Being a retail store owner is a challenging job at the best of times and we certainly are not in the best of times. You are trying to balance keeping your employees safe, keeping your customers safe, and keeping the doors open. The government has shown that they are capable and willing to close stores down and whether you made the cut last time or not, you know you could be on the chopping block next time. Whether the challenge is COVID or something else entirely though, it is the lean and adaptable businesses that will succeed.
The traditional method of accounting for a retail store states that Sales – Cost of Goods (COGS) = Gross Profit and Gross Profit – Operating Expenses = Profit. The second formula is technically correct, but practically wrong, but more on this later. Let us focus on the first formula for now.
In a retail store you biggest asset is your inventory. It is vital that you have a firm handle on your inventory and know the true costs of products. The true cost of your inventory is what is required to receive and sell each product. If your gross profit ever goes negative, you should stop selling immediately! I have seen a few retail business owners try to outsell a negative gross profit. I always ask the same question: “If a widget costs you $1 each to make, how many do you need to sell at 75 cents to make a profit?”. No amount of selling will ever fix a negative gross profit.
Sometimes it is not so obvious that the gross profit is negative. Business owners or bookkeepers unfamiliar with bookkeeping for a retail store, often make the mistake of miscategorising COGS as operating expenses. Costs to get your product to the store (i.e. shipping and handling, customs and duties, foreign exchanges, etc.) are all part of the inventories landed cost. However, often these are recorded as operating expenses. Merchant service fees to sell the products to the customer are another example of common miscategorized expenses.
Once you do know your variable costs (the cost to sell one unit) and your fixed costs (total of your operating expenses), you can determine your break-even point.
Break even quantity (BEQ) = Operating expenses / (Sales price per unit – COGS per unit)
For example, if your fixed costs (operating expenses) are 100,000 per year, your Sale price is 100 and your variable costs are 50:
BEQ = 100,000 / (100 – 50) = 2,000
Selling 2,000 units will result in no loss or profit.
Alternatively, if you were sure of the quantity you could sell at various price points, you could modify the formula to determine the price you’d need to sell at to break-even.
A quality retail bookkeeper can help you determine your BEQ and assist you in setting prices.
Another challenge in a retail business is bookkeeping for your inventory. Your gross profit may be right, and you know the amount of products you need to move in order to make a profit. However, come inventory count time, the numbers just do not match up. This could be due to several factors (primarily a poor inventory management system, theft, or spoilage).
If you are using spreadsheets, an outdated software package, or paper to track your inventory, there is a big chance that you will introduce human error. A proper inventory management system will tie into your accounting system and point-of-sales to much more accurately account for inventory. A proper inventory system will also help you track items that are not moving so that you know to stop ordering them in the future or order lower quantities. You can offer sales on items before they spoil or to make room for items that sell out quickly. Many shoppers will not return to a store to buy an item if you are sold out of it. Proper management can help you manage this all much more painlessly.
Obviously, theft can also have a negative impact on the bottom line as well. Regular inventory counts will help you more accurately track this and account for the cost. Depending on the cost of the stolen items, you may either want to spend more on preventative solutions or just account for the losses in you operating expenses. It does not pay to spend more protecting goods when the cost is greater than the value of the items!
Speak to your bookkeeper about what solutions they would recommend for your retail business.
Like I said earlier, technically the formula “gross profit – operating expenses = profit” is correct. However, the issue with this formula is that profit is last. When you put something last, it is not a high priority (you would never suggest that anyone puts their health last). What most retail business owner’s do, it spend the money in the bank on what they think the business needs to grow in the hopes that at the end of the year there will be some profit to take.
As a Profit First Bookkeeping firm, we recommend you make a slight change to this formula:
gross profit – profit = operating expenses
If you know any algebra, you will know that the equation is still correct. The phycological difference here is that you will now take your profit out first and restrict the number of funds you have available to spend on your operating expenses. At the end of each quarter, you WILL have a profit.
Of course, if you have not had any profit left at the end of each quarter, it is because you are spending at least as much as you have earned. So, in order to start taking that profit you will need to look at which expenses are driving a profit and which items are not necessary. This may involve thinking outside the box, which is what our Profit First consultants can help you do.