Mark has a doctorate from Drew University and teaches accounting classes. He is a writer, editor and has experience in public and private accounting.
Why Pay Catalog Prices?
You own a small company, and you are looking at one of your vendor's catalogs. Your company has been paying catalog, or list price when purchasing from this vendor. Recently, you found out larger buyers seem to be getting a discount on their prices. You call your vendor and ask why.
Catalog Price & Net Price
The vendor takes your call, explaining his pricing methods. Many companies have a catalog price, also known as the list price, which is based on an analysis of the market and the cost of the product. The catalog price should cover all of the production and operating costs of the company and provide a profit after anticipating trade discounts. Trade discounts are usually volume related and are typically expressed as a percentage of the catalog price. The larger the amount purchased, the lower the per unit sales price. Large volume purchasers will pay a net price of the catalog price less trade discounts. Suppose your vendor has a catalog price of $10.00 per unit. He offers a 20% discount if you purchase over 1,000 units. The net price for a volume purchase is as follows:
|Less 20% Trade Discount||2.00|
Low volume purchasers, including consumers, will tend to pay catalog price. Since your company is only an occasional buyer with a relatively small purchase volume, it pays catalog price.
Your vendor responds by saying trade discounts are really a function of economics. During the conversation, you recall from your accounting courses the total cost of any product includes direct labor, direct material, variable overhead, and fixed overhead. The first three increase or decrease with volume. Fixed overhead does not change. Larger production volumes spread fixed overhead costs over a greater amount of production, lowering the unit cost of the product. The vendor agrees with you and shows you the following example. The vendor agrees with you, sharing the following example:.
Suppose you have fixed overhead production costs of $100,000. Your sales must cover that fixed overhead cost. A company that cannot cover its overhead costs is doomed to fail. You notice something very interesting when you look at the average fixed overhead per item.
|Units of Production||Average Fixed Overhead Cost Per Unit|
You quickly see as production volume increases, average fixed overhead cost per unit decreases quickly. This is the justification for a sales discount. The vendor suggests your company should look at using volume discounts. Before setting trade discounts, it is important to understand how product costs will be effected by the increase in sales volume.
Sometimes sales personnel are given the authority to add another small trade discount to help close a sale. Customers can sometimes be persuaded to purchase a product if they receive just one more discount. Your vendor warns this practice has to be closely monitored and should be used sparingly. Other customers may demand the same discount, thereby reducing your company's profitability.
If market conditions have changed and competition for your product has heated up, it is sometimes advantageous to reduce prices. Most companies believe it is easier to lower prices than to raise them later on. They advocate using an additional sales discount rather than temporarily lowering the list price. This option preserves the list price for the future. A common situation when an additional trade discount is given occurs when there has been an inadvertent inventory build-up. In these and similar situations, an additional sales discount effectively reducing the sales price might move the product, making critical working capital available to your company.
The catalog price is also known as the list price. The actual selling price, called the net price will be the catalog price less any trade discounts the buyer is entitled to. The higher the sales volume the higher the trade discount since fixed overhead costs are spread over greater sales volume. Additional discounts can occur when salesmen need to 'close the deal' or because of inventory build-up.
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