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Brick and mortar retail stores are seeing the results of what the convenience of online shopping is doing to the retail industry.  If you have a physical store, you need to monitor your financial information even more closely to ensure you are operating at your highest capacity. The financial ratios of companies in the retail industry help you manage your selling operation and improve your performance. Analyzing these financial ratios help determine the long-term security, short-term efficiency, and overall profitability of a retail store. Financial ratios also help to reveal how successfully a retail company is selling inventory, pricing its goods, and operating its business as a whole. 

In this day and age of competition for consumers, you cannot afford to ignore your financial information, your benchmarks and your KPIs (key performance indicators).  You need to be monitoring your store’s performance every week so you can position yourself to change what you need to change.  You have to arm yourself with the information so you can be nimble and responsive in order to be more successful.

 A few things you need to know and monitor

  1. How your inventory is moving.  What is selling and what is not.  What is the cost of keeping inventory that does not move as quickly as it should.
  2. What is your gross profit margin on your different inventory categories so you know which items to sell more of by giving them more space in the store.
  3. What do your average daily sales need to be to reach your benchmarks for the month.
  4. What is the average cart value for your customers. You need to have ideas in place for increasing the average purchase so you can reach your daily sales goal.

In this series, we will explain several of the ratios you should be measuring so you can be ahead of the game in strategizing and changing course where and when you need to.

Current Ratio

The current ratio is measured by dividing a company’s current assets by its current liabilities. This financial metric measures the ability of a company to pay off its short-term obligations. A current ratio greater than one indicates that a company can cover its short-term debt with its most liquid assets. The current ratio gauges the liquidity and short-term stability of an organization during the potential seasonal fluctuations common to retail.

Gross Profit Margin.

The gross profit marginis a profitability ratio that is calculated in two steps. First, the gross profit is calculated by subtracting a company’s cost of goods sold (COGS) from its net revenue and then dividing the gross profit by net sales. This metric is insightful to management as well as investors concerning the markup earned on products. Higher gross profit margins are preferable as you make more money on each sale with higher gross profit margin items.

Retailers need to know which of their inventory items have a higher gross profit margin so they can concentrate on selling more of those items.  Lower gross profit margin items are not bad, but it is an indication that you need to sell many more of those items to generate the same profit as a higher gross profit margin item..  Great if you have items that naturally sell in high quantities.  But if low gross profit margin items take up too much space in your store when higher gross profit margin items could use that space, then you need to re-evaluate how you use your store retail space.

The takeaway from these two ratios: A higher current ratio indicates that your short term assets; Cash, Accounts Receivable and Inventory generate enough cash to cover your short-term liabilities: Accounts Payable, Payroll, Credit Card, etc.  It indicates that you operate in a financially sound enough manner to not need cash influxes to make ends meet so to speak.  The average current ratio for the retail industry is around 1.5.  If yours is less than that, then you might need to do some homework to see how you can make your business healthier.

Knowing your gross profit margin is key to being able to adjust the inventory you buy, the space you give inventory items and if what you sell generates enough gross profit to cover the rest of your operating expenses.  If it does not, then you are in trouble and you need to correct this problem as soon as possible or your business will go south quickly.

Time is of the essence with retail stores.  They have to know if they are selling enough to be profitable and how to adjust sales to create more gross profit.

Don’t be afraid of your financial statements.  Use them!  Have accurate and timely financial information so you can monitor your performance and be prepared, ready and knowledgeable to make changes.  Waiting until the month is over or worse, the quarter, half the year or year is over is obviously too late to do anything about it.

Business success is not a casual endeavor. You must have accurate financial information that you know how to use it. Start with accurate, timely financial statements and then add the financial ratios that are the most relevant to your business. If you stay on top of this information, you are on your way to managing a more successful retail store.

Post Author: Tricia O'Connor CPA MBA