A fairly common problem that I’m sure retailers have discussed with you, as their accountant, is “Why, if we’re selling so much product, aren’t we making a profit?”
My suggestion on your response to your client is as follows:
To answer this question we need to analyse how a retail business operates. In most instances, retailers purchase a variety of products from various suppliers and they then mark-up those products to a price that, they believe, will enable them to compete with their competitors.
If the product category that achieves the highest unit sales is the product that you can only achieve a fairly low mark-up on, you’ll probably not be generating enough revenue to trade at a profit.
Success for a retailer requires an adequate mix of products with variations of mark-ups so that the total sales generates a gross profit percentage and gross profit that will cover the retailer’s overhead expenses and contribute to a profit in the business.
Unfortunately, some retailers have been known to confuse the use of mark-ups and gross profit percentages and have used the gross profit percentage as a “mark-up”. This obviously will not compute into a selling price that is at a sufficient level to generate an adequate gross profit.
I’ve found that a simple mark-up percentage and gross profit percentage chart has helped many small business operators have a better understanding of mark-ups that they can use as they relate to gross profit percentages which is the jargon used by most accountants. (Click here) for a chart that explains this position.
I’d suggest that you then explain to the client that:
A retail business needs to analyse whether the stock mix and the mark-ups will generate an adequate profit for the business and this is where the accountant can assist. You would start with:
- The budget estimate for the employees of the business – wages/salaries, including the cost of labour on-costs (holiday pay, holiday pay loading, personal leave, superannuation etc).
- The overhead expense budget for the year would include items such as rent, advertising, accountancy fees, marketing, cleaning, interest, finance charges, insurance and the other incidental costs of running a business.
- The retailer needs to identify a targeted profit for the year, normally based on the cost of the investment in the business, calculated at a targeted rate of return.
- Targeted gross profit figure can be calculated after taking into account the total of:
- labour and labour on costs
- overhead expenses
- targeted profit
- The product mix strategy can then be examined to determine whether the products that the business intends to purchase and the mark-ups that the manager believes can be achieved on those products will generate sufficient sales to earn the required gross profit that will generate an amount to cover the overhead expenses and the net profit for the year.
If the initial product mix selected does not generate the required gross profit and therefore the targeted net profit, there needs to be a re-examination of the product mix and potentially the mark-ups to see whether a change of product mix within the business will generate the targeted gross profit which will then flow through to the targeted net profit.
This analysis enables accountants to offer real assistance to your retail clients, similar to the types of services that accountants provide when they are employed in commercial retail enterprises, because you would be involved in setting the targets on the product mix and the mark-ups to ensure that the overall profit target for the business is achieved.
This is not a strategy that should be prepared and then locked in for the year with no further review. Our suggestion is that, at the end of each month, or at the very latest every 3 months, a business review meeting should be convened with the leadership team to consider the financial results that have been achieved to date and to determine whether the profit earned is satisfactory and, if not, to re-examine the product mix/mark-up strategy.
ESS BIZTOOLS has developed a separate product package to assist accountants to deliver a range of services to assist their retail clients to have a better understanding of their product mix and mark-ups on those products as they attempt to generate sufficient revenue and gross profit to earn the retailer’s targeted net profit.
For more information on the “Industry Specific Advisory Product Package” – please click here.
Peter Towers | Managing Director