A business’s profit margin represents one of the most significant indicators of success, and many organizations make profit margin projections that reach years into the future. A new retail store just beginning operations can have a difficult time projecting its profit margin for the first year, though, as a number of factors affect this metric. Though most retail stores will not generate any profit at all during their first year, some successful locations may realize profit margins of up to 7 percent.
To understand why a first-year profit margin is difficult to calculate, business owners first must thoroughly understand the math behind this measurement. According to the business magazine Entrepreneur, two figures play into the profit margin calculation: sales and cost of goods sold. To determine the profit margin, a retail store owner first subtracts the cost of goods sold from the sales revenue; the difference is known as the store’s gross profit. The business owner then divides the gross profit by the sales revenue; the resulting percentage is the store’s profit margin.
While the basic calculation for profit margin seems simple, many business owners experience difficulty calculating the cost of goods sold. According to the financial website Oblivious Investor, business owners can arrive at this figure in one of two ways. Under the average cost method, owners must forecast the average cost of each unit sold, then multiply that number by the sales forecast for the first year of operation. Under the periodic method, shop owners add the store’s beginning inventory to projected inventory purchases throughout the year, then subtract the value of any inventory remaining at the end of the year. Both of these methods can present a number of challenges to calculating a first-year profit margin.
The first-year profit margin for a retail shop can vary significantly from industry to industry, and business experts at the National Bicycle Dealers’ Association caution that most retail shops do not generate a profit at all during their first year. Those that do survive can expect fairly small profit margins; according to a 2008 article on CNN Money, the most profitable retail businesses carried profit margins of between 3.8 and 7.0 percent.
Many entrepreneurs seeking funding to open a retail store must include first-year profit margin projections in their business plans, and calculating this figure can seem like an insurmountable obstacle in the absence of existing sales data. Many business owners simply estimate their expenses and inventory requirements, then make adjustments throughout the first year of operation. According to Entrepreneur, these adjustments may include conservative price increases, cost reduction initiatives, or a combination of the two efforts. In addition, Entrepreneur cautions new retail owners not to confuse profit margin with markup as the two figures have significant differences even though they derive from the same variables.