If you’re running any kind of retail business, then chances are your profit margin isn’t as high as you’d like it to be. Lower profit margins are a uniquely brick-and-mortar problem that impacts nearly all retail businesses, from your local bodega to that high-end clinic you walk past on your way to work that doesn’t accept insurance.
The retail industry is known for its thin profit margins due to fierce competition and various operational costs. Understanding the factors that affect retail profit margins is crucial for optimizing your business's financial success.
Factors that affect retail profit margins
Several factors can impact profit margins in retail. One of the primary factors is the cost of goods sold (COGS). This includes the direct costs associated with producing or purchasing the products you sell. If your COGS is too high, it can eat into your profit margins.
How to calculate cost of goods sold (COGS)
Here’s a simple formula you can use to determine your COGS for any specific product or service that you offer:
COGS = Beginning Inventory + P − Ending Inventory
P = purchases made during the accounting period (typically a quarter or a year)
Beginning Inventory = leftover inventory from the previous accounting period
Ending Inventory = leftover inventory at the end of the current accounting period
Let's say that at the beginning of the year, you had $10,000 worth of clothing inventory left from the previous year (Beginning Inventory). Over the course of the year, you buy $50,000 worth of new clothing to sell in your store (Purchases or P).
At the end of the year, you count up your remaining clothing inventory and find that it is worth $15,000 (Ending Inventory).
COGS = $10,000 (Beginning Inventory) + $50,000 (Purchases) - $15,000 (Ending Inventory)
So, the Cost of Goods Sold (COGS) for your clothing store for this year would be $45,000. This means that it cost you $45,000 to provide the goods you sold this year.
Of course, this is a very simplified example and actual business calculations would involve additional operating expenses including rent, utilities, employee wages, marketing costs, and other overhead expenses.
Keeping all of these costs in check is vital to ensure your retail profit margins remain healthy.
What goes into a pricing strategy?
Another significant factor that can impact your retail profit margins is your competitive pricing strategy.
For example, if you set your prices very low compared to your competitors, you may attract more customers...but your profit margins will undoubtedly take a hit.
On the other hand, setting prices too high compared to your competitors is almost a sure way to drive away potential customers. Striking the right balance is essential to maintain healthy profit margins.
Calculating and analyzing your business's profit margin
To calculate your profit margin, you need to know your total revenue and total expenses.
Going back to our earlier clothing store example, let's say you sold those clothes that cost you $45,000 in COGS for a total of $70,000 that year. Your net profit (or gross profit in accounting terms) can be calculated as total sales minus COGS.
Net Profit = Sales - COGS
Sales = how much revenue you generated from your sales during the accounting period
In this particular, hypothetical case:
Net Profit = $70,000 (Sales) - $45,000 (COGS) = $25,000
So your gross profit on the clothing sold during this year would be $25,000. This means you earned $25,000 after accounting for the cost of the goods you sold, which was $45,000.
Finally, to calculate your profit margin, you could use the following formula:
Profit Margin (%) = (Net Profit / Total Revenue) * 100
Total Revenue = Sales, just to keep things simple for the purposes of illustration
Putting it all together, we get:
Profit Margin = $25,000 (Net Profit) / $70,000 (Total Revenue) * 100 = 35.71%
So your profit margin for the year on the clothes you sold comes out to 35.71%. Not bad, considering the average retail clothing store’s profit margin is typically just 4–13%. Sheesh.
Once you’ve calculated your profit margin, it's important to analyze it regularly to identify trends and make informed decisions about how to lower your expenses while upping your margins.
Staying up-to-date on industry average profit margins
Knowing your industry’s average profit margins—which can change quite a bit over time, depending on the industry—will provide invaluable insights into your business's financial health.
Knowing what your local competition charges will allow you not only to benchmark your performance against industry standards and identify areas where improvements can be made but also to come up with an effective pricing strategy that is more likely to work in the first place.
If your profit margins are significantly lower than your industry average, you might not be running a tight ship.
To benchmark your profit margin, you can start by researching industry reports or consulting industry experts. Look for data that provides insights into the average profit margins for businesses similar to yours.
Keep in mind that benchmarking is not just about comparing numbers. It's about understanding the underlying factors that contribute to the profit margins of successful businesses in your industry, including what their expenses cost.
By gaining this deep understanding of the competition, you can identify smart strategies and best practices that can help you optimize your business's financial success.
Fortunately, NYU Stern School of Business regularly updates a Margins by Sector page with a lot of useful info—likely way more than you’ll ever need. You can even download the dataset as an Excel file, which is super helpful.
Strategies to optimize your business's financial success
Optimizing your business's financial success requires a proactive approach. Here are some strategies to consider:
Increasing revenue and reducing costs to improve profit margins
One way to improve your profit margins is by increasing your revenue while simultaneously reducing your costs.
Look for opportunities to attract more customers or increase your average transaction value. This can be done through effective marketing strategies, upselling, cross-selling, or introducing new products or services.
At the same time, analyze your expenses and identify areas where you can cut costs without compromising the quality of your products or services.
Negotiating better deals with suppliers, optimizing your inventory management, and implementing cost-saving measures can all contribute to improved profit margins.
Utilizing technology and data analysis for better financial management
In today's digital age, technology plays a crucial role in optimizing financial management.
Implementing a robust point-of-sale (POS) system can help you track sales, inventory, and customer data more efficiently. Real-time, 24/7 POS data can provide valuable insights into customer behavior, allowing you to make data-driven decisions to improve your profit margins.
Even something as simple as switching preferred merchant services providers can help, since modern providers will not only offer the most competitive card processing rates for your type of business, but they’ll be compliant with current laws.
Some preferred merchants, like Nadapayments, will even set you up with the best POS system for your needs and even integrate your payments with industry-specific software, like CRMs or ERMs.
Additionally, leveraging data analysis tools can help you identify trends, spot inefficiencies, and optimize your pricing strategies.
By harnessing the power of technology and data, you can gain a competitive edge and maximize your business's financial success.
Tips for improving gross profit margin in retail
Here are some tips to improve your gross profit margin:
- Negotiate better deals with suppliers to lower your COGS.
- Streamline your inventory management to minimize wastage and reduce carrying costs.
- Optimize your pricing strategy to ensure you are charging the right amount for your products.
- Monitor and control your operating expenses to prevent them from eating into your gross profit margin.
- Regularly review and update your product offerings to ensure you are offering a mix of high-margin and popular items.
By implementing these strategies and focusing on improving your gross profit margin, you can enhance your business's financial performance and optimize your overall profitability.
The more you charge, the more you lose to credit card fees
By implementing strategies to increase revenue, reduce costs, and leverage technology and data analysis, you can optimize your business's financial success.
Remember, improving your profit margins requires a proactive approach and ongoing evaluation. But with the right strategies and a focus on financial management, you can maximize your business's profitability and achieve long-term success.
Speaking of ways to reduce costs—if you run a high-ticket retail business like a private health clinic (e.g., waxing and laser hair removal, cryotherapy, cosmetic dentistry or surgery, etc.), you're paying a heck of a lot more in credit card processing fees than you should, sometimes by dozens or even hundreds of dollars per transaction.
The good news? Nadapayments can help put all of that money back into your pocket, where it belongs.