How Retailers can Increase Profit Margins: 5 Proven Ways to Improve Profitability
The relationship between your costs and sales is key to running a profitable business. One of the key metrics you should monitor is your profit margin. But how can you increase your profit margins?
It starts with understanding the difference between gross profit and net profit and how your operational costs, cost of goods sold (COGS), pricing, markdowns and sales volume all contribute to whether or not your store turns a profit.
And getting each down to a science is the key to profitability.
In this post, you’ll learn the following:
- What gross profit is and how to calculate it
- What gross profit margin is and how to calculate it
- What net profit is and how to calculate it
- The factors that contribute to profit margin
- What the ideal profit margin is
- 5 actionable ways to increase profit margins
What is gross profit?
Gross profit is your total revenue minus the cost of generating that revenue. Simply put, gross profit is your sales minus the cost of goods sold (COGS). Your gross profit tells you how much money your business has before paying for other expenses like payroll, marketing, utilities, etc.
Gross profit formula
Your gross profit is calculated by subtracting the cost of goods sold from your sales. Expressed as a formula, it looks like this:
Understanding gross profit
Let’s say that Johnny’s Bikes sold $20,000 worth of a Bike #1 in one month. Their inventory cost them $10,000. Bike #1’s gross profit is $10,000.
In that same month, Johnny’s Bikes sold $15,000 worth of Bike #2 and its COGS was only $2,000. Bike #2’s gross profit is $13,000.
Although Bike #2 sold for less than Bike #1, its gross profit is higher, therefore the bike is more profitable to sell.
What is gross profit margin?
Gross profit margin is when you express gross profit as a percentage. The higher the percentage, the more profitable an item is for a business to sell.
Gross profit margin applies to a specific product a business sells. Calculating gross profit margin enables businesses to set prices that make selling the product worthwhile.
Gross profit margin formula
Your gross profit margin is calculated by first subtracting the cost of goods sold from your sales, then dividing that amount by sales. Expressed as a formula, it looks like this:
Understanding gross profit margin
Taking the same example as we did for gross profit, let’s explore the gross profit margin of Bike #1 and Bike #2 at Johnny’s Bikes.
Bike #1 sold for $20,000 and its gross profit was $10,000.
Gross profit margin = 10,000 / $20,000
Gross profit margin = 0.5
Gross profit margin = 50%
Bike #1’s gross profit margin is 50%.
Bike #2 sold for $15,000 and its gross profit was $13,000.
Gross profit margin = 15,000 / 13,000
Gross profit margin = 1.15
Gross profit margin = 115%
Bike 2’s gross profit margin is 115%. Since its cost of goods sold is less than Bike #1, it’s more worthwhile for Johnny’s Bikes to sell Bike #2 than it is Bike #1 because they’re making more profit on each sale.
What is net profit margin?
Let’s say you wanted to express your entire business’s profitability rather than just one product; that’s your net profit margin. A business’s net profit margin is expressed as a percentage.
The higher the percentage, the more profitable the business is. A low net profit margin is a signal that there are issues impacting your business’s profitability potential, from high expenses (rent, utilities, labor, etc), issues with productivity or even management issues.
Net profit formula
To calculate net profit margin, you first need to find your net profit by subtracting your total expenses from your total revenues.
Understanding net profit margin
Let’s say Johnny’s Bikes’ gross sales are $500,000 and their total expenses are $250,000. Their Net profit would be $250,000.
Net profit = $500,000 – $250,000
Net profit = $250,000
To express your business’s net profit as a percentage, do the following:
Net profit margin = ($250,000 / $500,000) x 100
Net profit margin = 0.5 x 100
Net profit margin = 50%
What contributes to profit margins?
There are many things that factor into a retailer’s profit margins, including markdowns and promotions.
When you sell an item for less than your initial markup (IMU), you’re effectively lowering your profit margin on that item. That’s why having the right markdown strategy is so important. You never want to arbitrarily attribute a discount to a product; always pinpoint a retail price that will be both interesting for deal-hunters and profitable for your business.
Your point of sale system can also help. One of the main reasons retailers discount products is to liquidate old inventory that wasn’t selling at full price. A retail POS system with inventory management capabilities will keep you from ordering too many units of a product, preventing you from having to discount its price to get rid of excess inventory in the first place.
What is the ideal profit margin?
Profit margins vary greatly depending on a retailer’s sub-sector and what products or services they sell.
For instance, a fashion and apparel store’s profit margins will vary greatly based on what type of clothing it sells (is it fast fashion, mid-level or luxury goods?). If we were to compare the profit margins of a clothing store to that of a hand-made furniture store, they would vary greatly even if their respective profit margins are healthy for their respective sub-sector or niche.
5 ways to increase your profit margins
Now that you know what gross profit is and how to use it to attribute a product’s monetary value for your business, let’s look at eight tried-and-true ways to increase your profit margins and give a boost to your sales:
- Bring your brick-and-mortar store online
- Avoid markdowns by improving your inventory purchasing
- Plan ahead for each season
- Find ways to reduce operating expenses
- Increase your average transaction value (ATV)