Garage door industry magazine for garage door dealers, garage door manufacturers, garage door distributors, garage door installers, loading docks, garage door operators and openers, gates, and tools for the door industry.
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42 International Door & Operator Industry™ MANAGEMENT infuence COGS, but most prominently, many (perhaps most) sellers miscalculate markup. The miscalculation process is simplistic and occurs quite easily. For example, a dealer targeting a 40% "markup" for a garage door system that has a landed cost of $660 (invoice cost plus inbound freight) will too often (unfortunately) make the following calculation: Garage Door System Cost = $660.00 Markup = 40.0% INCORRECT Markup Calculation: $660 (cost) x .4 (markup) = $264 (markup $) $660 (cost) + $264 (markup $) = $924.00 selling price If this calculation were displayed as a conventional income statement, it would look like this: Sales $ 924.00 Cost of Materials Used 660.00 Gross Margin 264.00 GM % of Sales 28.6% If the objective of the markup was to yield a 40% GM, it fell woefully short. What happened to the 40.0 percent? From a margin perspective it was never there because "markup" was incorrectly calculated as a percentage of cost! Gross Margin is always stated as a percent of selling price (or net sales), thus if markup is to approximate planned GM, it must be calculated as a percent of selling price, not as a percent of cost. Multiplying dollar cost by a percentage, then adding the result to the cost to arrive at a selling price is called a "mark- on" calculation. Let us hasten to note that the "mark-on" procedure may work well in a given business environment to get to a desired price level, but our subject here is margin, not pricing (albeit, "pricing" might be a good topic for another business tools series). However, it must be remembered that using "mark-on" divorces pricing from gross margin planning. With our focus on margin it is important to remember that Selling Price minus Cost equals Gross Margin, thus Selling Price is always 100% of the equation. If, as in this example, we determine that GM should be 40%, then cost must be 60% (100% minus 40% equals 60%). If we know the cost of the product ($660 in this example), and we have a target margin (expressed as a 40% markup), then the $660 represents 60% of the selling price. Stated arithmetically, $660 is 60% of what number? Garage Door System Cost = $660.00 Markup = 40.0%, thus Cost = 60% CORRECT Markup Calculation: $660 (cost) divided by .6 (1.0 minus the markup) = = $1,100.00 selling price If this calculation were displayed as a conventional income statement, it would look like this: Sales $ 1,100.00 Cost of Materials Used 660.00 Gross Margin 440.00 GM % of Sales 40.0% Let us emphasize that we are not recommending that he product be priced at $1,100 instead of $924 (after all, it is a hypothetical product in a hypothetical market). Rather, margin must be a central focus in the business planning process, thus markup percentage should approximate the target GM percentage of sales. In this example, if competitive conditions mandate a price in the range of $925 to $930, the $660 cost should be divided by .71 (1.0 minus markup target of .29), which will yield a selling price of $929.60. Many people fnd it awkward to divide cost dollars by the markup residual (1.0 minus markup percent stated as a decimal). A multiplication alternative to accomplish the same result is to create a convenient table wherein selling price is expressed as a ratio of markup to cost, plus one. In the preceding example, the 40% markup is two thirds of the 60% cost, or a ratio of .667. Adding 1 to the ratio produces a multiplier of 1.667. Multiply $660 by 1.667, and you get $1,100 (plus or minus a small rounding error). A table of typical markup to cost ratios (plus 1) can be set up as an easy reference for determining selling prices. The Pivotal Role of Margin in Breakeven Analysis Few analytic tools are as immediately transcendent as the calculation of a frm's breakeven point. This may sound excessive, but with one calculation management may determine the frm's absolute volume, margin and cost-control points (or for those of us who remember the depths the cold war, the "fail-safe" point). Like all fnancial indicators, the breakeven point changes continuously as competition, customer mix, job-site effciency and other variables change. Never the less, by knowing and applying breakeven analysis, management produces quantitative targets to guide planning and tactical response to change. (continued from page 40) Continued on page 44 1/24/14 10:51 AM