Edge Retail Academy Blog

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!

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