mark-down ratio is not calculated directly
from data on the profit and loss statement since the mark-downs take place before the
MARK-DOWN RATIO
Method used to measure
the efficiency of various
retail departments and
whole business
MARK-DOWN
A retail price reduction that is
required because customers
will not buy some item at the
originally marked-up price
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710
Appendix D
products are sold—in fact, some products may be marked down and still not sold. Even
if the marked-down items are not sold, the mark-downs—that is, the re-evaluations of
their value—are included in the calculations in the time period when these are taken.
The mark-down ratio is calculated for a whole department (or profit centre) and not
for individual items. What is required is a measure of the effectiveness of a whole department and not of how well the department performed on individual items.
RETURN ON INVESTMENT (ROI)
RETURN ON
INVESTMENT (ROI)
The ratio of net profit (after
taxes) to the investment
used to make the net-profit,
multiplied by 100
BALANCE SHEET
An accounting statement
that shows a company’s
assets, liabilities and
net worth
INVESTMENT
Another ‘off the profit and loss statement’ ratio is return on investment (ROI), which is
the ratio of net profit (after taxes) to the investment used to make the net profit, multiplied by 100 to eliminate decimals. ‘Investment’ is not shown on the profit and loss
statement but it is on the balance sheet, an accounting statement that shows a company’s assets, liabilities and net worth. It may take some searching or special analysis,
however, to find the right investment number.
Investment means the value of resources the company has invested in a project
or business. For example, a new product may require $4 million in additional funds
for inventory, accounts receivable, promotion, and so on, and its attractiveness may
be judged by its likely ROI. If the net profit (after taxes) for this new product is expected
to be $1 million in the first year, then the ROI is 25 per cent—that is, ($1 million ÷
$4 million) x 100.
There are two ways to calculate ROI. The direct way is:
ROI (in %)
=
Net profit (after taxes)
x
100
Investment
The value of resources the
company has invested in a
project or business
The indirect way is:
ROI (in %)
=
Net profit (after taxes)
Sales
x
Sales
x 100
Investment
This indirect way makes it clearer how to increase ROI. There are three ways in which
to do so:
1. increase profit margin (with lower costs or a higher price)
2. increase sales
3. decrease investment.
Effective marketing strategy planning and implementation can increase profit
margins and/or sales, and careful asset management can decrease investment. ROI is a
revealing measure of how well managers are performing. Most companies have alternative uses for their funds. If the returns in a business are not at least as high as outside
uses, then the money probably should be shifted to the more profitable uses.
Some companies borrow more than others to make investments. In other words, they
invest less of their own money to acquire assets. If ROI calculations use only the
company’s own investment, this gives higher ROI figures relative to those who borrow a
lot, which is called leveraging. To adjust for different borrowing proportions—that is, to
make comparisons among projects, departments, divisions and companies easier—another
ratio has come into use. Return on assets (ROA) is the ratio of net profit (after taxes) to
the assets used to make the net profit x 100.
Both ROI and ROA measures attempt to measure the same thing—that is, how effectively the company is using resources. These measures became increasingly popular as
profit rates dropped and it became more obvious that increasing sales volume does not
necessarily lead to higher profits, ROI or ROA. Inflation and higher costs for borrowed
funds also force more concern for ROI and ROA. Marketers must include these measures
in their thinking or top managers are likely to ignore their plans and requests for financial
resources.
Q U E S T I O N S
A N D
1. Distinguish between the following pairs of items that
appear on profit and loss statements:
(a) gross sales and net sales
(b) purchases at invoiced cost and purchases at net
cost.
2. Explain the similarity between mark-ups and gross
profit. What connection do mark-downs have with
the profit and loss statement?
3. Calculate the net profit for a company with the following data:
Beginning inventory (cost)
Purchases at invoiced cost
Sales returns and allowances
Rent
Salaries
Heat and light
Ending inventory (cost)
Freight cost (inwards)
Gross sales
$150 000
330 000
250 000
60 000
400 000
180 000
250 000
80 000
1 300 000
4. Construct a profit and loss statement from the following data:
Returns and allowances
Expenses
Clothing inventory at cost
Mark-downs
Freight inwards
Purchases
Net profit (5%)
$150 000
20%
600 000
2%
30 000
1 000 000
300 000
P R O B L E M S
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Mar keting Arithmetic
711
RETURN ON ASSETS (ROA)
The ratio of net profit (after
taxes) to the assets used to
make the net profit x 100
?
5. Calculate net sales and per cent of mark-downs for
the data given below:
Mark-downs
Gross sales
Returns
Allowances
6. (a) What
$40 000
400 000
32 000
48 000
percentage mark-ups on cost are
equivalent to the following percentage mark-ups
on selling price: 20, 371⁄2, 50 and 662⁄3?
(b) What percentage mark-ups on selling price are
equivalent to the following percentage mark-ups
on cost: 331⁄3, 20, 40 and 50?
7. What net sales volume is required to obtain an inventory turnover rate of 20 times per year on an average
inventory at cost of $100 000, with a gross profit of
25 per cent?
8. Explain how the general manager of a department
store might use the mark-down ratios calculated for
the various departments. Is this a fair measure? Of
what?
9. Compare and contrast return on investment (ROI)
and return on assets (ROA) measures. Which would
be best for a retailer with no bank borrowing or other
outside sources of funds—that is, the retailer has put
up all the money that the business needs?