Markdown

A markdown is a reduction in the selling price of merchandise below its original retail price. Retailers use markdowns to clear seasonal goods at the end of a season, sell slow-moving or discontinued lines, move damaged items, match a competitor's price, or make room for new inventory. A markdown can be temporary, such as a weekend promotion, or permanent, such as a clearance price that stays until the stock is gone.

Markdowns are the opposite of the markup that a retailer adds to cost to set the original price. They directly reduce sales revenue and gross margin, so retailers track them closely as a sign of how well they buy and price their stock. In investing, the word is also used for lowering the value at which a security or private holding is carried, but this entry deals with the retail and accounting sense.

A markdown is usually expressed as a percentage of the original selling price:

Here $\text{Original price}$ is the retail price before the reduction and $\text{Reduced price}$ is the new selling price. A jacket that costs the store $40 and is originally priced at $100 is marked down to $70. The markdown is $30, or 30 percent of the original price.

At full price, the jacket would earn a gross profit of $60, a gross margin of 60 percent. After the markdown it earns $30, a gross margin of about 43 percent. If a store sells 1,000 of these jackets, 600 at full price and 400 after the markdown, its revenue is $60,000 plus $28,000, or $88,000, and its gross profit is $88,000 minus $40,000 of cost of goods sold, or $48,000. The overall gross margin falls from the planned 60 percent to about 54.5 percent. Retailers often report the markdown rate, total markdowns divided by net sales, as a key performance measure.

In the accounts, a markdown is not recorded as a separate journal entry when the price tag changes; the sale is simply recorded at the lower price. However, markdowns matter for inventory measurement. If goods are expected to sell below cost, the inventory must be written down to net realizable value, and under the retail inventory method, markdowns are tracked separately because they affect the cost-to-retail ratio used to estimate ending inventory.

Large retailers often negotiate markdown allowances, sometimes called markdown money, under which a supplier pays the retailer to compensate for price reductions on its products. Under US GAAP, consideration received from a vendor is generally treated as a reduction of the cost of the goods purchased, rather than as revenue, unless it is payment for a distinct service. Mistakes in accounting for these allowances have caused several retail restatements, and the area is a known audit risk.

• Markdowns are a normal cost of retailing, especially in fashion and electronics, where products lose appeal quickly.
• Frequent or deep markdowns can indicate over-buying, poor forecasting or weak demand, and they reduce gross profit percentage.
• Taking markdowns early, while demand still exists, usually recovers more cash than waiting, because older stock loses value and adds carrying costs.
• Heavy reliance on promotions can train customers to wait for sales, which weakens full-price selling over time.

Retailers now use pricing software that models price elasticity by product and store to choose the size and timing of markdowns. Analysts reading a retailer's results watch for falling gross margin combined with rising inventory or slowing inventory turnover, a common sign that heavy markdowns are coming. Markdowns are also distinct from inventory shrinkage, which reduces stock through theft, damage or error rather than through deliberate price cuts.