NOW THAT YOU HAVE established the amount of Gross Profit you need (see INSTORE, January 2008, page 88) we need to calculate the difference between your current annual Gross Profit and your required annual Gross Profit … this difference being the Gross Profit Gap.
Here’s how to do it:
Step 2: Calculate Your Gross Profit Gap
Retirement/Exit Planning – $30,000
Personal Exertion – $75,000
Return on Investment – $108,000
Overheads – $350,000
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Total Gross Profit Required – $563,000
In the example shown, the store requires a total of $563,000 of Gross Profit to satisfy all of the owner’s expectations. (Refer to the previous article for a full explanation and requirements)
Here is an example of how to calculate the Gross Profit Gap.
Example: In this example, the store has annual sales of $960,000 and at a 50 percent gross margin is producing annual gross profit of $480,00 … $83,000 less than the $563,000 needed according to the new GAP analysis.
Your current annual sales? – $960,000
Your current gross margin? – 50%
Your annual gross profit? – $480,000
Your required gross profit? – $563,000
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The Profit Gap – $83,000
(Note: We will talk about how to bridge the gap in a later issue.)
ACTION STEPS
- Using the example template above, calculate the gap between your current and required Gross Profit.
- Decide what gross margin you believe you will achieve this year. If it is currently less than 55 percent you have plenty of room for improvement!
Congratulations on successfully completing Step 2. Now, onto the next step.
Step 3: Calculate Your Sales Gap
The next step in the process is to convert your gross profit target into a sales target and then contrast this with your current sales – this difference being the Sales Gap.
Example: Based on the need to increase gross profit by $83,000, we have several strategies available to us. One such strategy is to increase gross margin so in this example I have worked on the assumption that margin will increase from 50 to 53 percent. Therefore, to increase gross profit by $83,000 at a 53 percent margin we need to increase sales by only $102,265.
Your current annual sales? – $960,000
Your required gross profit? – $563,000
Your target gross margin? – 53%
Your required annual sales? – $1,062,265
(divide required gross profit by target gross margin)
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The Sales Gap – $102,265
So now we have a meaningful sales budget that will genuinely meet the owner’s needs and we can start to develop specific strategies to achieve it.
Example: If you intend to pay commissions or bonuses based on sales then you need to allow for these in your original GAP analysis; i.e. if you pay bonuses for achieving your new sales target of $1,062,265, and those bonuses have not been budgeted for, then in reality you are eating into the profits you need for retirement, return on investment, etc.
(Note: We will discuss how to introduce highly effective ‘Profit Sharing’ incentives based on the GAP analysis in a future issue.)
ACTION STEPS
- Using the example template above, calculate the gap between your current and required sales.
- In preparation for dealing with how to bridge the $102,265 Sales Gap, please establish your sales key performance indictors (KPIs). There are only two of them: Quantity of Sales (the number of items you sold last year) and Average Retail Value (the average value of each item sold last year). A typical U.S. store is doing 5,000 sales a year at an average value of $200 — i.e. 5,000 x $200 = $1 million in gross sales. Once you know what your KPIs are we will discuss various strategies for increasing them and thereby bridge the $102,265 Gap.
Only now can we answer the question, “How much inventory do I need to achieve my sales budget?”
We’ll deal with the answer to this next month.
