SALES TAX & VAT/GST - Their applications in Retail

Taxes have become mandatory around the world. There is no clear evidence when actual taxation system began and how it spread around the world. More formal tax systems were created by British Colonial Rules in their empire which was also used as a means to suppress the indigenous people by exploiting their earnings via stringent tax systems.
There are currently 2 types of taxes applied on goods majorly across the globe.
1. Taxes on Sale of Goods to end customer
2. Values Added Tax (VAT) or Good and Services Tax (GST)

1. Taxes on Sales of Goods to End Customer or Sales Tax:
This is the tax applied on the final retail price of the goods i.e when the final finished good is sold to the customer or the consumer. In this case the goods at source, manufacturer, wholesaler, distributor are not taxed. Such taxes are collected as a percentage on the final value of goods sold and there could be multiple taxes applied such as state, central, luxury,  sin taxes, etc. This leads to inflation of price at point of sale.
But this process also simplifies tax collection as there is only one point where tax is collected in the entire supply chain but to control tax evasions the retail industry should be an organised sector like in case of developed countries like USA, UK, etc. Such taxes are difficult to be applied in a country where unorganized retail in more prevalent like in case of India, Bangladesh, etc.,

Let us see a simple example of sales tax applied in a state of USA.
A manufacturer buys raw material from farmer and makes 2 bottles of whiskey for total cost of $40. He applies 20% margin (25% Markup) and sells them for $25 each. The retailer buys them from manufacturer directly. He then sells them for $38.5 each after applying 35% margin. If there is a discount then the taxes are applied on the discounted values of the goods sold.

Manufacturer to Retailer : 25 x 2 = $50
Sale of Goods    : 38.5 x 2      = $76.9
State Tax 5%     : 76.9 x 0.05 = $3.85
Central Tax 3% : 76.9 x 0.03 = $2.31
Sin Tax 4%       : 76.9 x 0.04 = $3.08
TOTAL VALUE PAID BY CUSTOMER : $86.13
TOTAL TAX COLLECTED : $9.23
This tax amount collected is paid to the government as part of tax returns quarterly or more frequently based on respective country's finance policy.

2. VAT or GST:
This is the tax that the seller collects on the incremental value of good from the buyer. The major difference between sales tax and VAT is that Sales tax is applied only on the final price of the product that the consumer pays to the retailer and VAT is a stage wise application of tax on the value add all the way from manufacturer up till the consumer. In both the cases consumer is the one that bears the burden.
VAT and GST's definition is similar and the difference can only be made based on the application defined by the government. Some institutions apply VAT on tangible products and apply service tax on intangible services rendered to customers. GST is usually a blanket tax applied across tangible and intangible goods and services on the value added amount. In case of VAT or GST it is always included in the selling price unlike sales tax which are applied on the selling price.
Let us see a simple example of how VAT can be applied in a state of USA.
A manufacturer buys raw material from farmer and makes 2 bottles of whiskey for total cost of $40. He applies 20% margin (25% Markup) and sells them for $28 each. VAT applied is 12% i.e. $3. The retailer buys them from manufacturer directly, he buys them for $25 + $3 VAT. He then sells them for $43 each after applying 35% margin and 12% VAT on net retail. If there is a discount then the VAT/GST is applied on the discounted values of the goods sold minus the landed cost.
Total cost of manufacturing : $40
Manufacturer to Retailer      : (20/(1-0.2)) x 2 bottles = $50
VAT Amount (12%)             : 50 x 0.12 = $6 (paid to manufacturer by retailer)
Now 25$ becomes the cost of goods purchased by retailer and $3 is the VAT paid by retailer to manufacturer.
Retail to Consumer               : {((25/(1-0.35)) x (1+0.12))} x 2 bottles = $86.15
VAT Amount collected from customer = 86.15-{(86.15/(1+0.12))}= $9.23
VAT already paid to manufacturer = $6
Balance VAT to be paid to government =$3.23 i.e ($38.46 - $25) x 0.12
There by the VAT is applied only for the difference of the value in every movement of goods from manufacturer up till the consumer where in the total burden of VAT is born by the end consumer who bears the total VAT of $6 and $3.23 i.e total of $9.23

Formula for calculating net retail i.e. retail excluding VAT = ( Selling Price / (1+Vat%))
                                                                                              = (43.08 /(1+0.12))
                                                                                              = $38.46

Formula for calculating Selling retail from Cost = (Unit Cost / (1-Margin)) x (1+vat%)
                                                                              = 25 / (1-0.35)} x (1+0.12)
                                                                              = $43.08

In both cases the tax paid to the government is the same but in case of VAT the partial tax is already collected and paid to government even before the goods are sold. In the case of Sales Tax, the tax is paid only upon the sale of goods there by increasing the wait time for tax collection.
Also the unit retail paid by customer also remains pretty much the same in both the cases.

AN INTRODUCTION TO INCOME STATEMENT

We shall discuss on how we can arrive at our organisation's profit and loss without getting into the core financial side of the business, this is also known as Income statement. I have kept it as simple as possible for retail business users to understand the calculation mechanism and the various factors that impact our profits. I have not included capital expense, re-investment of funds, expansion expenses, paid-up stock value, creditors, debtors, dividends, etc. I have only considered a few simple expense and revenue components to give an understanding of how we can arrive at our Income Statement
Before we begin with the workings, let us understand the below terms that will be used in the calculations that follow :

TURNOVER
In simple business terms turnover is nothing but our front line sales i.e. the sales value realized after deduction of VAT, sales and service/miscellaneous taxes that are collected from customers.

COGS
This is the cost of goods that are sold i.e. (Weighted average cost of the goods sold X quantity sold). This helps us understand the purchase cost incurred for the sale of a good and this amount does not include VAT in it. This is the weighted average of the unit cost at which the goods are purchased. Refer "RETAIL FORMULAE - THEIR USAGE AND BENEFITS TO BUSINESS OPERATIONS" post to know how it is calculated

EBITDA
This is the Earnings that an organisation makes after its operational expenses and before applying Interests, Taxes on earnings, Depreciation of assets and amortisation cost. This is a simple base figure or percentage what a business makes from the turnover after incurring variable/ fixed operational costs. It gives us a picture on how efficient we operate our business and how much room we have for applying the other financial expenses as mentioned above.

PBT 
Profit Before tax or gross profit that an organisation achieves before paying the tax on earnings. This value can also be arrived at as a percentage by dividing it with Turnover value

PAT 
Profit after tax or net profit that an organisation achieves after paying the tax on earnings. This value can also be arrived at as a percentage by dividing it with Turnover value

OVERHEADS/ OPERATION EXPENSES
Every Business will have over head costs that are differentiated as fixed and variable cost for the given financial period. Examples for fixed expenses are Rent paid, Annual Maintenance Charges, etc.,
and for variable expenses are Marketing, Wages, Electricity & Water, Repair and Maintenance, etc.,
For further details check out the post "OPEX and CAPEX - Fixed and Variable Costs"

DEPRECIATION
Not all assets acquired by an organization will appreciate in value. Most of the assets depreciate in value over a period of time and it has to be eventually disposed for purchase of a new one. We cannot write off the total value of the asset after a few years in a single fiscal year in one go as it may lead pull down profits for the financial year drastically and more over it is not the right thing to do too for we have used the asset in business over a period of time. In order to manage this, the business will write off a percentage of the asset value as depreciation every year throughout the asset's life time.

AMORTISATION
Every Business will have to invest in technology, licenses and hardware but this should not be totally consumed as a expense for a single financial quarter or year because we will use them over a period of time though they are paid up front. So the lifespan of the technology, hardware and license investment is projected and the investment is split equally throughout the period. This is known as amortisation.

TAX
This is no the VAT or Service tax collected on behalf of the government. This is the actual tax on revenue that the organisation has to pay to the government. The revenue that will be considered here is the net revenue after deduction of all expenses, amortisation expense and depreciation.

I will summarise the workings at 4 levels i.e. Turnover, EBITDA, PBT and PAT with an illustration.

Retailer ABC has taken a franchise for Apple products in 4 States in India. He has 20 stores that are operational and sells all the latest apple gadgets. Lets see his sales for a quarter from April 2016 till June 2016 for both of his stores as given below

Based on the above sales figures we shall arrive at our EBITDA and PAT
Incomes
Total Gross Sales for the period  (A)                                             :  67,35,00,000
Total VAT Collected                                                                          :  8,27,10,526 (-)
Total Net Sales  (Turnover)(B)=(A/(1+VAT%))  or (A-V)           :  59,07,89,474
Cost of Goods Sold   (G)                                                                  :  49,00,00,000 (-)
Total Revenue  (C) = (A-B)                                                            :  10,07,89,474
Turnover Net Margin %  (A-G)/A X 100                                     :  17%
Expenses & Loss
Rental expense                                                                                  : 1,10,00,000
Salaries and Wages                                                                           : 1,20,00,000
Repair and Maintenance                                                                   :      3,50,000
Marketing Expense                                                                           :      6,00,000
Electricity and Water                                                                        :     12,00,000
Staff Welfare                                                                                     :     13,00,000
IT and Administrative Expense                                                        :     45,00,000
Insurance Expense                                                                            :     10,00,000
Logistics                                                                                           :     10,00,000

Shrinkage (Variance due to loss of stock)                                        :     10,00,000
Total Expense (D)                                                                            :  2,94,50,000 (-)
EBITDA   (E) = (C-D)                                                                    :   7,13,39,474
EBITDA %  (E/B X 100)                                                                :  12.1%

Interest Paid                                                                                      :     30,00,000 (-)

Amortisation value                                                                           :      55,00,000 (-)

Depreciation value                                                                            :     20,00,000 (-)

Total Income before Tax                                                                 :   6,08,39,474  

Tax Payable                                                                                       :   1,05,28,000 (-)

Profit After Tax      (P)                                                                    :   5,03,11,474

Profit Percentage to Turnover     (P/B X 100)                               :   8.5%                

The above shows how we can work a simple income statement by which we can get to know how our business operations is performing, which are the areas we need to work on and where we need to concentrate to reduce our expenses. All expenses can be expressed as a percentage of turnover to see which one of them actually eat into our profits more. I have shown the same in the below pictorial representation for all expenses as a percentage of turnover. I hope this helps to get an overview of an income statement.

WHAT ANALYSTS CAN LEARN FROM CHILLING BEER BOTTLES ?

As retailers we come across multiple issues in our day to day operations that cannot wait for an analysed corrective actions, so an immediate solution is needed that too a wise one. But we end up giving the same fix over and over again.
What we need to understand is that most of us keep doing repetitive spot fixes for the same problem over and over again without actually resolving the underlying cause to an issue. The solution can be explained with a simple example and I am sure this will change your perception and plan of action towards your day to day issues.
The answer is: How an out door caterer chills the beers in the Ice box for an event in less than 10 minutes and ensures that the chillness is retained throughout the event for the beers placed in the ice box. How does he do it? Its simple, he puts a layer of solid Ice at the bottom of the ice box and places the beer bottles above it. This will keep the beer bottles chilled for longer and to get that instant chillness, he fills with another layer above the beer bottles with crushed ice. That's the trick and yes some of you will be aware of this process.
We need to apply the same principle vice versa for our retail problems. Crushed Ice is a spot fix to an issue but it will not keep out the problem for long and it will repeat. The bottom layer of solid ice is the permanent fix to the problem which will keep out the issue for ever just like it does for the beer bottles throughout the outdoor event.
When you face a problem on the shop floor, it requires a spot fix and you have to give one before it escalates further and leaves the customer unhappy. But you should not forget the solid ice. Now you have to invest time and efforts to find the actual root cause to this recurring issue and provide the permanent fix to avoid a fire fighting situation again.
This will ensure that the issue doesn't resurface and also increase your management efficiency and customer satisfaction. A simple perspective that can give an effective solution to your day to day operational issues. CHEERS ! 

Porter's Five Forces - simplified !

This was originally formulated by Mr. Michael Porter, professor at Harward Business school in the late 1970s to analyse an industry based on five forces that influence an industry and its players. Porter's five forces have five forces or market elements that needs to be analysed to arrive at a successful business strategy. The derived business strategy can be implemented to achieve a clear and distinct position in the market and in the customers' minds. The outcome which also gives a clear picture of the current market situation which will help the organisation decide how they can use the market situation to their advantage or position themselves in the market where by increasing profitability and brand image.
To hear the original one from Mr. Porter himself, follow the below link :
https://www.youtube.com/watch?v=mYF2_FBCvXw

The below is my view of Porters's five forces and how they can be applied to analyse an industry and how well we can position our organisation.

MY VIEW OF APPLYING PORTER'S FIVE FORCES :

1. Competitors Rivalry
This gives insight into the rivalry that exists in the industry i.e. how competitive the players in the industry are and what are their strengths and weaknesses. It also answers the questions to how can a new entrant cope up with this competitive market and turn their business into a success model. A few of the questions that can help us draw a picture of competitors rivalry are as below :
- How competitive the industry in terms of margins and profitability ?
- How is the competitive intensity ?
- Who is the biggest player in the industry and what is the market share held by them ?
- What is the industry experience of each player in the industry and their strength ?
- What is the industry Growth in the near future ?
- Does it demand for capacity addition in large scale ?
- Brand value of competitors
- Is there a monopoly or hurdles put in place by big players to indirectly control small players' market share?
- Is it a high stakes industry where organisational structure requires highly skilled and efficient human resource ?

2. Threat of New Entrants
This gives insight into how easy it is to enter an industry or exit an industry and also how easy it is for a new entrant in the market to replace an experienced strong player in the industry. A few of the questions that can help us draw a picture or gain insight of this force are as below :
- How easy is it to enter the new market or the industry ?
- What is the economies of scale to be profitable ?
- How big and specialised capital investment needed for setup and distribution ?
- How brand conscious or brand loyal is the industry and its customers ?
- What is the increase in the inflow of supply with new entrants ?
- What are the legal complications for new entrants ?

3. Threat of Substitute Products
This gives insight into how the available substitutes for the original affects the latter's market share and sales. A few of the questions that can help us draw a picture or gain insight of this force are as below :
- How many products or service providers are available in the market catering to the same customer's need ?
- How loyal are the customers to brand ?
-  Can customer's need be satisfied by products from other industries serving the same purpose ?

- How easy is it for competitors to develop a new substitute or a clone ?

- What is the price and quality difference between the available substitutes ?

- How regulated is the market with respect to patent rights ?

- What is the switching cost for consumers ?

4. Bargaining Power of Consumers
This gives insight into whether the market favours the buyers or the sellers or a win win for both. This also explains the demand and supply quotient of the industry. A few of the questions that can help us draw a picture or gain insight of this force are as below :
-  What is the percentage of population dependent on the products supplied by the industry
-  What is the cost of switching between services or product to fulfil customer's need ?
-  What is the demand and supply, is there a surplus in supply or a shortage in supply to demand ?
-  Customer's price sensitivity, what is the elasticity of demand ?
-  What is the cost of backward integration for the customer ?
-  What is the frequency and volume of purchase ?
-  Are the products supplied by the industry come under luxury products or a necessity ?

5. Bargaining Power of Suppliers
This gives insight into whether the market favours the supplier or the organisation or a win win for both. This also provides insight into availability of capital goods and input costs. A few of the questions that can help us draw a picture or gain insight of this force are as below :
- How easily are the raw materials/capital goods available ?
- How many suppliers are available and how easy it is to find an alternative ?
- What is the possibility of backward integration  in order to negate the supplier in the process ?
- How easy is it to acquire skilled manpower in the respective field ?
- What is cost of switching between suppliers ?
- Are we to deal with government organisations in a industry involving consumption of natural resources ?
- What is your economies of scale ?
- What is the possibility of forward integration  by the supplier there by directly catering to the customers' needs ?

Once the five forces are analysed, a chart can be prepared in the below format to assess the opportunities and threats for our products/services in the industry. This will help us to define a robust business strategy to negate competition and make profits or to decide whether to enter a new industry or to exit a matured industry.

FORCES	OBERSVATIONS	OPPORTUNITIES	THREATS
FORCE - 1	Observation 1	How ?	How ?
	Observation 2
	Observation 3
FORCE - 2	Observation 1	How ?	How ?
	Observation 2
	Observation 3

GATE KEEPER MARGIN

Gate Keeper Margin is a retail term used to set a Fixed Margin level below which the margin should not drop i.e. the minimum expected 'net profit after tax' a retailer expects to make from the sale of goods or service.
This can be defined at SKU location level or at department location level and used as a alert mechanism or a hard stop mechanism.

We can use GKM to arrive upon our suggested selling Retail for every SKU listed in the merchandising system as calculated below :


Suggested Retail = [Unit cost x (1+{Vat rate/100})]/[1-(GKM/100)]
                            = [1800 x(1+{14/100})]/[1-(25/100)]
                            = [1800x1.14]/[0.75]
                            = 2025/0.75
                            = 2700 Rs.

So the retailer should sell the product at a minimum of 2700 Rs. To ensure the GKM is maintained at 25% Retailers can use this to put control on the Purchasing Cost based on the recommended retail price and GKM agreed

The below formula can be used to arrive at the GKM or Fixed Margin obtained from unit retail and unit cost of a product

GKM = [Unit Retail - (Unit cost x (1+Vat rate/100))]/Unit Retail

INVENTORY CONTROL AND PRODUCT LINE ANALYSIS

With increase in competition and customer demand, the product line has become infinite for Hypermarket retailers. Managing and analysing the SKUs (stock keeping Units / Items) have become a challenge. Few techniques can be used in analysis and classification of SKUs. We shall discuss the same in the below :


1. ABC Analysis
Methodology used in classifying the product range into 3 categories such as
-  'A' category products where tight inventory control is required because they contribute a lot to the profit of the organisation in terms of return on investment and sales. Regular perpetual inventory  checks are required to ensure minimal shrinkage. Reordering points are frequently amended to match the market demand
-  'B' category products are the ones with good inventory control deployed but there is no need for regular perpetual inventory checks. They contribute a good value to your sales as well
-  'C' category products are the ones with less inventory control and contribute a low percentage to sales. Retailers usually keep them in the product line due to customer requests or for clearance
This methodology uses Pareto's principle where in 20 % of the inventory contributes to 80% of the total sales value. It is also known as the 80-20 rule
Please do not confuse ABC analysis with Activity Based Accounting. These are two different terms and have their own importance in operations.


2. HML Analysis
Its a simple way to classify the products based on the selling price of the product i.e. 'H'igh value , 'M'edium value and 'L'ow value products. It helps in understanding what percentage of these stocks are held by us


3. VED Analysis
These are 'V'ital, 'E'ssential and 'D'esirable products that has to be maintained in our inventory. This is used in the field of pharmacy where inventory is based on the criticality of the drug and in spare parts store where criticality is based on the parts that ware out more often and needed on immediate basis for replacements


4. FSN Analysis
This methodology is used to identify the product sales i.e. 'F'ast moving, 'S'low moving and 'N'on moving. Please do not confuse this with ABC analysis. FSN analysis is based on the quantity of inventory flow for that particular product, it doesn't not evaluate the contribution of the product to sales value. It evaluates the contribution of the product to the sales quantity. In case of manufacturing the classification is based on consumption of the product


5. SOS Analysis
This is a simple way to monitor the seasonal products through the year lying in our inventory. They shift between 'S'easonal and 'O'ff-'S'easonal based on the seasonality. This is done to ensure the product is purchased and sold before the season expires or to ensure enough stock is kept on hand to facilitate sales during the beginning of the season. This method is critical with respect to seasonal fruits and vegetables


6. SDE Analysis
Methodology used by retailers in procurement side of the business operations.
- 'S'carcely available products are the ones which are imported and are not available locally. The supply does not meet the demand and it is difficult to procure due to its short supply. Hence extra caution and monitoring is required by the buyers to get the products on hand from the manufacturers
-  'D'iffult to procure products are those manufactured domestically but difficult to procure due to distance from supplier/manufacturer, short supply or less number of suppliers available in the market
-  'E'asy to acquire products are the ones that are locally available in plenty and the supply meets the demand


7. GOLF Analysis
This is the hybrid of SDE analysis where in procurement of inventory is classified based on :
-  'G'overnment supplied inventory
-  'O'rdinary available products which has supply meeting the demand, the product is easy to procure and is available within the country
-  'L'ocally available products from local vendors, these are usually perishable products with short shelf life procured locally within the state/city limits
-  'F'oreign source is required for the supply of the product

PRODUCT LIFE CYCLE IN RETAIL INDUSTRY

In Retail Industry the buying and merchandising team classifies their products into categories based on sales and product life cycle. This gives them the edge to price the products and stay ahead of their competitors in assortment planning and pricing. Before we get into product classification, we will discuss the various phases a product goes through right from launch to phase out.

1. Launch
2. Growth
3. Maturity
4. Decline

Prior to launch, all the products will go through a product development lifecycle and procurement process which we will discuss in detail in separate blogs.

1. Launch

This is the first Phase a product goes through in Retail market and as the name suggests it is the launch of the product. In this phase the product is new to the market and it is still untested. This is the phase where the product needs huge advertising and marketing push through hoardings, commercials and test samples. Hence usually newly launched products are priced a bit towards the higher side to accommodate these additional costs. The main goal for a company in this phase is to create a positive vibe for the product in the market and attract customer through awareness. At times due to high marketing cost, the company can incur loses which can only be recovered from the other phases but this phase is a zero compromise phase for every product. So we are left with no option other than to invest in marketing at proportionate level expecting future returns.

2. Growth

The second phase sees the growth of the product and the benefits of the marketing activities carried out during the launch. We can observe the market response and demand for the product in the market. This will help us evaluate whether the product will be a hit among its consumers and sustain the competitor's pressure or not and if yes then how long. Marketing for the product does continue but on a lesser scale and price for the product is revised based on its demand in the market. A sudden drop in price during this phase will impact the product's sales and image among its consumers. Usually pricing will see a marginal drop or remain static from its launch price.
This phase also sees increase in gross margin for the product due to drop in marketing cost and production cost. If the product has a successful launch then the growth phase will see the product peak in its market share and have a better reach to its consumers.

3. Maturity

As the name suggests, when a product enters this phase, it is already well establish and enjoys a good market share but it does come with its own challenges. By now a handsome volume of your customers have used the product and given their feedback based on which the sales would have peaked. The product's sales volume will be in its peak. The faster the product reaches maturity the longer the product can sustain in the market because the product can enjoy the market share up till competition heats up.
But this stage is also full of challenges like :
- Clones being introduced in the market by competitors at lower price slabs. The company has to reduce prices to compete with the competitors and retain its customers in this case
- With more competitors offering similar product will force us to reduce the price of the product leading to drop in price
Due to heavy competition from competitors the product will lose the market share, so we need to differentiate the product form the competitors through improvisations and making the product better. This usually leads to a partial first phase again i.e. through marketing and re-launching the product with better features to maintain the market share gained and to stay one step above the competition.
If the product is not re-launched then the product will hit Saturation in market share and hit the decline phase

4. Decline

With increase in competition and better products being launched in the market for the same price, the product will eventually get into its decline phase. The continuity of manufacturing the product will be dependent on the available market share and cost of production. Retailers will try to penetrate lower end markets and new markets by selling the products for lower price. Retailers provide discounts on the product to liquidate the existing stocks and ultimately the product will be phased out by the retailers from the market.

RETAIL FORMULAE - THEIR USAGE AND BENEFITS TO BUSINESS OPERATIONS

- Opening Month Inventory for an Item was 10 units at a total cost of  500 Rs. (unit cost : 50 Rs.)
- Closing Month Inventory for the Item is 4 units at a total cost of 200 Rs. (unit cost : 50 Rs.)
- The Item was being sold at 75 Rs. through out the period and total sold quantity was 6 units.
- The Vat rate for the item is 14 per cent (9.21 Rs. unit vat)
- The selling area provided for the product was 9 sq.ft stand

With the above business picture, we can look at a few formulae that can help us to do a business health check : 

1. Weighted Average Cost (WAC) :

Weighted average cost is the average cost at which an item is held with the retailer based on history purchases. It is calculated based on the weightage of quantity purchased and the cost at which they are purchased. It keeps changing over the period based on the cost and quantity of goods received, hence it is also known as Moving average cost.

WAC = {(SOH x unit cost) + (IQ x unit cost of purchase)}/ (SOH+ IQ)

SOH - Stock on Hand
IQ - Incoming Quantity / In-transit Quantity / GRN quantity

For example if our SOH is 10 units as 5 unit cost and a new PO is being received for 5 units at 6 unit cost then the WAC will be calculated as follows :

WAC = {(10 x 5) + (5 x 6)}/(10+5)
          = {50 + 30 } / 15
          = 80 / 15
          = 5.33 Rs.

Weighted average cost is the basis for all stock evaluations and capital expenditures in financials when the Retailer works on Cost Based accounting Method.

2. Gross Margin Percentage (GM) :

Gross Margin percentage is the percentage of profit made from selling a product at POS before Taxes. It is a very simple and effective formula to calculate the percentage of Margin made from the sales revenue minus the cost of goods sold

Gross Margin % = {(Selling Unit Retail - weighted average Cost) / selling Unit Retail} x 100
                           = (75 - 50)/75 x 100
                           = 25/75 x 100
                           = 33.33 % is the gross margin made from sales

3. Net Margin Percentage (GKM) :

Net Margin percentage is the percentage of profit made from selling a product at POS after Taxes. It is a very simple and effective formula to calculate the percentage of net Margin made from the sales revenue minus the cost of goods sold. Retailers highly depend on this margin percentage to set their Mark Up percentage. This is also known as Gate Keeper Margin (GKM)

Net Margin % = {(Net Unit Retail - weighted average Cost) / Net Unit Retail} x 100
where
  Net Unit Retail = [Selling Unit Retail/(1+(vat rate/100))]
                            = [75/(1+(14/100))]
                            = [75/1.14]
                            = 65.79 Rs. is the net unit retail after tax

Net Margin %    = (65.79 - 50)/65.79 x 100
                           = 15.79/65.79 x 100
                           = 24 % is the net margin made from sales after tax deductions

4. Gross Margin Return on Investment (GMROI)

This ratio helps retailers in particular Merchandisers, category buyers and investors to know what level of returns can be obtained upon the investment made for a stipulated time period. In simple terms it helps us understand the performance of a category/ item with respect to gross sales margins.
In financial terms this ratio will help us understand the rate of cash turnover upon inventory investment during a stipulated time period

GMROI = (Gross Margin value / Average Inventory Cost)
where
Gross Margin value= (Gross Sales value - Cost of Goods Sold)
Average Inventory
 ={(opening inventory cost of each month- Closing inventory cost of last month)/(No. of months+1)}

 = (450 - 300) / {(500+200)/(1+1)}
 = 150/350
 = 0.43

GMROI % = 0.43 x 100 = 43% of the total cost of inventory held for the period

The above example shows that the Item is low on sales and high on inventory holding cost because we need to hold the inventory for a longer period of time to clear stock through sales.

another formula for GMROI is

GMROI = (Gross Margin% X Sales) / Average Inventory Cost

where Gross Margin= (Gross Sales - Cost of good Sold)/Gross Sales

How to improve GMROI ?
- Reduce holding inventory value and increase sales
- Do not excess order
- Maintain a stable Margin% based on fluctuation in cost
- Keeping your production cost or Procurement cost low

Benefits of GMROI :
- Gives visibility to actual gross profit made from selling a product
- Helps in differentiating your STAR , CASH COW and DOGS in your product line based on actual
   margins made rather than sales value (Ref : BCG MATRIX)

5. Gross Margin Return on "Selling Area" / " Footage " (GMROS) / (GMROF)

This ratio explains the gross margin made by the product upon the selling area allocated for the product. This is used by retailers to find the gross margin per square feet in the selling area and take decision on expansion of selling area or reduce the selling area or discontinue the product all together

GMROS = (gross margin value/selling area)

                = (Gross Sales value - Cost of Goods Sold)/selling area (in sq.ft)
                = (450 - 300)/9
                = 150/9
                = 16.67 Rs / sq.ft


another formula for GMROS is

GMROS = (Gross Margin% X Sales) / Selling Area

Benefits of GMROS :
- Helps in space allocation of selling area as per the category performance
- Helps is designing shop floor planogram
- Helps is visual merchandising and changes is display area within the shop floor

How to improve GMROS ?
- Display the products at the right place within the shop floor eg. placing chocolates and gums near cash tills helps in reducing the display space and increase sales there by increasing GMROS
- Effective and easy access to products category wise to customers
- Reduce excess stacking of products on shop floor

6. Inventory Turnover :

Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year

Inventory Turnover  = Cost of Goods Sold / Average Inventory cost

                                    = 300 / {(500+200)/(2)}
                                    = 300 / {350}
                                    = 0.86 is the inventory turnover for the month

The above Inventory turnover of 0.86 means the inventory has not been sold out even once.
Inventory turnover is also known as stock turnover

7. Stock Turnover Days / Average Days to Sell the Inventory :

The average days taken to sell the inventory for a particular stock Turnover level

Stock Turnover Days = No. of Days in Year / Inventory Turnover ratio
            
                                      = 365 / 0.86
                                      = 424 Days

424 will be the days taken to clear the inventory with above Inventory turnover level and average inventory level


8. Rate of Sale  (ROS) :

Rate of sales percentage is the increase or decrease in sales percentage over a period of time.
This is a comparative figure, arrived at by comparing sales from two similar period in time.
For example month over month, year on year, week on week sales comparisons. It can be done at
cost, Retail or Quantity level

Rate of Sale = {(Current Period Sale - Previous Period Sale) / Previous Period Sale}x100

Lets take an example of an SKU which had sold 10 units in March 2014 and 8 units in March 2013.
Now to know the rate of sale :

ROS  = {(10-8)}/8 x 100
          = 2/8 x 100
          = 0.25 x 100
          = 25 % increase in Sales YOY for the month of March


Benefits of ROS:
- Helps in Identifying TOP selling SKUs
- Helps in identifying growth and decline in sales
- Helps in identifying the current status of the product in the Product lifecycle phase

How to improve ROS ?
- Proper availability of product all around the year
- Upgrading the quality and performance of the product on regular basis
- Ensure right product is available at the right time and sold at the right price


9. Return on Investment  (ROI) :

It is the percentage to measure the performance of gains obtained from the total investment made in a product or total capital invested in a business. It will give clarity on how soon we can recover our investment cost or what percentage of profit we can expect from our investment.
For example:  a food retailer has invested 2,00,00,000 Rs. to start his coffee Shop and after 1 year he has incurred an addition operational expense of 2,00,000 Rs. By year end he had total net gain after tax of Rs. 20,00,000


ROI = {Net Profit/Total Investment} x 100
        = (2000000/20200000) * 100
        = 9.9 % is the total investment recovered by Net Profits for the financial year.
With the current operational cost year on year, it will take around 10 Years to attain break even


10.Acid Test Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio.  This is one of the key parameters taken into consideration by investors, a simple health check of the organisation's financial status, this excludes the holding inventory value
Acid Test Ratio = (Current assets - inventory value)/Current Liabilities


10.Working Capital Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio inclusive of the inventory value.  This is a simple health check of the organisation's short term financial status, this includes the holding inventory value
Working Capital Ratio = Current assets/Current Liabilities

PEST AND PESTEL ANALYSIS

PEST analysis is a very effective tool used to analyse the catchment and other external environmental factors that will influence your business. This study is usually done by retailers before they setup a Business Unit or a Store in a location. Some retailers call it Catchment Study. PEST analysis analyses the below factors :

- Political Factor
- Economic Factor
- Social Factor
- Technological Factor

Recent studies and analysis required further addition of 2 more factors relating to Law and environment for better analysis and understanding of the areas impacting or affected by the business

- Environmental Factor
- Legal Factor

1. Political Factor :

This is one of the primary factors that you need to look at even before laying a  road map for your
business in that catchment.  You need analyse the stability of the ruling government, how encouraging are the government policies towards corporates, labour laws and subsidies on goods provided by the state and the central government

2. Economic Factor :

The economy condition of the country should be considered, for example when there is a recession and people are not willing to spend, we cannot launch new stores and expect business to double. Economic factors impact a grocery retailer when there is high inflation, so before setting a business unit we need to analyse the inflation for the last few years. We also need to understand the economic
condition of the catchment the store will cater to based on which the pricing and margin can be decided for the products sold at the store and also the class of product to be sold.
This also includes interests at which banks offer loans and exchange rate of the local currency.

3. Social Factor :

Social factors include the age, culture and behaviour of the people living in the country or state.
Due to high cost of living even the labour cost will be high in such areas. Sometimes it is also advisable to consult a local anthropologist to understand the clients or customers we will cater to. This is more particularly applicable when we open a fashion store or a restaurant, we must ensure we have the fashion and cuisine that is preferred by the locals apart from our signature products.

4. Technological Factor :

The technological development of the environment. For example we cannot launch in store promotions on mobiles for loyalty customers or launch RFID unless the customer or the staffs are
ready to embrace the technological change. With India having more villages than developed Urban areas, while planning for a chain of stores the sales and marketing strategy should be designed to accommodate both areas with technological advantage and rural areas with less technological advancement

5. Environmental Factor :

This includes the factors such as weather, climate change and the awareness the people have about the environment. Change is climate through the years will also lead to change in products required by the customers. For example, in India winters are getting colder and summer are getting hotter leading to extreme heat and cold in areas which were having milder weather. This change has led to new requirements such as winter clothing during winters and Air conditioners during summers in these areas.


6. Legal Factor :

Legal factors include the various laws enforced by the government and the impact of the same on our business. For example labour laws, food safety laws, customer law, establishment certificates, etc. which have direct impact on the way we will set our business practises. Frequent changes in legal structure due to change in political environment will lead to loss in business.

SELLING UNIT RETAIL CALCULATION FROM UNIT COST

Though it is simple, it seemed pretty confusing at first to me. It took a while for me to understand the method to calculate retail price from cost price, in fact when I did Google for the answer I found a lot of wrong answers or formulae online and sadly I did not find the answer I was looking for. Then I used the oracle retail calculation engine to understand how the same is being calculated.

Before going for the complete formula lets understand it step by step. I will explain you the way I understood it, hoping it will provide better clarity on the calculation :

Lets assume :

V - Vat rate 

C - Unit Cost

R - Selling Unit Retail 

NR - Net Retail i.e. selling retail before adding vat rate

M - Net Sales Margin 

Every merchandiser will set a fixed Margin percentage for each category which he would like to attain through sales. For example a buyer has procured a merchandise , lets say Disney soft toy for 1500 Rs. at landed cost. Now the merchandiser while doing the budgeting was to attain a margin of 35% , so he will use the below formula to calculate the Net Retail ;

C = NR -  (NR x M/100)

C = NR{1-(M/100)}

C / {1-(M/100)} = NR    

                      NR = C / {1-(M/100)}           --- this is the formula to calculate Net Retail ---

NR = 1500 / {1-(25/100)} 

      = 1500 / {1-0.25}

      = 1500 / 0.75

      = 2000 

So from the above , we can understand that to the merchandiser will set the Net Retail at 2000 for him to achieve a margin of 25% we can verify the same using the below formula 

             M % = { ( NR - C ) / NR } x 100    --- this is the formula to calculate Net sales Margin ---

M = { (2000 - 1500 ) / 2000 } * 100

    = { 500 / 2000 } * 100

    = 0.25 * 100

    = 25 %

 Now that we have the Unit Cost, Net Margin, Net Retail and Vat Rate we can easily calculate the 

selling unit retail 

R = NR + (NR * V/100) 

   = NR x ( 1+V/100)  

   = 2000 x (1+0.16)

   = 2000 x 1.16

   = 2320 

                        R = NR x ( 1+V/100)           --- this is the formula to calculate Selling Unit Retail ---

The consolidated formula to arrive at the selling unit retail from cost will be below 

                      R = {C x ( 1+V/100)} / (1-M/100)   

   

R = {1500 x (1+16/100)} / (1-25/100)

   = {1500 x (1 + 0.16)} / (1 - 0.25)

   = ( 1500 x 1.16) / 0.75

   = 2320 Rs.