Gross profit for shop owners, explained simply

Many shop owners know their takings and have a feeling for how the month went. Fewer can say how much of the money in the till is actually profit. The two are different, and the gap between them is where small shops get into trouble.

Sales tell you how busy you were. Gross profit tells you whether being busy was worth it. A shop can ring up a lot of sales and still earn very little, if the products it sells most carry thin profit or if costs have crept up without the prices following.

The good news is that the sums are short. Once you know three terms, you can work out gross profit for a single product, a day, or the whole shop. The rest of this guide takes them one at a time.

Revenue

Revenue, also called sales, is the money customers paid you for the goods they bought. Sell 10 items at $5.00 each and revenue is $50.00. Count it before any costs are taken out, but after discounts and refunds, so it is what you actually kept.

Cost of goods sold

Cost of goods sold, often shortened to COGS, is what you paid for the specific items you sold. It is not what you spent on stock this month. If you bought 100 items but only sold 40, the cost of goods sold is the cost of those 40. The other 60 are still on your shelf as stock, and their cost is waiting for them to sell.

This is the part that most often goes wrong. Spending money on stock is not the same as a cost of selling. It only becomes a cost of goods when the product leaves the shelf.

Gross profit

That is all. If you sold 10 items for $50.00 and each cost you $3.00, cost of goods sold is $30.00 and gross profit is $20.00.

A dollar figure is useful, but a percentage lets you compare. Is $20.00 on $50.00 good or poor? Gross margin answers that.

In the example, $20.00 / $50.00 = 0.40, so the gross margin is 40 percent. Out of every $1.00 you take, 40 cents is gross profit and 60 cents pays for the goods.

Margin is not markup

These two get mixed up all the time, and the mix-up can cost you. Markup is profit as a percentage of what the item cost you. Margin is profit as a percentage of what you sold it for. The same item gives two different numbers.

A 50 percent markup does not give a 50 percent margin. It gives a margin of 33.3 percent. If you set prices by adding a percentage to cost and then compare the result against a margin target, you will always land short. The markup and margin calculator converts between the two so you can set prices from the profit you want.

Start with one product. You buy a box of 24 packs of biscuits at $2.00 a pack, and sell them for $3.00 each.

You sold 20 of the 24, so cost of goods sold is the cost of 20 packs, $40.00, not the $48.00 you paid for the whole box. The other 4 packs, worth $8.00 at cost, are stock on the shelf.

Now the whole shop for a week

Add up every product and you have the week's picture. Here is a small shop with four product groups.

Groceries made the most sales but earned the thinnest margin, at 27 percent. Snacks took less in sales but made $153.00 of gross profit, nearly as much as groceries on half the sales. If you only watched takings, you would think groceries were your engine. The profit view says snacks are doing a lot of the quiet work.

That does not mean you drop groceries. Customers come in for them, and they bring other purchases with them. It means you now know where to look when you want to lift profit: a small improvement on snacks and drinks is worth more than a heroic effort on groceries.

The $600.05 above is not yours to spend. It is the money left to pay for everything else the shop costs to run: rent, wages, electricity, bags, phone, repairs, transport and licences. Those running costs, sometimes called expenses or overheads, come out of gross profit. What is left after them is net profit, and that is what the owner actually earns.

• Revenue is the total customers paid.
• Gross profit is revenue minus the cost of the goods you sold.
• Net profit is gross profit minus running costs.

If the weekly running costs in the example were $450.00, net profit would be $150.05. A gross margin of 33.3 percent sounds healthy, and it still leaves only about eight cents of every $1.00 in your pocket. That is why a few percentage points of gross margin make such a big difference: they come straight off the bottom line, before anything else has to be paid.

This is where gross profit gets tricky, and where many owners get caught out. You buy stock at one cost and sell it at one price, but costs and prices both move. When they move at different times, the profit on a product is not what you think it is.

The supplier raises their price

You bought 24 packs of biscuits at $2.00 and are selling them at $3.00. The next order costs $2.40 a pack. You keep the shelf price at $3.00.

The old batch is still on the shelf, so for a while your profit looks fine. Then the new batch takes over and profit drops by 40 cents a pack, a 40 percent cut, with no change to what the customer sees. If you only compare sales from week to week, nothing looks different. The fall shows up only when you track cost.

Say 10 packs of the old stock remain when the new delivery arrives. With both batches mixed together, the average cost of the 34 packs is ($20.00 + $57.60) / 34 = about $2.28, so the blended profit is about $0.72 a pack, or 24 percent. Tracking by batch, or by average cost, keeps that from being a surprise.

You raise your price on stock already on the shelf

This works in your favour. If you raise the biscuits to $3.50 while the old $2.00 stock is still on the shelf, those packs earn $1.50 profit each instead of $1.00, a margin of 42.9 percent. Many shops raise prices as soon as they hear about a supplier increase, and old stock sells at the new price. The extra profit is real, though customers may notice, so it is worth doing with care.

You cut a price or run a discount

The reverse of the above. Selling those $2.00 biscuits for $2.50 as a promotion leaves $0.50 of profit per pack, a 20 percent margin, and half the pack's usual profit is gone. A discount is only worth it if it brings in enough extra sales to make up for the smaller profit on each one. At half the profit per pack, you must sell more than double the packs to earn the same total.

What to take from this

• Compare selling price to the cost you paid for that stock, not to the price of the last delivery.
• When a supplier raises their price, work out the new margin straight away. Decide whether to absorb it or pass it on.
• Check margins again after every delivery where a cost changed.
• Before a discount, work out how many extra sales you need to break even on profit.

Treating takings as profit

Money in the till includes the money you will owe your supplier. Revenue is not profit, and a good sales week can still be a thin profit week.

Counting stock purchases as costs

If you spent $2,000 on stock this month and sold $1,200 worth at cost, your cost of goods sold is $1,200, not $2,000. The other $800 is sitting on shelves. Confusing the two makes a month with a big delivery look like a loss.

Mixing up markup and margin

Pricing at 30 percent markup and expecting a 30 percent margin leaves you about 7 points short, since the real margin is 23.1 percent. Decide which one you are targeting, and use the right formula.

Using an old cost

A margin worked out on last year's cost is fiction. Update costs when you receive new stock.

Forgetting discounts, returns and loss

A sold item that was discounted earned less. A refunded one earned nothing. Stock that was damaged or stolen has a cost but no revenue. Leave these out and profit looks better than it is. See where your stock goes.

Chasing margin on everything

A low-margin product that sells in large numbers can contribute more dollars than a high-margin one that sits. Look at both the margin and the total profit.

• Write the cost you paid next to every product, and update it when a delivery comes at a new price.
• Total up revenue for the period, after discounts and refunds.
• Work out cost of goods sold for the items that actually sold, not everything you bought.
• Subtract to get gross profit, then divide by revenue for gross margin.
• Break it down by product group to see which ones carry the shop.
• Compare against last month, and against your running costs.
• Check margins whenever a supplier price changes.
• Before any discount, work out the extra sales it needs to pay for itself.
• Look at your slow movers, which tie up cost without earning. See what to do about slow-moving stock.

Shopkeepa is built so profit is a number you look at, not one you work out on paper. When you add a cost to a product, reports show gross profit for any day, week or month alongside sales, best sellers and slow movers. Costs and profit are visible to the owner and hidden from cashiers.

Because Shopkeepa records stock coming in as well as going out, you can keep costs up to date as deliveries arrive. See sales and profit reports for more. Shopkeepa is in development, and early access shops will help shape it.