Definition
Markdown in finance refers to the difference between the original selling price of an asset and its reduced market price. It is often used in underwriting, where the underwriter purchases securities from the issuer at a markdown and then sells them to investors at a slightly higher price to make a profit. Markdown also applies in retail, where a product’s price is reduced to accelerate its sale.
Key Takeaways
- The finance term ‘Markdown’ refers to the difference between the highest current bid price among dealers in the market for a security and the lower price a dealer charges for that security.
- Dealers typically mark down a security to encourage potential buyers to purchase it. They make their profit from the spread between the purchase and selling prices.
- ‘Markdown’ can also refer to the decrease in the book value of a security showing on a dealer’s inventory due to a decrease in the market value of the security.
Importance
The finance term “Markdown” is important because it indicates a reduction in the selling price of retail merchandise, which directly affects profitability.
Businesses use markdowns strategically to boost sales, clear out old or obsolete inventory, compete with other businesses, or respond to decreased customer demand.
It’s a tool to stimulate customer demand and manage stock effectively.
Additionally, tracking and understanding the effects and use of markdowns can provide valuable insights into consumer behavior, product life cycles, and contribution margins, thereby allowing businesses to optimize pricing strategies, improve financial performance, and make informed business decisions.
Explanation
Markdown, within financial context, is a term rooted in the field of security trading and retail merchandising. In trading, it is essentially used to denote the difference between the original cost of a security and the actual selling price, which is typically lower than the initial price. It allows for the fluidity of transactions by inspiring increased purchasing when the market might be stagnating.
For traders, markdowns are most often used during the distribution phase of the market, bringing a sense of mobility and dynamism to the pricing system and ensuring assets do not remain unsold due lengthy periods of inactivity. In the realm of retail merchandising, a markdown signifies a planned reduction in the selling price of retail merchandise. The purpose of such a reduction is multifold.
It can be used to clear out old inventory, increase customer traffic, or meet certain sales goals. For instance, a merchandiser might use markdowns as a strategy to sell out-of-season clothing items or to push a product that may not otherwise be selling. The main aim of a markdown in this context is to speed up sales without resorting to an overall price reduction.
Overall, markdown serves as a useful tool ensuring both market fluidity and inventory turnover.
Examples of Markdown
Retail Clearance Sales: A very common example of markdown is the clearance sales in retail stores. When items are not selling as planned or are out of season, the store will markdown the prices to encourage customers to purchase them. For example, a retail clothing store may have a bunch of winter coats left at the end of the winter season. They’ll markdown the price to encourage customers to buy them and to free up storage space for new inventory.
Automobile Depreciation: Another example is the depreciation of new cars. As soon as a brand new car is driven off the dealer’s lot, it suffers an immediate markdown in value, often around 20%. The longer you own the car, the more its value continues to decrease, which is why used cars are priced lower than new ones.
Stock Market: In finance and investing, a markdown also refers to the difference between the price a broker-dealer pays for a security and the price at which it is sold to a customer. For instance, an investment banker might buy a bond at $1,000 (its “market price”) and sell it to a customer at $950 (a “markdown” of $50, or 5%). The markdown, in this case, is essentially a service fee for the broker’s part in facilitating the trade.
FAQ – Finance Markdown
What is the term ‘Markdown’ in finance?
In finance, ‘Markdown’ refers to the difference between the highest current bid price in the market for a security and the lower price that a dealer charges a customer. This discrepancy forms part of the dealer’s compensation.
How is a ‘Markdown’ calculated?
Markdowns are calculated as the difference between the transaction cost and the market value.
When is the term ‘Markdown’ commonly used?
The term ‘Markdown’ is commonly used in the bond market, mainly when dealers act as principals, buying securities for their own accounts and reselling them at a profit to other parties.
What is the difference between ‘Markup’ and ‘Markdown’?
While both are ways for broker-dealers to earn a spread, they are used under different circumstances. ‘Markup’ refers to the price, over and above the market price, that a dealer charges to clients when they sell securities from inventory. Conversely, ‘Markdown’ is the price difference when a broker-dealer buys a security from a client.
Related Entrepreneurship Terms
- Retail Price: Original price set by retailers on a product before any discounts or promotional sales.
- Discount: A reduction of the original price, often expressed as a percentage. Markdowns are one of the most common types of discounts.
- Pricing Strategy: A plan or method for setting prices of goods and services, incorporating methods like markdowns.
- Inventory Management: The process of ordering, storing, and controlling a company’s inventory which might include marking down prices for certain items.
- Clearance Sale: A strategy employed by retailers, including massive markdowns to quickly clear out old or overstocked inventory.
Sources for More Information
- Investopedia: A comprehensive online resource dedicated to empowering the individual investor, with an encyclopedia of terms including Markdown.
- The Free Dictionary – Financial Dictionary: A section of The Free Dictionary website dedicated to explaining financial terms and jargon.
- Corporate Finance Institute: A provider of online financial modeling and valuation courses, with a large glossary of finance terms.
- Morningstar: This site offers strong investment research and education resources, with a comprehensive glossary of investing terms.
