Retail by the Numbers

Remember those dreaded story problems from grade school? If Sally sells lemonade at 10 cents a cup and Jim buys lemons at $2 a pound, when will their lemonade stand announce its IPO?

Most retailers understand the value of those story problems they labored over as students. If the numbers aren’t coming out right, or are ignored for too long, it could mean the difference between a successful business and a struggling one.

Throughout history—from the Aztec trader counting knots on a rope to the Asian storekeeper flipping beads on an abacus—merchants learned the essential calculations on the job, and chances are, so did you. You helped an employer, manager or parent who worked on the store’s books, entering data and asking questions. Or perhaps you took business courses in college.

Did those experiences and other opportunities along your career path train you well to handle “retail math?” Do you know the ratios and formulas that are most helpful for tracking your store’s financial health?

Michigan Retailer spoke with three past MRA chairs and current board members with experience in providing consulting to retailers—along with a retail accountant—and asked what they thought retailers ought to know about retail math and what they advise clients to use in their businesses. Here’s an overview of their responses.

Don’t underestimate

Joe McCurry, a retired regional manager for Sears who has assisted retailers of all sizes, believes that some retailers don’t have a good grasp of their total cost of goods sold—where operating expenses get figured into the basic retail equation of pricing.

“You know what you’re buying it for, but for each item, there has to be percent that you add—that includes overhead, payroll, rent, all of that—that you need to know and then include as you figure out a fair markup,” he explained.

“Something might be selling well at what you think is a great price, but you’re losing money because you haven’t considered the total cost of goods.”

It’s not that retailers don’t understand this, it’s that they leave out some basic expenses, so they are underestimating the true cost of an item, according to McCurry. Just as different retailers have different strengths, they may also have different blind spots when it comes to their expenses.

“A common mistake I see with retailers figuring out their total cost of goods is overlooking their own salary or the wages paid to family members,” McCurry said.

In their occupancy expenses they may include rent and utilities, but may fail to include depreciation on furniture and equipment. In their payroll expenses, they may include wages, commissions, payroll taxes, benefits, workers’ comp insurance—but overlook the costs of recruiting, hiring and training staff or administering payroll and benefits.

A “general and administrative expense” category can be a useful catch-all, but are you catching everything that needs catching?

Obvious general expenses might include credit card processing, freight, website maintenance fees and office supplies, but what about business liability insurance, outside services such as accounting and legal services, and shrinkage?

If you neglect to figure any of these costs of business into your total cost of goods sold, then the information you use for merchandising decisions—whether to carry an item, how much to mark it up—will be flawed. Decisions based on incomplete information are not sound and will eventually catch up with you.

To calculate your operating expenses as a percentage of selling price, follow three simple steps.

1. Add up all of your operating costs;

2. Estimate your total sales;

3. Divide operating costs by sales.

This figure can go into a basic pricing formula, such as: cost of goods sold/unit + operating costs/unit + desired profit/unit = 100 percent.

One good turn

Mark Schrag owns Seasons, a successful home furnishings store in Okemos. He occasionally advises other retailers. Schrag emphasized the importance of increasing the store’s “turn”—but to know whether your turn is increasing, you have to know what your turn was last quarter or last year.

Inventory turn (Sales divided by Average Inventory at Retail) is a ratio that measures how often—theoretically—entire inventory is sold and replaced within a given period of time.

“A lot of retailers can tell you their turn, but some just do not look at it often enough, either overall or in various departments,” said Schrag.

Both Schrag and McCurry believe this to be a crucial error.

“You have to know this, you have to watch it over time, so you can look for ways to increase it,” Schrag said.

“The impact of higher turn is obvious at larger retail operations, but smaller retailers may not realize the value of turning the inventory one more time a year, or even just increasing it by half a turn,” said McCurry

Of course, the standard for a “good” turn depends on several variables, most notably the category—a good turn in jewelry or furniture might be absurdly low for an apparel retailer. Similarly, turns tend to be higher at mall locations than at other locations, but then so are occupancy expenses.

“You also might need to watch the turn in each department—depending on how diverse the store’s product mix is—because the turn will vary by department a lot, and a poor turn rate in one department might not be visible from the overall turn,” Schrag explained.

Knowing turn rates in various departments helps with buying decisions—perhaps you need to eliminate a department, line or item that is not moving. Many retailers reach these decisions more intuitively, but hard figures can bring to light what would otherwise escape notice.

Whether you compare your turn to the industry average or your own past performance, “everyone can use a higher turn,” McCurry said.

What’s your SPF?

All the consultants agreed that one of the most useful yet simple numbers a retailer should know is sales per square foot.

“Think of sales per foot in terms of sun protection factor—SPF. A healthy SPF will help prevent you from getting burned in a retail business,” said Pat O’Rourke, a DC-based accountant who specializes in retail work and produces the BizStats.com website, a useful resource for retailers seeking benchmarks.

“It’s also easy to compute—just divide sales by the store’s gross square feet. Some retailers calculate SPF based on selling feet (excluding in-store administrative, storage and other space), but that can be subjective and makes meaningful comparisons difficult.”

O’Rourke believes sales per square foot is the best gauge of a retailer’s efficiency and, ultimately, its profitability.

Schrag agreed: “If your expenses are going up and your sales per square foot are going down, that’s a red flag.”

Large retailers, retail analysts and investors use sales per square foot to evaluate a corporation’s health, but the importance of SPF applies equally to small retailers, the consultants agreed.

The most obvious reason for poor SPF—excessive space—means unnecessarily high fixed costs (rent, labor, floor costs, etc.).

But assuming the store size is reasonable, there are many reasons for a poor SPF relative to competitors—in fact, almost every retail problem (poor product mix, insufficient floor inventory, uncompetitive pricing, problematic location, poor sales or marketing) will show up in a poor SPF, according to O’Rourke. “That’s what makes it a critical general benchmark figure,” he said.

Despite the importance of this measure, many small retailers don’t use sales per square foot as a diagnostic tool. They may simply not know what to do with the number.

“Retailers who seek applicable SPF benchmarks can actually use numbers from the big retailers themselves,” suggested O’Rourke. “Many publicly traded retailers are simply chains of surprisingly small-sized stores.”

Benchmark debate

Chief financial officers at large retailers regularly use benchmarks to compare the company’s numbers to the industry average or to particular competitors.

Smaller retailers, on the other hand, often don’t use outside benchmarks. Some simply don’t see the value, others don’t know where to find benchmark data or assume it would be too difficult or costly to obtain. Some may not trust that benchmarks will be based on truly comparable companies, and don’t want to be comparing their apples with other companies’ oranges.

Schrag, for instance, prefers to measure his store’s performance against past performance.

“I don’t benchmark myself against any other stores or averages,” Schrag explained. “I use only my past experience as a benchmark. Most small retailers probably do the same.

“For some retail categories, of course, there are magazines and reports that collect that information—shoe stores or jewelry, for example, might find that data easily. But for many of us, it’s more important to know whether our own turn is going up or down, or how our own sales per square foot are trending.”

O’Rourke said he understands why some retialers don’t use benchmarks, but he encourages them to at least take a look. “It’s another piece of information you may be able to learn from.”

W. Bruce Rogers, a retail consultant in Traverse City, is a firm believer in using industry benchmarks, even for small retailers.

“You have to look at benchmarks if you want to be in business for the long haul,” said Rogers. “Knowing how your competitors are doing is just good business.”

Moreover, benchmark data may not be as hard to obtain as it once was. Along with traditional sources of corporate information like Dun & Bradstreet, the Internet-savvy retailer can find other useful and free benchmark sources (see sidebar: Benchmarks online).

More numbers?

The point of collecting all this data and calculating all these numbers is not to make you finally face your math anxiety, but to use them in your daily business decisions and your yearly or quarterly planning.

Figures that relate to your pricing strategy or inventory can give you more clout when dealing with suppliers or creditors.

Figures that help you understand your operating expenses can help you make the best decisions about benefit packages, technology upgrades and more. (How long until those anti-theft devices would pay for themselves in reducing shrinkage?)

Down the road, as you acquire a detailed financial track record, you’ll have the information you need to make bigger decisions, such as whether to open another location or to adopt more complex management systems.

Finally, lenders use these figures when you turn to them for help. If you have some clue about your “quick ratio,” (Cash plus Accounts Receivable divided by Current Liabilities) your “debt-to-worth ratio” (Total Liabilities divided by Total Equity) or your

Gross Margin Return on Investment (how much is returned in Gross Margin Dollars for each average dollar invested in inventory), you’ll feel more comfortable when sitting down with a lender to justify your request for a business loan.

In preparation for such a meeting, you’ll probably sit down with an accountant. But even if you turn the numbers task over to a professional, you will have more confidence in the process if you understand where these numbers came from and what they mean for your business.

Consultants say that what makes the task challenging—and interesting—is that each retailer’s strengths and talents are different. Not every retailer is fluent in retail finance, and that’s fine—some great retailers make it on their creative marketing, innovative sales strategies or finesse with customer service.

But small retailers are generalists—they tend to be pretty good at many things and probably very good at one or two things. Those who become comfortable with their store’s numbers, or bring on board someone who is, will fare better and have less anxiety about the future.

This article was written by Amy Buttery, Michigan Retailer staff writer.

Benchmarks online

Several free sources of benchmark data and other business tools—spreadsheets and retail calculators—are available on the Internet.

BizStats.com has benchmarks in numerous retail and service categories, based on data from public and government sources. Information on sales per square foot and sales per store as well as national averages on profitability, balance sheet, operating & financial ratios.

Retail Owners Institute (retailowner.com/projections/numbers.asp) offers benchmarks for 40 different retail categories, using data on businesses that do $1 to $3 million in annual sales. Its estimates are based on Risk Management Association’s 2003-2004 Annual Statement Studies.Benchmark data include median inventory turn, debt-to-worth and GMROI.

The Service Corps of Retired Executives (SCORE) is an excellent resource for less experienced business owners. Its website, www.score.org, has some great business tools (downloadable spreadsheets, online workshops) and provides free, confidential face-to-face and online business counseling.

Bplans.com offers free online business calculators, such as a cash flow calculator and a break-even calculator, as well as free sample business plans.

May I help you?

Where can a retailer turn for individual, confidential help? In many professions, mentoring has become a valuable way of tapping the wisdom of experienced colleagues.

Michigan Retailers Association would like to assess the level of interest among members in some form of mentoring program. MRA board members have a general sense that there are experienced retailers who would be willing to mentor less experienced small retailers.

Is there interest in such a program? Are there members out there who would be interested in being paired with a mentor?

Please send us your thoughts on this issue—contact Amy Buttery at 800.366.3699 or abuttery@retailers.com.