Do you ever feel like your retail store is bleeding money but you can't pinpoint the leak?
You’ve got incredible products, a fantastic team, and a loyal customer base. You’re making sales, but your profits are low or nonexistent. The numbers don’t add up.
With inventory costs skyrocketing, it’s more important than ever to defend your margins — and knowing your cost-to-revenue ratio is the key.
In this article, we’ll unravel the cost-to-revenue ratio, how it affects your profitability and overall store growth, and how to improve a poor ratio and cash flow management. This metric gives you the clarity you need to make informed decisions about cost management and revenue generation.
What Is the Cost-to-Revenue Ratio?
Simply put, the cost-to-revenue ratio is a financial metric that measures how much you spend to generate each dollar of revenue.
To calculate it, divide the cost of goods sold (COGS) by your total revenue. The COGS is any direct cost incurred by producing your goods or services. That includes:
- Inventory costs (wholesale costs from suppliers)
- Labor costs directly related to making or selling your product (e.g., labor costs for making prepared meals at a grocery store)
- Transportation and delivery costs
Total revenue is the total amount of money you generate from selling your products over a given time period.
Fixed vs. Variable Costs
In retail, your costs are generally divided into fixed and variable costs. Fixed costs include rent and salaries, which typically stay the same for long periods. Variable costs change with your sales volume and might include utilities, labor, and inventory.
Naturally, spending too much on fixed costs is risky. What if you have a slow sales period? Likewise, if your variable expenses are too high, your profit margins might shrink as you sell more. Using your point of sale (POS) system to track sales data and seasonal changes is a good idea to help prepare for fluctuations.
Your cost of goods is a good metric to track generally — and fairly easy to do on a modern POS system — as having a clear picture of your costs is essential for tracking key performance metrics and improving your pricing strategy.
Why Does Cost-to-Revenue Ratio Matter?
A higher number indicates there are inefficiencies in your processes or that your supplier costs are too high. Generally speaking, a high cost-to-revenue ratio means your profits are low.
A lower number is great news. It means you’re doing a good job controlling costs while maintaining steady sales. But there are always opportunities to identify inefficiencies, strategize cost management, optimize pricing, and, ultimately, increase profits.
Your cost-to-revenue ratio gives you a snapshot of your store’s financial health — but’s not the only metric you want to track. Combining this number with other key performance indicators like profit margins, average transaction value, and inventory turnover will give you a more complete picture of store performance.
Remember: Your goal isn’t just to sell products, but to do it efficiently. Even a high sales volume could lead to closing your store if your profit margins are nonexistent.
Related Read: The Guide to Grocery Store Profit Margins (and How To Improve Them)
What Is a Good or Bad Cost-to-Revenue Ratio?
A normal ratio for retailers sits between 75% and 85%. This number is higher than in other industries because most brick-and-mortar retailers have large amounts of inventory on hand and higher operational costs.
However, what qualifies as a “good” ratio depends on several factors:
- Industry standards: Cost-to-revenue ratios differ between retail sectors. What's suitable for a grocery store may not be good for a clothing boutique.
- Business size: Bigger companies can maintain a lower ratio because of economies of scale.
- Business age: New businesses may have higher initial costs as they establish their brand and form relationships with suppliers.
- Seasonality: Businesses with seasonal products might see their cost-to-revenue ratios fluctuate throughout the year.
What are the red flags to look out for? A high ratio that continues to increase over time is a sign of trouble. Your costs might be spiraling out of control, or you’re not selling enough to cover them. The last thing you need is financial strain. The earlier you spot red flags, the better.
7 Tactics for Lowering Your Cost-to-Revenue Ratio and Boosting Profits
Two elements are at the core of a low cost revenue ratio metric:
- High efficiency
- Lower costs
But as we know, these two terms can mean very different things for different types of businesses.
If you’re a grocery store with a large number of SKUs, focusing on inventory selection and processes might be your best bet to reduce costs. But if you’re a niche smoke shop specializing in high-margin cigars, that strategy won’t get the same results.
All of these tips are worth looking into, but it’s up to you to determine which tactic will have the most impact for your business.
1. Improve Inventory Accuracy
Retail cost revenue ratios tend to run high because they have a large amount of inventory on hand — you can’t tackle inventory costs if you don’t have accurate information on what products you have on hand.
You could track this information on a spreadsheet. But the reality is, if your business carries a large number of SKUs, manual inventory tracking methods will be nearly useless.
This is why modern stores need a digital inventory management system. This helps you get an accurate, real-time picture of stock levels. It also unlocks the ability to track important metrics like the cost of your inventory on hand and wholesale prices of individual items.
Combining this information with your sales data, you’ll see how fast your stock moves, profit margins, and other key metrics (including ways to spot shrinkage).
The bottom line: If your store has a large inventory, inventory management software is a must to identify problem areas and reduce costs.
2. Look at Your Margins by Product Category
For some businesses, looking at overall sales and profit margins won’t be much help when it comes to reducing costs. This is particularly true for industries like grocery and liquor, where margins between product categories and departments can vary drastically.
If this sounds familiar, start by filtering your sales data by product category. This is your ticket to identifying over- and underperforming areas of your store.
If a particular department or product category has chronically low margins, it might be time to reduce SKUs in those areas or adjust pricing to boost margins.
3. Upsell and Refine Store Layout for Higher Transaction Values
If you find that your profit margins per item are healthy, but basket sizes (or average transaction value in some POS systems) are low, it might be your store layout that’s to blame.
Remember, the goal of a great retail layout is twofold:
- Make items easy to find.
- Encourage customers to browse and impulse buy.
Make sure you put popular and high-margin items in easy-to-find places. Put commonly-purchased staples towards the edges of the store, so customers pass through other aisles full of tempting items on the way.
Another key component of boosting basket size is to upsell customers with standing displays. Place complementary items near each other (e.g., tequila and lime juice) to make the shopping experience more convenient and boost sales. You can also use buy one, get one (BOGO) deals to tempt customers into bulk purchases.
4. Be More Strategic With Discounts and Promotions
Speaking of sales tactics, not all promotions and sales ideas are good for your bottom line.
If you run discounts on popular (but low-margin) items, you might end up selling them at a loss. Similarly, running a BOGO or mix and match offer might seem like an easy way to boost sales — but you’ll quickly run out of stock if you’re not careful.
Here are some tips on how to run discounts in a way that will boost your cost-to-revenue ratio:
- Avoid discounting products that have thin margins unless they’re usually bought together with other, higher-margin items.
- Promote items with strong gross profit dollars that are easy to keep in stock.
- Use discount pricing as a way to sell slow-moving inventory, especially on short-dated inventory.
Put another way, run sales strategically instead of offering blanket discounts. This gives customers a good deal on select items without eroding your bottom line.
5. Consolidate and Renegotiate With Suppliers
Most retailers' highest operating expense is inventory. If you find that the culprit is the cost of the items themselves, it might be an indication that it’s time to renegotiate with your suppliers.
Sales data can be a powerful negotiating tool, since it shows your vendors the reasoning behind a pricing change. Here are some tips:
- Adjust your orders to account for seasonal changes in demand. Over-ordering in off seasons leaves you with excess inventory that’s wasting shelf space.
- Filter your inventory costs by supplier to see which are giving you the best margins overall. If items from certain suppliers are consistently netting higher margins, consider consolidating your orders.
- Focus on items with high sales volume to lower your minimum order quantity (MOQ). Sometimes items sell well, but you have too many on hand. If you can show vendors this data, they may be willing to lower the MOQ.
- Order more items from a single wholesaler. Most suppliers base MOQ on the total order volume, not a per-item limit. Ordering more items from a single vendor is an easy way to reduce costs.
Periodically assessing your vendor relationships is essential for creating better margins.
6. Reassess Your Payment Processing
Three in four Americans have a credit card, and it’s the preferred way to pay for many. However, each credit transaction comes with a payment processing fee, and these can add up over time.
Some free or lower-cost POS systems make their money back by charging businesses higher processing fees. If a lot of your customers use credit cards or contactless payment, you might save more money in the long-term by upgrading to an industry-specific POS system.
Some businesses, including liquor stores, tobacco shops, and convenience stores, are considered “high-risk.” High-risk businesses usually have to pay higher processing fees, especially if they aren’t using industry-specific payment processors.
7. Use Industry-Specific Technology To Reduce Manual Labor
Most of the points on this list are about getting better visibility and lowering costs. However, boosting efficiency is another huge component in achieving a lower cost-to-revenue ratio.
Stores that still do a lot of manual admin aren’t just losing time, but money. Updating your store’s point of sale system can help significantly reduce labor costs through:
- Streamlined inventory management, including faster ways to generate purchase orders, update stock, and run cycle counts
- Faster checkout and easier setup of discounts and promotions
- Better data analysis, helping you reduce trial and error and focus on the areas of your business that need the most improvement
Many stores have an old system that’s “good enough.” But good enough might be eating into your bottom line. If you notice a lot of your day is wasted on admin or that you spend hours and days tracking down sales data, it might be time for an upgrade.
Reduce Costs & Boost Efficiency With The Right Technology
Cost-to-revenue is an invaluable metric. It measures your financial health and whether you efficiently manage your store. It’s all about finding opportunities, even small ones, to boost efficiency and reduce costs.
But if you spend most of your day putting out fires, manually tracking inventory, writing purchase orders, and managing employees, you simply might not have the time. And even if you did, how would you know where to start?
The right technology can help. Using a modern POS system that’s tailored for your industry is a crucial first step in improving your margins and finding long-term success.
Speak with one of our experts to find a system that’s the perfect fit for your business.
by Brian Sullivan
