The Nature of Operating Expenses
As you head into 2024, it’s critical to focus on “The Big 5”.
Following a recent meeting of Management One Retail Experts, veteran John Adams shared his process for reviewing his clients’ financials. He focuses on what he calls the Big 5.
Cost of purchases – Cost of purchases is the amount you pay vendors over the course of a year for the merchandise you sell. This is a variable expense that is FAR more impactful than the traditionally well-known KPI of COGS (cost of goods sold). Why? Because it usually represents your biggest opportunity for creating cash. If purchases are 60% of revenue, only 40% of your cash is available to cover expenses and profit. Suppose purchases are 48% of revenue- that leaves 52% of cash to cover operating expenses and profit.
Payroll Expenses - The key here is to break payroll into fixed and variable expenses. Selling is a variable expense and should be managed and treated as a selling cost rather than as a fixed expense. Fixed payroll costs would include bookkeeping, buying, and other administrative functions not directly related to generating direct revenue. Overall payroll should be in the 18 to 20% range. Selling payroll includes commissions. The overall range for selling expenses runs from 8 to 12%. The balance covers administrative costs.
Rent and Common Area - Rent caps at 10% of total net revenue. This includes property taxes, base rent, common area maintenance and any other associated expenses.
Advertising and Marketing Expensese - This would apply to brick and mortar. Marketing today includes website management, social media, CRM software, traditional media if appropriate, and events. This is a growing and important expense to measure ROI. Historically marketing was typically 2 to 3%. Today that number can soar to 5% or more if the business is using marketing to acquire new customers. Measuring the frequency your customers shop with you is an increasingly important metric for measuring effective marketing.
Merchant Fees - the United States has the highest costs for credit card fees on the planet. Canada is a close second. European retailers pay half our fees and in some countries like Australia, it is a third. I think in the next few years we will see a great deal of disruption in credit cards in retail. Typically they run 2 to 3.5%, depending on the cards you take. Credit card processing fees should be part of an annual review.
If you have a line of credit or other notes, interest rates have increased significantly, and are now more of an issue when examining the nature of expenses. A high-interest loan can cripple a business and looking to term out short-term notes will put less stress on ongoing cash flow.
Lastly, if you have not used your EIDL funds, they can be used to meet normal operating expenses and working capital, prepay or pay commercial debt and make payments on federal business debt, rent, cost of goods sold, and payroll. While EIDL funds cannot be used to make direct payments to owners, pay bonuses, or pay dividends to shareholders, EIDL funds can be used for payroll. Paying yourself and your employees (if you have them) is not only legitimate but necessary to keep your business running.
Expense management can be a significant source of freeing up cash. As you work on your budgets for 2024, it is a good exercise for a deep dive with your M1 retail expert and accountant.
Wishing you a very successful holiday season.
Onwards and Upwards,
Marc
If you have any questions or feedback, please let us know in the comments section below.
You can also contact Management One directly for more information. We are always happy to discuss your results and share solutions for you and your indie retail business.