A business' gross profit is the money collected for goods and services minus the cost to the business to produce the goods or services. It is a fairly simple concept, but a very important one. Retail is all about the bottom line, and how healthy the bottom line is begins with the gross profit of the business. Business owners and managers price products according to how much value they believe will be perceived by the consumer and their desired profit margin. There are some basic factors that directly affect the profit margin and the overall profitability of a retail business.
COGS is the industry standard abbreviation for "cost of goods sold." A company's COGS is determined by adding up all the money spent to buy and ship the needed materials to produce the retail product. This may simply be the money spent on wholesale products that are put on the shelf and sold as is, or it could mean the amount of money spent on various products that are combined to create a new product to sell.
A company's COGS directly affects the gross profit since this money used to produce the retail items is ultimately deducted from the money taken in from sales. Therefore, it is important for a business to shop around for the best deal on wholesale products in order to reduce the COGS and make more profit. In businesses that do a high volume of sales, even a small savings on some items or cheaper shipping methods can add up to a considerably higher gross profit in the long run.
Markup is the amount above the cost of goods that the business sells its products or services for. It is not uncommon for some retail outlets to charge three times the cost of goods to its customers. This considerable markup may sound like a lot, but the markup must not only cover the goods themselves, but all of the costs associated with the business. Employees must be paid, a building must be rented and maintained, etc.
Markup directly affects gross profit because the higher the markup, the more gross profit there is. However, setting a price too high will actually reduce gross profit when consumers decide the product isn't a good value and refuse to buy. When this happens the cost of goods remains the same, but the money taken in from sales is reduced. On the flip side, a price too low may result in more sales, but the amount of gross profit may be too low to operate the business adequately.
Maintaining sensible stock levels can indirectly affect gross profit in many businesses. If a company stocks too much of a product, selling just a small percentage of the total purchased in a given time period, the cost of goods may outweigh the total sales.
On the other hand, ordering too few of an item could mean that you reduced cost of goods, but missed out on sales that could have been made. This too will reduce the gross profit, even though less money was spent up front.
The ideal situation is to develop a reordering schedule that will have just the right amount of items arriving just in time for sale. This is a delicate balance that may take practice.