Edge Retail Academy Blog

What’s Trending

Edge Pulse and Aggregated Data

At The Edge Retail Academy, we aggregate data from over 745 stores, through Edge Pulse. This allows us to give you up-to-date and meaningful reports and stats. Take a look at some of these stats below…

Loose Diamonds







How do your Loose Diamonds sales compare to the Average Store sales? This aggregated data thru March 12th indicates an Average Store – Sales $ of $14,698 with an increase of 6% over last year and showing an Average Store – Loose Diamond Average Sale $ of $3,581 with an increase over the previous year of $3,353 and indicating an Average Store – Loose Diamond Discount % of 30% down from last year at 32%.

Various Shapes – Loose Diamond Sales for 12 Months to Feb.2017







The aggregated data shows that Round Loose Diamonds were 57.9% of the sales, with a total of 9,602 sales, and the average sale being $5,419. Princess Cut Loose Diamonds were 7% of the sales, with a total of 1,478 sales, and the average sale being $4,267. Oval Loose Diamonds were 4.7% of the sales, with a total of 798 sales, and the average sale being $5,235. How did your Loose Diamond sales compare?

What Price is your Inventory Really Costing You?



by David Brown

If there is one question that I am asked more often than any other by my clients, it is “How do I deal with my excess inventory?” It is a little of a ‘glass half empty’ question for some. A better question would be “How do I deal with my lack of sales relative to the inventory I have?”

Inventory is only excessive to the extent that you don’t have the sales to match it, and it is important that you always have capacity to grow your business further. Strangling growth from a shortage of good product can be a bigger issue than being awash with surplus inventory. That said, we deal with clients in several countries and there would be few of our international clients who run with the high level of surplus inventory commonly found in the US. The level of overstocking reaches almost pandemic proportions in some stores, and in reality, I am less concerned by the number of clients who ask the above question than the number who don’t!

Many see their oversupply of aged inventory as a non-issue, being under the assumption that it is still good, saleable product that could be purchased tomorrow, or that somehow this “nest egg” represents a retirement fund when the business is sold. Certainly, given the price of gold, several of these pieces would cost more to purchase from vendors today than they would have originally, but are they really saleable, to either the public or somebody buying your business? The answer is generally “no”.

Sadly, there is more bad news, as the longer the items are sitting on your shelf, the more they are costing you –even if you didn’t use debt to purchase them.

Let’s do an exercise with a pair of gold earrings that have cost $100 to purchase from the vendor. What is the true cost of these earrings if they are sitting on your shelf twelve months later?

Let’s look first at the one-off costs at time of purchase. There is freight to get it in-store, computer processing, time spent selecting the piece and time spent getting it displayed in the store. Let’s allow $5 for freight and another $10 for staff and your time in selecting the piece, processing it in-store and getting it on display.

Vendor cost $100

Staff time $10

Freight   $5

 

Initial costs   $115

 

On top of this we have holding costs for the 12 months. Lets use 5% interest for the year (although in more prosperous trading times this would be closer to 10%). In addition, we have the time spent cleaning and showing the piece during the twelve month period even though it hasn’t sold, plus insurance, a percentage of rent, advertising, boxing, the tax you had to pay on it given that you diverted ‘profit’ to purchase it … and so on.

Interest $5

Staff cleaning and other costs $10

Note: Most financial and industry experts agree that the ‘holding cost’ associated with non-performing inventory is 20% per annum.

So even giving you the benefit of the doubt, we are already up to $130 cost for this item in just twelve months and we have not allocated any packaging yet because it hasn’t sold. If the item needs to be reduced and cleared after this period these costs will further reduce the profit on the item – if there is any.

But the real cost of this item is the opportunity cost that has been missed. Opportunity Cost is a term often discussed in economics. It represents the cost of the opportunity missed by choosing this particular action, as opposed to another. In the case of our jewelry example, the cost is the missed profit that could have been achieved if another faster selling item had been chosen.

So how much is the Opportunity Cost? Who knows for sure, but if another piece had been chosen that had sold, been reordered and sold again once more during the year and the gross profit on each of those sales was $100 then the opportunity cost of not choosing the other piece would be the $200 of profit that has been missed out on. This is best summed up by the phrase “stock-turn”. The more often a good item is sold and reordered the less this opportunity cost becomes. That’s why it is important to keep inventory fresh and turning over, and why not carrying excessive dead inventory is crucial. Suddenly, without stock-turn, these humble gold earrings start to look very expensive indeed!

We can’t all be crystal ball gazers and know with certainty what will sell, but the important thing is to acknowledge when an item has become old and “cut your losses” as soon as possible. Continuing to forget about it will only increase the ‘holding cost’ and the ‘opportunity cost’ of not sourcing another piece that could yield a profit.

So, that aged inventory you have is more expensive than you thought. Realistically, for every $100,000 you are overstocked you will be looking at $5,000 to $20,000 in holding costs – so carrying $400,000 in excess inventory will take $20,000 to $80,000 off your bottom line while contributing nothing to your sales. In fact, it may even reduce your sales, if your percentage of aged inventory is so high your customers can’t see the good product through the bad.

So, think carefully before deciding that surplus or aged inventory isn’t costing you anything. It may be more expensive than you think.

If you would like strategies for your excess inventory or aged inventory, please reach out to The Edge Retail Academy, and we can help!

Begin with the End in Mind, part 3 The ‘Inventory GAP’



by David Brown

After Reading Part 1 and 2 of this article, you should have completed a ‘GAP Analysis’ which will meet your future wealth & retirement requirements, as well as have calculated your ‘Gross Profit GAP’ and ‘Sales GAP’.

If you have not done these steps then please complete them before continuing with this step. You can find those articles in this blog as well.

If you have completed these steps then we are ready to answer the question, “how much inventory do I need to achieve my sales budget”, otherwise referred to as the optimum inventory level (OIL).

A definition of OIL is:

 Enough inventory to give your customers the best possible choice,

to give you the best possible return on your investment

and to allow for sustainable growth.

 The objective here is to help you understand and calculate your own OIL, however because this is a complex and highly important process it will be broken into smaller steps.

When calculating your OIL it is important to take into account other business circumstances such as:

  1. Is your business growing, static or declining?
  2. Are you intending to include new product ranges in your ‘buying plan’ to boost certain areas of your business?
  3. Are you planning to drop certain product lines that no longer fit your business model or market position?
  4. Categories which may show a below average gross return on investment (GROI) but deliver a high return on effort (ROE) … more on this later.

Having taken these factors into account, you are now ready to calculate your OIL but do so, understanding that GROI is not an exact science but rather a ‘rule of thumb’.

Also, remember that it is difficult to sell what you don’t stock … in other words investment precedes dividend. You don’t get interest from your bank until you deposit some money and so it is with retailing.

Arguably, it is possible to achieve a GROI of 200 i.e. $200 of gross profit per annum from every $100 invested in inventory. This should therefore be the basis for calculating your OIL if you are striving for ‘best practice’.

However, because most stores are achieving well below this, a more realistic ‘Rule of Thumb’ for a growing retail business is that every $1.00 of well chosen, well managed inventory will produce between $2.50 and $3.00 of retail sales per annum (excluding repairs, custom designs and special orders).

That means if your inventory level is $100,000, you should be achieving between $250,000 and $300,000 of retail sales.

Looked at another way, using our example of ‘GAP’ sales of $1,062,265 the OIL would be between $354,088 ($1,062,265 ÷ 3 = $354,088) and $424,906 ($1,062,265 ÷ 2.5 = $424,906).

GAP Sales Budget

Stock to Sales Ratio

Optimum Inventory Level

$1,062,265

3

$354,088

$1,062,265

2.5

$424,906

Important: Anything less than this level of performance, you are under performing, which means you either need to address the lack of sales compared to the inventory you are carrying, or you need to address the excess inventory. Our preference is that you consider both before deciding on a strategy because often the inventory is not the real problem … a lack of sales is (Do you have the right people?)

 Action Steps:

  1. Note any changes to your business circumstances as outlined
  2. Calculate your Optimum Inventory Level (OIL) as explained
  3. Calculate your ‘Inventory GAP’ by comparing your OIL with your current inventory level
  4. Based on your ‘Inventory GAP’ determine if your strategy moving forward will be to increase sales, reduce inventory or both

In part 4 of this article, we will explain GROI and how to calculate your OIL for each product Category.

As always, if you need strategies for your inventory, please do not hesitate to reach out to The Edge Retail Academy. We can do a complimentary Business Opportunity Analysis for you, which will highlight areas going well in your business as well as areas to strengthen.

What’s Trending

Edge Pulse and Aggregated Data

At The Edge Retail Academy, we aggregate data from over 730 stores, through Edge Pulse. This allows us to give you up to date and meaningful reports and stats. Take a look at some of these stats below…

Loose Diamond Sales for 12 months to Feb. 2017

$90.267M in sales

16,595 diamonds sold

H; SI2 was the most sold in the color and clarity for all shapes



Various Diamond Merchandise

Diamond Fashion Rings, Diamond Earrings, Diamond Pendants, Diamond Necklace, Diamond Bracelet, Diamond Other





Reorder Your Way to a Profitable 2017



by David Brown

Now the rush of another December trading has gone, the first couple of months of a new year can see more cash flowing out than flowing in as December purchases are due for payment. In an effort to keep the bank balance under control it is tempting to not reorder good sellers at this point, justifying the decision by the level of debt or, in some cases, claiming that items that sold well at Christmas won’t necessarily sell well during the rest of the year.

Now, more than ever, it is important to make sure those best-selling pieces are brought back in. Even catalog items that may have been featured during the month should be restocked, as many of these are available at the catalog price for an extended period after the catalog ends. If the item has been a good seller at a catalog special price it should still be given the opportunity to sell at its full retail. The reality is that if the style suits your customers in December there is no reason they will dislike it just because it is now March. The only issue may be one of price – and without testing the market how will you know what your customer is prepared to pay?

By not reordering your best sellers from December, the only choice you are leaving your customers are the old items that they have seen before or new pieces you have brought in that are yet to be proven. The old items have been seen before, and realistically if they haven’t sold during your busiest month of the year they are unlikely to sell when things are a little quieter. Your new items are unproven. They may become fast sellers however statistically; more the 65% of them will become old. New items are necessary to keep the selection revitalized – but they should never replace or in any way compensate for proven fast sellers.

Your daily sales sheet is like a wish list from your clients. It is their way of telling you what they like in your shop. The length of time the item takes to sell, tells you how much they like it. If your sales sheet shows you sell a lot of diamond earrings that are worth between $500 and $1000 then this tells you what your next customers are likely to want to buy. It also tells you which styles your customers like – and chances are if they liked those styles your future customers will probably like them too. So why not get these good sellers back in? This has never been more clearly illustrated than in the bead market where good sellers repeatedly sell again as soon as they are reordered. I have witnessed very few store owners who have not reordered their fast selling bead items, many of them couldn’t imagine doing anything else. However, when it comes to other product lines the same philosophy goes right out the window, or if it is followed there can be a wait of up to a month before the reorder is done

The effects of this can be disastrous. I have witnessed stores that have seen their sales volume half in diamond rings because of a failure to restock the core items that were selling well in catalogs. The assumption was made that this product wouldn’t be required once the catalog ended, however, without it, this key price point was not being met. The store was waiting until the next catalog to buy in fresh new unproven product to meet the market demand, leaving customers who were seeking these sorts of items to shop elsewhere in between. Once the store owner realized the problem, he was able to ensure the good sellers were restocked at the end of the catalog, and was able to secure better margin to compensate for a slower stock turn. Take the following steps to ensure you have the good selling items your customers want to see:

  1. Print a stock list of fast sellers from December (including items not currently in stock). Look to see which items haven’t been reordered back in, then immediately go to reorders and process an order for them.
  2. SEND THE ORDER. Ordering without sending the order is like going to the gym and not lifting the weights. You can’t leave orders sitting open indefinitely.
  3. Follow up on backorders outstanding. These are potential missed sales that you need back in store as soon as possible

It is a proven fact that the most successful stores have a higher percentage of fast sellers than those that achieve lower sales levels. This is not because they are more successful at selling them, but that they are better at doing their reorders. Reordering your good sellers and sending the orders regularly is a recipe to seeing your business grow.

Begin With The End In Mind, part 2



by David Brown


Now that you have established the amount of Gross Profit you need (see GAP Analysis below) 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’.

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 part 1 of this article for a full explanation and requirements) See below for an explanation of the ‘Gross Profit Gap’.


In this example, the store has annual sales of $960,000 and at a 50% gross margin is producing annual gross profit of $480,000 … $83,000 less than the $563,000 needed according to the new GAP analysis.

Note: We will talk about to ‘Bridge the Gap’ in a later issue.


Action Steps:

  1. Using the example template above, calculate the gap between your current and required Gross Profit.
  2. Decide what gross margin you believe you will achieve this year. Note: If it is currently less than 55% you have plenty of room for improvement!

Congratulations on successfully completing Step 2.

The next step is to calculate your Sales ‘GAP’

Begin with the end in mind – Step 3

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’.

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%. Therefore, to increase gross profit by $83,000 at a 53% margin we only need to increase sales by $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.

Important: If you intend paying commissions or bonuses based on sales then you need to allow for these in your original GAP analysis ie 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.

We will discuss how to introduce highly effective ‘Profit Sharing’ incentives based on the GAP analysis in a future issue.

Action Steps:

  1. Using the example template above, calculate the gap between your current and required sales.
  2. In preparation for dealing with ‘How to bridge the $102,265 Sales GAP’, please establish your sales KPI’s (key performance indictors). There are only two of them namely Quantity of Sales (the number of items you sold last year) and Average Retail Value (the average value of each item sold last year). Note: A typical US store is doing 5,000 sales a year at an average value of $200, i.e. 5,000 x $200 = $1m in gross sales. Once you know what your KPI’s are we will discuss various strategies for increasing them and thereby ‘bridge’ the $102,265 GAP.

Only now can you answer the question, “how much inventory do I need to achieve my sales budget?”

This concludes our 2-part series on knowing what you need to have in place, to retire successfully and with ease. Please reach out if you would like more personalized advice on your retirement plans.

What’s Trending

Edge Pulse and Aggregated Data

At The Edge Retail Academy, we aggregate data from over 700 stores, through Edge Pulse. This allows us to give you up to date and meaningful reports and stats. Take a look at some of these stats below…

Mother’s Day is right around the corner – Here are a few suggestions.


Colored Stone Rings, Pendants, Bracelets, Earrings and Necklaces, Pearl Strands, Necklaces, Bracelets, Earrings, Rings and Pendants, Other.

The aggregated data indicates in the Average Store that the Average Sale is $513 up from previous year of $461 – Great news!


Diamond Fashion Rings, Diamond Earrings, Diamond Pendants, Diamond Necklaces, and Diamond Bracelets, Other.

The aggregated data indicates in the Average Store that the Average Sale is $1372 up from previous year of $975 – Fantastic news!


Ladies Watches, Watches – No Gender

The aggregated data indicates in the Average Store that the Average Sale is $1,226 up from previous year of $1,115 – Timing is everything!!

 

Focusing on the Key Measures in your Business



by David Brown

Like many readers, I am always devouring the results of Instore Magazine’s Big Survey of Instore readers. Many of the results were to be expected and some are surprising. Sadly, many of the disappointing answers were no surprise and served to reinforce the approach I regularly hear from many retailers.

One of the most concerning results was the method that many jewelers use to determine their store’s health. Over 50% saw sales as the sole criteria in determining if the business is doing well or not. While all businesses need sales in order to survive, relying entirely on this can lead to problems. Many large businesses have become a statistic (we’d all love the revenue of many of the financial institutions that have hit the wall in the last twelve months) because they have neglected other key areas of their performance.

If margins are maintained, then sales can be as accurate an indicator as gross profit. But often stores will grow their sales at the expense of margin with the result that the extra revenue generated is being done so on an increasingly diminishing profit. Let’s illustrate with an example:

 

                                                                                       Year 1         Year 2

 

Sales                                                                          $1,000,000   $1,200,000

Margin                                                                           52%               47%

 

Gross Profit                                                              $   520,000    $ 564,000

 

Wages                                                                      $   120,000    $   160,000

Advertising                                                             $     30,000    $     60,000

Interest Expense                                                    $     20,000    $     30,000

Other Expenses                                                      $   250,000    $   250,000

 

Net Profit                                                                 $   100,000    $     64,000

 

In the above example our sample store has achieved sales of $1 million dollars on a margin of 52% during the first year. With a strong focus on sales the management has decided to focus on increasing sales with a strong discounting approach promoted through increased advertising. The result in year 2 has been an increase in sales of 20% – on the face of it this strategy appears to be a success. But there are a number of hidden factors that have contributed to a poor end result. The discounting strategy has cost margin with the result that the extra $200,000 of revenue has only generated an additional $44,000 of gross profit ($564,000 – $520,000). Let’s not forget that the discount strategy means that margin is being lost on the original $1,000,000 of sales also – those people who were happy to buy at the higher margin are now reaping the rewards of the new reductions. The business has effectively lost $50,000 of gross profit on this first million dollars of sales before it even starts to sell any extra ($520,000 gross profit in year one – ($1,000,000 x 47% margin in year 2). The business would have to be certain of achieving $1,106,382 from its reduced pricing structure to be sure of even getting back to its first year gross profit of $520,000 ($1,106,382 of sales at 47% margin would equal the $520,000 GP achieved).

But achieving a higher gross profit is only half of the problem. Extra sales normally result in higher expenses. To achieve these sales the store above has increased its advertising by $30,000 and has had to take on extra staff to cope with the increased volumes. More inventory has been required to meet the demand so the interest cost of holding this extra inventory has increased. The result has seen expenses increase by $80,000 ($30,000 extra advertising + $40,000 extra wages + $10,000 extra interest expenses). Given the gross profit increased by only $44,000 ($564,000 – $520,000) then this business is worse off by $36,000 ($44,000 – $80,000) than it had been in year one. $100,000 profit in year 1 has reduced to $64,000 in year 2 – and there’s been a lot more work required to get there.

So, what should store owners concentrate on to measure their store’s health? No one factor is more important than the rest. At the end of it, profit is the primary measure, however a lot of factors serve to achieve this profit and to focus only on profit, can see you failing to take action until it is too late. A concentration on profit only, is like driving from one end of the street to the other by focusing only on the horizon. You have to keep looking just in front of you to watch for the turns in the road, the pedestrians crossing, other cars and a myriad of factors that you must negotiate before you reach the far end. By all means, keep your eye on that horizon but a successful business is built one step at a time and profit is only achieved by ensuring all the variables that affect profit are looked after. But never forget that profit is ultimately what you must achieve.

Another concerning result in the survey was the 22% of businesses that had no idea what profit they were making. Let me ask you this question…If you were an employee for someone else, would you take on a job never knowing what your hourly rate or salary was going to be? Would you purchase an item of clothing from a department store and not ask how much you are being charged – just hand them your credit card and throw away the receipt without looking? Of course not, yet 22% of those surveyed are doing just that; working long hours (65% of those surveyed are doing in excess of 45 hours per week) for an unknown reward if any.

If you don’t know what profit you are making then pack the personal possession you have in your store, walk out the front door and don’t ever go back. If you don’t care about the profit you are making then you shouldn’t care if the looters take your entire inventory. There are staff, vendors and customers depending on the ongoing continuation of your business and it can only continue if you are making a profit to survive.

What other factors are crucial for a business to measure? Aside from gross profit, net profit and expenses a business needs to keep a careful eye on its inventory. Having the right level of inventory is important-too little and sales will be lost, too much and the business will suffer cash-flow issues. It’s not just the level of inventory but the age that is also important. Aged inventory is dead inventory which is doing you no favors. Keeping your inventory fresh through new items and re-ordering fast sellers is proven to increase business sales. Return on Investment (often referred to as GMROI), is also crucial. This is a measure of how much gross profit you make for every dollar invested in inventory. There is no point in earning $200,000 per year if you have $10,000,000 tied up in inventory to achieve it. You would get a better return by putting your money in the bank!

Determine the key factors for your business success and make sure you measure them on a regular basis. Take the actions steps you need to make your business a success today.

Begin with the End in Mind, Part 1



by David Brown

Is your retail business helping you with your future wealth & retirement requirements or is it just providing you with a job?

Beginning with the end in mind means demanding more from your business and for yourself. It requires an understanding of the ‘Gap’ between required/desired performance and current performance … something we refer to as the ‘GAP Analysis.’

Your retail business is simply a ‘tool’ to help you achieve your living and wealth needs both now and in the future.

It’s important to remember that the return on your business investment comes over and above your ‘market’ income each year. Your market income reflects your daily activity and is therefore excluded from any return on investment.

So a business has to generate not just each person’s living wage (more on that later), but also a surplus to build wealth. If a business cannot post a surplus after owners’ salaries, it might also be hard to substantiate goodwill to a potential purchaser.

Understanding the ‘GAP’ Process

Otherwise referred to as the ‘Bottom Up’ budget, there are four steps to the ‘Gap’ Process. These are:

  • The ‘GAP Analysis’
  • The Gross Profit ‘GAP’
  • The Sales ‘GAP’
  • The Inventory ‘GAP’

Because we are committed to you actually using this powerful process, we will only cover one step at a time and then have you complete some action steps of your own.

Step 1 – The ‘GAP Analysis’

The ‘GAP’ analysis also consists of four steps:

  1. Retirement / Exit Planning (including Succession planning)
  2. Personal Exertion
  3. Return on Investment (this is different to GROI)
  4. Overheads (operating expenses)

Let’s take a closer look at these.

Retirement / Exit Planning

Do you work to live or live to work? For those people who work to live, this topic is for you.   If you live to work, we recommend staying healthy to enable you to work a long time as retirement is not something you would seriously contemplate right now.

Setting a retirement / exit target date is not something to be taken lightly or done quickly. The date becomes a ‘stake in the ground’ that allows further calculations to be completed. This can also be looked on as a timeframe to be ‘able’ to retire rather than an end date … so going to work becomes a choice rather than a necessity.

When determining your personal wealth goals, you need to make assumptions about your future lifestyle needs and life expectancy. We urge clients to take specialist financial planning advice in this area.

It is widely considered that you need a minimum of $700,000 of investment capital (over and above your house, art collection, boat etc.) to retire modestly.

Example:

Let’s say you want to retire with $700,000 of investment capital in 2027 (i.e. – 10 years from now) and you currently have $400,000. That means you need to generate a further $300,000 of investment capital over ten years which is $30,000 per year after tax.

We will talk more about actual exit / succession strategies at another time.

So the first figure to go into your ‘GAP Analysis’ is:

       a. Retirement / Exit Planning –          $30,000

Action Steps:

  1. Determine required retirement wealth
  2. Set retirement / exit date
  3. Calculate the extra annual gross profit required

Personal Exertion

Your personal work effort each week (exertion) reflects your market salary. This is normally consumed and does not form part of your wealth calculation. However, any superannuation plan arising from savings (after living costs) are included in your wealth calculation.

A good way of looking at this is to ask yourself what you would pay someone else (a manager) to do what you do or what you would expect someone else to pay you if you worked for them. We are trying to establish what you would earn with your skills / experience when running another person’s store. This is to ensure your salary is based on strictly commercial terms.

If you have to work 50 – 60 hours per week to complete your role, please add the kind of premium over and above your salary that you’d expect if you were an employee. The business must pay for the hours worked to create the result.

Example:

If the market salary for your role is let’s say $50,000 for a 40 hour week and your work a total of 60 hours, your adjusted market salary would be $75,000 because you are essentially doing the work of one and a half people.

The second figure to go into your ‘GAP Analysis’ is:

  • Retirement / Exit Planning –           $30,000
  • Personal Exertion –          $75,000

Action Steps:
       a. Complete your Personal Exertion calculation
       b. Add it to the ‘GAP Analysis’

Return on Investment

Putting a figure on a ‘required return’ is as much an art as a science.

We recommend you seek help from your professional advisers (accountant) in this area as each jeweler’s return will be unique to their specific financial circumstances.

Action Steps:

  1. Determine the investment you have made in your business or what your business owes you i.e. $400,000.

Some of this may be reflected in your business balance sheet and will include your capital & current account, however let’s say in Step 2. ‘Personal Exertion’ you calculated your market salary at $75,000 but your business has only been paying you $50,000 for the last five years … your business has been short paying you $25,000 for five years which is $125,000 and you won’t find that on your balance sheet. This is payback time. If you have trouble with this, please seek advice from your accountant.

  1. Ascribe a financial return that warrants your business risk. As a rule of thumb, we use a figure of 27% which is approximately half way between what a willing buyer will offer you for your profit (they normally want a 33% return) and what you think is fair (normally 20%) … in other words if your business is making an annual net profit of $100,000 a buyer would offer you $330,000 for your business (a 33% return) and you would want $500,000 (a 20% return). So, a 27% return is roughly where a willing buyer and a willing seller would settle.

This return of 27% is made up of two parts:
          a) The ‘risk free’ return i.e. the rate any bank would pay you for having your funds on deposit with them.
          b) The ‘risk premium’. Consider general small business risk, the fact your funds cannot easily be withdrawn and specific industry risk such as a competitor opening next door to you.

Example:

If your business owes you say $400,000, at a 27% return you should expect to generate $108,000 of extra gross profit from your capital investment.

The third figure to go into your ‘GAP Analysis’ is:

      a. Retirement / Exit Planning  – $30,000
      b. Personal Exertion –  $75,000
      c. Return on Investment – $108,000

 Overheads

In this context, overheads are all other costs below your gross margin line. As your gross margin (profit) is profit after the cost of the item only, overheads are simply everything else. The list would include wages (excluding your own because this has been allowed for in your personal exertion calculation), rent, power, bank fees etc. Basically, everything in your Profit & Loss list (excluding product).

 Example:

If your other business costs are $350,000, this figure needs to be added to the ‘GAP Analysis’ as shown:

       a. Retirement / Exit Planning –  $30,000
       b. Personal Exertion –  $75,000
       c. Return on Investment  –  $108,000
       d. Overheads –  $350,000

________

Total Gross Profit required:  $563,000

 Action Steps:

  1. Complete your Overhead calculation
  2. Add it to the ‘GAP Analysis’
  3. Add a), b), c) and d) together. This is the amount of gross profit your business needs to generate to fulfill your ‘GAP Analysis’.

In the next article, we will calculate your Gross Profit ‘GAP’. Stay tuned!

Congratulations on successfully completing Step 1!