Dude, Where`s my margin?

You started a business to make profit, right? Buy for $50, sell for $100 and net at least $20 after all the expenses. Well, what looked good on paper is more complex in the real world. Suddenly, you realize that competitors sell for $90 and your costs are out of control. Let`s look under the hood of your business and tune it up.

1. Start with the P&L
Profit and Losses statement is the ultimate diagnostics tool. It shows you where every dollar you earned goes. QuickBooks and other accounting packages have a standard report that can be used under certain circumstances.

Most of the vendors give you 30-60 days terms whether you dropship or buy in into inventory. This means your costs lag the sales. And if you have a terrific month – P&L will overstate the profits because you have collected the money but have not paid the bills yet.

For diagnostics purposes it is enough is you use one of the two months with approximately the same revenue and similar product mix. For most of the products July is a perfect month to run the numbers. Sales for June and July are very close and unless you launch new stores – your product mix will be similar too.

So, take July and use your accounting software to generate a P&L.

2. Look at the big picture first
Here is a P&L of a hypothetical $10 million company selling furniture and fitness products:

Total, $ % of Net Revenue
Gross Revenues
Cancellations, Returns and Chargebacks
-700 7.00%
Net Revenues
10,000 100.00%
-5,900 59.00%
-1,500 15.00%
Dropship and warehouse fulfillment charges
-200 2.00%
Credit Card Fees
-250 2.50%
Total Cost of Revenue
-7,850 78.50%
Gross Margin
2,150 21.50%
-1,200 12.00%
-900 9.00%
Net Margin
50 0.50%

A couple of high level observations
  1. The company is barely profitable. A tiny fluctuation in returns, COGS, Shipping or Marketing costs can put it out of business.
  2. Cost of revenue is 78.5 %. Investors should be very concerned about operational efficiency.
  3. Company is losing 7 % of net sales due to Cancellations, Returns and Chargebacks. There is not enough data to make conclusions but this line item is worth investigating closely.

3. Identify your improvement targets
COGS is by far the biggest cost driver. In theory there is one invoice for one order. In practice, there are numerous occasions when you overpay or do not receive appropriate credit. To name just a few:
  • Incorrect wholesale discounts/ dropship fees applied.
  • Double invoices for for double-shipments or wrong/ defective products.
  • No credit memos for manufacturer-approved returns.
These incidents are more frequent than you might think. In my experience, by having proper controls in place you can reduce your COGS from 59 % to 55 % or by 4 % of sales.

Shipping costs would be the second target. Our hypothetical company pays 15 % of it`s sales to shipping companies. My benchmark is 10 %, so there is a 5 % of sales savings opportunity.

Marketing costs are 12 %. Since this is a bit outside of my focus, I will only mention that I`ve seen companies doing much better and paying 9-10 % of sales for their Marketing.

Finally, Cancellations, Returns and Chargebacks result in 7 % lost sales. This number is on the high side too and is worth further inspection.

So, we have identified 4 areas to focus on. In the second part of the article I will focus on Cost of Goods sold and how inaccurate numbers take back your business.

Till then - ask yourself - Dude, Where`s my margin?

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