Financial Ratios in the Retail Industry

The retail industry has become highly competitive. However, at the same time, the retail industry has also become quite data intensive. There is a wide variety of data which is available to the average retailer. For some retailers, this can lead to an analysis paralysis situation wherein they become obsessed with data and are not able to take any decisions. However, for many other retailers, the data can provide some meaningful insights.

There are many ways in which data can be drawn up and analysed in order to find insights about the business. However, financial ratios is one of the key ways in which retailers try to evaluate their own financial performance.

In this article, we will have a closer look at some of the financial ratios as well as how these ratios can be used to obtain meaningful information.

Average Transaction Value

Average transaction value is the ratio of total sales which happen in a store divided by the number of unique transactions which took place.

For example, if a store is able to generate $10,000 in sales in 200 transactions, then the average transaction value is $50. A higher average transaction value is better for the store. This is because acquiring customers can be very expensive. Hence, if each customer only purchases products worth a small amount from a store, then it can be detrimental to the retailer.

A higher average transaction value means that the store is able to generate higher sales with a relatively lower marketing budget.

Sales Per Square Foot

Real estate is a huge cost for most traditional retail companies. This is the reason that retailers want to ensure that their real estate expense is optimized. One of the ways to do this is by ensuring that the real estate deployed by the retailer is able to generate maximum sales. This is done by using a metric called sales per square foot. This ratio is calculated by dividing the total sales of the company by the total square footage that the retailer has deployed towards retail operations.

Real estate which is not directly deployed in generating sales such as office space and warehouses should be excluded from this calculation.

Sales per square foot provides a good idea about how efficiently real estate has been deployed by the retailer. Retailers which have a higher sales per square foot ratio have better shopfloor management techniques.

For example, the manner in which products are arranged can have a huge impact on the sales results. Small techniques such as placing more products at eye level as well as placing consumable impulse purchases near the cash counter have shown to increase sales significantly. Once the sales per square foot data is available at a macro level, it can further be drilled down to identify patterns.

Customer Retention Rate

Retailers have realized that they tend to make more money if they sell repeatedly to the same customers. Acquiring new customers is an expensive process. This is the reason why retailers want to derive a higher percentage of their sales from repeat customers. It is for this reason that the ratio called customer retention rate is used by retailers. This ratio enables the company to identify the percentage of sales which can be attributed to old customers. Such a ratio also helps retailers gauge the effectiveness of their marketing spends.

Footfall Ratio

Footfall ratio is another important ratio which is used in the retail industry. This ratio is calculated by dividing the sales generated with the footfall during that period.

A lot of the marketing spends done by retail companies is aimed at increasing footfall. This ratio enables the retail company to then calculate whether the increased footfall results in increased sales. Otherwise, it is quite possible that the amount of money being spent in marketing is driving the wrong kind of footfall which is not translating into sales.

Gross Margins Return on Investment (GMROI)

Retailers are always walking a tightrope when it comes to inventory management. If they have too much inventory on hand, then they are blocking capital unnecessarily and this capital can be deployed for better gains. On the other hand, if they invest too little in inventory, then the chances of stock outs as well as losing customers increases exponentially. This extensive focus on inventory is the reason that a ratio called Gross Margins Return on Investment (GMROI) has been created.

The purpose of this metric is to compare the amount of return generated by investing working capital into holding inventory. This ratio helps retailers develop a better understanding of their inventory management practices. Retailers which have better inventory management practices generally have a better Gross Margins Return on Investment (GMROI).

Financial ratios have generally been used in all industries. There are a certain set of common ratios which are used across industries. However, the retail sector has a certain set of specialized financial ratios which can be used to gauge the effectiveness of the organization.

These ratios help to serve as important starting points for retailers. The results of such a ratio analysis can then form the basis of further analytical studies by the retailer.