How to calculate profit from a percentage mark-up
The Sunday Nation
Nairobi,
27 February 2011
The question of how to calculate profits has excited and confused readers in equal measure. Amongst the puzzled is one who asks: “If my sales are Sh15,000 and my mark-up is 35 per cent, how can my profit be Sh3,889 (according to your calculation); yet 35 per cent of Sh15,000 is Sh5,250?
To find out, let us test the reader’s calculation: if sales are Sh15,000 and the profit is Sh5,250, it means that the goods were bought at Sh9,750 (15,000 – 5250). Now, the “mark-up” is the amount that a trader adds to the buying price. In this case it is 35 per cent.
Thus; 35 per cent of Sh9,750 (the buying price) is Sh3,412.50. Adding the two (buying price and mark-up) we get Sh13,162.50. This is far from the actual sales of Sh15,000. Therefore that calculation is wrong.
Now let us test my figures: The sales are Sh15,000; I worked out that the profit should be Sh3,889, therefore the buying price was Sh11,111. Now 35 per cent of Sh11,111 is Sh3,889 (check it with your calculator!). Adding the two (buying price and mark-up) takes us back to Sh15,000.
So what’s going on here? This is a common mistake: if you add a certain percentage to any number and then subtract the same ratio from the result, you do NOT get back to the original figure!
For example: if we add 20 per cent to 100 we get 120. If we subtract 20 percent from 120 we get 120 – 24 = 96. Many people blindly assume that we should get back to 100. The reason is that they forget that 20 percent of 120 is NOT 20 – it is 24!
Therefore, if a trader makes sales of Sh15,000 and the mark-up is 35 per cent of the buying price, the profit will NOT be 35 per cent of Sh15,000! The correct method of working it out is the one I explained two weeks ago. It sounds like one of those mathematics questions from school: “I think of a number; if I add 35 per cent to it I get 15,000; what is the number I thought about?”
Another reader was excited by the discussion; he writes: “The calculation of profit when selling prices are different was quite a revelation for me. I’ve been doing things kienyeji! But what happens is the buying prices change as well?”
In such a case, you have to make an estimate and there are two common methods available: first-in-first-out (FIFO) or last-in-first-out (LIFO). In FIFO, you assume that the goods that are bought earliest will be sold first. Therefore, you use the older buying prices when calculating the value of purchases during the period. Further, you use the newer prices for closing stock.
LIFO works the other way round.
Since prices are going up most of the time, FIFO will underestimate the cost of goods sold and therefore give a higher profit. At the same time, since the unsold stock is assumed to have been bought last, FIFO overestimates the assets of the business. LIFO has the opposite effect.
 |
 |