Backward costing
When the market sets the price, you work backwards: what is left after discounts, and what profit is that on total cost?
Worked example
The market allows a list price of £5,260.00. Customers get a 10% trade discount and a 2% cash discount. Total cost is £4,360.72. How much profit is left (backward calculation)?
Worked solution
- 1.After trade discount = £5,260.00 − 10% = £4,734.00
- 2.Cash price = £4,734.00 − 2% = £4,639.32
- 3.Profit = £4,639.32 − £4,360.72 = £278.60; as % of total cost: £278.60 / £4,360.72 × 100 = 6.39%
Typical mistake: Relating the profit mark-up to the cash price instead of total cost.
Your turn
Three problems of exactly this type, each time with new numbers. Amounts with or without thousands separators.
Task
The market allows a list price of £3,780.00. Customers get a 20% trade discount and a 2% cash discount. Total cost is £2,631.50. How much profit is left (backward calculation)?
Cash price in £
Profit in £
Profit mark-up in % of total cost (2 decimal places)
Amounts like 12,500 or 12500.50; percentages as a number (12.5). Round to the penny or 2 decimal places.
Formulas for this topic
- Material cost = direct materials + material overhead
- Conversion cost = direct labour + production overhead
- Production cost = material + conversion
- Total cost = production cost + administration and selling overheads
- Discounts are deducted from the higher price: divide by (1 − rate)
Typical mistake: Relating the profit mark-up to the cash price instead of total cost.
Frequently asked questions
What is the typical mistake in "Backward costing"?
Relating the profit mark-up to the cash price instead of total cost.
Why divide for discounts?
The customer deducts the discount from the higher price, so you divide by (1 − rate) to end up with the price you need.