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Retail Math 101
Calculating the Cost of Business
Retailing mathematics might not exactly be the same as the calculus or trigonometry you took in high school or college. To begin with, it doesn't use all of those funny little signs and give you information about lines and shapes. Probably when you took calculus or trigonometry, you asked yourself if this information was something you would ever use in life. For anyone who has gone into business - whether it be home based, storefront, commercial or even Internet, retailing mathematics is something you should be using every day of your life.
If you have yet to have your first day of business, you most definitely need to complete this exercise. For too many folks opening a business only requires using a very simple formula. They add up the cost of all of the parts of a product, double it, and then expect this is enough to carry them through.
Even this calculation is wrong as shown by a Gift Basket Review magazine survey. Looking at the most profitable businesses, they have gone to a multiplier factor of 2.5 times the wholesale cost of each of the components as a starting point. Looking past the cost of inventory and labor, what are the ingredients you should be considering as you work to have a profitable business?
Starting with a blank legal pad, the first group of expenses you need to write down are those associated with occupying a building. Of course, if your business is in your home, your calculation will be different. For those home businesses, you will probably want the guidance of an accountant. But the basis of your calculation will be to determine what percentage of your home the business will occupy. With that number, you should be able to take that percentage of your mortgage, electric, heating and cooling oil or gas, insurance, taxes, a phone other than your primary residence number, and other related utility bills as a cost of your business.
The accountant will probably explain that the space within your home must be dedicated to the business; clearing off the dining room table to create a basket won't qualify.
For a business that operates in a traditional store front or even in a business district, your occupancy expenses are much more clearly defined. In addition to those we have already outlined, you may be paying to a landlord a percentage of sales and a monthly property maintenance fee. For expenses that are paid on an annual basis, you will need to divide the expense by 12, or as an alternative divide the expense using the percentage to annual sales as a guide for each month.
The second group of expenses deals with employees. But didn't we say earlier that we were looking at expenses after merchandise and labor costs? Yes, but what we are now looking at are support expenses. The direct labor costs are for the time it took to create the basket. The other costs of labor include the person answering the phone, the sales person whether they are on a sales floor or calling on a potential customer in their office or business.
With this staff, as well as the labor for building the basket, we have withholding, medicare, and social security taxes. You may also be offering benefits to your staff. This can include health, dental, life and disability insurance. For some businesses you may have a profit sharing program, and for many businesses the cost of a paid vacation has to be factored in. Think of the employee earning $8 an hour. Over the course of 50 weeks, they will work 2,000 hours for a cost of $16,000. However, as our example person gets a two week vacation, we are paying another $640 for their non productive vacation time.
Now their 2,000 hours are actually costing $16,640 which becomes an hourly wage of $8.32. And again not including any of the benefits we have already discussed.
As we continue looking at businesses regardless of their location, there is a sizable miscellaneous group of costs to consider. These include, advertising, office supplies, bank charges, bank card charges, postage for mailing statements and promotional pieces, accounting and legal fees, the cost of items we have donated as door prizes for groups, expenses related to the delivery of a basket, expenses for a vehicle if we are out making sales calls, chamber of commerce membership dues, networking organization memberships, travel to Jubilee!, computer supplies and maintenance, an allowance for bad checks and debts, and various supplies.
And just when you thought we had included everything, there is the cost of depreciation of the equipment and income taxes.
What if you are just starting your business and don't have these figures? You will want to get some estimates. With regard to building expenses, the information from the previous occupant of the space you now have can be a great help. With other numbers, this is where an accountant comes in. Their job is not just to calculate a financial statement from the information you provide; they are instead, to be a counselor and advisor. If the accountant you are talking with cannot do that, it may be time for you to shop around for another accountant.
Once we have collected all of the figures related to your business, you will want to create two business tools. The first is a budget and the second is a cashflow chart.
The budget will look like a profit and loss statement. Each of the numbers instead of being historical will be your estimate of what will be occurring in your business. The cashflow chart takes this information one step further by taking into consideration your checking account as well as the inventory you order and when you pay for it.
Are these two items important? The answer is a solid yes. Especially when you consider that of all the businesses that fail, over half have a final financial statement that indicates the business is profitable. The business died due to a lack of cash on hand.
There are businesses that have existed that have never taken into consideration the ideas and techniques we have discussed. But considering that the odds are against their success, are you willing to take that gamble?
This article is copyrighted by Tom Shay and Profits Plus Solutions, who can be reached at: PO Box 1577, St. Petersburg, Fl. 33731. Phone 727-464-2182. It may be printed for an individual to read, but not duplicated or distributed without expressed written consent of the copyright owner.
Profits Plus Solutions, Inc.