In previous articles, I've talked about how important reviewing financial statements can be to increase your store’s profit. In this article, I’m going to share ten things to focus on. Depending on how frequently you review your financials, many things can be observed and acted upon that will have a dramatic impact on your retail business. For example over the past year, we've used financial reviews to help clients significantly reduce payroll costs, detect internal fraud and avoid over-paying income taxes.
Here are 10 areas to review on a regular basis. The first nine are found on the income statement and the last one is on the balance sheet.
1) Sales Income
As a business owner, you should have sales goals. So the first thing to look at is how your sales income compares to defined goals as well as well as to the store’s breakeven level.
2) Cost of Goods Sold (COGS)
I find this is one of the most frequently misleading entries on an income statement and it represents a significant portion of expense in relation to income. To verify its accuracy, I recommend comparing it to your point of sale system’s cost of sales value assuming that you properly have configured and are correctly using your software. You can also compare your COGS as a percentage of income to industry norms.
3) Gross Profit (GP)
Gross Profit of course is what remains when COGS is subtracted from sales income. This represents the amount of money remaining for operating expenses, debt service and profit. A good gross profit percentage varies by type of retail. For example, many apparel stores should aim for a GP percentage of approximately 45 to 50% of sales.
4) Total Expenses
Overall, total expenses obviously needs to be less than gross profit so that you have a profit (gross profit minus total expenses equals profit). Again, it varies by type of retail business. but generally total expenses should be 40% of sales income or less.
5) Rent Expense
Typically, a retail business needs to keep rent at 10% of sales income or less. There are exceptions, but most of my clients with strong profit and cash flow meet or do better than this threshold.
6) Salary Expense
For most independent retail stores, salary needs to be in the mid-teens as a percentage of sales income. If owner compensation is excluded from salary expense, it should be on the low end of the teens - it can be in the high teens if owner compensation is included. Most healthy stores are in this zone.
7) Marketing Expense
In years past, marketing costs needed to be around 3% of sales. When you went lower than that, it wasn't sufficient to generate effective results. When spending was higher than this target, there was a rapid diminishing return on the addition expenses.
Since the emergence of Internet social media and web marketing tools like email, many types of retail business have been able to reduce their marketing costs as a percentage of sales. The key to determine the right percentage is the nature of your target customer. In broad terms clients catering to young women and teens often have marketing costs around 1% to 1.5% of sales. Other types of retail businesses often find that other forms of marketing are more effective and end up the range of 2.5% to 3%.
8) Credit Card Merchant Fees
Trying to figure out a credit card merchant statement is worse than a cell phone bill. Like other expenses, start with the percent to total income. Merchant fees should be around 2.5% of sales for most retail stores. This factors in a mix of cards including AMEX and assumes that most sales transactions are done by credit card. If yours is much higher, I’d contact your rep and tell them it’s high and you want it reviewed. If they decline, I’d consider switching to a more affordable provider.
The mix of the first eight items that we covered above will vary by store and type of business. But the combination of these expenses has to obviously leave you with profit. But what is a good target? It might come as a surprise, but most industries consider 5% a realistic expectation. However there are other things to consider. For a small to medium business, I would expect the owner to be compensating themselves fairly in addition to the 5% profit in order to be a healthy business. Another consideration is how much loan or debt principle has to be paid with the profit. A business can show a profit but not be able to pay their bills if debt service exceeds the profit.
10) Cash Compared to Current Liabilities
There is a lot of important information on a balance sheet which is beyond the scope of this summary article. But one initial step is to compare your cash with current liabilities. By current liabilities, I refer to things like payables and credit card debt that typically has to be paid in the near future. So by comparing this to cash in the bank, you can gauge if this current liability debt a problem or not. The next logical step would be a cash analysis that factors in income, cash and all forms of expenses and debt over a given period of time.
This article is not an all encompassing list, but it should provide you with starting tips to analyze your own financial statements monthly.
About the author
Stephen Fingerman founded Avalon Retail Consulting, Inc. in 1996 out of a desire to assist retailers in growing successful retail businesses. Avalon Retail Consulting also has recently launched avalonretailacademy.com, a web-based resource for retail stores and retail consultants. Steve can be contacted by email at firstname.lastname@example.org or by phone at (504) 314-9211.