As a small business consultant, I advised over 140 clients on profit and expense control jobs. One valuable project was evaluating profitability per square foot of my retail clients.
Approaches to Evaluate Profitability
There are two primary ways to look at the profitability of your small business:
- Profitability per product or service
- Profitability per square foot of store displays
While profitability per product or service works really well for manufacturers and service companies, profitability per square foot applies to retail businesses. It's one way to determine how effective your products selections are and your merchandising of your displays. Although major corporations invest lots of time and effort in getting really precise results, a small business can get usable data to guide decisions more simply.
Determining Profitability per Square Foot
- Measure total display area
- Determine gross profit
- Calculate profit per square foot
Measure Total Display Area
First, measure your store's available space. More meaningful than measuring floor space would be to calculate you display space and shelf space. Tally them.
Determine Gross Profit
For your first go at this, take your annual sales and subtract your cost of goods sold. This will give you gross profit.
Sales - Cost of Goods Sold = Gross Profit
Calculate Profit per Square Foot
Divide gross profit by area to get profitability.
Gross Profit / Total Area of display space = Profit per Square Foot
The primary benefit my clients got from this number was that it gave a store average value against which to compare profitability of different products.
Individual Product Profitability
- Next, for each product, calculate your gross profit.
- Measure the space devoted to that product - don't forget end caps and standalone display space
- Divide the product's gross profit by the area allocated to it to get its profitability
Impact of Turnover
It might surprise you to see the profitability of very low profit margin items. This happens because of 'turnover.' In retail businesses, like grocery stores, pharmacies, clothing stores and boutiques, after a customer buys a product, the store restocks that space so other customers can buy it.
For instance, major brand cereals, like Kellogg's Frosted Mini-Wheat, typically have very low profit margins per box. However, consumers buy them so often that they are restocked several times per week all year long. Thus, the 2.5 square feet devoted to Frosted Mini-Wheat cereal boxes proves highly valuable.
2.5' x 12" = 36" / 2.5" wide = 12 boxes of Tasty Toasties (mythical brand)
$4.79 per box
Gross profit margin per box: 2%
Gross profit per box = $.0958
Each box gets restocked three a week x 52 weeks = 156 turns per box
$.0958 x 156 turns = $14.9448 annually per 2.5" x 1' of space per box
$14.94 per box x 12 boxes/2.5 feet = $179.28 for Tasty Toasties
$179.28 / 2.5 feet =
Profitability per square foot: $71.12
Ways to Increase Profitability
This example shows you can improve your profit per square foot by the following:
- Increase number of turns
- Increase profit margin
- Raise the price (more profit per sale)
- Decrease costs
The purpose of this exercise is to give you a tool I used with my clients to evaluate the profitability per square foot for their products and to have a benchmark of the store's average profit per square foot. Although there are other considerations in deciding to keep or replace a given product, using this process to evaluate your profitability per square foot can significantly improve your small business' financial health.
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