Thursday, February 23, 2017

Effect of Initial Markup and Markdowns in Garment Costing

Initial Markup:
Initial Markup is called as IMU which is the difference between the cost and selling price of garment when it is first introduced for sale. It is also called Initial Mark On, Markon or Markup. The formula for this calculation is:

Initial Markup = Selling price – cost

Initial markup is the amount of money, expressed as a percentage of initial cost.

For example, a retailer that buys a shirt for $10 from the manufacturer and sells them to customers for $20 has an initial markup is 100 percent. 
Initial markup and markdown in garment costing
Fig: Initial markup and markdown in garment costing
Initial Markup in Garment Costing:
Initial mark-up is very important in garment industry, and is widely used. Initial mark-up is placed on the garments upon receiving them into the store. It can either be calculated in dollars or in percentage. It is important to bear in mind that this initial mark-up should be sufficient to cover reductions, expenses, etc. It is marked to obtain the original retail price of the garment. As it is hard to achieve 100% forecast accuracy in the garment industry, there will be a situation when more garments are ordered than are sold, so some percentage of garments will be put on sales or the prices will be marked down. The discounted price means the retail prices now are less than the original retail price. So to have a decent profit in business, a company will need to put the initial mark-up high enough to average out the mark-downs, which is given by the formula:

Initial mark-up = (expenses + profit + reductions) / (net sales + reductions)

We can define markdown is the temporary reduction in the selling price of an item to stimulate its demand or to drive a competitor out of the market.

Markdown in Garment Costing:
The vibrant nature of the garment industry pushes companies to adjust the prices either by increasing or decreasing from the original retail price. Normally, an increase in price does not happen in the garment industry, which means reductions in the retail price that was previously set higher. All the garments cannot be sold at the original retail price set by the company, and the downward adjustment of the retail price is known as markdown.

For example, a sweater sold at retail price of $150 and was now sold at $85, perhaps due to being in the warehouse for too long. This lowering of the retail price from $150 to $85 is called mark-down. In this case, the mark-down is of $65. So the company will be gaining lesser profit by selling the garments at this price. The markdown percentage is a function of net sales. Mark-downs are also a promotion tool to increase sales.

Purposes of markdown:
There are numerous purposes of mark-downs, which are as follows:
  • To encourage the sales of the garments.
  • Buying error, such as purchasing the wrong styles, designs, etc., which cannot be sold and need to be marked down.
  • Miscalculation at the time of ordering.
  • If the demand is low and supply is more.
  • If the products are not displayed properly and out of the reach of customers.
  • To compete in the market for the same category.
  • To provide money to the business to buy more products for next season.
  • To create seasonal sales, which may include winter ending and summer coming in, or any occasion such as Christmas, birthdays, etc.
  • To sell slow-moving items because slow-moving items increase the inventory cost.
  • A high number of returns due to quality issues or other reasons.
The major cause of mark-down is buying more quantity than required. In this fast fashion world, it is very difficult to estimate the exact number of garments to be sold, so estimation has to be done, which is known as forecasting. Although forecasting is a scientific discipline, 100% accurate forecasting is not possible as customer’s demand can change at any time.

It is very important to decide the timing and amount of the mark-down, which is an experienced person’s job. When the stock is not being sold, that means customers are not interested anymore in that style, so mark-down may help in getting the customer’s interest back.