Robbie BrownWritten by

Understanding the 4 Elements of Profitability

Business Trends| Views: 778

While tackle retailers fundamentally love their sport, their primary motivation is to generate abundant profits and to accumulate wealth over time. But where do profits come from?

Most students of retail would say that profit is a biproduct of sales versus cost of goods sold and therefore gross margin dollars minus all expenses. Although this is fundamentally true it overlooks the spectacle of inventory velocity or the speed at which inventory comes in the back door and goes out the front door. Expressed alternatively, how long inventory sits around before it is sold.

Profuse profit is generated when these four elements of profitability (sales, margins, expenses and inventory velocity) are functioning at their best. Let’s drill down and take a closer look.

Sales

Sales do not happen automatically nor are they just a function of time, consumer demand and good luck. Sales are maximized when the retailer has properly gauged the demand curve of their consumer base, has impeccable timing, offers enticing products and promotions and is capable of generating sales per square of $200/sq./ft. or greater.

One’s sales are optimized only if there is a mix of products sufficient to sustain such a sales figure. Thus, if you only stock tackle and accessories with no ancillary apparel, footwear and related accessories, you may not be able to reach the sales number you desire.

Margins

Margins (aka gross margin) is a function of what you paid for specific inventory versus what you sold it for, after all markdowns. You can increase your margins by selling at a higher price, buying the product at a lower price, or simply sell more of the product at whatever price. What is important here is total gross margin dollars and not necessarily gross margin percent.

Expenses

From this pool of gross margin dollars, we now subtract the totality of all expenses: fixed, variable, cash and non-cash alike. Non-cash expenses will be depreciation and amortization. The net result of all this math is net profit before taxes. It all sounds rather straight forward . . . . not exactly.

Inventory velocity

What’s missing from this equation is the speed of inventory in and out of the company. In simplistic terms, the slower inventory moves in and out of the store, the greater the total expenses incurred and therefore the lower the total net profit for the company.

Consider, the slower the inventory, the longer cash is tied up in inventory and therefore cost of cash is incurred (you have paid the vendors but not yet collected cash from the customers). Similarly, the inventory sitting in your store(s) must be insured, handled and subject to damage, obsolescence and shrinkage, all of which costs the retailer significant dollars.

There is also a more subtle cost of lost sales resulting from inventory that sits around too long. If inventory is allowed to grow “stale” or lose consumer interest because the product becomes shopworn, overly exposed or out of date, then markdowns occur and net profit is decreased.

An ancillary benefit of fast moving inventory is heightened consumer interest because of the constant parade of new products, styles and colors. With high inventory velocity, cash flow becomes positive and most of the carrying costs are reduced, yielding larger profits.

The pursuit of profit commensurate with the retailer’s investment (equity plus retained earnings) is the end game. Profit as a percent of investment should be 10% or greater. And to make it all happen, remember to carefully analyze the four components of profit, those being sales, margins, expenses and inventory velocity. Make it happen! 

Joe Sills Hi there, did you know? Each week, we curate a list of the Top 5 stories in fishing and send them right to your inbox. Reading Tackle’s Top 5 is one of the best ways to become or remain an industry expert. -Joe Sills, Digital Editor

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