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March 12, 2008
The Acid Test
In economic downturns like the one we're currently experiencing it's important for retailers to not only focus on sales but also on their gross profit analysis. For example, one of my clients saw a 10% drop in their women's wear business last month, yet their gross profit was up by $30,000 because they had managed their inventories and didn't have to take excessive markdowns to clear out older seasonal merchandise.
I use a critical tool to help my clients stay in-line with their profit goals. I call it the Acid Test. The Acid Test measures the relationship between how much we buy and how much we sell. It compares your purchases at cost for a season or a year with your sales over the same period. You can also use the concept to project gross profit.
You can do an Acid Test on your business by taking your purchases at cost over a defined period of time (such as the last 12 months or year to date) and divide that number with your sales for the same period. Your goal is to get a factor that is the inverse or cost complement, of your planned margin. For example, if your planned margin is 55% you want your Acid Test to come out at 45%. If the factor is higher than the inverse complement, you are building inventory, turn rates are slowing and cash is being squeezed. If the inverse complement factor is lower, you are driving down your inventory and freeing cash.
For retailers, this number is one of the most powerful indicators we can use to assess the profitability of a business. Give the Acid Test a try and if the numbers don't line up, give Blacks a call. With a little analysis an optimum factor can be determined for your company.
Posted by Steve Pruitt at March 12, 2008 06:28 PM
