What Are the Key Drivers of Profitability
Five key metrics will drive your short-term growth and long-term profitability:
1. Rent should be less than 25% of sales. You’d like to see rent below 20% of sales, but you can make do with 25%. The differentiating factor here is the dramatic range in rents between urban and suburban areas and different parts of the country. If you're in a less expensive part of the country, you may be able to find rents in the $20s. At the end of the day, what you're buying is quality foot traffic. Rent is one factor that you shouldn’t cut corners on. It's a lot less expensive to pay for a location with high traffic than it is to try to bring customers to a mediocre location.
2. Labor costs should be 30% of sales or less. Your budget for part-time payroll will not be tied to sales, but rather the minimum staff required to run the store. You need one or two people on the floor, whether you expect $300 in sales or $1,000 in sales. You might not need a third person on the clock unless you're expecting sales to exceed $1,200 for the day, as sales rise above the "minimum staffing level", total labor costs should track at or below 30% of sales. You also have to factor in any benefits, payroll taxes, and insurance costs. They are all part of the cost of labor.
3. All other non-product-related expenses should be less than 8% of sales. This category includes utilities, marketing, office supplies, cleaning supplies, insurance, and other miscellaneous costs. You should be able to break even with these expenses at 8%, but a good long-term target is to keep non-product costs to 5% of sales.
4. Total Cost of Goods Sold should be 40% of sales or less. If you've been doing the math, you know that 25% rent, 30% labor, and 8% other expenses have already eaten up 63% of every dollar you sell. If you hit the metrics above, you’ll be losing money if you have to pay more than $3.70 for a product that sells for $10. In addition, Cost of Goods Sold (COGS) covers a lot more than just what you pay for a product. It also has to factor in credit card fees (approx. 2% of sales), shipping, and packaging
Shipping can quickly eat up profits. For example, many teaware companies are located in California. Shipping teaware from LA can cost between 10% and 15% as much as the product. To keep your COGS under 40%, you would need to buy a teapot for $20, pay $3 to ship it, and then sell it for $65. That's just to break even, and does not include packaging.
Packaging can vary dramatically depending on your average sale. Let’s assume that you buy 4oz of tea for $2.00, pack it in a $1 tin, give the customer a $0.50 shopping bag, and include in the bag a $0.50 brochure about your company. The tea costs you $2, and the packaging costs an additional $2, so you need to sell that tea for $10 to break even, and that doesn't include shipping.
5. The size of my average sale is one of the most important measures of profitability. This metric ties into most of the other measures of profitability. If you can achieve a large average sale, you’d need to attract fewer customers and may get by with a smaller space. Fewer customers also reduce labor costs as a percentage of sales. Finally, larger sales decrease the relative price of marketing collateral and packaging (the flier and the shopping bag cost you $1 whether you make a $5 sale or a $50 sale).
1. Rent should be less than 25% of sales. You’d like to see rent below 20% of sales, but you can make do with 25%. The differentiating factor here is the dramatic range in rents between urban and suburban areas and different parts of the country. If you're in a less expensive part of the country, you may be able to find rents in the $20s. At the end of the day, what you're buying is quality foot traffic. Rent is one factor that you shouldn’t cut corners on. It's a lot less expensive to pay for a location with high traffic than it is to try to bring customers to a mediocre location.
2. Labor costs should be 30% of sales or less. Your budget for part-time payroll will not be tied to sales, but rather the minimum staff required to run the store. You need one or two people on the floor, whether you expect $300 in sales or $1,000 in sales. You might not need a third person on the clock unless you're expecting sales to exceed $1,200 for the day, as sales rise above the "minimum staffing level", total labor costs should track at or below 30% of sales. You also have to factor in any benefits, payroll taxes, and insurance costs. They are all part of the cost of labor.
3. All other non-product-related expenses should be less than 8% of sales. This category includes utilities, marketing, office supplies, cleaning supplies, insurance, and other miscellaneous costs. You should be able to break even with these expenses at 8%, but a good long-term target is to keep non-product costs to 5% of sales.
4. Total Cost of Goods Sold should be 40% of sales or less. If you've been doing the math, you know that 25% rent, 30% labor, and 8% other expenses have already eaten up 63% of every dollar you sell. If you hit the metrics above, you’ll be losing money if you have to pay more than $3.70 for a product that sells for $10. In addition, Cost of Goods Sold (COGS) covers a lot more than just what you pay for a product. It also has to factor in credit card fees (approx. 2% of sales), shipping, and packaging
Shipping can quickly eat up profits. For example, many teaware companies are located in California. Shipping teaware from LA can cost between 10% and 15% as much as the product. To keep your COGS under 40%, you would need to buy a teapot for $20, pay $3 to ship it, and then sell it for $65. That's just to break even, and does not include packaging.
Packaging can vary dramatically depending on your average sale. Let’s assume that you buy 4oz of tea for $2.00, pack it in a $1 tin, give the customer a $0.50 shopping bag, and include in the bag a $0.50 brochure about your company. The tea costs you $2, and the packaging costs an additional $2, so you need to sell that tea for $10 to break even, and that doesn't include shipping.
5. The size of my average sale is one of the most important measures of profitability. This metric ties into most of the other measures of profitability. If you can achieve a large average sale, you’d need to attract fewer customers and may get by with a smaller space. Fewer customers also reduce labor costs as a percentage of sales. Finally, larger sales decrease the relative price of marketing collateral and packaging (the flier and the shopping bag cost you $1 whether you make a $5 sale or a $50 sale).