Retail Math is probably one of the most misunderstood parts of running a business for new entrepreneurs. The premise is simple enough. You purchase goods or services at one price, and then you sell them at another for a profit right?
Over the course of my career, and in my interactions with clients large and small I’ve learned that for first time entrepreneurs there is a lot of confusion about how to properly price their products and services, apply discounts both on purchases and sales, and how this all affects inventory values, appreciation, and depreciation. In this post I will go over some high level principles of retail math, and it’s direct effect on profitability.
What’s the difference between a Mark Up and Margin?
Quite simply a Mark-Up is a multiplier used to calculate the selling price of an item from the cost of the item. This is the most common way to calculate the selling price of goods and services. The most common mark up is called a Keystone Markup. This is where you are doubling the acquisition cost to determine your selling price.
For example, your cost of goods sold (COGS) on a blouse is $10. To determine your wholesale price you would multiply that by 2 for a wholesale price of $20. You then multiply your wholesale price by 2 again to determine your Suggested Retail price of $40. This is a Keystone Mark-Up. In other words, your mark-up is 100 percent.
Why overriding prices is not a proper Discount Methodology
I see this time, and time again. It’s one thing when it’s an employee, because that’s a training issue that can be resolved. It’s entirely another thing when it’s being perpetuated by an owner. At best, overriding the price in a POS (Point of Sale) system is lazy accounting, and should never be done. Why you ask?
- Discounts are tax deductible.
- By overriding the price it makes it next to impossible to track your discounts just as you would any other business expense.
- You are under stating top line sales on your P&L (Profit & Loss) statement.
How To Calculate your Break Even Point
I bet right now your asking yourself, “what’s a break even point?” In the simplest of terms your break even point is that magic number when sales = expenses. Knowing this number will help you manage your business better, and improve your ability to properly determine your margins.
Break Even Formula
Fixed Costs/Price – Variable Costs = Sales Volume Required
$30,000/$20 – $8 = 2,500 units
Based on this example if your annual fixed costs are $30,000 you would need to sell 2,500 units per year just to cover your fixed costs. This is what we call being Net Neutral, or Breaking Even. You didn’t make a profit, but you didn’t lose money either.
In order to generate a profit in this scenario you would either need to sell more units, or increase your selling price.
I hope this very high level post on some vary basic accounting principles helps you operate a more profitable fashion business.