"What If" calculations to set retail pricing strategies
Setting retail prices to achieve a predetermined profit is an important strategy for retailers.

cash cowIn this case study we summarise Collins Hume's "what if" calculation approach to planning business operations. Firstly, we identified the labour costs and labour oncosts applicable to the various categories of team members working in the business covering:

  • annual leave
  • shift worker allowance (if applicable)
  • statutory holidays
  • personal carer's leave
  • superannuation 
  • payroll tax (if applicable to this business)
  • work care
  • training
  • long service leave entitlement

We then determined and prepared a schedule of the number of team members in various classifications expected to be required to enable the anticipated sales. The calculation of the labour oncosts and the labour costs gave the business a projected labour budget for the forthcoming 12 months.

Assuming that the total estimate for labour and labour oncosts for the 12-month period was $460,000, the expected overhead costs for the 12 months' operation of the business could be estimated. Our budget included all expected business outlays excluding labour, labour oncosts, direct material purchases for products to be sold to customers, capital expenditure, loan repayments, etc.

For this exercise the total budget for overhead costs was $535,000.

The next calculation was to prepare is how much profit the owner wanted to achieve from their business. This is normally based on a realistic return on investment.
We asked how much the business was worth and what rate of return the owner wanted to achieve on their investment

We assumed that the business was worth approximately $700,000 and that the rate of return required was 20%, which meant that the projected profit for the year, if everything worked to plan, would be $140,000.

Where this type of strategy was very important is where, last year, the business only achieved a profit of $20,000 so the owner was seeking advice on how to earn a realistic profit from the effort they were putting into the business.

The next calculation was targeted gross profit for the business for the 12-month period.

Based on costs, the following figures were taken into account to determine a projected gross profit target for this business:

  • Labour Cost (including Labour Oncost) = $460,000
  • Overhead Budget = $535,000
  • Projected Net Profit = $140,000
  • Projected Gross Profit = $1,135,000

The next phase of our "what if" calculations was based on the owner's business knowledge of what they expected their average gross profit percentage to be over the full 12 month period?

Based on their previous trading history this figure was in the vicinity of 53%. This would be their targeted gross profit percentage for the year for the initial "what if" calculation."

With a projected gross profit of $1,135,000 and an expected gross profit percentage of around 53%, this meant that sales needed to be $2,141,500 (Gross Profit/Gross Profit Percentage x 100/1 = Sales).

It would be a rare retailer that is able to achieve an identical mark-up percentage for each type of product that is purchased by the business. Every retail business has different categories of stock, identified as:

  • Stars – great products to sell – the main reason for being in business
  • Cash Cows – price promotions, price sensitive lines
  • Problem Lines – dead stock, ex-promotional stock
  • Dogs – difficult to sell

Each of these stock classifications would normally have different, and in many cases, multiple mark-up percentages applicable to them.

In undertaking our "what if" calculation, we analysed the mix of purchases that applied to this business showing the expected purchase price to be paid for various types of products and the normal mark-up percentage the owner expected to apply to each product category. This enabled the calculation of a projected mark-up amount and a sales figure for each component of stock to be purchased by the business.

By totalling the purchase price, the value of mark-ups and sales, we were able to determine how close the owner had come to the targeted figures relating to sales of $2,145,000. If there was a shortfall it was then necessary to "tweak" the stock purchases and perhaps the mark-up percentages to determine what the results might be.

There were various types of "what if" calculations made depending on the types of products purchased for the business, purchase prices negotiated with wholesalers or manufacturers or the mark-up percentage charged. All of these calculations resulted in projected sales figures.

The idea was to get as close as possible to the business owner's sales expectation of $2,145,000 and to achieve their targeted net profit.

By adopting this approach we then needed to monitor on a regular basis e.g. monthly trends for purchases and sales actually achieved to ensure that, over the 12-month period, various targets in the strategy were achieved.

If you would like Collins Hume to work with you to develop a retail business strategy along these lines utilising "what if" calculations, please contact us on 02 6686 3000. We can assist you with the preparation of this type of calculation suitable for a retail or wholesale business.

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