What Is Gross Profit Margin in Retail?
Calculating the Health of Your Retail Store
Typically in a meeting with retailers, we will discuss their retail profit margins. It is the fastest way to determine financial health. Low-profit margins mean you have to have high revenues (sales) to cover expenses. High-profit margins mean sales can be lower and still make the same amount of money.
Example: Hudson Shoes #1 sold $30,000 in one month. The inventory cost them (Cost of Goods Sold or COGS) $15,000. Hudson Shoes #2 sold $20,000 in one month, but the COGS was only $5,000. So Hudson Shoes #2 is more profitable been though it sold $10,000 less. Now you may read that and think, but they made the same amount of money? How is Hudson Shoes #2 more profitable? Good question. Consider the effort (payroll, staff, etc) it takes to sell $30,000 versus $20,000. In our example, we are comparing similar ticket averages, just higher margins.
Simply defined, the profit margin is the ratio of profitability calculated as earnings divided by revenues. It measures how much out of every dollar of sales a retail business actually keeps in earnings.
Gross profit is the total revenue minus the cost of generating that revenue. In other words, gross profit is sales minus cost of goods sold. It tells you how much money you would have made if you didn’t pay any other expenses such as payroll, utilities, advertising, etc. When you express this as a percent, then you are speaking to margin.
Example: Hudson Retail Store sells sweaters for $50 each. It costs Hudson $10 to buy the sweater and it also pays an additional $5 for shipping. That makes the company's net income $35 per sweater (50 - ($10 + $5)) and its revenue $50. The profit margin is calculated as 100 - ((35/50)*100) or 30 percent. The math above will give you a .70 number (35/50) but you need to multiply that by 100 to convert to a percentage.
Another Example: Hudson Tools sells drills for $100 each. The cost of the drill is $75 including freight. So the gross margin on the sale is 25 percent.
What Contributes to Profit Margins?
Many things contribute to profit margins. Markdowns and sales promotions are just one example. Anytime you sell the item for less than the initial markup or IMU, you are cutting into your margins. This is why using tools like open-to-buy systems are so important. They keep you from having too much inventory and thus having to discount your prices in order to get rid of it.
Profit margin can be expressed in both dollars and as a percentage. (Read this article for the difference.) And you should analyze your business from both angles. But typically, when someone is asking you about margins, they are inquiring about the percent.
Net Profit Margin
Net profit margin is another term you will hear accountants use. This is the same calculation as above, except you are dividing net revenue (after markdowns) by every single expense in your store. Items such as taxes can be factored here, but most companies now calculate EBITA (Earnings Before Interest, Taxes, and Amortization.) This is due to the fact that interest and amortizations are a financial date on the profit and loss statement often times from previous month's or even year's activities.
By looking at the number before EBITA, you can see how the store did this month. After EBITA you are looking at how the store is doing long term.
What Is the Ideal Profit Margin?
While gross profit margin is good for comparing one of your stores to another, it should not be used to compare your store to other stores outside your industry. I often get asked, "What is the ideal profit margin for my store?" And that is an impossible question to answer across all retail. It is possible, however, to answer it when comparing like stores together.
Example: I used to manage computer stores. We had profit margins of 14 percent. Later I opened a small chain of shoe stores and we had a profit margin of 50 percent. So, the Net Profit numbers of these 2 stores are dramatically different even though both stores were very healthy for their respective industries.