Purchasing Products for Resale
Nearly all business owners who deal with physical products (versus services) will have to understand the difference between margin vs. markup. The simple explanation is that markup is the actual cost of a product versus the selling price of a product while margin is the selling price of the product versus the profit that will be earned on that product.
An example of this would be a book is purchased from a distributor for $8.99, and then sold to a consumer for $14.99 meaning the markup is $6.00 per book. This does not necessarily mean that the business owner has earned $6.00 on the book. The reason for this is that there are operating expenses associated with the sale of the book that must be deducted to determine the business owner's margin.
Operating expenses and margins
Operating expenses must be taken into consideration when determining the margin on all products. The cost of doing business includes salaries (or commissions, wages, etc.), leases (or rent) on property or equipment, repaying loans that have been taken out on the business (or for the purchase of inventory) and cost of utilities.
In addition, other factors must be included in this calculation such as how much the products cost the business or how much the business may lose due to merchandise that is damaged or merchandise that is stolen. In addition, if a product is not moving off the store shelves, it may be necessary to reduce the cost meaning this will also have to be included in operating expenses.
Operating expenses examples
Here is an example of how a business owner would record operating expenses to determine how much of a markup they need to allow for items that are purchased:
Annualized Expenses (excluding product costs):
- Rental/Lease property: $80,000
- Utility expenses: $10,000
- Wage expenses: $40,000
- Loan expenses: $8,000
- Misc. expenses: $5,000
- Product loss (est.) $500.00
Total expenses: $143,500
This means that before a business owner begins to earn a profit, they must make $143,000 before they can even consider purchasing their products. Using the book example above, here is what this would look like assuming that the business had a target of selling 50,000 books in a year.
Necessary sales price is then calculated by adding these two figures together (for a net total of $593,000) to calculate how much the seller must charge a consumer for the books. In this case, the cost would be $11.86 before the seller will make a profit on the books. To secure a profit, the seller could then increase the price to $15.00 which would make the margin $3.14 per book sold. This amount then represents the net profit on the product or approximately $156,824 (rounded and based on losing approximately 56 books to theft or discount). Netted out over a year, the profit would be approximately $13,100 per month which would be sufficient to purchase additional items for sale without incurring debt.