Stock estimation

Stock estimation

This is the process of determining the stock in hand when the business does not use perpetual inventory system and physical stock taking is not desired or feasible. When the business uses periodic inventory system it is administratively cumbersome and costly to determine the quantity of inventory on hand unless a physical stock-taking is done at that particular time. This is because in this system, no detailed flows of inventories are maintained. To overcome this problem, the business may make estimations of the figures of closing inventory.

Gross profit method

This method uses the gross profit rate to find the amount of gross profit and cost of sales. In this method, the estimated inventory cost at the end of the period, is calculated by deducting the cost of sales from the figure of cost of goods available for sale. To use this method the company needs to know the sales revenue, cost of goods available for sale and gross profit rate. This method assumes that all sales are made at a constant gross profit rate.

There are two gross profit ratios that can be used under the gross profit method, these are mark-up and margin.

1. Mark-up

   This is the percentage of gross profit on cost of sales.

   $\text{Mark-up} = \frac{\text{Gross profit}}{\text{Cost of sales}} \times 100$

   Alternatively:

   $\text{Mark-up} = \frac{\text{Gross profit}}{\text{Sales} - \text{Gross profit}} \times 100$

2. Margin

   This is the percentage of gross profit on sales calculated as:

   $\text{Margin} = \frac{\text{Gross profit}}{\text{Sales}} \times 100$

   Alternatively:

   $\text{Margin} = \frac{\text{Gross profit}}{\text{Cost of sales} + \text{Gross profit}} \times 100$

   However, the mark-up percentage can be changed into margin, or margin percentage to mark-up using the following guidance:

   $\text{Changing mark-up to margin} = \frac{\text{Numerator}}{\text{Numerator} + \text{Denominator}} \times 100$

   $\text{Changing margin to mark-up} = \frac{\text{Numerator}}{\text{Denominator} - \text{Numerator}} \times 100$

Question

Mwembeni shoe traders, sell their products (ladies shoes) at a mark-up of 25%. One customer have just paid them TZS 40,000 being price of the pair of shoes she has taken. Mwembeni shoe traders are struggling to know how much percentage of profit they have made from that sale.

Required: Calculate the percent of profit on sale (margin), and state the amount of profit.

Solution

Margin is the percent of gross profit on sales value

Sales = TZS 40,000

But:

Mark-up is the percent of gross profit on cost of sale = 25% = $\frac{25}{100}$

$\text{Changing mark-up to margin} = \frac{\text{Numerator}}{\text{Numerator} + \text{Denominator}} \times 100$

Numerator = 25 and the denominator = 100

Therefore:

$\text{Changing mark-up to margin} = \frac{25}{25 + 100} \times 100 = \frac{25}{125} \times 100 = \frac{1}{5} \times 100 = 20\%$

Margin = 20%

Gross profit on sale of a pair of shoes = TZS 40,000 × 20% = TZS 8,000

Cost of sales = TZS 40,000 – 8,000 = TZS 32,000

Retail method

This method is used by businesses dealing with large amounts of stocks of relatively low unit price. All items are usually quoted at retail prices. Example of business using retail method is supermarket.

Steps in using the retail method are:

1. Determine the cost of goods available for sale in retail price and cost price

2. Calculate the cost to retail ratio, by dividing the cost of goods available for sale at retail price by the cost available at cost price.

   $\text{Cost to retail ratio} = \frac{\text{Cost of goods available for sale at cost price}}{\text{Cost of goods available for sale at retail price}} \times 100$

3. Calculate the value of closing inventory at retail price by deducting sales from the cost of goods available for sale at retail price.

4. Closing inventory at retail price = Cost of goods available for sale at retail price – Sales value

5. Obtain the closing stock at cost by taking step (b) × step (c)

6. Closing inventory = Cost to retail ratio × Closing stock at retail prices.