Retail 101: Calculating Margins and Markups
You’re a retailer; whether you have a store or an e-commerce website (or both), this means you are responsible for many areas of your business. From marketing to employee management to finding new products, you’re the primary driver of your own success.
When it comes to buying and bringing in merchandise, most likely, you’re trying to balance price to profit based on what people are buying. You know that trends drive sales, but you also know that your top-selling merchandise is what keeps your customers coming back. When you add holidays and your customer’s personal celebration dates, your merchandising mix
quickly becomes a matrix. To remain profitable year-round, it’s important to find products
that allow for high retail markups and larger than average profit margins.
Finding Profitability in Your Product Pricing
As a retailer, your margins and markups are where your livelihood comes from. In 2020, it’s important to align your buying and inventory decisions to your store’s overall sales goals. Ask yourself the following question:
How much do I want to make this year? What are my profit goals for our store?
Here’s a free profit and loss sheet
to help you establish your goal if you need to look at all your costs. Once you set this number, look at your inventory. How have you priced the products in your store or online? Do you know how they are helping or hurting your goals? Your inventory is your profit center.
You are most likely going to have:
- Low-profit goods: Items that bring people in stores and/or items people buy in volume.
- Medium-profit goods: Items that sell for a slightly higher margin, sell consistently, but they don’t sell at the volume of other items.
- High-profit goods: Items that sell at good margins or high markups but their sales may be seasonal or trend-based.
Within low, medium and high-profit margin goods, the sales patterns can vary depending on many factors. Sometimes your high margin goods could be consistent sellers (one item that you pay $5 for and always sells for $45). Sometimes lower profit goods sell so regularly that they bring people into your store to make other one-time purchases and you see a sales bump.
Because of the factors surrounding sales and traffic, you must track your inventory and sales data accurately so that you can easily understand how to sell more based on what’s moving in your store or what your customers are buying online. The only way to strategically price your merchandise is by knowing how to use margins and markup to your advantage.
Retail Pricing Terminology
Before we talk about margins and markups, it’s important that you understand several terms. These terms have a huge impact on your calculations:
- Price/Revenue: The selling price of goods to your customers and how much you make from those goods.
- Cost/Cost of Goods Sold (COGS): The total price to produce the item. This includes the expenses that go into making your products and providing your services. Calculating COGS also includes materials and direct labor costs.
- Gross Profit: The profit left over after you pay the expenses of selling your products.
Now that we’ve covered these, let’s move onto better understanding margins and markups.
What Are Retail Margins?
Calculating product margins are based on the wholesale price you pay for your inventory and the retail price you charge your customers for that merchandise. Many retailers believe that a strong margin is double the cost of an item – so if you purchase something for $5, selling it for $10 means you doubled your money!
Other retailers aim to gain higher margins to help them make more money and cover their costs while increasing their profit. That same $5 item could be retailed for $15, $25 or even $50 based on a variety of factors. When calculating margins, you need to factor in your gross profit and the costs associated with making the sale (your overhead expenses).
Let’s create an example. You sell a self-care kit for $200. Each self-care kit costs you $100 to purchase at wholesale. First, find your gross profit, or the difference between the revenue ($200) and the cost ($100).
The margin is 50 percent. That means you keep 50 percent of your total revenue. You spent the other 50 percent of your revenue on buying the self-care kit. Margin measures how much of every dollar in sales, you keep after paying expenses. The higher your margin, the more money you make.
The larger the retail margin, the greater the profit you can make on each sale. However, if you set your prices too high to increase your margins, other competitors can set prices lower and steal your customers. What retail margin doesn’t consider is the cost associated with making a sale. Taxes, overhead, and marketing are all paid by your profits so take that into account as you price items.
What Are Retail Markups?
Markups are different than margins. A markup shows the percentage of profit, meaning it shows how much more you make from the selling price less than the amount the item costs you. Like a margin, you start finding a markup with your gross profit (revenue minus COGS). Let’s use the same example of a self-care kit but we change the price: you sell each kit for $175. The self-care kit costs you $100. First, find the gross profit.
The markup is 75 percent. That means you sold the kit for 75 percent more than the amount you paid for it. The higher the markup, the more revenue you’re making.
When Should You Use Margin and/or Markup?
Margin and markup are closely related. Understanding how to use both will always help you with becoming and remaining profitable. When it comes to choosing which one to use, a retailer uses markup to ensure they are making money with each customer purchase. In general, markup is extremely helpful when you’re first starting because you can use it to set pricing to cover your operating costs. You use margin once your business is more established and you’re ready to start diversifying your pricing strategies to meet your overall revenue goals (based on those customer purchase patterns we mentioned at the beginning of the article).
You Need A Great Accountant and Great Software
To be successful as a retailer in 2020, having great software and a great accountant is one of the single best investments you can make for continued growth. You may find an accountant is more important to your business than outsourced business functions like marketing. Look for local accountants that specialize in retail businesses as they are going to have the most knowledge about retail taxes and laws.
When it comes to software, most retail point of purchase (POP) systems come with some built-in inventory features, but we’ve found many are limited in helping retailers make sense of their cash flow as it correlates to their inventory. Shopify is a go-to for many retailers who sell online. If you have a store and need something that’s made for retail locations, check out StitchLabs and Inventory Flow which offer easy to use and best in class platforms designed for retailers.
Mastering your finances as a retailer and understanding how you price goods is one of the most important things you can do as your income is what drives the reinvestment you make in your business. Make your profitability your top priority!
Want to learn more about retail finance and running your business? Register to attend our next show and gain access to 100+ free business seminars designed for retailers like you!