When setting up your high street shop or wonderful new website, the sheer volume of work required and short time frames leads many to forget a critical component for business success...planning!
As part of your business planning and strategy, it's imperative that you focus on margins and the staggering effect they can have on the success or failure of your new venture.
Firstly, it's important to understand the difference between Markup and Margin, as they're two different calculations that can easily be confused, as they both answer questions around your selling price.
MARGIN VS MARKUP
While the margin is the portion of a products selling price (your profit), markup is how much you add to the cost of a product to get to your selling price.
For example, for an item that costs you £10 that you sell for £20, the markup is 100% but the margin is 50% - that's why it's critical to understand the difference and build a decent 'margin'. If you confuse the two, you can be 50% or even worse out of pocket on every single sale!
THE VAT CONUNDRUM
An added curve ball is factoring in VAT. Many small businesses completely ignore VAT as it's not compulsory to register or pay VAT until you're selling around £85,000 of product/services within that financial year. However, if you intend to turn your business in to anything other than a hobby, you'll find that you can reach the VAT threshold incredibly quickly.
For example, £85,000 sounds like a huge sum but monthly, it equates to £7,083 and weekly around £1,770...daily? That's just £236! So, if you're products sell for an average of £24 and you sell just 10 items per day, you'll quickly find yourself over the VAT threshold and you'll need to register and pay your outstanding VAT balance every quarter.
Bigger companies, who are established and have been VAT registered for a few years, often remove VAT from their calculations completely. It's a tax and is not your companies money, so it's easier for larger companies to put it to one side and do all of their calculations ex. VAT, simply adding 20% on all of their prices at the end of their calculations to give the final retail price.
There are also those that run small businesses and simply say 'oh, you can claim back the VAT anyway, so it doesn't matter' ... this belief carries some danger though, as VAT is not reclaimable against everything and the rules around VAT are incredibly strict. Also, you'll be reclaiming any VAT against the 'cost price' not the selling price. For example, if you pay £10 inc. VAT for a product, you can reclaim up to £2 but if you go on to sell that product for £20, you actually have to pay HMRC £4. The house always wins!
So, from the outset, it's important to think about how big you want your business to be in the next 2, 3 or 5 years and by the time you've factored in your wages, an assistants wages, a shop or warehouse and a website, we're pretty sure that £85,000 a year in sales will be the minimum you'll be targeting after launch.
It's also important to check your supplier pricing for the VAT pitfall! At Humber Distribution, our wholesale prices are excluding VAT, as we feel this is much more accurate. VAT is added at the very end automatically, once our website has calculated the total value of your basket. The VAT you pay us, is then paid to HMRC every quarter automatically through our bank.
You may have heard this term before. Loss leaders are products that are offered to entice customers to enter your high street or internet shop. There is very little profit, if any, in these products but they are primarily used as a customer acquisition tool, usually by established businesses.
For example, a retail shop may sell expensive branded trainers. To encourage new customers to try their in-store experience, they may place some products in their windows (or website homepage) at incredibly low prices. They may even advertise the fact that these products are giving the customer an unbelievable discount, up to 70% OFF! The purpose of doing this is to encourage a new wave of visitors to convert in to shoppers and spend money at the tills. These heavy discounts also have the added benefit of clearing stock and liquidating, to free up cash for buying in new, seasonal products. You don't want to be paying to store products in a warehouse for months, you need them turned over as quickly as possible.
Money is the life blood of a business, without transactions and money coming in and out, your business is likely to become stale and quickly die.
EBAY / AMAZON / COMPETITORS
Getting your margins right is also a critical part of your competitor research and understanding your competitors margins.
For example, if you purchase a product for £10 and your competitors are selling the same product for £15, you have a pretty good estimate that (excluding any VAT or delivery costs) they're taking £5 in profit from that order. You can then begin to factor in things like VAT, for example, they'll have to pay £3 on that order but they'll reclaim £2 a few months later. So they've actually only made £4 gross profit after tax!
Now you know that your competitor is making roughly £4 on that product, you can begin to understand your own margins and limitations. You can also work out the maximum amount of discount you can allow for promotions or special events, such as Black Friday or Cyber Monday. If you were to offer a 10% discount, using the data above, you'd be giving away £3 and would make just £1 of profit. See why margins are so important? That little discount code has just cost you £2 per sale!
Don't forget to bookmark this guide, we will update it regularly, as we get asked questions by our amazing trade customers.