How To Calculate and Improve Your Retail Profit Margins
With retail businesses struggling to stay profitable across the country in the face of unprecedented challenges, you need a quick and reliable way to measure the solvency of your retail store.
That metric, the heartbeat of your store, is your profit margin.
According to a recent Software Advice survey (methodology below), 50% of retail businesses have experienced a moderate or significant decline in sales due to the impact of COVID-19. How are they responding? The same survey found that 34% of retail businesses have prioritized cost optimization more since the beginning of 2020.
Your profit margin is one of the best indicators of whether your retail business is operating efficiently and how profitable it is. In other words, it is one of the best ways to quickly determine whether or not your retail business is in a good position to survive and thrive. It also answers critical questions about your business, such as whether products are priced correctly or if operational costs need to be reduced.
In this article, we’ll cover the importance of knowing your profit margins and recommend ways for improving your profit margin.
What is retail profit margin?
Retail profit margin is the measure of your business’ profitability, that is your capacity to earn money. It represents the percentage of overall revenue that constitutes profit.
Retail profit margin takes into account the initial cost of goods and expenses a business has to pay to produce and sell a product. More importantly, it demonstrates the portion of each revenue dollar that is actually earned.
What is a good retail profit margin?
Right after how much it costs to open a store, the most commonly asked question by startup retailers is, “What’s a profit margin that I should aim for?”
What constitutes a good retail profit margin varies by industry and products sold. Industries with minimal overhead costs, such as ecommerce or thrift shop, typically have higher profit margins. Building supply and distribution retailers tend to have the strongest margins, as high as 6%, according to Investopedia. Here are some examples of industry margins from an NYU Stern study, with industries like banking, healthcare, and tech leading the way.
Consider your industry and its common costs: A teaching or consulting business will likely have higher profit margins than a retail business, which pays more overhead expenses, such as rent, payroll, and creation or procurement of inventory.
The 2 types of retail profit margin
There are two types of profit margin calculations that retailers should know about: gross profit margin and net profit margin.
1. What is gross profit margin?
Gross profit margin is a metric that indicates how efficiently your business—i.e., processes, systems, etc.—is operating.
Stable and consistent profit margins are a good sign that your business is doing well. If, however, your gross profit margins are significantly lower than your competitors, then you might need to re-evaluate your pricing and expenses.
If you’re a retailer that’s just starting up, don’t panic if your gross profit margins aren’t as high as expected. It’ll take time to get your pricing, sales, and operations aligned.
How to calculate gross profit margin
Gross profit margin is always represented as a percentage, and calculates your revenue minus the cost of products sold over a period of time.
Example: Your company’s total revenue is $25,000 for the quarter, and the cost of goods sold is $20,000. Your gross profit margin would be:
$25,000 – $20,000 = $5,000
In dollar value, your gross profit margin is $5,000 for the quarter. To determine that as a percentage value, divide your gross margin amount by total revenue, and multiply by 100.
$5,000 / $25,000 X 100 = 20% (gross profit margin)
2. What is net profit margin?
Net profit margin is a metric that measures how much of your business’ profit is generated from revenue. It tells you how much of your total sales revenue is profit and is defined as the percentage of revenue that becomes profit after all expenses are paid.
The higher your net profit margin is, the better it is for your business.
How to calculate net profit margin
*Net profit = Revenue (total sales earned by a business) – Expenses (total costs needed to operate the business)
Also represented by a percentage, net profit margin takes into account your revenue minus the cost of goods sold, operating expenses, interest, taxes, and other expenses.
Net profit margin is calculated by taking the total sales of your store over a period of time, subtracting total expenses, and then dividing that amount by total revenue.
Example: Your retail store generates $20,000 in sales for the quarter. Your product costs and operating expenses came out to $15,000, and your overheads costs amounted to $2,000.
Below is how you would get your net margin percentage:
$20,000 – ($15,000 + $2,000) = $3,000 (your net profit)
$3,000 / $20,000 = 0.15
0.15 X 100 = 15% (your net profit margin)
What is the difference between gross profit margins and net profit margins?
The difference between gross profit margins and net profit margins lies in whether you want your calculation to consider all business expenses (net profit margin) or just the cost of goods sold (gross profit margin).
Put simply, your net profit margin takes into account how much profit you retain after tax for every dollar generated in revenue. Your gross profit margin takes into account how much profit you keep after subtracting the cost of goods sold.
No one metric is more important than the other. Both should be measured as they take into account different aspects of your business’ profitability.
How to improve profit margins
From revenue sources like new contracts to expenses such as utilities, it is important to track everything and not leave anything off the books. Doing so gives an accurate picture of your business’ profitability. Below are a few ways you can drive your profit margins.
Increase your prices: Making the decision to raise prices can be tough, especially when you’re competing with big box retailers. However, when executed well, raising prices can significantly improve your bottom line. Research competitor pricing, your costs and margins, as well as price sensitivity of your customers to figure out your sweet spot.
For example, if you run a small hardware store and you provide personalized instruction to customers, you can charge a little more than the giant home improvement store down the road that does not provide that same level of customer service.
Decrease expenses: Reducing expenses can be another viable option for increasing revenues. These typically include rent, utilities, phone bills, salaries, etc. Find opportunities for reducing costs, such as eliminating unnecessary overtime or excess packaging. Having an efficient retail POS that tracks your manpower and inventory in one system will help inform you on where you might be able to trim back.
For example, if you run a health food store, you might find that your customers prefer to bring their own reusable bags, allowing you to cut back on providing bags.
Remove low performing products: If you’re tracking the financial performance of each product, you’ll know which products have the lowest profit margins. Is there a product that is produced at a higher cost that isn’t selling as well as others? Brainstorm ways to improve their margins or consider cutting that dead weight.
For example, if you run a clothing store, you might consider removing seasonal styles such as sweaters from your racks and selling them online where customers from colder climates will still be able to find them.
Introduce new products: Launching new offerings can inject new life into your retail business. Doing so not only allows you to meet changing customer demand—it also taps into and rejuvenates an existing loyal customer base.
For example, if you run a garden center, introducing seasonal items such as holiday wreaths and plants can really generate excitement and sales among new and old customers.
Next steps for improving retail profit margins
If you want to calculate your profit margins accurately, keeping track of your expenses and the performance of your products is crucial—but it isn’t always easy, especially when done by hand.
Here’s what you can do to more accurately track your retail profit margins leveraging technology.
To learn more about retail POS systems, check out our video buyers guide (Source)
Automate data tracking through your POS: While formulas are useful, you’ll be able to save precious time and effort with a retail POS that has robust reporting and analytics capabilities.
Identify areas for improvement: It’s not enough to just know the numbers behind your profit margins; you need to do something with the data. Based on your numbers, evaluate your expenses and assess the actionable ways to improve your profit margins.
There are plenty of software systems that can help take care of those for you, as well as provide an accurate forecast of your profit margin and other key metrics.
Most retail POS systems have the ability to integrate with software that offers sales reporting and analytics capabilities. These features provide users with easy-to-read dashboards that highlight key performance metrics like overall profit margins, profit, revenue, and expenses.
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