Using Gross Margin % or $ to Analyze Cash Flow
Which is more important? Gross Margin $ or Gross Margin %? The answer — BOTH! When I was a COO for a retail company, I used to look at the gross margin in both $'s and %. The reason was that many of the products had great margin %, but the sale price was so low, that the actual dollars generated to run the business were not that much.
In other words, I could get very excited seeing 65% margins on accessories, but accessories only made up 10% of the total sales in the stores — therefore meaning although it was exciting, it could be misleading.
Using an Example
Gross Margin 50% or $5,000
Gross Margin 30% or $7,500
So, in this example, we see that we have more money to cash flow our business from Product B even though its Gross Margin % was almost half of Product A.
In my stores, we wanted "keystone" margins or 50%. It meant that if we paid $50 for the item, then we needed to sell it for $100 to get a 50% gross margin. You use the margin % of the category you are working with to set the IMU or Initial Markup. If you are just starting out, we recommend studying your peers to know how to set your margins. The truth is, an independent retailer rarely gets any advantage on cost from a supplier when they only have a couple of stores. To make a big difference, you have to have lots of stores. In fact, most suppliers give the same cost (price) to every retailer in the country. Therefore, you either have to raise your IMU and be overpriced for your market or look to control your margins in your markdowns.
Examine your sales in categories to determine maximum profitability. For example, if you are a shoe store, the shoes themselves will have different margins based on the category. Dress shoes will have a higher margin than athletic shoes. It is due to the cost to produce the goods. I have seen many retailers make the mistake of managing their gross margin by total store versus by category. While most people will admit that accessories have a higher margin than the regular goods, most do not realize the ways to generate cash flow by viewing and managing your inventory by category or classification.
Examine Your Sales in 4 Ways
1. Gross Margin % on Total Sales
2. Gross Margin $ on Total Sales
1. Gross Margin % by Category
2. Gross Margin $ by Category.
If you are like some people who just examine the total gross margin, what you are missing is margin opportunities within your store. What is the number one cause of lowered margins? Sales. And what do you like to run in your store every week? Sales. So, I could run a sale on all of my shoes in the store and try to get my accessory % up for the month which in turn will impact my margins. But the impact is small.
The key to running a retail business is cash flow. Most people think that the P&L is the determiner of your efforts (or success.) The truth is, the P&L can say you are profitable, but you do not have enough cash to pay your bills. Your gross margins can be 50%, but you do not have enough cash to pay your bills. It is why looking at the margin dollars is so important. You need to ensure that you are generating enough cash flow each month to maintain your store. I have always been a big fan of marking an item down and "dumping" it if it was not selling. The cash in my pocket is better than the hope of more cash in the future.