When considering buying a retail business or franchise it is important to understand some basic retail numbers to ensure that you are getting a profitable business with your hard earned investment money.

In retailing you must understand the importance of your first margin potential or buying margin mix across the products that you intend to sell.

Let's look at one item as an example exclusive of GST. If you buy an item for $48 and plan to sell for $100 then the potential profit that you will achieve to enable you to pay for your overheads is $52 or 52% of your sales. This profit is call First Margin (or your buying margin).

Now let's assume that you cannot get $100 for the item but you have to reduce that to say $90 or a discount of $10 or 10% (welcome to retailing- discounting or markdowns occur in every retail business despite how good you are as a retailer). The supplier of the item will still get their $48 for the cost however you now only receive $42 for your efforts ($90 sale price less $48 cost price). This means as a percentage of your sales your final Gross Profit is $42 divided by $90 = 46.7% expressed as a % to total sales. This shows that a 10% discount will now only provide 46.7% GP dollars as opposed to your planned 52%. To get the same dollar ($) Gross Profit that you had at 52% GP you would need to lift sales to $111.40 or a massive 24% over the $90 you achieved. This is a real danger to any retail business and shows the importance of product planning and margin management.

The main reason you want to buy a retail business is to provide an income stream that will not only provide you with a standard of living but also lead to you building passive income via superannuation. Therefore PROFIT must be your focus on deciding to buy the business.

Now that you understand that even though the first margin or buying margin is 52%, the actual finishing Gross Profit achieved is likely to be 46.7%. Now express your major costs as a % of the planned or actual sales. These are rent, wages plus all oncost, interest, depreciation and other costs. Remember generally rent and wages are 90% of a retail business expenses and are generally fixed. (Don't forget to put in your own wage). If you are buying a franchise business add in to your costs their franchise fee. After all of these costs what does this leave you in $ and % terms? As a general rule speciality retailing should net between 9-12% before taxation, for example 46.7% GP less total costs as a % say 37.7% will equal 9% . (In all cases you must seek independent financial advice from your accountant in review of these numbers.)

So now let's get back to your purchase of that franchise or retail business. What are the questions that you should be asking yourself?

  1. What is the potential First Margin or Buying Margin that I can achieve based on the product mixes in the business? Hopefully they can provide you with a report that quantifies this important retail KPI. Another approach is to take the top selling ten items in each category (assuming they have category management!!) and work out the first margin on each item and therefore the mix of First Margin across the categories.

  2. What is the final achieved Gross Profit achieved after markdowns (and shrinkage- stock losses). Now compare this to the First Margin - the drop from first margin to the final gross profit is an indicator of how good or bad the buying and management has been in the business and perhaps what is going to happen to you.

  3. Does the point of sale provide details by category of first margin and gross profit?

  4. What systems are in place to assist you in developing a forward buying plan to minimise mistakes in buying that will lead to loss of first margin?

  5. What training is available to you ongoing to improve your retail skills not only in buying but in all retail basics?

These questions will enable you to understand the potential profit outcomes from the business. Understanding retail financial disciplines is critical to the success of any retail business.