Markdowns

Once the price of an item has been established, there is no guarantee that will represent the ultimate selling price. Downward adjustments of the selling price are often necessary to induce customers to buy. These are referred to as markdowns. The seller is in effect forced, perhaps because of overstocking or too high a selling price, to abandon the original price. Markdowns take the form of direct price reductions.

Example 1

A cell phone listing for $125 was marked down 25 percent. What is the new selling price?

Markdown  $125 X 25% = $31.25

Selling price $125 - 31.25  = $93.75

Turnover-Ratios for Inventory

The firm's investment in inventory also has a direct effect on its working capital. Excess inventory means that funds are tied up in inventory that could be used more profitably elsewhere. Also, additional cost are being incurred for storage, insurance, and property taxes, not to mention the danger of a price decline and obsolescence of goods.

Whenever any consideration is given to pricing and profit planning, it is important to consider the merchandise inventory turnover. This is the number of times the average inventory is sold during a year. The turnover shows how quickly the inventory is moving. Assuming that the company maintains a reasonable inventory for its type of business, a high turnover rate (such as for a grocery store) indicates that only a relatively small profit need be added to the price of each item to maintain a high profit overall. Turnover is also a good indication of the amount of working capital that needs to be tied up in inventory at one time.

Merchandise inventory turnover can be computed from the cost of goods sold section of the income statement. It should be noted, however, that the turnover is an annual rate and should not be computed from interim statements.

Merchandise inventory turnover =    cost of goods sold                
                                                    average merchandise inventory

*Beginning inventory + ending inventory / 2

Example 1

     Cost of Goods Sold:
     Merchandise Inventory, Jan. 1                 $10,000.00
     Net Purchases                                          88,000.00
     Merchandise Available for Sale                $98,000.00
     Merchandise Inventory, Dec. 31                15,000.00
     Cost of Goods Sold                                                       $83,000.00
        

Merchandise inventory turnover =  $83,000.00
($10,000 + 15,000) /2                    12,500.00

  = 6.64

In a retail business, such as a department store, turnover may effectively be computed either by departments or by classes of items. This can be accomplished by using the following turnover formula, which will yield approximately the same turnover rate as above:


Merchandise inventory turnover =            sales in units           
                                                      average inventory in units


Example 2

ShehGarLynn Dress Shop sells uniform in four sizes, small, medium, large, extra large, all of which sell for the same price. What is the turnover for each color as computed from the data below? What, if any, problems does reveal?


Size                Sales in Units                 Beginning Inventory                  End Inventory
Small                  800                                                140                                     120
Medium              900                                                200                                     150
Large                  600                                                 75                                      125
Extra Large         300                                                210                                    190

Small turnover   = 800 = 6.15
                            130

Medium turnover = 900 = 5.14
                               175

Large turnover  = 600  = 6
                           100

Extra Large  =     300 =  1.5

                           200

The Extra Large uniform should be eliminated because of its low rate of turnover.