Inverse of Profit
To include profit at a targeted percentage
of 20 percent, why do we divide the break-even rate by 80 percent?
Also, what is the difference between Markup and Margina Profit ?
Why below we are using Marginal Profit and not markup?
For an employee who is paid a salary equal to $20 per hour
($41,600/2,080 hours) in a firm with an overhead rate of 1.30, the break-even rate
for such an employee would be: $20.00 × 2.30 = $46.00 per hour.
That means for the fi rm to break even on this particular employee’s hourly salary
and their respective portion of the fi rm’s overhead cost, the hourly billing rate for their
direct labor can be no less than $46.00 per hour. To include profit at a targeted percentage
of 20 percent, divide the break-even rate by 80 percent (the complement of 20%).
This will establish an hourly billing rate of $57.50 ($46.00 ÷ 80% = $57.50; to check:
$57.50 × 20% = $11.50 + $46.00 = $57.50).
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To calculate profit, you must divide by the inverse target profit percentage. In this case, the inverse target profit percentage is. . . (1.0 - 0.2) x 100% = 80%
In comparison, a mark-up of 20% would be achieved by multiplying the base price (break-even rate in this case) by 1.2.
A mark-up is exactly as the name implies - an increase on the base price of some percentage to arrive at the selling price. In other words, it is a premium tagged on to a base price. In the world of construction, mark-ups may be applied to products and materials sold by distributors. This differs from profit margin in that the profit percentage is equal to the billed amount minus the break-even rate.
For a more in-depth explanation of the difference between profit margin and mark-up, refer here or search "margin vs markup" on the web.
It's unclear whether NCARB understands this difference. The ARE Handbook has at least one example question that is calculated incorrectly, which is well documented here. However, it seems they are at least aware of the confusion, because current versions of the ARE appear to avoid similar questions.
Hope this helps.
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bowermb Hi, thank you so much for your explanation. Can you please clarify Target Profit and the Inverse of Target Profit %? Is it the same as the Utilization Rate? I cannot find anything on target profit and I am getting confused. My exam is in 2 days so I appreciate any clarification in advance. Thank you! :)
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