How Retailers can Increase Profit Margins: 5 Proven Ways to Improve Profitability

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: 

Let’s dive in! 

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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: 

gross-profit-formula

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: 

Gross Profit Margin Formula

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.

Net Profit Formula

Net profit margin formula

Next, divide your net profit into your total revenue and multiply the result by 100 to express the value as a percentage. 

Net Profit Margin Formula

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: 

  1. Bring your brick-and-mortar store online
  2. Avoid markdowns by improving your inventory purchasing
  3. Plan ahead for each season
  4. Find ways to reduce operating expenses
  5. Increase your average transaction value (ATV) 

1. Bring your brick and mortar store online

It’s imperative that your customers are able to find your retail business online

This can be as simple as creating a Google My Business profile to help more local customers find your store either through Google Search or Google Maps. According to Google, 88% of people that search for a local business online either call or visit that business within 24 hours. Setting up a GMB profile helps businesses convert online visibility into in-store transactions. 

Fashion and apparel retail C'est Beau's Google My Business profile

If you want to take it a step further, consider launching an online store. While getting started may seem like a daunting task, you can always start small and work your way up as you have time and resources. 

Even a basic (but well-designed) website that features your business name, location and contact information is beneficial for helping customers find your store. But the real benefit of setting up an online store is creating a secondary sales channel to complement brick-and-mortar sales. 

With Lightspeed eCom, you can build a transactional website using handy templates, sync your physical store’s inventory with your online store and manage both from the same backend. 

An online store can increase your exposure and sales while costing far less than opening a second physical location. 

Key takeaways:

  • Set up a GMB profile to increase your retail store’s visibility and convert that into in-store sales. 
  • Create a transactional online store to increase sales at a lower cost than if you were to open a second brick-and-mortar location.

2. Avoid markdowns by improving your inventory purchasing

Whenever you lower the price of an item, you’re also lowering that item’s profit margins. That’s why it’s best to avoid markdowns whenever possible. 

The most effective way to avoid markdowns is to improve your inventory management, the merchandise you have on hand, the products sell quickly at full price and the ones that don’t. That information (which you can typically find in your POS system’s sales reports) will help you decide which products to stock up on and how much to buy to fulfill customer demand, prevent overstocking and avoid the need for markdowns and promotions altogether. 

Key takeaways:

  • Use your sales and inventory data to get a clear understanding of how much inventory you have, which products sell at full price and what doesn’t sell unless marked-down (or doesn’t sell at all). 
  • Leverage those insights when purchasing inventory to assure that buying products that sell at full price and not over-stocking either. 

3. Plan ahead for each season

Most retail businesses have a season where their sales peak. A retailer’s peak season will vary based on their sector, product-type and their location. Even then, most retailers in the US will experience a fluctuation in sales from one month to another. 

Retailers should get into the habit of looking at their annual sales reports, broken down month-by-month. Which months do they make the most sales in? Does that pattern persist year after year? 

Use those patterns when planning your seasonal inventory purchasing. If you notice that you sell a higher volume of certain product types in a given season, consider purchasing more units of that item to capitalize on its seasonality and maximize sales. 

A secondary benefit to planning your seasonal inventory ahead is that suppliers may offer discounts for advanced or bulk orders. You may be able to lower that item’s COGS, maintain it’s retail price and maximize that item’s gross profit. 

Key takeaways: 

  • Look at your annual sales reports broken down month-by-month and take note of any patterns. 
  • Use that data to plan what seasonal inventory you will carry in advance. Suppliers may offer discounts on purchase orders submitted in advance. 

4. Find ways to reduce operational expenses 

Krista Fabregas, a retail analyst at www.FitSmallBusiness.com, suggests that retailers find ways to streamline their operations as a way to increase profit margins. 

There are several key areas where a retailer can reduce operational costs. For starters, look at labor costs and avoid overstaffing. Next, look at other costs like your product packaging, shopping bags and even your store lighting. Are there any costs that can be reduced? In the case of lighting, it may be worthwhile to invest in energy-efficient commercial lighting. 

Another way to reduce operational costs is by streamlining productivity. Are there certain repetitive tasks that are taking up chunks of you and your staff’s time? A usual culprit is anything to do with data entry. 

The good news? Most time-consuming data entry tasks can be automated. For example, rather than manually transferring sales data from your point of sale system to your accounting software, consider using a two-way integration like Lightspeed Accounting, which automatically pushes information from one system to the other. Spend less time punching in numbers (or avoid paying someone to do that task for you) and benefit from accurate bookkeeping. 

Key takeaways: 

  • Find places where you can lower your overhead spending without sacrificing the quality of your customer experience. 
  • Automate time-consuming, repetitive tasks to save time and lower your expenses. 
  • If you use Lightspeed, visit our integrations page to find tools that help you automate tasks. 

5. Increase your average transaction value (ATV)

Increasing your store’s average transaction value (ATV) is both an excellent and achievable way to increase profits. Retail is an inherently social activity and, although technology helps merchants serve customers, nothing can replace the connection between an empathic and informative (but not pushy) sales associate and their customer. 

But how can you use social interactions to boost ATV?

Teach your sales associates the art of suggestive selling. Once a customer is in your store, it’s on your sales associates to build a rapport, listen intently to their needs and find products that fulfill those needs. In our 2020 Retail Trends Report, we found that 82% of consumers want more human interaction when they shop and those interactions between sales associates result in higher in-store sales. At the NBA Store in New York, for instance, conversions increased by 182% when customers engaged with a sales associate. 

Your store layout has an impact on in-store sales, too.

How you promote and display your products in-store, known as visual merchandising, can help customers find what they’re looking for, discover related products and make a purchase. Point of sale marketing (placing low-investment products near the checkout) is another tactic retailers use to increase impulse purchases and a customer’s transaction value. 

Key takeaways: 

  • Teach your sales associated the art of suggestive selling to help them close more sales without coming off as pushy. 
  • Assure that your visual merchandising helps customers find what they’re looking for, discover related products and add more items to their transaction without the help of a sales associate. 

 

Take action to increase your profit margins 

Although the tactics you use to increase your store’s net profit margin will vary depending on your sector and what type of product or service you sell, several things are constant across all types of retail businesses: 

  • Selling online is an excellent way to generate more sales and costs less than opening a second retail location.
  • Avoiding markdowns and discounts by improving your inventory purchasing will help maximize each item’s gross profit. 
  • Purchasing seasonal inventory in advance may reduce its COGS and increase your gross profit. 
  • Reducing operational expenses will result in you having more liquid capital to invest elsewhere. Just make sure you aren’t sacrificing the customer experience as a result.
  • Look for ways to increase in-store sales and your customers’ ATV.  

Ultimately, each of these tactics has a similar objective: spending less and selling more. As you prep your retail store for long-term growth, consider applying them in your day-to-day operations and monitor their impact on your bottom line.