Absorption Rate Calculation As A Measuring Tool?

Absorption Rate Calculation has been a measurement tool used by equipment dealers since the 1960's. It is still a valuable measurement today.

In my work with dozens of equipment dealers all over the world I have found that the dealers that I consider to be on "the leading" use this measurement every month.

This measurement tool is driven by the senior management of the dealership - it is not to be taken lightly.  When senior management finds that the rate falls below the standards set they take immediate action to improve it.

Absorption Rate Calculation - here is the definition!

It is the percentage of dealership expenses absorbed by the gross profit generated from Parts and Service sales.

Sounds easy doesn't it!. No so fast! I don't want to make the definition of absorption rate too complicated but look at what Wikipedia has to say about the factors used in Absorption Rate calculations. Wikipedia Total Absorption Costing

Dealer's accounting methods vary greatly.

One example is in the way cost of goods sold is calculated in the Parts department. There are some dealers include the cost of freight in the cost of goods sold to determine gross profit in the Parts department.

Is this the correct method? More will be discussed on that topic later.

Another accounting variance among dealers is the calculation of Service gross profit. There are dealers that include all benefits costs in the calculation of cost of goods sold.

Other dealers chose to account for this as an expense. What is the correct method?

The answer to what is the correct method is found in another question.

What is the dealer trying to measure by calculating absorption rate?

The answer is, "Will the gross profit coming for the Parts and Service departments pay the expenses for the dealership"?

Some dealers might ask, "Are there any expenses that should be excluded in the calculation or is it all dealer expenses?"

Great question!

How should "interest expense" and "allocated expense" and "administration expenses" be treated"?

The dealer must be certain that interest, allocated and administration expenses are reasonable, controllable, and justifiable?

What does that mean?

Interest rate should be associated with accounts receivable and accounts payable (but exclude interest on mortgages).

Allocated and administration expenses should not exceed 10% of sales.

Click here to see the Absorption Rate Formula

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