A PUBLICATION OF THE NATIONAL SPORTING GOODS ASSOCIATION
Volume 10 | No. 2 | March/April 2021
Q&A with Schutt
Key Retail Metrics
NOCSAE Update
Kicking Around
Participation by Decade
RETAIL NOW
When reviewing a profit and loss statement one of the traditional benchmarking metrics is Cost of Goods Sold (COGS). What exactly is COGS anyway? Also referred to as Cost of Sales COGS is just what it says it is the cost of all of the inventory sold during a given period. Paul Erickson a colleague of mine at Management One describes COGS as “the most misleading metric in retail.” He prefers to use Cost of Goods Purchased (COGP) as it more directly relates to cash flow and thus the financial health of the business. COGP is determined by simply subtracting purchases from sales for the same period. Erickson’s claim is using COGS can provide a retailer with a somewhat unhealthy financial perspective since selling very little at full price can result in a very good COGS. Using COGP on the other hand relates purchases directly back to cash flow.
The following example illustrates the difference between the two.
Let’s assume you bought a new style of 50 pairs of hockey skates for the current season. After four months you were only able to sell 5 pairs of the skates but they all sold at full price. Your Cost Of Goods Sold (COGS) would be excellent since the cost of selling the skates did not require any discounting to generate the sales. Herein lies the problem … you still have 45 pairs you have already paid for remaining in unsold inventory. The Cost Of Goods Purchased (CODP) in this example would paint a much different picture and it wouldn’t be pretty.
Not to complicate issues but it needs to be stated that varying accounting methods will have a bearing on COGS. FIFO (first in first out) and LIFO (last in first out) are the most widely accepted accounting methods and FIFO is the most trusted and easiest to
Use
Simply stated FIFO assumes items purchased first were also the items sold first. LIFO (last in first out) on the other hand would recognize that items purchased last would be the ones sold first. Whichever method you use know that there will be a difference in profits and therefore income taxes.
FISH Method
Although clearly not recognized by generally accepted accounting practices this is where the FISH (first in still here) accounting method comes into play. I see this all too often. Has this ever happened to you? A style or styles get purchased generally with no regard to the merchandise plan get put on the “wall” amidst the rest of the assortment and end up getting lost. The style doesn’t sell as it should and for reasons unknown to all does not get returned or marked down. The result is — COGS-excellent COGP-horrible! The lifeblood of any retail establishment is cash flow and COGS does not take that into account. To add insult to injury if the item is still in the store at inventory time you get to pay taxes on merchandise that shouldn’t have been bought in the first place and should have been either stock balanced with the vendor or marked down. This is what is meant by the FISH method of accounting.
Cost of Goods Purchased Provides More Realistic Outlook on Health of Retail Business
By Ritchie Sayner
Advanced Retail Strategies
NSGA NOW >> March/April 2021
Understocked/Overstocked
I know this may sound like a contradiction in terms but I see this situation often. When reviewing data at the total company level it often appears at first glance that a store has way more inventory than needed to do the business forecasted for a given time period. However when you drill down to the class/subclass level what you find is an inventory level void of current fresh seasonal product that is way below levels sufficient enough to produce planned sales. As a result sales suffer and both inventory…
Turnover and GMROI (Gross Margin Return on Investment)
Turnover and GMROI are reduced. In addition unless the merchant is paying attention open-to-buy is also restricted due to the inventory number being inflated with unsaleable merchandise. If this situation is not recognized and dealt with no new merchandise is purchased and sales get even worse.
Overstocked/Understocked Dilemma
You can also encounter the overstocked/understocked dilemma when stores have broken sizes discontinued vendors and dated inventory that has not been identified. I refer to this situation as having “a whole lot of nothing.” A store operating this way can never achieve its true upside potential.
One simple way of self-checking is to pay attention to purchases. A retailer typically should receive somewhat more than it sells. If not chances are good the store is not buying enough new merchandise. If receipts are way over what is to be sold for a given period the store is most likely in an overbought situation leading to potential cash flow issues let alone future markdowns.
The Solution
The solution is clearly to recognize mistakes quickly and take action. Margin is great but it’s no substitute for CASH. Consider this would you rather have:
- A store full of aging inventory decreasing sales slow turnover low markdowns and poor cash flow BUT … a healthy gross margin percentage on the profit and loss statement
- The potential for higher sales due to tighter inventory levels with fresh new product open to buy (OTB) for fill-ins off-price merchandise and new vendors and faster inventory turnover (cash flow) even though it may mean (but not always) sacrificing a few precious margin points?
COVID-caused issues notwithstanding this shouldn’t be a difficult choice yet we often see examples of stores choosing option A.
Next time you are complimenting yourself on a “healthy” COGS figure go one step further and simply subtract your purchases from your sales to determine COGP. If you are doing it right
You can pat yourself on the back with both hands. If not we are always here to help.
Ritchie Sayner
Sayner has spent the past four decades helping independent retailers improve profitability. In addition to speaking to retail groups nationwide Sayner is a regular contributor to retail industry publications. Prior to embarking on his retail consulting career he was the general merchandise manager for an independent department store in the Midwest.
Ritchie is a graduate of the University of Wisconsin-LaCrosse. He is also the author of the book “Retail Revelations-Strategies for Improving Sales Margins and Turnover.” He can be reached through his website at www.advancedretailstrategies.com.
NSGA NOW ® >> March/April 2021 | 9
Summary
The article discusses the importance of using Cost of Goods Purchased (COGP) over Cost of Goods Sold (COGS) to gain a realistic view of a retail business’s financial health. It highlights how COGP provides a better perspective on cash flow and inventory management compared to COGS which can be misleading when unsold inventory remains. The article also emphasizes the need for retailers to manage inventory effectively to enhance cash flow and avoid overstocking or understocking issues.
“Margin is great but it’s no substitute for CASH.”
Real-World Examples of Retail Metrics and Inventory Management
Understanding the impact of Cost of Goods Sold (COGS) and Cost of Goods Purchased (COGP) is crucial for retail businesses. Here are a few examples that illustrate these concepts in real-world scenarios.
- A clothing retailer buys 100 winter coats for the season. By the end of the season only 20 coats are sold at full price resulting in an excellent COGS. However the remaining 80 coats are unsold tying up cash flow and highlighting a poor COGP.
- A shoe store purchases 200 pairs of sneakers but due to a lack of marketing only 30 pairs sell without discounts. The COGS appears favorable but the COGP reveals a significant cash flow issue due to the unsold inventory.
- A bookstore orders 500 copies of a new bestseller. While 100 copies sell quickly at full price the remaining 400 copies remain in inventory. The COGS metric shows good performance but the COGP indicates a need for better inventory management to avoid cash flow problems.
