Appendix 2: Marketing Arithmatic



Appendix 2: Marketing Arithmatic | |

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|[pic]|Operating Statement |

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| |Analytic Ratios |

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| |Markups and Markdowns |

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One aspect of marketing not discussed within the text is marketing arithmetic. The calculation of sales, costs, and certain ratios is important for many marketing decisions. This appendix describes three major areas of marketing arithmetic: the operating statement, analytic ratios, and markups and markdowns.

|[pic]|Operating Statement |

The operating statement and the balance sheet are the two main financial statements used by companies. The balance sheet shows the assets, liabilities, and net worth of a company at a given time. The operating statement (also called profit-and-loss statement or income statement) is the more important of the two for marketing information. It shows company sales, cost of goods sold, and expenses during a specified time period. By comparing the operating statement from one time period to the next, the firm can spot favorable or unfavorable trends and take appropriate action.

Table A2.1 shows the 2000 operating statement for Dale Parsons Men's Wear, a specialty store in the Midwest. This statement is for a retailer; the operating statement for a manufacturer would be somewhat different. Specifically, the section on purchases within the "cost of goods sold" area would be replaced by "cost of goods manufactured."

|[pic|TABLE A2.1 |OPERATING STATEMENT: DALE PARSONS MEN'S WEAR, YEAR ENDING DECEMBER 31, 2000 |

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|Gross sales |

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|$325,000 |

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|  Less: Sales returns and allowances |

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|    25,000 |

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|Net sales |

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|$300,000 |

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|Cost of goods sold |

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|  Beginning inventory, January 1, at cost |

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|$ 60,000 |

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|  Gross purchases |

|$165,000 |

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|  Less: Purchase discounts |

|    15,000 |

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|  Net purchases |

|$150,000 |

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|  Plus: Freight-in |

|    10,000 |

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|  Net cost of delivered purchases |

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|$160,000 |

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|  Cost of goods available for sale |

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|$220,000 |

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|  Less: Ending inventory, December 31, at cost |

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|$ 45,000 |

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|    Cost of goods sold |

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|$175,000 |

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|Gross margin |

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|$125,000 |

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|Expenses |

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|  Selling expenses |

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|  Sales, salaries, and commissions |

|$ 40,000 |

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|  Advertising |

|5,000 |

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|Delivery |

|      5,000 |

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|    Total selling expenses |

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|$ 50,000 |

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|Administrative expenses |

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|  Office salaries |

|$ 20,000 |

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|  Office supplies |

|5,000 |

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|  Miscellaneous (outside consultant) |

|      5,000 |

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|    Total administrative expenses |

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|$ 30,000 |

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|General expenses |

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|  Rent |

|$ 10,000 |

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|  Heat, light, telephone |

|5,000 |

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|  Miscellaneous (insurance, depreciation) |

|      5,000 |

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|    Total general expenses |

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|$ 20,000 |

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|      Total expenses |

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|$100,000 |

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|Net profit |

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|$ 25,000 |

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The outline of the operating statement follows a logical series of steps to arrive at the firm's $25,000 net profit figure:

|Net sales |$300,000 |

|Cost of goods sold |-175,000 |

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|Gross margin |$125,000 |

|Expenses |-100,000 |

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|Net profit |$ 25,000 |

The first part details the amount that Parsons received for the goods sold during the year. The sales figures consist of three items: gross sales, returns and allowances, and net sales. Gross sales is the total amount charged to customers during the year for merchandise purchased in Parsons's store. As expected, some customers returned merchandise because of damage or a change of mind. If the customer gets a full refund or full credit on another purchase, we call this a return. Or the customer may decide to keep the item if Parsons will reduce the price. This is called an allowance. By subtracting returns and allowances from gross sales, we arrive at net sales—what Parsons earned in revenue from a year of selling merchandise:

|Gross sales |$325,000 |

|Returns and allowances |-25,000 |

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|Net sales |$300,000 |

The second major part of the operating statement calculates the amount of sales revenue Dale Parsons retains after paying the costs of the merchandise. We start with the inventory in the store at the beginning of the year. During the year, Parsons bought $165,000 worth of suits, slacks, shirts, ties, jeans, and other goods. Suppliers gave the store discounts totaling $15,000, so that net purchases were $150,000. Because the store is located away from regular shipping routes, Parsons had to pay an additional $10,000 to get the products delivered, giving the firm a net cost of $160,000. Adding the beginning inventory, the cost of goods available for sale amounted to $220,000. The $45,000 ending inventory of clothes in the store on December 31 is then subtracted to come up with the $175,000 cost of goods sold. Here again we have followed a logical series of steps to figure out the cost of goods sold:

|Amount Parsons started with (beginning inventory) |$ 60,000 |

|Net amount purchased |+150,000 |

|Any added costs to obtain these purchases |+ 10,000 |

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|Total cost of goods Parsons had available for sale during year |$220,000 |

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|Amount Parsons had left over (ending inventory) |- 45,000 |

|Cost of goods actually sold |$175,000 |

The difference between what Parsons paid for the merchandise ($175,000) and what he sold it for ($300,000) is called the gross margin ($125,000).

In order to show the profit Parsons "cleared" at the end of the year, we must subtract from the gross margin the expenses incurred while doing business. Selling expenses included two sales employees, local newspaper and radio advertising, and the cost of delivering merchandise to customers after alterations. Selling expenses totaled $50,000 for the year. Administrative expenses included the salary for an office manager, office supplies such as stationery and business cards, and miscellaneous expenses including an administrative audit conducted by an outside consultant. Administrative expenses totaled $30,000 in 2000. Finally, the general expenses of rent, utilities, insurance, and depreciation came to $20,000. Total expenses were therefore $100,000 for the year. By subtracting expenses ($100,000) from the gross margin ($125,000), we arrive at the net profit of $25,000 for Parsons during 2000.

|Analytic Ratios |

The operating statement provides the figures needed to compute some crucial ratios. Typically these ratios are called operating ratios—the ratio of selected operating statement items to net sales. They let marketers compare the firm's performance in one year to that in previous years (or with industry standards and competitors in the same year). The most commonly used operating ratios are the gross margin percentage, the net profit percentage, the operating expense percentage, and the returns and allowances percentage.

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Another useful ratio is the stockturn rate (also called inventory turnover rate). The stockturn rate is the number of times an inventory turns over or is sold during a specified time period (often one year). It may be computed on a cost, selling price, or units basis. Thus the formula can be

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or

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or

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We will use the first formula to calculate the stockturn rate for Dale Parsons Men's Wear:

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That is, Parsons's inventory turned over 3.3 times in 2000. Normally, the higher the stockturn rate, the higher the management efficiency and company profitability.

Return on investment (ROI) is frequently used to measure managerial effectiveness. It uses figures from the firm's operating statement and balance sheet. A commonly used formula for computing ROI is:

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You may have two questions about this formula: Why use a two-step process when ROI could be computed simply as net profit divided by investment? What exactly is "investment"?

To answer these questions, let's look at how each component of the formula can affect the ROI. Suppose Dale Parsons Men's Wear has a total investment of $150,000. Then ROI can be computed as follows:

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Now suppose that Parsons had worked to increase his share of the market. He could have had the same ROI if his sales had doubled while dollar profit and investment stayed the same (accepting a lower profit ratio to get higher turnover and market share):

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Parsons might have increased its ROI by increasing net profit through more cost cutting and more efficient marketing:

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Another way to increase ROI is to find some way to get the same levels of sales and profits while decreasing investment (perhaps by cutting the size of Parsons's average inventory):

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What is "investment" in the ROI formula? Investment is often defined as the total assets of the firm. But many analysts now use other measures of return to assess performance. These measures include return on net assets (RONA), return on stockholders' equity (ROE), or return on assets managed (ROAM). Because investment is measured at a point in time, we usually compute ROI as the average investment between two time periods (say, January 1 and December 31 of the same year). We can also compute ROI as an "internal rate of return" by using discounted cash flow analysis (see any finance textbook for more on this technique). The objective in using any of these measures is to determine how well the company has been using its resources. As inflation, competitive pressures, and cost of capital increase, such measures become increasingly important indicators of marketing and company performance.

|Markups and Markdowns |

Retailers and wholesalers must understand the concepts of markups and markdowns. They must make a profit to stay in business, and the markup percentage affects profits. Markups and markdowns are expressed as percentages.

There are two different ways to compute markups—on cost or on selling price:

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Dale Parsons must decide which formula to use. If Parsons bought shirts for $15 and wanted to mark them up $10, his markup percentage on cost would be $10/$15 =67.7 percent. If Parsons based markup on selling price, the percentage would be $10/$25 = 40 percent. In figuring markup percentage, most retailers use the selling price rather than the cost.

Suppose Parsons knew his cost ($12) and desired markup on price (25 percent) for a man's tie and wanted to compute the selling price. The formula is:

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As a product moves through the channel of distribution, each channel member adds a markup before selling the product to the next member. This "markup chain" is shown for a suit purchased by a Parsons customer for $200:

| | |$ Amount |% of Selling Price |

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| |Cost |$108 |90% |

|Manufacturer |Markup |    12 |    10    |

| |Selling price |120 |100    |

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| |Cost |120 |80    |

|Wholesaler |Markup |    30 |    20    |

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| |Selling price |150 |100    |

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| |Cost |150 |75    |

|Retailer |Markup |    50 |    25    |

| |Selling price |200 |100    |

The retailer whose markup is 25 percent does not necessarily enjoy more profit than a manufacturer whose markup is 10 percent. Profit also depends on how many items with that profit margin can be sold (stockturn rate) and on operating efficiency (expenses).

Sometimes a retailer wants to convert markups based on selling price to markups based on cost, and vice versa. The formulas are:

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Suppose Parsons found that his competitor was using a markup of 30 percent based on cost and wanted to know what this would be as a percentage of selling price. The calculation would be:

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Because Parsons was using a 25 percent markup on the selling price for suits, he felt that his markup was suitable compared with that of the competitor.

Near the end of the summer Parsons still had an inventory of summer slacks in stock. Therefore, he decided to use a markdown, a reduction from the original selling price. Before the summer he had purchased 20 pairs at $10 each, and he had since sold 10 pairs at $20 each. He marked down the other pairs to $15 and sold 5 pairs. We compute his markdown ratio as follows:

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The dollar markdown is $25 (5 pairs at $5 each) and total net sales are $275 (10 pairs at $20 + 5 pairs at $15). The ratio, then, is $25/$275 = 9 percent.

Larger retailers usually compute markdown ratios for each department rather than for individual items. The ratios provide a measure of relative marketing performance for each department and can be calculated and compared over time. Markdown ratios can also be used to compare the performance of different buyers and salespeople in a store's various departments.

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