Basics of Retail Math (Part 1)
Retailing is all about change, because consumers change and so do their tastes. If you don’t change, you don’t grow.
—MARVIN TRAUB, former CEO of Bloomingdale’s
Financial freedom. Setting your own schedule. Being your own boss. Take your pick. No matter what your collateral reasons for opening a retail store, the numbers are obviously what drive your decision about whether or not to invest the large and intense amount of time and effort it takes to build a business you can call your own.
If you’re anything like me, seeing a lot of numbers all at once can be intimidating. Initially, that is. However, as the saying goes, there is “strength in numbers.” In fact, having a basic understanding of how to interpret these numbers makes many decisions that seem gray at first quite black and white.
This series of posts will touch on the meaning of the basic numbers you’ll encounter in the retail business. If you are coming from another industry, such as manufacturing or real estate, the way retailers figure their numbers may look a little strange to you. Most other industries deal with markups, the profit as a percentage of cost; retailers deal in margins, profit as a percentage of retail selling price.
Retailers typically keep a two-column ledger in order to fully understand what is going on with their business. In the left column, they keep a running record of the cost of the merchandise, the landed price including the cost of goods and shipping costs. In the right column, they keep a running record of the retail value of the merchandise, the sum of the retail price tickets on all the items in the store.
This method lets you keep track of the markdowns in the right column so you can see at a glance the profitability of an item, department, and store. Also, this approach shows you the profit or loss in the month it occurs, and resets the margin for the new month, giving you a true month-to-month comparison. Make sure that any accountant you involve with your business fully understands retail accounting. If not, you could truly be at a loss.
Under the retail methodology, the selling price of an item is always 100%. Therefore, both cost (the amount you pay for an item) and markup (the amount by which you increase the price to cover your expenses and profit) must equal 100%.
For instance, if you paid $0.55 for a spatula and sold it for $1.00, your gross profit margin would be $0.45 (45%) and your cost of goods would be $0.55 (55%). (In other industries, the $0.45 profit might
be expressed as a percentage of cost, giving you a markup of about 82%.)
Health of Your Business
To determine how well or (perish the thought) how badly their business is doing, retailers routinely compare each month with the same month a year prior. This is because, given the large seasonal swings almost all retailers experience, there is little meaning in comparing this month’s sales with last month’s. So, if this February you did $110,000 in sales and last February you did $100,000, your business would be 10% ahead of last year. And, if this continues for a while, you can be happy with your trend. Of course, if the numbers were reversed and you did $100,000 this year and $110,000 last, you would be 9% behind, and you would have to take prompt remedial action.
In looking at these figures, you must exclude new stores or departments you opened. To determine how healthy your business is, the comparison between years must be apples to apples, that is, same store performance.
Establishing Initial Margin
To discuss the retail concept of margin it is important to have a few definitions under our belts first. For starters:
- Cost. Cost of Goods (COG) is what you pay the vendor for products.
- Retail. Selling Price of Merchandise is what your customers pay the store for these goods.
- Initial Margin $. Initial Margin is the difference between retail and cost (Retail – Cost = IM$), expressed as a percentage of retail. So, if you buy a shirt for $3 and sell it for $7, your initial margin is $4 or 59.1%. If you (like me) didn’t pay attention in ninth grade algebra, let me give you a quick update. (If you, unlike me, were an algebraic whiz kid, please skip this section.)
In retailing there are three ingredients needed to figure out what your margin is and what the margin should be. If you know two out of three, calculate the third. Then, you can decide whether or not what you have to pay fits into your business plan. Let’s run through an examples.
When cost and retail are known (and you want to find out what your margin percentage will be):
Retail – Cost = Initial Margin % retail
Example: If you buy a lamp for $6 and it retails for $10, Initial margin % is 10 – 6 = 4 = 40%