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Profitable Times Newsletter

Retail Math: Part I

All good museum store managers already know the importance of comparing store results to visitation. This has been especially critical during the economic downturn where in many instances store revenue may have been down but not as much as visitation, illustrating that the store was doing relatively well. Revenue per Visitor, Average Transaction and Capture Rate are some of these key measurements.

This article, however, is about basic, more typical retail formulas that give deeper insight into the financial condition and performance of the store. Remember, retail is detail and a combination of art and science. The art primarily has to do with product selection, merchandising, displays, etc. However, much of the important detail is derived from the science of financial numbers so important to successful retailing.

Explanations and formulas for the following financial factors and ratios are included in this article:

  • Net Sales
  • Cost of Goods
  • Average Inventory
  • Gross Margin
  • Inventory Turnover
  • Costs as a Percentage of Net Sales

Net Sales

Gross Sales
+
  Additional revenue attributable to the store
  Deductions for discounts, returns, sales tax, etc.

=
  Net Sales

Different museums will start with different Gross Sales and add and subtract different items to get Net Sales. Net Sales is the number against which all expense (and income) numbers are compared. It is the divisor for every line item in a Profit and Loss Statement. This is like using visitation as the divisor to facilitate fair comparisons among periods of time with different levels of visitation or institutions of different sizes. Using Net Sales as the divisor for all line items allows income and expense categories to be compared among museums with less concern about the size of the retail operation.

Average Inventory @ Cost

A key reason to calculate Average Inventory at Cost is to be able to use this number in the very important calculation of Inventory Turnover.

Yearly Average Inventory Calculation #1

Beginning of Year Inventory + End of Year Inventory

2

Although a popular method of calculation Average Inventory, using only two numbers for the year can be misleading, especially if the goal is to drive down stock levels just before inventory is taken or inventory is taken at a time of the year when inventory levels are unusually high or low.

Preferred Yearly Average Inventory Calculation

End of Month Inventory for each of twelve months

12

By including month-end inventory numbers from throughout the year the final number more accurately represents Average Inventory.

Inventory Turnover

Cost of Goods Sold

Average Inventory @ Cost

Visually, Inventory Turnover is seen as product coming in, being sold and ordered again, sold again and reordered, etc. However, the real importance of Inventory Turnover is as a measurement of the efficient use of inventory dollars. The higher the Inventory Turnover rate, to a limit, the more efficient the use of inventory dollars and the fewer dollars that need to be invested in inventory at any one time.

For example, if your Cost of Goods Sold is $100,000 and your average inventory is $50,000, your Inventory Turnover would be 2.0 ($100,000/$50,000=2.0). If the average inventory is only $33,333, the turnover would be 3.0 ($100,000/$33,333=3.0), requiring an average of $16,667 less in inventory.

There are two things to remember. First, because some categories will turnover at a significantly different rate than others, Inventory Turnover is best measured by product category to get a more detailed understanding. Second, too high a turnover rate will have a diminished positive effect because it generates excessive work in the form of ordering, receiving, pricing and merchandising. And, if turnover is too fast, it is more difficult to keep your fastest moving most popular products in stock.

Cost of Goods (Sold) Percentage

Cost of Goods
x
  100

=
  Net Sales

The biggest expense of any museum store is Cost of Goods and it should be the focus of constant attention. In my consulting experience, excess inventory is the most common and negative impact on profitability. Cost of Goods includes the cost of 'freight in' and is commonly expressed as a percentage of Net Sales.

In many ways the discussion of this cost can end by simply stating that the lower the price paid for product the better. However, if getting a lower cost through show specials, free freight, marketing assistance, etc., requires ordering too much product, in most cases the impact of having to reduce the retail price to sell the excess product increases the Cost of Goods percentage and negates the advantage of the lower initial cost. Don't misunderstand, take advantage of cost lowering programs but use them prudently and don't exceed your inventory needs.

There is a unique wrinkle to the museum store's cost of goods not usually encountered with commercial retail stores. Catalogues, books and multi-year proprietary product inventory, if not handled properly, can badly distort the Cost of Goods Percentage. It is recommended excess inventory of these types of products be placed in a 'virtual warehouse' to separate them from the inventory that meets the immediate needs of the store. When the store needs some of these products they are 'bought' from the virtual warehouse and only then entered into the store's inventory. Treating these products in this manner will make the contemporary calculation of Cost of Goods more accurate and instructive. Although this product is entered into the store's inventory only when purchased from the virtual warehouse, the virtual warehouse inventory is counted as part of yearend inventory for IRS, audit and other purposes.

Gross Profit/Margin

Gross Profit is equal to Net Sales less Total Cost of Goods. In other words, it's the money remaining for other expenses and potential profit after Cost of Goods (including freight 'in') has been deducted.

Net Sales
  Total Cost of Goods

=
  Gross Profit/Margin

The bigger the number the better the chance, after deducting all other expenses, there will be a profit.

While the raw Gross Profit number is, of course, important, it is most typically expressed as Gross Profit as a Percentage of Net Sales. The higher the percentage the stronger the indication sales are growing faster than the Cost of Goods.

Gross Profit as a Percentage of Net Sales

Gross Profit
x
  100

=
  Net Sales

A couple examples may help to understand this ratio. If Net Sales is $100,000 and Cost of Goods is $55,000, the Gross Profit is $45,000. In this case the Gross Profit as a Percentage of Net Sales is 45%. If Net Sales remains the same at $100,000 but the Cost of Goods is lowered to $45,000 the Gross Profit is $55,000 and the Gross Profit as a Percentage of Net Sales increases to 55%.

Also read Retail Math: Part II

 
See the complete list of Profitable Times™ Newsletters.

 

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