The
Double Bottom Line Benefit to Managing Markdowns!
Markdowns influence Gross
Profit, but markdowns, as they relate to cost of goods,
have a direct influence on cash flow. If markdowns are
high then purchases are higher than normal to sustain
revenue projections. This causes a tremendous stress
on cash flow.
Retailers
with a high expense structure can soon run out of cash
to pay vendors and find their accounts payable running
late. Then current year proceeds are used to pay off
previous year’s payables. Lines of credit increase
and do not get paid off. Often additional capital is
needed to keep the business afloat and assure a fresh
flow of inventory.
For example at a 55% Initial Mark up and markdowns of
25%, Gross profit is reduced to 43.75% due to the markdowns
taken.
The
markdowns also create a need to buy more inventory to
achieve a sales rate that is attained when markdowns
are under control. On an $800,000 business, take a look
at the additional purchases needed to generate Revenue
of $800,000. Based on the above example with an Initial
Markup of 55%, Markdowns of 25% and Revenue of $800,000.
Here is how the scenario plays out.
Markdowns of 25%= Gross profit of 43.75%
That means that cost of goods (100- gross profit) is
56.25%
$800,000x 56.25= $450,000
Purchases = $450.000
$800,000-$450,000= $350,000 in Gross profit dollars
Now let’s say on the same revenue markdowns are
20%
Effect on profit:
That equals a Gross Profit of 46% instead of 43.75%.
The difference is 2.25% or .0225 x $800,000= $18,000
in additional Gross Profit.
A
5% decrease in markdowns generates an additional $18,000
in Gross Profit.
That is the First benefit. Now let us look at the benefit
to purchases.
Effect on Purchases:
If Gross Profit is 46% instead of 43.75% then cost of
goods drops from 56.25% to 54%.
With revenue of $800,000 and cost of goods of 54% =
$432,000 in cost of goods.
The total improvement is:
An increase in Gross Profit of $18,000
A decrease in purchases from $450,000 to $$432,000 or
a decrease in payables of $18,000.
That
makes a bottom line benefit of $18,000 in extra Gross
Profit as well as $18,000 in cash due to decreased purchases.
The total impact is now $36,000.
As
we have said before retail is detail. What can you do
to knock markdowns off an extra 5% in your business?
In Summary:
The
change in gross profit is direct cash generated. The
change in inventory needed is a lower investment cost.
It affects the ROI as the investment is lower but not
the cash generated. There is a $36,000 cash benefit.
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